Like all planning, financial planning is about the future. We plan our financial affairs because we want to enjoy more secure, more productive, more comfortable and more harmonious lives if things work out as we hope. We plan because we want to be prepared for whatever happens otherwise. Most of us want to be free to change our plans, and that sort of flexibility requires good planning.
Not many people pay attention to financial planning when they first enter adulthood. This is not to say that most young people don’t need financial planning; they do, from the moment they become independent of their parents, and sometimes sooner. But most pay little heed to personal finances, beyond day-to-day bill-paying and the financing of education and cars, as young adults. It is the things that come with time and maturity, such as building a career, starting a family, buying a home and devoting ourselves to important endeavors or causes, that gradually direct our attention toward the future rather than the present.
I have been a financial planner for 28 years. In my experience, the people who are most diligent, but also the most anxious, about planning tend to be about 55 years old or older. I believe I am only slightly biased by the fact that I turned 57 at the end of 2014.
This later-in-life focus on financial planning is counterintuitive. At 55 or older, the future is like the flexibility in your joints and (for men, at least) the hair on your head: You find less of it every time you check, but what remains is all the more precious. This may be why so many people focus more intently on planning as they get older.
I am not talking just about estate planning, which is one area where older people understandably are highly engaged. And I am not talking just about planning for incapacity and the potential need for long-term care, which is also a preoccupation of older people.
People near and in retirement tend to pay very close attention to saving and investing. This attention is deserved, although young people – who have longer time horizons over which to accumulate assets – have even more reason to focus on thrift and wealth building.
If you are older, there is a good chance you are more careful about how you use credit, how you budget and spend money, and about how you keep records, than you were when you were younger. Together with thrift, these are the basic tools of financial management. Use them well and you will most likely be happy with the results. Use them poorly, or not at all, and your chances of a good outcome are much less. You can borrow and spend recklessly and still end up with a small fortune, but you will need to start with a large fortune.
Don’t overlook taxes. From the moment we engage in economic activity, whether by spending money or earning it or saving it, taxes are a big part of our financial lives. Yet there may be nobody, not even someone like me who is a CPA and an experienced financial planner, who really knows how much we pay in total taxes. But while taxes are a large and complex topic, no discussion of financial planning would be complete without at least mentioning the way taxes affect how much we keep of the money we earn, how much things cost us when we spend it, how much we can pass to our heirs or other beneficiaries, and how we might be affected by future changes in the law.
We probably should begin, however, by defining the term “financial planning.” My colleagues and I consider ourselves financial planners, but we view our field in a way that is different from many members of the public, and even from many other financial planners. In our view, it comprises a variety of topics, all worthy of careful attention.
Investment Management. Many people use the terms “financial planning” and “investment management” interchangeably. We do not. Investment management, albeit important, is just one element among many that must be part of any thoughtful and effective financial plan for an individual or family. In fact, “investment management” by itself is almost meaningless in the context of an individual’s portfolio.
If you run a mutual fund whose mission is to invest aggressively in stocks, your goal is pretty simple: Generate the highest return you can possibly achieve. Chances are, you will take considerable risk in pursuit of this goal, because high returns invariably are accompanied by high risk. But the risk is someone else’s problem. You just want maximum results, meaning maximum returns for your investors, maximum assets in your fund and maximum compensation for you.
Individuals and families don’t usually operate this way. I have yet to meet anyone whose most important financial goal in life is to die with the maximum possible net worth. If this were your goal you would never give anything to charity and never give anything to relatives. You would send your children to the cheapest possible colleges, or tell them to pay for college themselves. You would never take a vacation, at least not one that required you to spend money on travel or other leisure pursuits. Come to think of it, you probably wouldn’t have leisure pursuits. You would just work as long as you are physically able, and then you would stay home and watch whatever happens to be available on basic cable TV.
We have a variety of personal goals, often interrelated, sometimes conflicting, and frequently not very clearly defined. We hold jobs or pursue careers not only because they pay adequately (or better) but because we find the work interesting, fun or personally rewarding. We want to be financially comfortable in old age, but we want to have active and engaging leisure pursuits while we are young and healthy enough to enjoy them. We want to raise our children to be well-rounded adults. We want to see them get good educations. We want to support charities and other causes that are important to us. We want to travel. And many of us want to be able to retire, at least from our primary careers, while we are still vigorous enough to pursue other activities that seem appealing.
So, for individuals, investment planning does not exist in a performance-driven, risk-taking vacuum. We invest to achieve specific short- and long-term goals. We must balance our desire to achieve good investment returns with our preparedness to tolerate risk, and with our potential need to convert the investments to cash sooner than planned. Managing an investment portfolio without first deciding on financial goals is like driving a car without first deciding on a destination.
To my colleagues and me, investment management is part of an interrelated set of planning activities that focus on setting goals and deciding how to achieve them. If a client asks us to help manage investments that will be used in retirement, we offer to help determine how much he or she will want to have in the portfolio when retirement commences. Then we look at how much is in the portfolio today and we try to estimate how much the client will be able to add to the portfolio, through savings, during the rest of his or her pre-retirement career. We project how rapidly the portfolio might grow, based on how aggressive the client is prepared to be with the investments. We determine whether the target amount is realistic. If not, we’ll talk to the client about changing the parameters, such as planning to retire later, spend less in retirement, save more before retirement, or invest more aggressively.
We have a lot of tools at our disposal: computer-based cash flow and investment projections, the client’s earning history, and decades of statistical information about how investments perform under various market and economic conditions. One tool we do not have is a crystal ball. The future never plays out exactly as we expect. So we typically produce more than one projection, using a variety of scenarios and assumptions, to try to offer a realistic range of possible outcomes.
This is why I often tell people that financial planning is a process, not an event. You have to revisit it regularly so you can adjust your plans or your behavior when, inevitably, things fail to go precisely according to plan. I would not simply write a five-year budget for my business and then go away on a round-the-world trip and expect to return home, five years later, to find that everything has happened the way I expected. I can’t do that for my personal financial plans, either.
Taxes. Taxes affect how we accumulate wealth, how we deploy it and how we ultimately dispose of it. Every advanced economy has a tax system that is complicated, because modern life is complicated. An income tax must define “income” so it does not become a tax on gross revenue or receipts. For people of modest or average means, income taxes are typically quite low and might even be zero. But various other payroll taxes, mainly for Social Security and Medicare in the United States, can take a significant chunk from earned income.
A modern tax system usually must also contain some mechanism so the same income is not taxed more than once. This is why the U.S. government allows Americans who work abroad to exclude some foreign-earned wages from tax, and it allows U.S. taxpayers to claim a credit for some foreign taxes that are applied to income from sources outside the country. But income earned by large American corporations is, in fact, taxed twice – deliberately – through the corporate income tax, and then through the personal income tax that applies to dividends the corporation pays to its shareholders. This is a policy choice. It also is a planning opportunity, since most privately held businesses can be structured to avoid this double taxation.
Similarly, at the state level, a taxpayer’s state of residence may allow a credit for taxes paid to another state, to avoid taxing the same income twice. But the credit is limited to the amount of tax that would be owed to the individual’s home state. If you live in a low-tax state like Georgia but derive income from a high-tax state like California, you will pay tax at California’s higher rate on income you obtain from that state. There may be opportunities to shift income away from California’s aggressive taxes back to Georgia – or even to avoid Georgia’s tax if the taxpayer’s domicile can be shifted to an even less taxing jurisdiction, such as Georgia’s neighboring states of Florida and Tennessee.
Then there are general sales taxes, which can tack on 5 percent to 20 percent of every dollar you spend on taxable goods and services. Property taxes are a significant expense for homeowners and other holders of real estate. There is an additional raft of hidden taxes that affect most of us but are designed to escape our notice, such as taxes on hotel bills, airline tickets and utility bills.
For wealthier Americans, another major consideration is the potential impact of gift and estate taxes on the assets we hope to eventually transfer to children and other heirs. There is even a special tax, the generation skipping transfer tax, which applies to some transfers that we make to grandchildren and other beneficiaries who are much younger than ourselves. There are many ways to plan to minimize these taxes, too. We just need to plan properly.
Over the course of many years, diligent tax planning can add up to a significant difference in the wealth a family accumulates. Such planning can also have a major impact in just a single year, especially if the year includes a major transaction such as the sale of a business. It is critical to plan carefully before a transaction is structured or consummated. The best approach is to build tax planning into a regular review of an individual or family’s financial plan, and to update tax strategies periodically, especially if there is a signifi cant change in the law or if a major financial event is on the horizon.
Insurance. We cannot plan around the fact that we are all human and mortal, but we can plan for the risks that this entails. Sickness, disability and premature death can happen to any of us. So can property loss due to theft or disaster, or liability because of an accident, or financial harm due to a failed relationship. We cannot make these risks disappear, but we can manage them by taking preventive steps – such as installing sprinkler system and burglar alarms, or getting a prenuptial agreement – and by buying suitable and adequate insurance.
We cannot insure against everything, however. Life insurance does not protect us financially against death, because everyone dies eventually. There is no place for the insurance company to spread the risk of death. Not everyone dies prematurely, however. In fact, highly premature death is so rare that the cost of insuring against a death of a healthy 20- or 30-something is quite low. On the other hand, life insurance for a 90-year-old who is in marvelous condition would be extremely expensive, if you could buy it at all.
We also cannot insure against old age. If we don’t die prematurely, we all get old, and most of us don’t die prematurely. So, once again, there is no place for an insurance company to spread risk. How, then, does long-term care insurance work? Such insurance is marketed as being something we all need when we get old, because most of us are going to need care at some point in our lives. The answer to my question, how does it work, is simple: not very well. My colleagues and I do not sell long-term care insurance (or any other insurance product), and we don’t recommend it, either. How should you deal with the costs of maintaining yourself in old age instead? Save for it and plan for it.
Business Planning. Starting a business can also be a rewarding “second act,” something constructive to do after retiring from a primary career. Often, financial gain is not the main motivator for someone who starts a business late in life. If your financial position is secure, starting a new enterprise can be a way to do important or enjoyable work and to remain engaged with the world. This can be a fine capstone to a professional life. There are, of course, some issues to consider when starting a business after concluding an earlier career. Even when future financial gain is not the major motivation, planning is important.
As I mentioned, we are all human. Eventually we all must leave the scene, voluntarily or otherwise. Whether a business is a second act or the result of a life’s work, planning a successful business transition is one of the most difficult of all financial planning tasks. It is also one of the most important.
No business operates as an island. Even before you take your first order or deposit your first receipts, you are likely find yourself working with people who want very much for you to succeed. Yes, your landlord has a financial stake in your business, since a successful enterprise is more likely to pay its rent and renew its lease. But over the 20 years I have spent building a business, I found that the people with whom I did business – landlords, bankers and other vendors – really did root for my success, almost as though my venture was a sports team and they were our fans.
Our clients, too, have been major supporters, not to mention by far the best source of new business, via referrals. I have hired most of our staff straight out of college, in effect “raising” them professionally at our firm. Clients take a strong interest in our staff’s development and success. When someone is quoted in a prominent publication or receives some sort of professional recognition, clients often take the trouble to send their congratulations. The most satisfying part of building the business for me has been the opportunity to watch intelligent, caring young people grow into intelligent, thoughtful, caring professionals.
One of the nicest comments I ever heard from a client came a few years ago from a man who retired as the chief executive of an international corporation. “Elkin,” he said to me, “your people are all different, but they’re all good.” Of course I agree, but it was good to hear him say it.
We do not have a homogenized style or personality at Palisades Hudson, even though my colleagues and I share a common approach to financial planning. Confronted with the same set of facts, we would offer similar alternatives and suggestions. But we each have our own way of communicating and our own experiences to offer. A really good relationship between a financial adviser and a client is, inevitably, deeply personal as well as professional.
You might think personal finance is a dry, often boring, topic. We don’t see it that way. Our field is personal financial planning, but for us the dominant word is “personal,” not “financial.” In business, the bottom line is the bottom line. It doesn’t work that way in personal life.
As professionals, we are always trying to prepare our clients for all the things that might possibly go wrong. Our contingency plans have contingency plans. Yet that does not stop us from being basically optimistic, hopeful and confident. Financial planning is about trying to create the future that we want to create.
The past is past. We need to understand it, but we don’t need to plan for it.
