Financial Abundance

Your largest single asset is likely to be your ability to generate earned income.  This asset is commonly call “human capital.”  When developing appropriate asset allocations for investment portfolios, it is important to include the human capital asset.  Let’s look at some ways that including human capital could change your approach to allocating assets in your investment portfolio.

There are three major components of human capital.  These include: 1) your annual income from work,  2) the number of years remaining to work, and  3) the variability of your annual earned income.   Variability can be fairly large if your income is based on commissions.  It also can be large if you have a job in which you may be furloughed or laid off when economic conditions deteriorate.

There are studies that correlate various occupations with stocks, bonds and treasuries/cash.  We will look at only three occupations to demonstrate how human capital can be included in asset allocation decisions.

Tenured Professors – There are few professions more secure than that of a tenured professor.  Their annual income has historically been very predictable, with the main variance being additional income generated by consulting, research or publishing.  Thus, a tenured professor’s income is very similar to the yield from a high quality bond. 

Since there is little variance of annual income, younger professors should typically have higher asset allocations in riskier assets, such as equities and alternative investments.  As a professor approaches retirement, with a decreasing number of remaining work years, the amount of riskier assets should also decrease.

Real Estate Brokers – Real estate brokers receive most, if not all of their income from commissions.  While established brokers have some expectations about annual income, their income is highly variable, depending housing market conditions, interest rates etc.  While a realtor can often work for as long as they wish,  the variability of income makes their human capital asset very similar to equities (stock). 

If you are a realtor, you might be better served by having a greater portion of your investible assets in fixed income (bond) investments.  This will make your investment portfolio more stable as your income varies.  Stable investment income can be very beneficial in lower earning years, which often occur when the stock market is also in decline.

Entrepreneurs –  If you work for an entrepreneurial company, both your income and the number of years that your income will continue are variable.  In down years, entrepreneurial companies are typically the first to cut salaries and benefits as well as to have layoffs.  Having worked most of my life as a “high tech” entrepreneur, I am very familiar with the “bipolar” nature of many entrepreneurial companies.  As an entrepreneur, your human capital is similar to microcap stocks and commodities, either going up dramatically or dropping to $0. 

Not only should an entrepreneur have higher than normal fixed income positions in their investment portfolio, they should only buy equities in relatively risk free companies.  Entrepreneurs have their human capital linked to the success of their companies, which are typically small and highly vulnerable.  It is important that they take less risk in their investment portfolios to offset the high risk of their human capital.

While you may not work in one of these three occupations, your human capital will likely have characteristics of one these.  When you and/or your financial adviser are developing your asset allocations, be sure to consider your human capital as an asset that can compliment your other financial assets.

Regardless of your type of human capital, it can always be terminated by death or disability.  Life and disability insurance need to be a central component of any financial plan.  Properly constructed, they will provide the funds required for you and your family, if you are no longer able to contribute the expected human capital.

Human capital is an asset that should not be ignored.  Including your human capital when allocating your investments portfolio can help you choose the amount of risk that is most appropriate for you and your family. 

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During these stressful times of financial turmoil, are you finding it difficult to live with a sense of financial abundance? Have your decreasing financial assets increased your fear of financial uncertainty? Have you lost the feeling of serenity about your ability to meet your financial goals?

If you answered yes to any of these, now is the time to commit to actively managing, protecting and controlling your finances. To move from a fear of financial scarcity to a sense of financial abundance, it may be time to practice:

The 7 Steps to Financial Abundance

1. Spend less than you earn.
2. Maximize your financial resources.
3. Minimize your taxes.
4. Manage your investments.
5. Protect your financial resources.
6. Control your personal finances.
7. Have faith in continued abundance.

Transforming financial fear into financial abundance requires a personal commitment to actively managing your finances. While practicing the Seven Steps to Financial Abundance will not guarantee fiscal security, as a minimum it will help reduce your fear of financial scarcity, leading to more serenity about your finances.

To help you get started on the path to financial abundance in 2009, let’s focus on the two most important steps, Step 1 and Step 7.

Step 1: Spend Less Than You Earn

This step is critical to maintaining a life of financial abundance. The time from which you begin working until you retire is your “financial accumulation period.” During this time, you accumulate financial resources to pay for your children’s college education, buy and furnish your house, meet on-going financial commitments and provide for an abundant retirement.

Unfortunately, many people are not using these critical years to accumulate the financial resources required to meet their financial goals. Due to “easy credit” provided by credit cards, home equity loans, interest only mortgages, etc, many people spend more than they earn during their critical accumulation years.

In 2009, to increase your financial health, commit to following Step 1. Attempt to save at least 15 percent of after-tax income. If you have a 401(k) or other retirement savings plan, funding this plan can be an excellent, tax deferred method of meeting this goal.

When you do not have a company provided retirement savings plan, use the “pay-yourself-first” savings approach. On payday, make your first payment to your savings account. If you cannot afford an initial 15%, save 5% in 2009, 10% in 2010 and 15% in 2011. This “forced savings” approach requires you to make decisions between “must have” and “nice to have” items and helps you begin the journey to financial abundance.

Use your savings to pay off any credit card, home equity or other non-mortgage debt. Once this is accomplished, build an “emergency fund.” This is a fund with at least six months of after-tax income that can protect you if a short-term emergency occurs. With an emergency fund, you can weather a job layoff or short-term disability, without prematurely using funds from your retirement account.

If you are not certain about whether you are spending less than you earn, if you contact me and I will send you a free Excel based Budget Worksheet that allows you to determine your annual financial accumulation or deficit.

Step 7: Have Faith in Continued Abundance

Overcoming the fear of scarcity requires developing faith in your continued financial abundance. The first six steps to financial abundance are based on actions that you can control and financial habits that you can change. One these are practiced, you have done everything in your power to control your financial abundance.

The seventh step is a spiritual step in which you decide to turn over the things that you cannot control (the economy, the stock market, etc) to your higher power. Knowing that you have done everything possible to ensure your financial abundance, having faith in your continued abundance is critical to your financial serenity. Without faith, doubts and fears of the unknown and the uncontrollable will often become overwhelming.

Practicing the Seven Steps to Financial Abundance requires that you control consumer-driven consumption patterns, maximize and protect your financial resources and nurture faith that financial abundance will continue, as long as you do your part.

Some people find that they need help in practicing these steps. If you would like to practice the Seven Steps to Financial Abundance, but find that you require assistance in their implementation, I would be honored to serve as a guide to help you on this journey.

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If you are like most of the people I talk to, you are spending a considerable amount of time worrying about how the recent stock market downturn will affect your financial future. While losses in the stock market are a serious concern, your own actions may be even more damaging to your financial future.

The personal savings rates in the US have deteriorated from 10% in 1985 to 5% in 1990 to 2.5% in 2000 to 0% today. Personal savings rates today are the same as they were from 1929 through 1931, after the stock market crash that led to the great depression. This dramatic reduction in personal savings has been caused by an equally dramatic increase in personal consumption.

In inflation adjusted dollars, per capita consumption in the US has climbed 25% from 1985 to today. Including inflation, per capita spending has increased 150% since 1985. From these figures, it is easy to see why the average American now saves nothing, compared to a 10% savings rate in 1985!

What may not be clear is why this has occurred. We all know that, until recently, credit was extremely easy to get. Credit cards, interest only mortgages, home equity loans and 0% down car loans helped transform us from a society of savers to a society of debtors.

Since the vast majority of our Gross Domestic Product now comes from consumerism, US industry encourages you to spend. Our financial institutions have made significant profits from credit card interest and other forms of personal indebtedness. Even our government encourages spending over savings by providing tax deductions for mortgage interest while taxing savings interest at the same rate as earned income. State and local governments get much of their income from sales taxes that are placed on the goods and services that you buy.

Our President has said that we are addicted to oil. I would take that statement a step further and say we are addicted to consuming. All you need do is notice how often the media refers to you as a “consumer. “ Have you ever seen the US population called “savers” in our media?

If you have an addiction to consumption, now is the time address your addiction. Modifying an excessive spending habit is a way to begin your journey toward financial abundance. So how do you begin the process of transforming from a consumer to a saver?

When you get your pay check, always pay your self first by putting a portion of your paycheck into savings. This can be through a 401(k), a self directed IRA or a taxable savings account. If you began saving $50 per week at age 30, with a 7% investment return, your $50 payment would be worth almost $400,000 when you are age 65. If you are older, you will need to save more, but you will likely have more income than you did at age 30.

As your pay continues to increase, try to increase your saving amount until you are “paying yourself” at least 10% of your take home pay. By paying yourself first, you will likely have adequate resources to live an abundant retirement.

By learning to live on the other 90% of your income, you will begin to break your “consumption addiction.” The “cartel” of industry, financial institutions and the government are all hoping that you will never break this addiction. Only you can decide if you will become a saver or remain a consumption addict.

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If you read the Wall Street Journal or watch the financial news, you will likely see stories stating that the Fed is not concerned about inflation, since, as our economy cools, there will be less pressure on the prices of commodities such as oil and food. These articles imply that the recent reduction in oil prices is a good example of why inflation is not a significant concern.

However, from July 2007 to July 2008, the Consumer Price Index (CPI-U) was up 5.6%, the highest in 17 years, oil is 75% higher than it was in 2007 and the dollar is down 10% against the Euro in 2008. From my perspective, the reason that the Fed is ignoring inflation is that, while maintaining a Fed funds rate of 2% and increasing the US dollar money supply, they are willing to trade the risk of high inflation against the risk of collapse of major US financial institutions. These, of course, are the same financial institutions which created the current financial crisis.

I do not have enough data, nor am I wise enough to evaluate the risk of failure of our financial services institutions. I will trust that this data and wisdom resides in the Fed and that they have made a calculated decision to create an inflationary environment in order to minimize the risk of financial institutional failure.  However, regardless of their reasons, the Fed policies are destined to increase inflationary pressures.

In today’s financial environment, there are several reasons why low interest rates are beneficial to financial institutions. Two examples include:

1. Adjustable rate mortgages are often tied to the Fed funds rate. A low Fed funds rate helps keep payments on adjustable rate mortgages low. While in ordinary times this might not be in a bank’s best interest, in today’s mortgage marketplace, maintaining the current 2% Fed funds rate may help decrease the number of mortgage defaults by keeping the adjustable mortgage payments lower

2. Lending institutions typically pay depositors interest that is based on short term interest rates, while the interest they receive on loans is often based on longer term rates. Lending institutions can maximize profits when there is a significant difference, as there is today, between short term interest rates and longer term interest rates.

Unless the Fed radically changes course, the US could repeat the hyper inflation of the 70s. At this point, there is no commitment by the Fed to address their current inflation stimuli. Until this changes, my plan is to remain “invested for inflation.” Our past experience has demonstrated that once inflation is imbedded in our financial systems, it will likely take years before it can be lowered.  Let’s hope that the Fed takes action to correct this situation, before it is too late.

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Is too much of your income vanishing due to interest payments on credit cards, car payments, mortgages and other debt? Perhaps the American family’s ever-increasing debt helps explain why 75% of Americans think that the economy is in bad shape, when unemployment is only at 5%, interest rates are close to historic lows, inflation is not (yet) spiraling out of control and the stock market is approaching its historic high.

In the past, my financial planning clients mainly came to me for investment advice, to help determine if they were saving enough for their children’s college expenses and their retirement and/or wondering if their retirement savings would last throughout their lifetimes. Recently however, more clients are seeking help in reducing their massive debts. These clients are unable to spend less than they earn due to the high cost of servicing their debt.

Many of my clients earn over $200,000 annually. After paying their taxes, home mortgages, home equity loans, car loans, credit card debt and vacation home payments, they often have less than 30% of their gross income remaining. They have no remaining income to save for educational expenses and retirement. Often, even paying their current bills puts them deeper in debt.

In the past 20 years, Americans have gone from saving 10% of their gross pay to saving less than 0%. Over the same time period, the average mortgage payment has increased from 15% to 30% of gross pay and average non-mortgage family debt has increased from 5% to 35% of gross pay.

After taxes, mortgage payments, non mortgage debt service (such as car loans and credit card interest payments) the average American family has less than 45% of their gross income remaining. Twenty years ago, the average family had 60% of gross income remaining after these payments.

Are you in the “debt danger zone?” To find out, calculate your total annual “debt,” including all taxes, mortgage payments, car payments, home equity loan payments, credit card interest payments, second home costs (net of income) and any other interest paid to service debt. If the sum of these payments exceeds 50% of your gross income you have entered the debt danger zone. If the sum exceeds 60% of your gross income, immediate action is critical.

If you are in the debt danger zone, consider the following:

1. Examine your spending habits. If you are spending more than you earn (including all of your “debt” payments) reduce non critical spending and put nothing further on your credit cards until their balances are completely paid.
2. If you have a vacation condo, selling it will not only provide equity to pay down other debt, it will also eliminate mortgage payments and HOA fees.
3. Use funds held in a savings or a brokerage account, to pay off credit card debt. However, do this only if you can still maintain an “emergency fund” that will cover at least 6 months of your total living expenses
4. If your 401(k) contributions are greater than the maximum employer matching amount, reduce your contributions to the matching amount cap until your high interest rate debt is eliminated.
5. To pay off credit card debt you could borrow from your 401(k) account, if your plan allows. The interest rates for repayment of a 401(k) loan will be considerably less than credit card interest rates. However, if this is done, immediately begin a scheduled repayment plan of the borrowed funds.
6. If you are still in the “danger zone,” consider downsizing your home. Reducing your mortgage by $100,000 can save you over $7,500 annually.

Because our government and financial institutions encourage us to increase debt and reduce savings, it is easy to fall into the debt danger zone. By paying close attention to your personal finances, you can reject this path to financial scarcity and discover the “path less traveled” to financial abundance.

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I recently read an article by Henry K. (“Bud”) Hebeler at Bankrate.com. Bud, the former President of Boeing Aerospace, has spent his retirement years helping people prepare for retirement. His popular web site, analyzenow.com, has many helpful retirement tools. Bud was also kind enough to provide a technical edit of my book, before it was published, as well as to write my book’s Foreword.

In his article, Bud shows that the personal savings rates in the US have deteriorated from 10% in 1985 to 5% in 1990 to 2.5% in 2000 to 0 today. Personal savings rates today are the same as they were from 1929 through 1931, after the stock market crash that led to the great depression.

As savings rates have receded, personal consumption has climbed. In inflation adjusted dollars, consumption per capita in the US has climbed 25% from 1985 to today. From these figures, it is easy to see why the average American now saves nothing, compared to a 10% savings rate in 1985.

What you may not realize is why this has occurred. We all know that, until recently, credit was extremely easy to get. Credit cards, interest only mortgages, home equity loans and car loans helped transform us into a society of debtors instead of savers.

Since the vast majority of our GDP now comes from consumerism, US industry wants you to spend. Our financial institutions make significant profits from credit card interest and other forms of personal indebtedness. Even the government encourages spending over savings by providing tax deductions for mortgage interest while taxing savings interest at the same rate as earned income. State and local governments get much of their income from sales taxes that are placed on the goods and services that you buy.

Our President once said that we are addicted to oil. I would take that a step further and say we are addicted to consuming. Look at how often the media refers to you as a “consumer “ and see if you ever see the US population called savers.

If you have an addiction to consumption, now is the time to break it. As I often recommend, when you get your pay check, pay your self first by saving a portion of your paycheck. If, at age 30, you save $50 per week, with a 7% investment return, that $50 payment will be worth almost $400,000 when you are age 65.

As your pay increases, increase your saving amount until you are “paying yourself” at least 10% of your take home pay. By paying yourself first, you will have adequate resources to live an abundant retirement. This approach will also help you overcome the “consumption addiction” that industry, financial institutions and the government are all hoping that you will never break.

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Faith is defined as a belief that is not based on proof. While we can never have absolute proof of continued financial abundance, by following the 7 Steps to Financial Abundance, we can begin to believe that through our continued commitment to control our finances, our abundance will continue. Our faith in continued abundance is important in conquering the fear of scarcity.

Fear is defined as a distressing emotion, aroused by impending danger, whether the threat is real or imagined. Without faith that abundance will continue, doubts and fears of the unknown and uncontrollable future can become overwhelming. Even though the fear of scarcity may be irrational, it can consume us and leave us unable to live with a sense of abundance.

Living in financial abundance requires controlling consumer-driven consumption, maximizing and protecting financial resources and faith that abundance will continue. By implementing the first six steps, we have done everything in our power to discover the path to financial abundance.  Having faith that abundance will continue, is sometimes the hardest step.  However, without this faith, fear and doubt can take control over our financial lives.

The Seven Steps to Financial Abundance are designed to help us control of our financial future. I authored Financial Abundance Guide to provide an easy to understand “guide” for non-financial professionals to explore their path to financial abundance. You may learn more about my approach to financial abundance at www.finabguide.com

Once you escape the fear of scarcity, you may find true serenity. When living in financial abundance, you may even decide to share more of your abundance with your favorite charitable organizations.

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The stock market, tax codes, the economy and negative world events are outside of our control. Too often, the things that we cannot control increase our fear of financial scarcity. When this occurs, it is can be comforting to remember the serenity prayer.

To achieve serenity, we are encouraged to accept the things we cannot change and have the courage to change the things we can. We can control our consumer based spending habits, our prioritization of saving for our family’s future and our decision to plan for our financial well-being. By changing old habits that lead to the fear of scarcity and implementing the practices of the first 5 steps, we are doing everything in our power to control our finances.

With this control, we have significant power over personal finances. Once this power is recognized, the fear of scarcity is diminished and a feeling of financial security begins to permeate our lives, leading us toward financial abundance.

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Fear of the unknown can produce a sense of scarcity. Since no one can predict the future, insurance products help protect us from financially catastrophic events. Properly using insurance can protect your financial resources, keeping this fear in check.

For most people, the need for automobile and home owner’s insurance is fairly well understood. However, by increasing your deductibles, you can often cut insurance premiums significantly. As an example, if you have a $500 deductible on your auto insurance policy, you might consider raising it to $1,000.

If you have a loss that is slightly more than $500, it may be better to pay for the loss yourself and not report it. Sometimes, reporting a small loss can significantly increase your future insurance premiums. If you will likely not report a smaller loss, why pay the additional premiums required for the lower deductible?

Life insurance is a requirement for any family member that contributes financially to the family. Typically, term insurance is the most cost effective type of life insurance. Consider a term period which will last until you no longer require life insurance. If you are in your thirties, this may mean a thirty-year term. To determine how much life insurance you require, go to www.finabguide.com for the free life insurance estimator under the “Advice” tab.

Many people fail to understand the critical need for a long term disability insurance policy. Under age 65, you are more likely to become disabled than you are to die. As Peter Ubel, well known professor of psychology states, “If people are smart, they will invest wisely in disability insurance.” A serious, long-term disability can destroy even the best financial plan.

Another protection to consider is an umbrella liability policy. In our litigious society, the liability limits of your home owner’s and auto policies may not be enough to protect your hard earned assets. For a relatively small additional premium, you can increase your liability coverage by $1 million or more.

Protecting yourself from catastrophic financial risks will help reduce the fear of the unknown, a necessary step to obtaining financial abundance.

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