Windfalls and Excess Income

It seems like we get news on a fairly regular basis that some professional athlete, movie or rock star is going bankrupt or owes the government taxes.  I’m flabbergasted by how anyone could make that kind of money and blow it. I always say, “Give me a person who earns over a million dollars for even 2 years of their life, and I can show them how to set themselves up financially for the rest of their life!”

Last week I watched a documentary on ESPN’s 30 for 30 Series called Broke. They highlighted why such a large percentage of NFL and NBA athletes end up broke instead of set for life. The Documentary cited the following statistics:

The average length of an NFL opportunity is only 3.5 years. 65% of players leave the game with permanent injuries. By only 2 years into retirement, 78% of NFL players have gone bankrupt or are under financial stress. Similarly, within 5 years of retirement, an estimated 60% of former NBA players are broke. (Sports Illustrated 03/23/2009)

This really is not new information for me. Over the 25 years of my professional life as a financial planner, I’ve read many studies of what the documentary called The Sudden Wealth Effect. In the past I’ve seen a similar study of why a large percentage of lottery winners eventually go bankrupt, and I’m sure many of the same explanations apply to professional athletes.

In this ESPN special, they cited many reasons why players are ill equipped to handle the sudden wealth that occurs upon entry into professional athletics. Generally speaking, most come from the lower middle class on down to poverty level and don’t have the money skills to plan for their investments. They are naturally drawn to investments that are sexy versus safe. Many put their money in the hands of agents who are not financially savvy either. The best explanation I heard in the show was that the NFL or NBA (or for that matter a movie career, hit TV series, or bestselling album or book) is an opportunity, not a career. In each of those examples, people are given a limited amount of time to earn big bucks, but it’s unlikely that it will be forever.

People that experience sudden windfalls, can also succumb to similar downfalls. The chapter titled Windfalls and Excess Income in my book, It’s Just Money, So Why Does It Cause So Many Problems?; details stories about salespeople who had a banner year of earnings and people who came into an inheritance or business windfall that could have made a serious impact on their future financial success, but instead, frittered the money away.

There is a tendency for anyone who experiences a significant increase in earnings to believe that this is going to continue indefinitely. That is in essence, the big mistake. Perhaps you will be one of the lucky ones to experience a long-term run of significant financial success. But if you are more like a professional athlete, where it’s a short period of time, you might miss the opportunity to capitalize on those earnings for your future. The even bigger mistake is leveraging a future on the necessity of those increased earnings to maintain that lifestyle. This is where people tend to go broke.

In so many instances it comes down to the fact that as Americans, we simply like to spend. We feel entitled to nicer things, we feel compelled to “Keep up with the Joneses”, and quite frankly, spending is more fun than saving. This generation, unlike those of the past, is more about living in the moment, versus worrying about the future.

But as a Financial Planner, totally invested in helping my clients get to a point of financial independence, it’s been a bitter pill to swallow. One of my most challenging situations is watching people I know struggling financially, that could have made better financial decisions along the way to prevent the situation they are currently in.

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The American Dream: Buy vs. Rent

After the Real Estate market imploded during 2008 – 2009, many people changed their opinion that Real Estate was the BEST investment they had and there was no need to diversify into anything else. The debate continues to rage on from the possibility that home ownership isn’t for everyone and perhaps the American dream could include just renting, to what kind of mortgage a person should consider if they are going to buy.

In today’s blog, let’s first review the past mistakes that people have made with their Real Estate purchases and finish with a good sense guide to buying Real Estate in the future.

I’ve always advised people that there are two different types of Real Estate purchases; one being their home and the other being investment property. I think many of the troubles started for Americans when people confused the two. Because Real Estate prices were rising so precipitously in the prior decade, it seemed that even one’s home was a great investment. But like any market sector that experiences great run up in values; what goes up, must come down. Remember the technology stocks in the late 90’s that imploded between 2000 and 2002? Many of those companies never regained their prior value even a decade later. The same will be said of much of the RE properties that peaked in 2007.

Your home is a place you live. The American Dream was to buy a house, pay it off, and own it outright. I remember watching the news with my husband when the concept of the interest-only loan came into play many years ago. I said to him, “This will be a house of cards, just waiting to fall.” Because I understand human behavior, I knew that unfortunately, too many people would use this inappropriately. They would stretch to buy a higher-cost home based on the fact that it was made more affordable by the lower payments of an interest-only loan. Don’t get me wrong, it’s always good to pay less interest on borrowed money. But use the lower interest to help you pay off your loan more quickly with the underlying goal still being to pay off your home!

The next big mistake was the equity line. With home values rising so quickly and interest rates dropping, why not take equity out of your home for a renovation, new car, special trip, whatever? Why not use the equity of your home as a savings account? Because you really DON’T OWN YOUR HOME! And once again, borrowing on the equity of your home, is the antithesis of the American Dream to OWN YOUR HOME outright! The excuses were endless…well I’m planning on selling this home one day anyways….so how did that work out???

Now I’m regularly asked, “Is home ownership still the way to go” and “Is now a good time to purchase a house?” The answer is a resounding YES! Interest rates are at a 50+ year historic low, and prices have bottomed out. Some people would say, “But is it too late, haven’t I missed the bottom?” The answer is, “Who cares, it’s your home and you’re going to try to pay it off and live there a long time!”

So let’s review Karen’s rules for prudent investing in Real Estate:

  • Put 20% down – this shows the bank you have some skin in the game and will get you the lowest interest rates available.
  • Get a fixed-rate mortgage; ignore ARMs and interest-only loans even though the rates are lower. Most people don’t have the discipline to make extra payments towards principal.
  • Don’t stretch your budget for the most house you can afford the payment on. What if you (or your partner) lose your job, or unforeseen financial issues come up? Better to get something you can afford to keep even in the worst of times.
  • Work towards paying your home off, even if you hope to have a different house in the future. Things don’t always work out the way we plan!

So, for those of you who aren’t homeowners yet, or aren’t underwater on your current home and looking to move…go for it and happy house hunting!

Could You Be One Paycheck Away From Financial Disaster?

Of course you couldn’t be, right? You’re educated, on top of your game, and have a good job or business! The people who fall victim to financial disaster live extravagantly, lost their jobs and couldn’t find work for longer than a year or perhaps took too much risk and bet the farm on a get rich quick scheme.

Well, I’ve recently been given the honor of serving as a Board Member for The Drake House which is near my home in Roswell, GA. The Drake House offers transitional crisis housing for single mothers and their children. The residents must adhere to some very strict rules, including zero tolerance for drugs and alcohol, as well as mandatory programming and planned savings. For meeting these requirements, the women and their children receive free housing for 90 days with up to 3 – 30-day extensions, as well as access to a food bank and laundry facilities.

As part of the mandatory programming, the women take a 9-week course on basic finances. I was honored to run week 3 of the last series and got a chance to meet the 15 women currently residing at The Drake House.  We talked openly about our relationship with money, and some of the women shared specifics on how they found themselves teetering on homelessness.

I was BLOWN AWAY by what I learned! I assumed they would be a room full of uneducated, lower class, inner city women who simply never earned enough to make ends meet. Boy was I surprised! The group was diverse, including Caucasians, African Americans and Latinos, and the ages were from mid 20’s to upper 50’s. What was really mindboggling was the number of women who had gone to and completed college, held upper-level jobs, and come from relatively affluent upbringings.

The stories were across the board; many including broken marriages. However, they all shared the common thread of how our relationship with money greatly affects our spending behavior and thus the inability to live within our means. Bar none, the group admitted to the emotional attachments they have to money and stuff, and the sense of entitlement that being an American fosters! It’s hard to live in one of the most affluent countries in the world and not feel somewhat entitled.

It made me realize that many of us, our families or dearest friends could be one paycheck away from a financial train wreck! Here are a few basic tips to help prevent you and yours from becoming the next casualty:

  • Don’t just live WITHIN your means, live BENEATH your means.
  • Have a MINIMUM of 6 months expenses as an Emergency fund, but 12 months is better.
  • NEVER EVER spend money you haven’t already earned.
  • Know your budget intimately and be prepared to slash discretionary expenses, BEFORE things get really bad.
  • Don’t SKIMP on insurance. One bad claim can destroy your financial plan if you aren’t adequately covered.
  • If you are already in trouble with debt, seek debt consolidation help IMMEDIATELY.

As I have said for over 2 decades, Financial Planning is the science and art of planning for the worst, and praying for the best. I hope that each of you gets everything you hope and dream for, but you must prepare for the worst case scenario. As we have all now experienced since 2008 – 2009, things can get really bad, really quickly. Believe it or not, you can navigate even the worst financial storm if you are set up correctly.

Plan for the Future Without Looking to the Past: The Importance of Retirement Planning

The financial metaphor of a three-legged stool, representing Social Security, pension and personal savings, which was the theory when I went into Financial planning, is far outdated.

First you have the debate about whether the Social Security bank will be depleted. But that argument isn’t worth having as it was never intended to be a person’s full source of retirement income. I meet an occasional person, who grew up in the Depression, who is able to live on this very small amount.  But today’s Boomers and their children are used to a much higher standard of living. As for pensions, they are a thing of the past, especially for people in their 20s. More than half of people now in their 40s will not get any pension benefits. With that in mind, I suggest the following:

Save as if your personal savings are 100 percent of what you will retire on. My mantra is: Save ten percent of every paycheck, you ever earn, for the rest of your life, no matter what and make no excuses! There will be lean times where you will think you can’t do it, but if you can stick to that credo and never waver, you will never have to worry about retirement. You will have enough money.

Never sacrifice saving to pay debts. Saving is like a bell curve. Even when the initial 10 percent amounts to very little, over time, your money will double and quadruple. Make sure to  save another 10 percent for emergency funds of at least six to 12 months of living expenses.

Take advantage of 401(k) benefits at work. Remember that any matched amounts are free money. Due to the recent downturn in the economy, many workers actually have stopped putting money into a 401(k). This is the time to be unwavering in your long-term savings commitment.

Combined wealth in stocks, bonds and other investments also falls under the personal-savings category. Although “investment” sounds intimidating, I don’t believe it takes a genius to work with stocks and bonds. It is not rocket science. You can learn what you need to through a financial adviser, college classes, books or on the Internet by reading various mutual-fund families’ information.

If you have 10 years until retirement, you can still make money. I’ve learned that it’s not about how much you make, it’s about how much you save. That’s how I came to be a millionaire by the age of 37. The key is constantly investing an appropriate amount throughout a long period of time so it can grow exponentially.

Married couples often struggle  with retirement plans if they don’t agree with the importance of saving money. Many parents want to give their children non-essential, expensive things, better than they had during their childhood. Often one partner becomes the money manager and has the burden of dealing with the finances: frustrations and resentments can be a consequence of that arrangement.

This stress can lead to a marriage’s demise. Communication is essential. Everybody has been brought up differently when it comes to dealing with money. People’s view of what to spend their money on and how much to save can vary greatly. Have a sit-down as early as possible in a marriage or joint-fund relationship. Even if it’s uncomfortable, a middle ground must be reached in respect to budgeting, and saving.

My book “It’s Just Money, So Why Does It Cause So Many Problems?” covers these topics and more using examples, stories and practical planning guidelines. It is available at Amazon.com

Live Beneath Your Means– and Build More Prosperity

By following some simple guidelines, you can learn to live within your paycheck and enjoy a solid, less stressful financial future.

Here are three suggestions to help shift your mindset about money and spending.

Consider Needs vs. Wants
Money is a means to an end. It buys us necessities like food and shelter, and it buys us “stuff.” We think that STUFF makes us happy and that other people love us and want to be around us because of our STUFF. But that’s simply not right. We need to learn to detach from money and see it as a simple mathematical formula…if this is what I earn, then this is what I can spend. Think about an item before you purchase it. Ask yourself, “Do I really need this stuff?”

Mitigate Your Risks
“Live for today, yet plan for tomorrow” is great advice to consider when looking at expenses. For example, when it comes to life insurance, we certainly hope it won’t be needed prematurely, but most people recognize how important it is to address the risks and plan accordingly.

With regard to disability insurance, think of it as “income replacement” insurance. If you depend upon your income, you should have disability insurance in place in case you become disabled and need a “replacement” paycheck to support your family.

And finally, as you start to get closer to retirement age, long-term care insurance can help to supplement your retirement cash flow to meet the additional costs of an extended long-term care event.

Make It a Family Affair
Money consciousness should be a family goal. Create a money-conscious household. Talk with your spouse or partner and family members. Reinforce the message that everyone needs to be careful about spending. Consider instituting a contest where everyone tries to operate within his or her budget or allowance. Suggest a “go-without day” when everyone gives up one of his or her usual items, like the mocha latte or iPhone app download.

It’s important for everyone in the family to understand the reasons for cutting back and the difference it can make in the family’s financial situation. Big savings are important, but it’s often the little things that really add up and can make a huge difference in your budget!