Financial Abundance

The Federal Reserve continues to fret over low inflation rates and how this could lead to deflation.  While the Fed claims that we have virtually no inflation, my recent personal experience has been just the opposite.  The cost of living, especially the cost of food, energy and health care, appears to be rising at rates that were last seen in 1981.

To understand this apparent dichotomy, let’s take a look at how the Consumer Price Index (CPI) is calculated.

The CPI is calculated by examining monthly price changes in eight different categories of consumer expenditures.  Each category is assigned a “weight” based on the government’s estimate of what the “average” consumer spends in each category.  The following table provides each category of expenditures as well as the percentage weighting, assigned by the Bureau of Labor Statistics.  The right hand column provides an alternative weighting for a “hypothetical consumer” with lower housing costs.  This could be a consumer that has paid off their mortgage or remained in the same house for many years.

Expenditure                                     CPI-U                  Hypothetical

Category                                       Average                 Consumer

———————————————————————————-

Total (all items)                               100.0%                      100%

Food and beverages                        15.7%                        25%

Housing                                            40.9%                        10%

Apparel                                              4.4%                          5%

Transportation                                  17.1%                       20%

Medical care                                       5.8%                        25%

Recreation                                          6.0%                         4%

Education and communication            5.8%                         3%

Other goods and services                   4.3%                         8%

———————————————————————————-

Total, all items                                  100.0%                  100.0%

If you are interested in exploring the CPI in more detail, this information can be found at   http://www.bls.gov/news.release/cpi.t01.htm

The CPI data supplied by the Bureau of Labor Statistics accurately shows that, with the current governmental category weightings, the CPI increase over the past twelve months is only 1.1%.  However, looking at the increases by expenditure category shows that transportation costs rose 4.6% and health care costs are up 3.4% over this time frame.

The large increases in transportation and medical care costs are offset by housing costs, which are given a weight of 41% of the total CPI basket.  The CPI data shows that housing costs decreased by 0.3% over the past year.  However, unless a home was refinanced or one moved into a smaller residence, most people’s housing costs have increased over the past year due to higher energy prices, property taxes etc.

Since recent costs increases appear to be accelerating, we examined CPI change data that is also available for the past three months.  Using the government provided CPI average weighting and annualizing the data by expenditure category over the last three months, we calculate the current three month “run rate” for the CPI increase as 2.7%, instead of the past year’s 1.1%.

To further test the CPI data, using the published annual CPI increases by expenditure category, we calculated the annual CPI change with the category weightings of the “hypothetical” consumer.  When the “hypothetical” consumer expenditure weightings are used, the inflation rate over the past twelve months doubles to 2.2%.

Finally, we calculated the “hypothetical” consumer expenditure weightings combined with the current “run rate” of inflation.  When the hypothetical consumer weightings are applied to the government supplied CPI data over the past three months, the annualized rate of inflation for our “hypothetical” (but realistic) consumer was a startling 4.0%.

Quantitative Easing Two, due to be announced at the November Fed meeting, will add vast amounts of cash to our economy.  The justification for this program is that our inflation rate is so low that the government needs to increase our rate of inflation.  Would that reasoning be acceptable if the current inflation rate is 4%?

The next time you are paying for groceries, your utility bill or your health insurance, you might discover that you are more like our “hypothetical” consumer whose inflation rate is running at several times the government provided CPI rate.  We can only hope that the Fed changes directions before our inflation rates match those last experienced in 1981.

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Do financial concerns ever keep you awake at night?  Are financial issues putting stress on your marriage?  Do you live in fear of financial scarcity?   If any of these apply, your personal finances may be controlling your life.

People often believe that financial abundance means having more money.  I have met many people, with lower incomes, who live from a sense of financial abundance.  I also know wealthy individuals who live from a sense of financial scarcity.  Let’s discover how you can begin living a healthier financial life style by discovering the pathway toward financial abundance.

Living with a sense of financial abundance requires “action” and “faith.”  Using a sports analogy, financial “action” involves preparing a personal (or family) “financial scorecard.”  The “scorecard” helps determine if our financial resources are aligned with our goals and values.  When financial resources are aligned with financial goals, stress levels are reduced, leading to happier interpersonal relationships and a sense of financial serenity.

I recommend including the following on your “financial scorecard”:

1. Do you have an “Emergency Fund,” which has highly liquid assets that will cover a minimum of six months (ideally one year) of expenses.  If you are ever unemployed or suffer a short term disability, an emergency fund can serve as a life line to help avoid financial disaster
2. Are savings adequate for your children’s education and retirement?   A minimum of 15% of after tax income should be saved in retirement and taxable accounts.
3. Are your investments appropriate for your level of risk-tolerance?  If you lie awake at night, worrying about your investment portfolio, investments risk is probably too high.
4. Is your “debt load” reasonable?  You should be paying no more than 28% of your pre-tax income for your mortgage (Principal and Interest), and no more than 35% of pre-tax income for all debt, including car payments.
5. Are you paying more in taxes than legally required?  Our tax code is riddled with exceptions and exclusions that are often known only by the wealthy.  Discover every legal method of lowering your taxes, as each dollar in tax reductions provides an additional dollar to be saved, with zero financial pain.
6. Have the risks associated with a financial catastrophe (death, disability, major health expenses, long term care) been properly addressed, so that your family can survive, should the unthinkable occur?
7. Are all of your financial obligations paid on a timely basis?  If so, your FICO score should be Excellent (above 750).

If the answer to any of these questions is no, your “financial scorecard” can be improved.  Every action taken to increase your financial health helps reduce financial stress, improves overall well being and leads to a sense of financial abundance.

With our country’s financial turmoil, it is difficult to maintain faith that personal financial resources will be adequate to meet future financial requirements.  However, having faith in your financial actions is critical to finding the path to financial abundance.  Once the changes required for a healthy financial life style are made, the serenity associated with financial abundance can be discovered, if you maintain faith that everything possible has been done.

If you do not have the time, inclination or energy to determine your required financial actions, elicit the help of a fee only Certified Financial Planner^®.   A fee only CFP^® will have the knowledge and training to help define what financial actions are required.  A CFP^® will also have signed a code of ethics, ensuring a fiduciary responsibility.  A fiduciary is required by law to always place their client’s best interests before their own.

My book, Financial Abundance Guide, provides a detailed approach to creating your own financial action plan.  Financial Abundance Guide is available, free of charge, when you visit  www.finabguide.com .

Living life from a position of financial scarcity or financial abundance is a personal choice.  While the path to financial abundance takes commitment, action and faith, you may find that the peace and serenity it can deliver is worth the effort required.

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Many people are questioning what they should do in these uncertain financial times.  My best advice is to have a current financial plan.  Now, more than ever, the sage advice that, “if you fail to plan, you plan to fail” is applicable.

Financial planning is not mysterious and does not require that you pay a “financial planner” to do it for you.  The following eight steps will provide an outline of how to begin planning your financial future:

1. Become a saver, not a consumer. Why do our media call Americans consumers?  While food, clothing, medicines, etc., are required, much of our consumption is discretionary.  Your financial plan must determine your current savings amount.  Between now and retirement, individuals should save at least 10 percent of their net income.  This saving can be accomplished through company 401K plans or a combination of tax deferred retirement plans and individual savings.  The key is to start saving now, to help ensure that you will have the financial resources required when you retire.

2. Establish a Budget. It is important that you have a budget to understand your current expenses.  I recommend a two-step budgeting process.  First, budget for items that are absolutely required for your day to day living.  The second part of this budget would be expenses that you would like to include, but are not critical to your enjoyment of an abundant life.  If the budget is not at least 10 percent less than your after-tax income, cut items from the “nice to have” list until reaching the 10 percent savings goal.

3. Pay off all non-mortgage debt. The first use of the savings generated above is to remove any non-mortgage debt.  This means to paying off credit card debt, student loan debt, or any other debts that you may have.  Other than your fixed rate mortgage, all other debt should be eliminated through the use of your savings.

4. Build an emergency fund. With unemployment at ten percent, it should be obvious why everyone needs an emergency fund.  An emergency fund provides for at least six months of required expenses.  This fund can be used  for unemployment, disabilities or unexpected medical expenses.   Keep the emergency fund in very safe investments such as money markets, short term bond funds, and CDs.

5. Save for college expenses and retirement through tax favored vehicles. With an emergency fund in place, it is time to begin saving for longer term financial goals, such as helping fund college expenses and/or saving for retirement.  Coverdell Education Savings Accounts and 529 College Savings Plans are tax-deferred ways of saving for college education.  Retirement savings can be placed in IRAs or 401(k) plans that also provide initial tax savings and longer term tax deferred investment accruals.  Use tax deferred vehicles to the maximum extent possible when saving for your retirement.

6. Invest appropriately for the goal you are trying to achieve. If your investment objective is short term (three to five years), use very safe investments, including certificates of deposit, money market funds and short term bond funds.  If your investment goal is medium term (five to ten years) riskier investments such as government backed bonds, municipal bonds, highly rated corporate bonds and some equities can be added to the investment pool.  If your investment is long term, (over 10 years) riskier investments, including emerging market stock funds, REITs, commodity funds, and other riskier investments can be added to your portfolio.  Only a small portion of your portfolio should be dedicated to the riskier investments.

7.  Stay on target. It is very easy for fear (or greed) to enter into our financial decisions.  Bubbles will continue to occur in our economy and markets will continue to rise and fall.  However, by maintaining your strategic investment approach, you can avoid making irrational, fear based decisions when conditions get uncertain.  While it may be beneficial to make well-reasoned tactical investment plan modifications, it is unwise to make emotional, reactionary decisions regarding your investment strategy.  A written plan on your investment approach will help avoid this pitfall.

8. Update your plan at least annually. Revisit all aspects of the financial plan, at least annually, to determine if circumstances have changed.  If a change has occurred, it is time for a plan update.  With an active, up to date plan, you minimize the fear of financial uncertainties and maximize your ability to live from a sense of financial abundance.

As a very wise person once said, “a rich person is not the one who has the most, but the one who needs the least”.  By honestly planning for your financial requirements, you can determine your requirements for an abundant financial life.

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Thanksgiving is a day of gratitude for our many blessings and a time to appreciate our abundance.   Do you live from a sense of financial abundance during the other 364 days of the year or do you often live in fear, from a belief in scarcity?

To view the complete Bankrate.com article please click   Abundance or Scarcity It’s Up To You

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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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