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- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Sprache: Englisch
Discover the ten key issues to achieving your financial goalsand how to use them to realize your dream of financialindependence From saving to purchase a first car, to putting kids throughcollege to planning for retirement, to preserving your estate foryour loved ones, our financial goals change from one stage of lifeto the next. While those goals and the challenges we face inachieving them may differ, all of them have certain things incommon. Saving, budgeting, managing debt, minimizing taxes andliving within your means. These are a few of the 10 Key WealthManagement Issues which come into play (to varying degrees) whenworking toward specific financial goals. But there's one goal forwhich success relies on all ten keys coming together in perfectharmony: financial independence, also known as "Point X." No matterhow you define it--whether it's a retirement income of $25,000a year, or an estate worth $250 million--your future financialindependence requires that you deal effectively with all ten keyissues. And now this book shows you how to get it done, along withthe guidance of a trusted advisor. * Supplies you with a complete roadmap for arriving at "Point X,"financial independence with key milestones and important twists andturns clearly defined * Identifies the 10 key wealth management issues and offerspriceless advice and guidance on negotiating each on your road tofinancial independence * Provides you with both success and failure stories so you canlearn from others' real life experiences * Provides you with tax planning facts and strategies within thewealth management issues that will show you how to minimize yourmost significant expense and at the same time maximize your savingson the road to your "Point X"
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Seitenzahl: 593
Veröffentlichungsjahr: 2013
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Contents
Preface: Living the American Dream
Acknowledgments
Introduction: Getting to Point X
Chapter 1: Committing to Living within Your Means
The American Dream Becomes the American Nightmare
Living within Your Means: The Essential Step
Simple Saving
Chapter 2: Understanding Taxes
A Brief History of the U.S. Tax System
Organizing and Retaining Your Records
Tax-Preparation Services
Accumulating Wealth through Tax Planning
Chapter 3: Determining Your Financial Position
Figuring Your Financial Net Worth
Case Study: How One Couple Learned They Were Spending More Than They Earned
Making Sense of Cash Flow
Establishing Your Financial Goals
Finding Trusted Advisors
Chapter 4: Managing Debt
Case Study: How Two Doctors Went Bankrupt in Only a Few Years—What Not to Do
Basic Principles for Managing Debt
Good Debt versus Bad Debt
Credit-Card Debt
Auto Loans
Student Loans
Home Mortgage Loans
Business and Investment Loans
Understanding Credit
Your Credit Report and Your Credit Score
Preventing Identity Theft
Analyzing Your Debt
Chapter 5: Insuring Your Health and Life
Choosing a Health Insurance Plan
Long-Term Care Insurance
Disability Insurance
Life Insurance
Buying Insurance Policies
Chapter 6: Protecting Your Property with Insurance
Case Study: How a Lack of Insurance Wiped Out One Woman’s Life Savings
Homeowner’s Insurance
Automobile Insurance
Umbrella Liability Insurance
Buying Insurance Policies
Chapter 7: Paying for College
Case Study: How Not Saving for Your Child’s Education Can Ruin Your Finances—and Your Child’s
Conducting a “Needs Analysis” for Your Children’s College Educations
Strategies for Saving Money for College Education
Education Tax Deductions and Credits
Chapter 8: Planning for Retirement
Case Study: Saving versus Not Saving for Retirement: The $1.7 Million Difference
Retirement Equation: Calculating Your Personal Point X
The High Cost of Waiting to Save for Retirement
What You Can Expect to Receive from Social Security
Qualified Retirement Plans
The Difference between Traditional IRAs and Roth IRAs
Fixed and Variable Annuities
Retirement Funding: “Needs Analysis”
Chapter 9: Managing Your Investments
Analyzing Your Risk Tolerance
Stocks, Bonds, Mutual Funds, and Exchange-Traded Funds
Diversification and Modern Portfolio Theory
Asset Allocation and Rebalancing
Dollar-Cost Averaging
Inflation and Taxes: The Biggest Drains on Investment Return
Medicare Surtax on Net Investment Income
Chapter 10: Preserving Your Estate
The Federal Gift and Estate Tax System
Legal Documents to Consider for Estate Planning
The Probate and Administration Process and Why You May Want to Avoid It
Using a Planned Gifting Strategy
Ownership of Property and How It Is Transferred
Reasons for Creating a Trust
Benefit from a Family Limited Partnership
Estate Tax Planning and Life Insurance
Chapter 11: The Time Value of Money
The Rule of 72
Appendix A: Selecting a Trusted Advisor
Appendix B: 101 Ways to Save $20 or More per Week
Appendix C: Basic Concepts and Definitions of Various Types of Taxes
About the Author
Index
Additional Praise forFinancial Independence
“It is without reservation that I recommend John Vento’s book Financial Independence. Not only does the book cover the myriad of information that one needs to know for financial health, but it is presented in a clear, concise and readable manner. Too often, the jargon thrown at a reader about financial affairs makes the average person feel ignorant and ready to give up all decisions to the ‘professional’ advisor. John makes it clear that the average person needs to be a participant in this process and provides the clear guidelines to make it possible.”
—Lynn K. Robbins, PhD
“Drawing on 25 years of investment experience and a rich legacy of immigrant parents, John Vento defines the American Dream in realistic financial terms through his 10 Commandments of managing your finances and lifestyle. Step by step, he lays out in readable prose what he calls ‘10 Key Issues to Comprehensive Wealth Management,’ the road to financial self-reliance, revealing the wisdom of that old tune so many of us failed to heed, ‘Little Things Mean a Lot.’”
—Donald Martin Reynolds, PhD, art historian and the author of numerous books, articles, and reviews on American art and architecture
“I have known John Vento for more than 30 years. When it came time to decide who to entrust my private accounting practice clients, I did not have to think twice. John, to me, is a perfect example of success story. His professional and teaching experience enabled him to make complex issues understandable.”
—Vladimir Slizinov, CPA, President, Savara Group
Cover Design: Paul McCarthy
Cover Images: both Istockphoto, © jodiecoston / © scanrail
Copyright © 2013 by John Vento. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions.
Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.
As of the time of writing, John J. Vento is an advisor with H.D. Vest. The views and opinions presented in this book are those of John J. Vento and not of H.D. Vest Financial Services® or its subsidiaries. All investment-related information in this book is for informational purposes only and does not constitute a solicitation or offer to sell securities or insurance services. Securities offered through H.D. Vest Investment ServicesSM, Member: SIPC, Advisory Services offered through H.D. Vest Advisory Services SM, 6333 North State Highway 161, Fourth Floor, Irving, TX 75038, 972-870-6000. Investments & Insurance Products: Are not insured by the FDIC or any federal government agency; Are not deposits of or guaranteed by the bank or any bank affiliate; May lose Value. Comprehensive Wealth Management, Ltd. is not a registered broker/dealer or independent investment advisory firm
For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002.
Wiley publishes in a variety of print and electronic formats and by print-on-demand. Some material included with standard print versions of this book may not be included in e-books or in print-on-demand. If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at http://booksupport.wiley.com. For more information about Wiley products, visit www.wiley.com.
Library of Congress Cataloging-in-Publication Data:
Vento, John.
Financial independence (getting to point X): an advisor’s guide to comprehensive wealth management / John Vento.
p. cm.
Includes index.
ISBN 978-1-118-46021-4 (cloth); ISBN 978-1-118-52636-1 (ebk)
ISBN 978-1-118-52643-9 (ebk); ISBN 978-1-118-52638-5 (ebk)
1. Finance, Personal—United States. I. Title.
HG179.V457 2013
332.02400973—dc23
2012039488
This book is dedicated to the memory of my parents, Rosario Vento and Concetta Giuffre Vento, for the sacrifices and commitments they made throughout their lives to provide their children with the opportunity to live the “TRUE” American Dream.
Momma and Poppa, I love you, miss you, and think about you every single day!
“Financial Independence”
To achieve financial independence, one must know the difference between invested assets, personal use assets, and liabilities, as well as the difference between needs and wants. Wealthy people focus on accumulating investment assets, while the middle class and the poor focus on increasing their standard of living based on their cash inflow. The wealthy understand that the more investment assets may grow, the greater cash inflow from these investment assets may be. The greater cash inflow from these investment assets, the more investment assets may continue to grow. If you are able to accumulate sufficient investment assets to maintain your desired standard of living, your money will be working for you, instead of you working for your money.1
This is point X: financial independence.
1Investments are subject to market risks, including the potential loss of principal invested.
Preface
Living the American Dream
My first clients were quintessential examples of successful American Dreamers. They came to the United States from Italy after World War II with nothing, and they created a wonderful life for themselves and their children by working hard, living modestly, and saving. I confess I learned more from their example than from any college course or studies to gain my licenses. As you might guess, these clients were my parents.
Rosario Vento, my father, was born in the small town of Messina, Sicily, in 1923, and my mother, Concetta Giuffre Vento, born in 1921, came from an even smaller village nearby called Sant’Agata. They lived through the Great Depression (which was as bad in Europe as it was in the United States), survived World War II by seeking shelter in the hills of Sicily, and were married shortly after the war’s end. It was clear that opportunities in Sicily and throughout Italy were limited as a result of the devastation of war, so they made the difficult decision to place their hopes and dreams on a new life in America.
Because he could not afford to pay for two tickets, my dad initially came to America alone. After a year, he was able to afford to rent a small but comfortable apartment in Bensonhurst, Brooklyn, and had saved enough money to pay for a one-way ticket to the United States for my mother. She joined him and they began the great journey of their life together, eager to work hard and reap the rewards of living the American Dream.
Neither one had more than an eighth-grade education, nor did either one speak English very well. After arriving in the United States, my father worked as a barber, and my mother got a job as a seamstress in a sweatshop. They had three children in quick succession, and then after a gap of eight years, one more (me). Together, they earned a modest income, but they always managed to live within their means and save what they could. They never owned a car; instead, they got around the city by walking or using public transportation. They rarely went out to dinner; instead, they always prepared fresh, homemade meals. Before they spent a dime, they always asked, “Is this necessary?” If the item was in fact a necessity, they would then ask: “Is there a less-expensive alternative?”
This was my parents’ attitude toward money throughout their lifetime, in good times and bad. During the early years of their life in Brooklyn, they saved enough for a down payment for a house and obtained a mortgage, which they paid off over 30 years. They put all four of their children through college; one became a teacher, one a medical doctor, one a social worker, and one, a certified public accountant and a Certified Financial Planner (again, me).
After I graduated from college, I began helping my parents manage their finances, although as mentioned, they taught me much more about money than I was ever able to teach them. Each year, I prepared a Statement of Financial Position and a Statement of Cash Flow for them, an exercise that for me was not only a pleasure but a reconfirmation of the values they had taught me. They always lived well within their means, were careful savers, and were usually able to add funds to their investable assets. Over the years, I was able to assist them in developing a well-diversified investment portfolio.
Ultimately, the year my mother turned 75, they achieved a financial milestone that they had never thought possible. I was sitting at their kitchen table, sipping the espresso that my mother always prepared for me whenever I came to visit. On this particular day, I was there to talk to them about their finances. To my great joy, I was able to look my mother straight in the eyes, and say: “Congratulations, you and Papa are millionaires!” The combined value of their home, their invested assets, and their cash totaled just over a million dollars—and of course they had no debt.
Words cannot do justice to the expressions on their faces and the tears of joy in their eyes. At that moment, my parents knew they had accomplished one of their most cherished goals—financial independence. For them, the American Dream was not just a dream anymore; it was now their reality.
My mother passed away in 2006 and my father in 2011. They left this Earth knowing that they had lived comfortably and responsibly. They had been able to raise, care for, and educate their children, and they never became a burden to us. In fact, upon their passing, they were able to leave their children with a solid financial legacy that could be measured both in dollars and by example. This book is dedicated to them and to the hope that the guidance in these pages can help you achieve your financial dreams, too.
John J. Vento
Acknowledgments
I want to thank everyone who helped make this book possible.
I want to first thank my three children, Christine, John, and Nicole, for working with me late at night and on the weekends in my office. Their assistance with typing, proofreading, and researching helped put all these words on paper. All of this “one on one” time brought us closer together, and their interest and willingness to help inspired me to get this done.
I’d like to thank my administrative assistant and good friend, Melanie Maguire, for keeping me and my office together no matter how demanding the workload. Your dependability, loyalty, and willingness to work hard to get the book completed are truly appreciated.
I want to give a special thanks to Norman J. Axelrod, CPA, who is one of the most knowledgeable and detail-oriented professionals I have ever had the pleasure of working with. Thank you for all the assistance with the exhibits and technical expertise in the area of taxation. I cannot thank Susan C. Axelrod enough for all her painstaking efforts in proofreading my manuscript.
To my good friends Richard Gravante and Vincent Schott, thank you for your support and invaluable input in the creation and development of this book.
I want to give a special thanks to Pamela Thomas for guiding me through the process of becoming an author and getting me through the starting gate.
Also, I want to thank Ruth Mills for helping me to rework my manuscript into a book and getting me through the finish line.
I’d like to give a huge thank you to everyone at John Wiley & Sons for giving me this opportunity to expand financial literacy throughout the country by sharing the knowledge necessary to achieve financial independence. Special thanks to Laura Walsh, Senior Editor, Digital Business Development, at John Wiley, for having confidence in me and in this book.
Last but not least, to my wife Doreen, thank you for your patience and understanding for all the late nights and weekends I was away from home writing this book. I cannot possibly thank you enough for all the encouragement and enthusiasm you have shown me throughout our life together. Every time I am about to take on a challenging project you are always there to cheer me on and tell me, “just do it!”
J.V.
Introduction
Getting toPoint X
Every kid over the age of five knows this expression. It can refer to many things, but the strongest image for most of us is an ancient, moldy pirate’s map showing precisely where a long-lost treasure is buried. This book is about helping you discover your own “buried treasure.” Of course, this is not a child’s game. It is a guide to the necessary knowledge (with a special focus on tax facts and strategies) to help you accumulate the wealth you need to lead the life you desire.
I have been a certified public accountant (CPA) and a Certified Financial Planner™ (CFP®) for many years: I started my career working for KPMG (one of the Big Four accounting firms) and then established my own practice in 1987. I have worked one-on-one with literally thousands of individuals, assisting them in their pursuit of a secure financial future. I have helped these people pursue their financial goals, and this has given them and me tremendous pleasure. However, I have also seen people who, for many reasons, have been unable to achieve financial security. Needless to say, this is unfortunate.
With this book, my hope is to help everyone find financial security and financial independence: from the eager teenager who just received his first paycheck to the dual-income couple at mid-life who are paying their mortgage, putting their kids through college, and perhaps helping aging parents to the retired grandmother who wants to make sure her estate is in good order for the benefit of her loved ones. By combining financial planning with tax strategies, this book may help readers increase their personal wealth and pursue their financial independence, a position I refer to as point X.
Financial Literacy and the New Norm
Before I explain in detail how to reach point X—financial independence—I want to talk a bit about how and why I came to write this book. The term financial literacy is not new, but it appears in our general lexicon more and more frequently these days, especially since the worldwide financial crisis of 2008, which continues to this day. Indeed, today’s unsettled economy has been described by the Wall Street Journal and other sources as “the New Norm.” Experts believe that the recent recession ushered in a “new norm” (or “new normal”), where the spendthrift ways indulged in by many before the 2008 crisis have been substituted with an increasing interest in saving, general frugality, and need to develop a stronger sense of financial literacy.
Basically, financial literacy means having a firm understanding of fundamental financial concepts and strategies, and the ability to manage money responsibly in order to ensure financial security. Financial literacy is essential to ensure the financial stability of individuals and families as well as the overall economic health of society as a whole.
As a result of the 2008 economic meltdown, it became stunningly obvious that many people have not managed their finances in such a way as to provide financial freedom for themselves and their families at any stage of their lives—much less after they retire. In fact, many financial organizations report that most (yes, most!) Americans currently reaching retirement age—the infamous Baby Boomers—have not planned or saved adequately for retirement.
Somehow over the last several decades—I believe since the end of World War II—many people in our society have come to believe many incorrect notions about money. These financial myths include such ideas as:
“Owning your own home is everyone’s right.”
“The real estate market will always rise.”
“You can live ‘large’ on credit and never pay any consequences.”
“If you need to work, you can always find a job.”
These myths—a warped conception of the American Dream—exploded in a puff of smoke in 2008. (In fact, they were eroding for many years, but most people failed to heed the warnings.) As a result, many people have suffered financially, some tragically. Many of us are disenchanted about this new norm in our society, as can be seen by the Occupy Wall Street movement and similar protests throughout the world. The lessons in frugality learned by earlier generations—people who lived through the Great Depression of the 1930s and World War II—had been lost, and many Americans were living way beyond their means, and they now had to pay up.
As a result of the 2008 Great Recession and its aftermath, we all must now relearn some essential financial truths, become financially responsible, and prepare for the financial realities of life. In other words, we must become financially literate. We must learn all we can about our money so that we can make the most informed financial decisions in all facets of our lives.
Point X: Our Fundamental Financial Goal
Point X is literally and fundamentally the point at which we can stop working for our money and our money starts working for us. It is the spot at which our savings and investments alone generate enough income to support our chosen lifestyle, and allow us to continue to live that lifestyle without having to work for a paycheck. It is the place where we have achieved true financial independence.
For most of us, getting to point X is our most fundamental financial goal. It is the position we hope to achieve so that we can retire. Even if we do not wish to retire from productive and enjoyable work, we all still yearn to arrive at point X—often sooner rather than later—to feel financially secure and financially free.
What that number may be in terms of dollars is different for each of us. Some people can manage rich full lives on a modest income, and seem to be able to find their point X with ease and clarity. Others have multimillion-dollar annual incomes, yet still find themselves living way beyond their means and view getting to point X as an arduous and perhaps an impossible journey. How you determine your personal point X depends on several variables, including:
Understanding your present standard of living.
Projecting how you want to live after you retire (or after you stop receiving a paycheck).
Figuring out how many years of saving it will take for you to reach
point X.
Figuring out how many years of financial independence you hope to enjoy after you reach
point X.
Determining your personal point X also involves some mathematical calculations, including:
The rate of return you hope to achieve on your investments.
The effects of inflation and taxes on your investments before and after your retire.
Although this process of defining point X may look like grad-school calculus right now, I promise you it is really not all that difficult, and my purpose in writing this book is to explain this process in the simplest way possible.
Ten Key Issues to Comprehensive Wealth Management
No matter how you define your particular point X, whether it is an annual income of $25,000 or an estate of $250 million, you need to not only understand but effectively deal with 10 fundamental wealth management issues. They are:
Throughout our lives, we are in a perpetual state of change, financially and otherwise. Our needs and wants are constantly altering along with our income and our standard of living. What may seem like a financial priority at the age of 18 (buying a car; paying for college or graduate school) is probably quite different by the age of 30 (purchasing a first home or planning for the birth of a child). At 60, we may be considering retirement while simultaneously paying for a child’s college education or an elderly parent’s care—or all of the above. What makes these financial issues even more challenging is that our economy is also in a constant state of change.
Throughout our lives, we will encounter many questions and problems relating to money, but every one of them will fall, in some way, under one or more of these 10 key wealth management issues. It is important that you understand them and work within them productively—that you become financially literate. Depending on how you prepare and handle each of these wealth management issues will determine how successful you will be on your path to financial independence, point X. Moreover, these issues are interrelated, and how you deal with one very often will have an effect on how you treat the others. For example, if you fail to manage debt properly, you will find it difficult to save for a home of your own, your child’s education, or your retirement. Or, if you neglect to properly insure yourself against sickness or premature death, your spouse and family could be wiped out.
Woven into the issues of wealth management is a common variable. Throughout this book, I provide facts and strategies that will focus on minimizing this most significant expenditure, that is, taxes.
Our Biggest Expense
Have you ever gotten to the end of the week, the month, or the year, and asked yourself where did all my money go? Many—maybe most—people are baffled by this question and do not understand how, even if they are earning a respectable salary, their entire salary could be used up, particularly when they were not especially extravagant. They find themselves with little or no savings, or even worse, in additional debt.
What do you consider to be your biggest expense? Most people think it is their mortgage or their rent. Others who have children in college feel sure that it is those endless educational expenses. Still others who may have serious health issues may believe it is their perpetual doctor, hospital, and prescription bills.
Well, I promise you, it is none of the above. It is taxes!
Yes, that is where most of your money has gone—and continues to go: Taxes, taxes, and even more taxes. For 2013, the maximum federal income tax rate is 39.6 percent. On top of that, the combined Social Security rate is 15.3 percent (half paid by the employer and half paid by the employee). Employers also have to pay additional payroll taxes under the Federal Unemployment Tax Act (FUTA) and State Unemployment Tax Act (SUTA). Depending on the state and city you live in, you may also be paying well over 10 percent of your paycheck for these taxes; for example, New York City residents pay a combined state and city income tax, which is as high as 12.7 percent.
If payroll taxes were not enough, we also pay income and capital gains taxes on our other earnings, such as income from investments. We also pay sales tax on many items we purchase, and numerous excise taxes and other special taxes on many items we frequently do not even think about, such as alcohol, tobacco, and fuel. We pay for certain licensing fees, registration fees, parking meters, tolls, tickets, and summonses, all of which are forms of taxation. We also pay real estate taxes, school taxes, water and sewer taxes, mortgage recording taxes, and transfer taxes on property. If you choose to give large gifts to a friend or family member, you may be subject to a gift tax. Clearly the government will tax you to death; in fact, ironically it already taxes you for dying—a little something called estate tax.
If you take a close look at how much you pay for various taxes, chances are this number would be more than 50 percent of your overall expenditures. Keep in mind that some of these taxes are hidden but nevertheless included in your cost of living.
So, if you want to increase your savings, what would be the single most important expenditure for you to focus on in order to keep more of what you make and dramatically increase your savings? The answer, of course, is taxes—taxes, taxes, and more taxes.
But the fact is, most people completely overlook the importance of minimizing their taxes in order to help maximize their wealth accumulation.
Throughout this book, I provide hundreds of tax facts and strategies that will help you accelerate your wealth accumulation and dramatically increase your chances of reaching point X, financial independence.
Take a Financial Planning Checkup
Before we begin to discuss hard figures, you should evaluate your financial situation by completing the Comprehensive Wealth Management Questionnaire. This questionnaire will help you start thinking about the financial issues you have under control and others that may need attention.
How to Use the Questionnaire
To answer many of these questions, you will need to gather certain documents including copies of your will, health care proxy, insurance policies, and banking and brokerage statements. After you have answered these questions completely and honestly, you will quickly be able to identify the major wealth management issues you need to focus on.
Many of these issues should be addressed no matter what your age or situation. For example, even if you are single and still in your twenties, you should have sufficient health insurance, be saving for the proverbial rainy day, and be planning financially for retirement, if only by participating fully in your company’s retirement plan. Also, you may need a will, a health care proxy, and a power of attorney. If you are married, have children, own a home and other valuable property, additional issues will become increasingly important, like sufficient life insurance, health insurance, and property insurance. As you get into your fifties and beyond, you will be more and more concerned with paying for your children’s education, possibly caring for aging parents, and (again) saving for retirement.
All of these subjects are addressed in detail in subsequent chapters of this book.
The Power of This Book
Becoming financially independent is not something that happens by chance; it requires focus, discipline, determination, sacrifice, and a lot of hard work. If you are serious about achieving financial independence and are willing to make the commitment to do what it takes, then this book will provide you with the necessary tools to pursue your financial goals. In short, I will guide you toward reaching your own personal point X, financial independence.
Using financial planning strategies—the 10 key issues to comprehensive wealth management—and many real-life (though anonymous) client stories—I show how to navigate through the most critical factors that affect you and your family’s financial life. Most important, I explain how to employ current tax facts and strategies in order to save hundreds—and perhaps thousands—of dollars every year. By doing so, you will not only minimize your biggest expense, you will maximize the money you can put into your pocket (or your investment portfolio), helping you reach financial independence.
Thus, this book is a complete resource for anyone concerned with building wealth and financial security in today’s no-guarantee financial environment. Authoritative, comprehensive, and up to the minute, it is my hope that this book will become the essential financial guide for every individual and every family.
Chapter 1
Committing to Living within Your Means
Live within your means, never in debt, and by husbanding your money you can always lay it out well. But when you get in debt you become a slave. Therefore I say to you never involve yourself in debt. . .
—Andrew Jackson, seventh president of the United States
We all want to live the American Dream. Beginning with the earliest European settlers, Americans have sought the height of success and prosperity for themselves and their children, and we have believed firmly that we could achieve it, no matter our race, religion, nationality, or gender. All it took was hard work and discipline.
The American Dream Becomes the American Nightmare
Our country was founded on the conviction that it was the land of opportunity and prosperity—that was the definition of the American Dream. In the early years of our country’s existence, infinite real estate was available for the taking, a great boon for a basically agrarian society. If you wanted more land, all you had to do was pack up your wagon, travel farther west, and claim it. If you were willing to work hard, you could earn an honest living, rear and educate your children, and save for your family’s future. These principles stood firm for almost two centuries.
Nevertheless, perhaps because of the decades of affluence that followed World War II, this land of “equal opportunity” turned into the land of “expected entitlements.” People came to believe that living beyond their means—usually on credit—was acceptable, and “living large” became the norm. Younger people no longer thought they needed to save for a down payment on a house, a new car, or a luxurious vacation. They could just put the costs on a credit card or take out a loan. Even professional financial institutions fed into this false sense of affluence, giving credit cards, large home mortgages, and home-equity loans to people they knew full well could never pay them off. This distorted definition of the American Dream significantly contributed to the financial crisis of 2008, which we are still experiencing today and may well continue to feel for decades. Our rich American Dream has become a nightmare.
Still, despite these gloomy facts, if my parents were able to come to a foreign land with only an eighth-grade education, barely able to speak the language, and end up as millionaires, certainly, anyone blessed with the education and opportunities available to most Americans today can become financially independent. Anyone can get to point X—the point at which you can support yourself and your family financially with your investments, not a salary. All it takes is knowledge of good financial practices and the discipline to carry them out.
Living within Your Means: The Essential Step
The single most important step any individual must take to become financially independent is to commit to living within his or her means. This sounds obvious; this sounds easy. But believe me, it is not!
Amazingly, many people do not understand what “living within your means” actually implies! I believe that the definition of “living within your means” is living on less than your take-home salary and any other resources you receive, such as income from an annuity or a trust. Living within your means does not mean existing from paycheck to paycheck. Living within your means does not mean living on credit or on loans. Living within your means does not mean turning to parents or friends to pay the tab when you cannot quite meet the rent or need to buy a new computer. It means not only figuring out how to pay for your needs and wants, but budgeting your income so that you still have a little money left over.
Paying Yourself First
In addition to living within your means, if you are ever going to get to point X, you must also save money. (You will ultimately need to invest this money productively, but I’ll cover that in Chapter 9, Managing Your Investments.) I call this exercise paying yourself first. Therefore, “living within your means” includes not only such necessities as shelter, food, utilities, and clothing, but also payment into your personal savings. Ideally, that payment should be 10 percent or more of your gross pay. You may think that this is impossible, but once you get started, you will realize how easy it can be. And, of course, if you can afford more, by all means, put those funds in savings or invested assets.
The following is an example of how this could work and how this will help you achieve financial independence. If you are earning $52,000 a year, that is $1,000 a week gross income, and you are probably bringing home about $700 of that after taxes. If you pay yourself first by funding your 401(k) plan and save 10 percent of your gross income, that is $100 per week (or $5,200 a year), which may earn a rate of return with compounding over the time invested. If you start saving that at age 21 and retire at age 65, you will have saved $228,800 over those 44 years. Also, that $100 you save affects your take-home pay by only $70 (assuming a 30 percent tax rate), so you will be taxed on $900 instead of $1,000 per week, which means you will bring home $630 instead of $700 per week. Yes, that is $70 less money you have to spend on your needs and wants, but you get the full benefit of $100 saved. Assuming you can earn 7 percent per year on your 401(k) investments over the 44-year period,1 you may be able to accumulate $1,383,829 by the age of 65. I believe this is a small price to pay for financial independence in the future. I do not know any easier way to achieve financial independence. By the way, this does not even factor in employer matching dollars, which can significantly increase your savings.
“Paying yourself first” must be as much a necessity to you as the roof over your head, the food on your table, and the clothes on your back. It is not a luxury, not something you will start doing next week, or next month, or next year, but an essential expense that you must pay now.
Know the Difference between What You Need and What You Want
If you asked most people to define the necessities (or essentials) of life, they would probably say: shelter, food, and clothing. I have just added another essential to that list, that is, saving money on a regular basis, or paying yourself first. However, defining what is essential (and not essential) in terms of shelter, food, clothing, and savings, requires some additional attention:
Shelter should not be the biggest house in the best neighborhood decorated with the most expensive furniture (
not essential
); instead, shelter means a house or apartment that gives comfort and safety to your family, and which you can pay for and maintain with the money you have available (
essential
).
Providing food for yourself and your family does not mean eating out every night at the fanciest restaurants or even ordering in from the local pizzeria or Chinese takeout (
not essential
); but preparing healthy meals from foods paid for within a food budget you have established (
essential
).
Clothing does not mean buying the latest $200 jeans or other overpriced designer apparel (
not essential
), but planning for your family’s clothing needs based on a well-thought-out budget (
essential
).
In terms of saving money, you need not try to sock away 25 percent of your salary, especially if money is tight (
not essential
); you simply need to get in the habit of saving 10 percent or more of your gross pay (
essential
).
In other words, you need to begin to discriminate between the nonessentials and the essentials, your wants from your needs.
In working with thousands of people with regard to their finances over the past 25 years, I have noticed one common trait in every person who ultimately achieves financial independence: He experiences anxiety every time he is faced with the decision to make a purchase that is not essential. Whether it is an expensive cup of coffee or an expensive car (or even a not-so-expensive car!), if he buys it, he experiences anxiety and guilt. In other words, for these people, the pain of purchasing a nonessential item exceeds the pleasure.
Usually, when faced with such a decision, instead of acting impulsively, they ask themselves if the purchase is necessary. (Do I need a new suit for my first day at a new job?) If the answer is no, they are comfortable with the decision. (I can wear my old suit; I’ll have it dry-cleaned and pressed, and no one will know that I’ve had it for three years.) If the answer is yes (My old suit is looking a little worn—and having a new suit will help me to feel confident on my first day on the job!), they always look for a less-expensive alternative. (Can I find an equally good suit at another store or on sale? Will a less-expensive suit look just as good—and make me feel just as self-confident?)
The fact is, most Americans view this essential versus nonessential concept in completely the opposite way. Many people believe it is imperative to “keep up with the Joneses,” to quote that old-fashioned expression, which implies a perceived necessity to appear as affluent as our friends, neighbors, and professional colleagues. Other expressions such as shop till you drop and retail therapy are now commonplace in our world, and are considered acceptable, amusing, and even cool! Shopping till you drop is thought by many people to be as beneficial to one’s health as an afternoon of bicycling in a park; retail therapy is firmly believed to be a form of entertainment, and even an antidote to anxiety and stress.
We are supposed to feel good about racking up thousands of dollars on our credit cards—and many people actually do get immense pleasure from excessive shopping. (At least until the bills arrive.) And, as for putting money into the bank instead of splurging on a new big-screen TV—forget it. This behavior has nothing to do with providing the essentials of life, it has to do with satisfying our wants, not our needs. And, of course, more often than not, it has everything to do with whether or not we are living beyond our means.
Discerning the difference between essentials versus nonessentials, wants versus needs, is imperative if you are going to live within your means, save sufficient money, and ultimately get to point X. You may need to train yourself to associate anxiety and guilt instead of pleasure with making those exciting, but nonessential, purchases. You may need to frequently remind yourself and members of your family that short-term gratification from buying nonessentials is not nearly as important or satisfying as achieving the long-term goal of financial security. When the pain you associate with sacrificing your financial future is greater than the immediate gratification of providing yourself and your family with nonessential items, you have mastered the skills necessary to becoming financially independent.
Simple Saving
A traditional savings account is the first place you should consider putting the money you are paying yourself. Having enough cash on hand to see you through an illness, injury, job loss, or other financial emergency can help you avoid taking on debt or tapping into your retirement assets. It is just a smart move.
How much you save will depend on your needs, responsibilities, and comfort level, but my rule of thumb suggests that you should have enough cash in savings to cover at least three months of expenses for couples (if both partners are earning an income), and enough cash in savings to cover six months’ expenses, if you are single or for married couples with only one spouse earning an income. If you fear that your job is in jeopardy, or you think it will take you longer than six months to get back on your feet financially should you lose your job, you should try to have even more in savings. Also, if you are saving for anything other than the proverbial rainy day, such as for a house, wedding, new car, or special trip, count these funds as extra. (It might even be helpful to open a separate savings account for these larger separate items you are saving for.)
Given the relatively low interest rates offered at this time on cash instruments (which include savings accounts, money market funds, and certificates of deposit, or CDs), and the fact that the current rate of inflation is higher than the interest rate, you may actually be losing money on the ultimate purchasing power of your savings. However, do not let this alarm you too much. Saving in this way is still an essential part of getting to point X. Also, these savings come with Federal Deposit Insurance Corporation (FDIC) insurance of up to $250,000 per depositor, so your money is safe.
What Is the FDIC?
It is important to understand the added safety and reduced risk of saving your money with the protection of the FDIC. For some people, having the peace of mind of knowing their money is guaranteed to be returned to them is priceless. Traditional types of bank accounts, such as checking accounts, savings accounts, and CDs, are insured by the FDIC. Banks also may offer what is called a money market deposit account, which earns interest at a rate set by the bank and usually limits the customer to a certain number of transactions within a stated period of time. All of these types of accounts generally are insured by the FDIC up to the legal limit of $250,000 per depositor, per institution, and sometimes even more for special kinds of accounts or ownership categories. For more information on deposit insurance, go to the FDIC website at www.fdic.gov.
Many banking and brokerage institutions also offer consumers a broad array of investment products such as mutual funds, annuities, life insurance policies, stocks, and bonds. Unlike traditional checking or savings accounts, however, these nondeposit investment products are not insured by the FDIC. Many people are under the false impression that if they purchase something through their bank that they will be protected by the FDIC. This clearly is not the case and you must always understand the risks associated with putting your money into non-FDIC-insured accounts.
Saving for Special Situations
There’s an old saying: “All work and no play makes Jack a dull boy.” We could adjust that adage slightly and say, “All saving and no splurging makes Jack a dull boy.” But perhaps it is the word splurge that needs the adjustment.
Getting to point X primarily refers to achieving ultimate financial independence, where you can stop working for your money and your money can start working for you. But for most of us throughout our lives, other expensive essentials (and nonessentials) will undoubtedly present themselves, and these will require special savings. These might include major purchases, such as buying a first home, paying for your own or a child’s lavish wedding, celebrating a daughter’s “sweet 16” birthday party or your parents’ 50th wedding anniversary, or finally taking a lifelong dream vacation, such as going on a safari to Africa or a trip to the Far East.
When planning for these special events and purchases, you need to view them as requiring additional savings, beyond your cash security savings, and add them as line items to your budget. You might even consider opening separate savings accounts to help you budget for these special situations, and earmark these funds for that special purpose. Nevertheless, you should never sacrifice your primary long-term goal of achieving financial independence in order to meet these other shorter-term desires.
Easier Said Than Done
Granted, a world of difference exists between knowing what to do and actually doing it. We know that in order to reach point X and become financially independent, we must spend less than we make and save more from our salaries, or pay ourselves first. But now comes the hard part: We must actually do it! And the prospect can be overwhelming, both emotionally and financially.
We live in a society of instant gratification; we want more and we want it now, whether it is a daily $5 cappuccino from the local coffee house, a $500 pair of shoes, a $50,000 car, or a $500,000 house. These examples may be exaggerations, but many of us feel bad about ourselves if we seem to be faring less well financially than our friends and colleagues. We feel a need to maintain a high standard of living, even if that standard of living is based on borrowed money and is measured in such superficialities as designer coffees and prestigious labels. Also, as discussed, many of us have learned to experience excessive spending as pleasurable, not painful. These emotional factors attached to living within our means can be troublesome, powerful, and difficult to overcome. But, like dieting, it is essential to your health that you become aware of these feelings and correct them.
For many people, the reality is that they have already dug themselves into a huge financial pit, and getting out of it is going to be time consuming and painful. They may need to pay off thousands of dollars of credit-card debt (see Chapter 4, Managing Debt) or enormous school loans (see Chapter 7, Paying for College), before they feel that they can begin to seriously save. This is daunting, to be sure, but not hopeless.
Stop the Insanity
Albert Einstein defined insanity as “doing the same thing over and over again and expecting a different result.” If you have been living beyond your means and not saving—and wondering why you never have any money—now is the time to stop the insanity! Stop splurging on small nonessentials and start saving for the big essentials, the greatest being your own and your family’s financial security. You must commit to living within your means, discriminate between nonessential wants and essential needs, and save for your future. It is your treasure, and ultimately, it is your point X.
1 The rates of return shown above are purely hypothetical and do not represent the performance of any individual investment or portfolio of investments. They are for illustrative purposes only and should not be used to predict future product performance. Specific rates of return, especially for extended time periods, will vary over time. There is also a higher degree of risk associated with investments that offer the potential for higher rates of return. You should consult with your representative before making any investment decision.
Chapter 2
Understanding Taxes
The hardest thing in the world to understand is the income tax.
—Albert Einstein, father of modern physics
Taxes are the price we pay to live in our society. Our federal and state income taxes pay for everything from roads, public schools, public libraries, and hospitals to national parks, dams, the U.S. military services, and the salaries of all the people who work for the U.S. government, including the President of the United States. Our taxes also pay for Social Security, Medicare, and other social services. Although we want, need, and appreciate these services, many of us fear that a tremendous amount of money is wasted in the management of government—and we are paying for it.
The fact is, the average American family pays more than one-third of its income in federal, state, and local income taxes—and even more in property taxes, excise taxes, sales taxes, and other hidden taxes, such as taxes on cigarettes, liquor, and certain luxuries. In other words, for just about everyone, taxes are our biggest personal expense, by far.
In order to reach point X, it is imperative that you understand the basics of our tax system, and that you practice careful and creative tax preparation and planning so your personal tax burden does not deplete your income unnecessarily, and your wealth accumulates quickly and safely. Tax laws are incredibly complicated, and there is no reason for you to read up on or understand the virtually infinite ins and outs of the often arcane U.S. Tax Code. Most people do need help from professional tax advisors to benefit from tax strategies; however, you should have enough basic knowledge about taxes and the tax system to ask the right questions and find the appropriate help to suit your own unique financial and tax needs. And that is what this chapter provides: an understanding of the basics you need to know to be financially literate.
A Brief History of the U.S. Tax System
I begin this chapter with a very brief history of taxes in the United States, so you can be prepared for what is to come. I remember sitting in my first history class as a child and my teacher saying “The reason we study history is because our history tends to repeat itself.”
The subject of taxes has been a significant part of American history since long before the American Colonies became the United States of America. Every school child remembers the Boston Tea Party of 1773, when the citizens of Boston dressed as Indians and dumped tea into Boston Harbor in protest to Britain’s unfair taxation on tea throughout the Colonies. This rebellious act played a strong role in the start of America’s Revolutionary War.
Actually, at the time of the Boston Tea Party, taxes had already been a part of the American Colonial government since almost the moment the first Colonists arrived. In addition to taxes imposed by Britain, each individual Colony imposed local taxes on themselves. The first property taxes were imposed on Colonists as early as 1634, less than 15 years after the Pilgrims landed at Plymouth Rock.
