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Lauren's Blog

Lauren’s blog covers topics that impact your finances, your family, and your future. Is there a topic you’d like Lauren to tackle? We’d love your suggestions and feedback.

When risk is a good thing, embrace it!

When risk is a good thing, embrace it!

Risk. It’s a word that makes most of us feel uncomfortable—at best. Even if you’ve been blessed with an appetite for adventure, when it comes to taking risks with money, you may find your stomach feeling a bit queasy. While I can’t recommend skydiving or cliff jumping (especially for my retired clients!) taking the right amount of risk with your money isn’t a bad thing. In fact, it’s often the best way to help grow your assets to meet your retirement goals.

Anne is one of my favorite examples of a smart risk-taker. She loves (and I mean loves!) Las Vegas. She loves pitting the thrill of victory against the agony of defeat—even when it is her money at stake. And yet, despite her penchant for slot machines, she’s clearly not much of a true thrill-seeker. She has had the same gambling budget since the first day she walked into a casino over 30 years ago, and she’s never lost more than she can afford to lose. “I started with $100 of ‘play money’ in my wallet, and I promised myself I’d never let myself dip below my $20 reserve,” she says with a smile. And she does have something to smile about. Over the years, Anne has won (and lost) thousands of dollars, just playing the slots. “For me, it’s my favorite form of entertainment,” she says. “It’s a ‘safe’ risk that makes my adrenalin go crazy!”

A ‘safe’ risk. What an interesting term.

The dictionary definition of risk—“exposure to danger, harm, or loss”—sends a pretty clear message that risk is something we should avoid if at all possible. And yet, as counterintuitive as it may sound, when it comes to investing, risk is the one thing that drives reward. In fact, in a capitalist economy like ours, investors are paid to take risk. It’s that simple. Every time you invest in a company you are, in essence, assuming ownership of that company and are entitled to the rewards that owners receive. When earnings grow, you reap the rewards. If the company fails, your investment will fail as well. That’s the risk.

In skydiving, the risk is pretty clear—particularly if your parachute doesn’t open! In investing, risk is a bit more complicated. To understand why investment risk is something to embrace, let’s look at the three basic kinds of risk:

  • Credit risk. When a bank loans money to a borrower, there is a risk that the borrower may default on the loan. If that happens, the bank loses the principal of the loan, and the interest associated with it. That’s credit risk. Your own credit rating dictates your ability to borrow money and the interest you pay, and the same is true for bonds. Lower-yield Treasury bonds are “safer,” so they pay less than high-yield or “junk” bonds. That means that, as a bond investor, when you take more risk by lending to less credit-worthy borrowers, you get paid more interest.  
     
  • Term risk.When you buy a bond or CD, you are lending money for a fixed period. When the bond is due, your money is repaid. When you lend money for a few days, that’s a short term. When you lend money for ten years, that’s clearly a longer term. Long-term is riskier than short-term because you don’t expect the borrower’s situation to change in a month, but in 10 years? Anything can happen. That’s term risk. That is why a one-month CD pays far less interest than a five-year CD. So, term risk is another way investors get paid more to take on more risk.
     
  • Equity risk.Every time you hold stock in a company, you accept the risks of ownership. As an owner, you are paid a share of earnings, and the value of each share increases with company growth. Because of the risk of ownership, investors are paid an equity risk premium to bear uncertainty, price fluctuations, bear markets, business failures, and other perils. Earning the equity risk premium is how investors get paid more for owning stocks.

As an investor, by definition, you must be willing to take some level of risk to reap the rewards. Whether you take on credit risk, term risk, equity risk, or a combination of all three, risk creates value. While risk and reward may not be a perfect relationship, if you add time and discipline to the equation, it’s nearly perfect. It’s what capitalism is all about, and it’s what gives every investor (including you!) the opportunity to leverage assets for continued growth.

Of course, just like Anne and her slot machines, the smartest way to play is to know how much risk you can accept. If you’re a younger investor with years of saving ahead of you, you have time on your side. You can breeze through a bear market, happily buying up equities at sale prices, and waiting for the inevitable bull market to come your way decades from now. If you’re already retired, you may still have years ahead to enjoy growth, but you’ll need a strategy to meet your changing income needs. Whatever your life stage, remember that risk is your friend. Unless you’re skydiving, in which case I can only recommend that you check that parachute just one more time before you jump!

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What would you change if you were rich?

What would you change if you were rich?

I’m a theatre lover, so it won’t surprise you that I know the lyrics to “If I Were a Rich Man” from the classic musical Fiddler on the Roof by heart. In the song, Tevye sings about how his life would change if he were, indeed, a rich man. For the peasant Tevye, his dreams are pretty simple. But have you ever asked yourself how you would change your life if you were rich?

I sat down with Jack and Mary last week and asked this very question. Both recently retired, they’re financially fortunate. They have been very careful with their money, have saved a significant amount and, as icing on the cake, five years ago they received a large family inheritance. Logic would say that they should be able to relax now and simply enjoy the benefits of a well-planned, well-funded retirement. But when it comes to money, logic doesn’t always prevail. Instead of enjoying their assets, they focus on being frugal—to an extreme. And because Jack is even less comfortable spending money than Mary is, it’s a source of tension in their relationship.

To help de-stress the situation, I gave Jack a little homework: I asked him to simply write down what he’d do differently if he felt rich. When I read his answers, I couldn’t help but think of Tevye’s simple dreams. Why? Because while they aren’t the dreams of a fictional peasant, Jack’s dreams are almost as simple., Jack said that if he felt rich, he would eat more sushi, buy more books on his Kindle, and eat out at nice restaurants more often. If he felt really wealthy, he said he would think about replacing his 10-year-old car, fly first-class on an airplane (at least once!), and treat himself to a new camera. Even in his wildest dreams, Jack is anything but a spendthrift!

My good friend Ava is another example of someone who has turned frugality into an art form. Divorced when her children were still small, she was determined to create a financially sound life for herself and her family. She spent as little as possible, saving every penny she could in jars labeled as “lunch money.” Today Ava’s “lunch money” amounts to tens of thousands of dollars. She may not be rich (yet), but she’s well on her way to a very comfortable retirement. The problem? She rarely lets her frugal mindset—or herself—take a luxury vacation. Over the years, I’ve done everything I can to persuade her to use some of her savings to do things that will make her happy today.

Happily, we’ve made great progress. I’ve had more than a few calls lately that burst with excitement: “Lauren, you’ll be so proud of me!” Ava is finally remodeling her home (something we’ve talked about for over a decade!), and she’s now planning to go to a yoga retreat… in Hawaii. I couldn’t be happier for her. She’ll never overspend, but at least she’s allowing herself to enjoy the fruits of her labor—and her “lunch money.”

If you’ve built your life around saving, it can be quite a challenge to suddenly change your mindset, no matter what the numbers tell you. As an advisor, I know that I can’t solve internal problems with external solutions. You can look at all the charts and projections in the world, but that won’t change how you feel on the inside, and that’s what matters most when it comes to financial confidence and peace of mind. So what’s the answer?

Start by recognizing that the process is different for everyone, and that it takes time. Just as it can be difficult for someone who has overspent their entire life to put boundaries on their spending habits, if you’ve never let yourself feel comfortable spending—even when you have the money to spend—it can be difficult to open your wallet without feeling those old pangs of guilt.

The next step is to take a close look at your assets and your budget. Are you under-spending? If so, do you know why? Are you scared of outliving your money? Did your parents teach you that saving was “right” and spending was “wrong”? Perhaps start by journaling about it to get to your essential truth. Ask yourself why you have trouble spending. And if you’re ready to have some fun, ask yourself the Tevye question: How you would change your life if you were rich? Your answers may surprise you!

Of course, finding the level of spending that’s right for you is a balancing act, and very few of us have such unlimited assets that we can completely forget about budgeting. A trusted advisor can help you understand how much money you have today, establish a realistic budget based on your cash flow, and help you start to internalize your boundaries moving forward. It can be a freeing experience, but it has to come from the inside.

My friend Donna is newly widowed, and understanding how to set her spending boundaries is a learning process. She calls me often for help. “Can I buy this?” she asks. My reply is always the same: “I don’t know… tell me, exactly how long are you going to live?” We both laugh, and then we move on to the reality of helping her find her new balance. It will come. Until then, I just keep reminding her that she does have assets. Her real challenge is to gain the confidence and peace of mind to know she’s not overspending, while still being generous to herself. Donna deserves it. Don’t you?

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In Your Best Interest: Our Spring 2017 Newsletter

Click here to view the full newsletter, including recent news, important dates, financial tips & tools, and more.


MARKET HIGHLIGHTS: Q1 2017

We’re living in interesting times. 
 

In the aftermath of the Brexit vote, last week the UK gave formal notice to the European Union that it would formally exit the EU in two years. The UK’s unprecedented decision will have unexpected consequences. On the home front, the Trump presidency continues to deliver unwelcome surprises. A key example: Trump’s baffling cabinet picks, which include Steve Mnuchin, a 17-year Goldman Sachs executive, as Secretary of the Treasury. So much for “draining the swamp.” Trump (fortunately) failed to deliver on another campaign promise: to repeal and replace the Affordable Care Act, which some attribute to the administration’s lack of political skill and experience. It seems business interests, not the wellbeing of our citizens, are the thrust of this administration’s agenda. On the flip side, the Democratic resistance learned some lessons from the Tea Party movement and rallied its base to participate actively in the budget and legislative processes. This new activism means the budget, as well as any pending tax reforms, will need bipartisan support to proceed. 

Beyond the political headlines, market indices continued to reach new levels. Buoyed by rising corporate profits and expectations of corporate tax cuts, the S&P climbed 5.5% for the quarter, and both the Dow and Nasdaq reached—and held—historic highs. The Dow hit the magic 20,000 mark in January, and consumer inflation topped the Fed’s 2% target rate for the first time in five years, which drove March’s interest rate increase of . percent (25 basis points). While rate hikes sometimes cause an unfavorable reaction in the market, this increase seems to have been priced in, and investors nodded their collective approval and moved on. 

All of these factors, combined with unfailing investor confidence, added up to deliver a solid quarter, with each of the indexes listed below posting impressive gains over their fourth-quarter closing values. 

One notable star in the market constellation was Apple (AAPL), which reported record Q1 revenue and earnings. It is counterintuitive, but Apple is now classified as a value stock rather than a growth stock. Based on its market cap, Apple has another claim to fame: the stock is the largest component in both the Dow and the S&P 500—an interesting indicator of the power of innovation and globalization, and the importance of technology moving forward. 

As we begin Q2, the fundamentals are certainly in place for continued economic growth. Employment, hourly earnings, disposable income, and consumer spending are all on the rise, and consumer prices are up 2.7% for the year—the highest rate of growth in almost five years, and solidly above the Fed’s 2.0% target for inflation. Even the core rate, which excludes energy, is holding steady at 2.2% since February 2016. As 2017 progresses, we look forward to continuing to leverage the power of investing to support your personal financial goals.

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How long do you plan to live? (And are you planning for it?)

How long do you plan to live? (And are you planning for it?)

Back in January, I dove into Jonathan Clements’s fantastic book How to Think About Money. My blog Money really can buy happiness introduced the first step in this great guide: Buy more happiness. The second step may be even more important, in part because it’s something almost everyone I know seems to be in denial about. What is step two? Bet on a long life!

It’s quite an anomaly. Humans embrace anti-aging remedies and strive for immortality, but when planning for our financial life, we frequently place our bets on living fewer years than is reasonable to expect. The data is out there. We are living longer. In 1900, the average life expectancy was just 52 for men, and 58 for women. What a difference a century makes! Men and women who are in their mid-60s today can now anticipate living to age 90, and 10% can plan to celebrate their 95th birthdays! Knowing that, why do so many people plan their finances as if they were still living in the olden days? If our golden years are likely to last two to three decades, it’s time to start getting serious about planning to sustain a long, happy, healthy life. And while there are lots of pieces to the planning puzzle, here are five ways to help propel you on the right path forward:

  1. Reset your expiration date. For years, we’ve been conditioned to see our 60s as the final stage—the denouement—of our lives. Get over it! The fact is, if you only live to your 60s, you’ll be among the unfortunate few. The good news is that once you change your mindset and reset your target date, almost every decision you make about the future will change. Your approach to investing will shift (see #2). You’ll suddenly have permission to make a mid-life career change and finally explore a passion that brings even greater joy in the decades ahead. Instead of seeing the years ahead as a slow, inevitable decline, you’ll start to look at—and hopefully realize!—all of the breathtaking opportunities ahead.
     
  2. Invest (and keep investing!) in stocks. When it comes to investing, the golden rule is to “invest early and often.” Thanks to the magic of compounding, the longer your dollars stay invested, the greater the compound (i.e. exponential) growth. My client Polly is my favorite example of this in action. She and her husband bought shares of great companies in the 1950s, reinvested dividends, held the splits and spinoffs, and didn’t react the to “the market.” When her husband died a few years ago, she was assured a secure widowhood and is planning her charitable legacy. Intuitively Polly and her husband know that capitalism works. Markets work. Downturns happen, but over the long term, the market continues to climb skyward. Invest as early as possible, and you can sit back for the ride.

    Twenty years ago, there was a rule of thumb to “hold your age in bonds” to protect your savings from any untimely downturns in the market. Why doesn’t that rule apply today? It assumed that retirement would last only a decade or so. Imagine a 30-year-old pulling out of the market to “protect her assets” at age 50. It’s unthinkable! In the same way, while you may choose to get slightly more conservative in your later years, staying in the market continues to provide the greatest potential for continued returns. Invest—and keep investing—and you’re much more likely to enjoy a lifetime of financial freedom.
     
  3. Delay claiming Social Security. The Social Security claiming decision is one of the most critical retirement decisions most American will make. For most of us, it should be a no-brainer. Claiming benefits before Full Retirement Age (FRA) costs you a bundle. In fact, between age 62 (when most people become eligible for Social Security benefits) and FRA at age 66 or 67 depending on your birth year, your monthly check increases by 5% a year. Waiting until age 70 increases your benefits even more, by a whopping 8% for each year you delay, up until age 70. Knowing that the chances are good that you’ll live another 15-20 years (especially if you’re a woman), why would you not take advantage of this guaranteed, inflation-adjusted longevity insurance? You can’t get much better! (For more details, see my blog Social Security & Women: Tackling the Challenges.)
     
  4. Consider other income streams.  While traditional pensions are largely a thing of the past (consider yourself lucky if you do have one!), guaranteed lifetime income is something for which we all strive. Consider options such as income annuities (an entirely different product than deferred annuities, which I hate, and so should you!), fixed income strategies, and longevity insurance (a less expensive option that starts paying a guaranteed income when you reach a certain age, say 80 or 85). Everyone’s situation is different, so be sure to work with your advisor to do a detailed analysis and identify the options that are best for you. The most important thing: don’t delay. The earlier you put your plan in place, the more optimal your outcome.
     
  5. Stop worrying about dying young. One of the biggest arguments I hear from clients when it comes to longevity planning is, “What if I die earlier? Won’t I be leaving money on the table?” It is true that most analyses will provide a “break even point” for Social Security and certain insurance benefits, and if you do die earlier than hoped, you may have given up a small percentage of potential earnings. But just look at the alternative: by making your decisions based on a long life—not a short one—you can create more income, which gives you more choices and more freedom, no matter how long you are lucky enough to live. Focus on the amazing possibilities a longer life has to offer and bet on living it to the fullest!

If you groan, roll your eyes, and say “God forbid” when someone mentions the possibility of living beyond 100, give me a call to discuss how to make your money last. The sooner we start planning, the more prepared you’ll be if (when?!) you reach that triple digit!

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There’s no such thing as an unexpected expense!

There’s no such thing as an unexpected expense!

When I met Carolyn for the first time in January, she was distraught. What finally got her to pick up the phone and get financial help was this year’s extreme rainy season—and a big financial surprise. “I didn’t even realize how old my roof was, or that it needed repair, until the water started coming in!” And come in it did. Carolyn had been out of town on business when the leaks opened up, and her home was a mess by the time she found it three days later. Her homeowner's insurance was covering the interior damage (minus a hefty deductible), but she was told she needed a whole new roof. The cost: $22,000. A high-earning corporate executive, Carolyn had lots of credit, but her emergency fund was non-existent, and a new roof was one thing she couldn’t put on a credit card and pay off over the next few months. She needed cash, and she needed it now. “I thought I was in great shape financially,” she told me. “Who knew I’d need so much cash with no notice?”

The answer? I knew. Or at least I could have provided a pretty close estimate, even though I’d never met Carolyn until she walked through my office door that afternoon. I’m no psychic (if I were, there’d be no need for financial planning!). How did I know Carolyn would need that much cash for a home repair? It’s all in the numbers. It’s all in the budget. I repeat: There’s no such thing as an unexpected expense!

All I needed to know was this: Carolyn owns a home in Newport Beach. If her home is worth anything close to the median price of about $2M, a 1-percent rule tells me that her home maintenance will average about 1% of the purchase price of her home—or $20,000—per year. Suddenly $22,000 doesn’t sound that surprising at all! But without a budget, every expense was unexpected. Without a budget, Carolyn didn’t have a clue.

The 1-percent “rule” means that when you purchase a large, illiquid, expensive-to-own asset like a personal residence, almost everything will have to be repaired or replaced eventually. I guide people to set aside a replacement fund of 1% of the purchase price each year for these very predictable costs. The work may not occur each year. It could be a roof, a kitchen, a driveway, plumbing… but it will be something. It always is.

The new roof is just a drop in the bucket (pun intended) when it comes to Carolyn’s money challenges. She was earning a substantial income but wasn’t setting aside cash for irregular discretionary expenses. She had no revolving debt, and she was saving for retirement. But her cash flow planning was a non-starter. In hindsight, maybe her leaking roof was a good thing; it was just the wake-up call she needed to get her to take action.

We began by finding the cash she needed to fix her roof (thank goodness for her good credit and a good chunk of home equity!). But we didn’t stop there. Next, we worked together to create a budget so she knows what she earns, what she spends, and what she can afford. She began to use eMoney (my favorite personal financial management software) to be sure she stays on track. She’s now building an emergency fund rather than relying on credit cards, and she’s earmarking cash reserves for those not-so-surprising expenses such as car replacements, home repairs, annual vacations, and even a planned future nip-and-tuck. The next time a large expense hits her, I have no doubt she’ll have the funds in place to cover the bill.

What Carolyn has discovered is that cash planning is the foundation for a solid financial plan. A cash budget creates a wonderful sense of financial freedom. “I always thought budgeting was like dieting—that I’d always feel deprived—so I just didn't look at how I was spending,” she told me. “Now, I feel the exact opposite. Because I know how much I have and where I want to use it, I don’t get stressed about an expensive dinner that I know is in the budget. Even better, I know I’ll never have surprises, and I don’t worry when I see my credit card statement arrive!” She’s also building a “freedom fund” to be sure she has the funds to support her dreams down the road, whatever they may be. (Read my blog Celebrate Retirement Planning Week: Create a “freedom fund” to learn more!)

Like many of my clients, Carolyn has discovered one of the great financial secrets: cash planning is empowering. Remember, there’s no such thing as an unexpected expense! Making intentional, conscious choices about when, where, and how to spend your hard-earned dollars is key. Align what you want with what you need and (finally!) relax about your finances.

Ready to get started? Check out 7 Steps to a Budget Made Easyor use NAPFA’s find an advisor guideto find a fee-only financial advisor near you.

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All written content on this site is for information purposes only. Opinions expressed herein are solely those of Lauren S. Klein, President, Klein Financial Advisors, Inc. Material presented is believed to be from reliable sources and we make no representations as to its accuracy or completeness. Read More >