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THE CHOICE IS YOURS
The word conjures up different emotions. One is dread. We know dieting isn't fun. A piece of chocolate is so comforting, the smell of a steak on the grill so enticing, a scoop of ice cream so satisfying. There's no way around it, it's difficult to give up the short-term gratifications of eating.
But the other emotion the word can bring to mind is satisfaction. That's how we feel when we see the results of a diet. Drop a couple of dress sizes and you feel better about everything—the way you look, the way you feel, the way others look at you. Life is better.
I know what you're thinking: If this is a book about investing, why am I reading about dieting?
You may not realize it yet, but there are many dieting principles that are applicable to investing. Both require discipline, both take time, and, if we're successful, both provide us with substantial rewards. The parallels are uncanny. I promise that you will find the concepts of investing and personal finance a lot more familiar than you think.
As you read this book, try to approach it with the same level of interest and focus you would use exploring an exciting new diet. Here's the truth: You don't need an MBA in finance to understand and take control of your financial life any more than you need a Ph.D. in nutrition to work toward your health and fitness goals. Understanding the basic concepts and tools of investing is attainable—anyone can do it.
The world is changing and a big part of that change is financial. In the past, a financially secure retirement was based on personal savings supplemented by Social Security and your employer's pension. As an individual, you had little risk and even less responsibility for planning your financial future; we didn't need to do much or make many decisions. But those days are gone forever. Today companies are reducing or eliminating guaranteed pension plans and politicians are talking about reductions in future Social Security benefits. Increasingly, we are being forced, whether we like it or not, to assume the burdens of planning and acting to ensure our future self-sufficiency. The risk and the responsibility are becoming ours. No longer is it enough to work hard; today we have to make conscious decisions to save, invest, and manage our assets.
Why have these changes occurred? In short, over the past twenty years or so corporate America has come face-to-face with new economic, demographic, and regulatory challenges. Business has become much more competitive. Severe cost pressures have forced companies to operate more efficiently by cutting costs and reducing overhead. At the same time the average American is living longer and using more resources in his or her retirement years. When traditional retirement plans that put the risk and responsibility on a company began, the average person spent somewhere between two and five years drawing retirement benefits before passing away. Today the time spent in retirement can be more than thirty years. Do you think companies want to keep paying you money for more than thirty years after you worked for them for maybe twenty years?
Of course not.
Some of you may think I'm being a little overoptimistic when I talk about retirement lasting more than thirty years. Our perceptions and expectations play a big part in financial planning and the sad fact is, we're usually wrong! Here's a fact: According to the U.S. Census Bureau, centenarians, people one hundred years old or older, are the fastest-growing segment of our population. The second fastest is the age group eighty-five or older. Currently, there are about 40,000 people at least one hundred years old in the United States. That's more than one centenarian for every 10,000 Americans. Of those, 85 percent are women. More important, it's estimated that 40 percent of women who reach the age of fifty this year will live to be one hundred years old. (If you want to get an idea of your own life expectancy, go to www.livingto100.com.) Now, remember the results of these kinds of exercises are based on averages and are not an exact science. So if the Web site tells you that based on your lifestyle you will live only to sixty-five, don't bet on it! You still need to save as if you had a longer life expectancy. I know too many people who maintained an unhealthy lifestyle—smoking, drinking, and carousing—until they drew their last breath in their nineties. Hey, Alfred Hofmann, the father of LSD, lived to be 102.
No matter how long you think you may live, you're going to have to apply the same three principles to your own finances that you apply to your diet: self-awareness, discipline, and commitment. What it all boils down to is who you are, what you want, and what you're willing to do to get there. Both dieting and financial success come down to one word: choice. Both disciplines require you to make the same kinds of decisions about instant gratification or delayed gratification on a regular basis. When you're dieting, you're constantly making a basic choice between indulging now or looking and feeling better later. That choice is forced on us by unchanging physical laws: The only way to lose weight is to reduce our calorie intake below our calorie expenditure over a reasonably long period of time. The calories that we take in go one of two places: Either they're burned as you go about the daily tasks of living, including exercise, or they're stored as fat. A pound of body fat is equivalent to about 3,500 calories. All else being equal, if we cut back our calorie intake by a thousand calories a day, we can expect to lose about two pounds each week. With that in mind, we can choose to have a bowl of ice cream now, but only at the expense of having to shed that extra five hundred or so calories sometime in the future if we want to lose twenty pounds. In the end, successful dieting boils down to that ancient maxim "You can't have it all." That's true of financial planning, too. There are only two things you can do with money: spend it or save it. If you want to build a solid financial future, you're going to have to make the constant choice between spending and saving. If you spend now, you won't have that money later. Worse, if you spend more than you make, you not only won't have that money later, you'll owe others more money. But if you save instead of spend, you'll discover the great secret of compounding (making interest on interest): Over time, the money you save will go to work for you making more money. It takes time for compounding to work its magic, but it can provide you with more money than you ever thought possible.
The following chart should give you a sense of the power of compounding. It shows the value of $10,000 compounded annually in five years and ten years at various interest rates.
We all know how easy and tempting it is to put off the start of a diet. I'll start Monday. I'll start next month. And, of course, every day that you delay adds more pounds that you're going to have to get rid of later. That same kind of procrastination in getting your finances in order is costing you money every day. Worse, just like dieting, the longer you wait, the harder it's going to be to start. Think about metabolism: It's always easier to lose weight when you're younger and your metabolism is nice and fast. Maybe you thought you could always stay thin without having to exercise. Then, as you get older, your metabolism starts to slow down, parts start to sag (and sag some more), and suddenly you're faced with the unpleasant reality of having to diet and go to the gym. The same is true in wealth planning, except the longer you wait to take control, the harder it may be to get what you want because you are not taking advantage of the miraculous power of compound interest.
Similarly with money, when we're young it's easy not to think much about our long-term future. We're too busy building careers, enjoying friends, and experiencing new things. But eventually the future arrives and we're forced to think about it. Sometimes that intrusion comes late in life when there is little time to do much about it. If we're lucky, something spurs us to think about the future earlier. Maybe it's the idea of retiring early and traveling, or figuring out how to finance a couple of college educations while our kids are still in diapers. The earlier we realize what we will need or want and what financial assets will be required to realize our long-term goals, the longer we have to build an effective financial program that gets us where we want to go. But no matter where you are in your life, remember this: It's never too early to begin a financial plan, and it's also never too late.
As a financial adviser, I find that one of the most puzzling aspects of helping people set up financial plans is the reluctance so many have to talk about money. I know when I'm out having drinks with friends we'll share the most amazing and intimate secrets about ourselves, except how much we earn and how much we have. I can't tell you how many stories I have heard about married couples where it turns out the wife hasn't a clue about how much money her husband earns or what kinds of investments they have. There are also some women who handle the day-to-day finances but don't make investment decisions. Their husbands take care of the long-term decisions—and as a result they have a very narrow view of their finances.
In either case, my advice is to open up! If you are single, seek out people with whom you can discuss your investment needs (if it's your father or boyfriend, "discussing" does not mean "do it for me"). If you're married, become a full partner or at least an educated one in your family's financial life. If your husband has more expertise in financial matters than you do, that's okay. I'm not saying you have to be a financial whiz. What you do have to be is aware and engaged in the process. At the very least you must have the confidence of knowing what the plan is and the comfort of knowing that should something happen to him, you won't be at the mercy of financial predators, and that you can safely keep the financial plan on track.
A cautionary note: If you think having your husband educate you about investing may be as torturous as when your father taught you how to drive (I can't remember how many times I walked home!), it may be a good sign that you need to work with a financial adviser, someone to help take some of the emotion out and be able to answer your questions over and over again. Don't be embarrassed; that's what they're paid to do. The only stupid question is the question not asked. To me, that is the biggest risk in investing because in that case what you don't know can hurt you. The risk I worry about the most is your failure to educate (and protect) yourself.
Whether you are single or married, an important aspect of working with an adviser is honesty, and not just partial honesty. Just as you wouldn't go to your doctor and tell her only a few of the symptoms that are troubling you, you shouldn't withhold critical financial information from your adviser. Without a full financial picture, the adviser won't be able to prescribe the best solutions to reach your financial goals. We'll talk more in Chapter 9 about choosing and using a financial adviser.
SETTING YOUR GOALS
Most people setting out to devise a financial plan think the first step is to take an inventory of income, spending, and assets so that they know where they stand. It doesn't work that way. Certainly it's important on any journey to know where you're starting from, but when talking finance, it's a lot more important to know where you want to go, otherwise you wind up wandering aimlessly and arriving somewhere you might not want to be. So the first step in taking control of your financial life is to understand what you want from it. The way to do this is to set goals, both short term and long term, and rank them in order of importance.
Goals are critical because they dictate the shape of your financial plan. They also provide discipline. Without goals it's too easy to become susceptible to what ever is happening at the moment. Distractions are endless and expensive. Keeping your eye on your goals will do a lot to prevent you from getting sidetracked and falling short of what you want to achieve.
I cannot emphasize enough the importance of prioritizing goals. Too often I see people make lifestyle changes without really comprehending what, if any, future needs or wants they are sacrificing. Unfortunately, we can't escape it: For every action there is an equal and opposite reaction. Every dollar spent today cannot be spent for something else tomorrow. No matter what your choices, they have consequences, both now and later. As you go through this exercise, keep one of my favorite expressions in mind: "My wants always outweighed my needs until my needs became critical." Knowing what is truly important to you now and in the long run will bring you a great sense of fulfillment in your life.
To further explain the importance of goals, let's look at how goals work in dieting. If you think about it, dieting is a four-step process. The first thing you do when starting a diet is to decide what your target weight is. That sets you up to take the second step, which is determining which foods will be part of the diet and which ones will be excluded, as well as how much and what kind of exercise you have the time, motivation, and skills to undertake. The third step is to plan each of your meals to be sure you're getting balanced nutrition and avoiding the high-calorie foods with little nutritional content. Finally, you periodically weigh yourself to see how well your plan is working and what adjustments, if any, should be made.
Believe it or not, that's exactly the way you set up a financial plan. The goals come first: What do you want to do and what will each goal require in financial assets? The second step is to use those goals to determine how to save and invest your money. In financial terms it's called "asset allocation," and all it means is balancing your investments among the "big three" asset classes: cash, stocks, and bonds. Cash is used to meet short-term goals, and stocks and bonds are typically for your longer-term goals. (There are other investments, too, that can be used to fatten up your assets and we'll talk about them later, but the core of any portfolio is built on the big three.) The third step is to decide what specific investments you should have to implement your asset-allocation strategy. This involves decisions about where to put your cash so that it is making at least a little money for you but is easily available when you need it, and which stocks and bonds to include in your long-term portfolio (don't worry, I won't be asking you to pick your own stocks and bonds; there are plenty of ways to invest in them without having to be a stock picker). Finally, just as you weigh yourself to measure how well your diet is working and to make adjustments if necessary, you will also periodically review your finances to be sure your plan is producing the results you want. If it is, fine, keep it up. If it isn't, make what ever changes are needed to get it on track.
THE PROCESS OF INVESTING
Step 1: Set goals.
Step 2: Develop asset-allocation strategy.
Step 3: Select investments.
Step 4: Continue to review.
Repeat process as needed.
So let's get back to setting goals. First we need to figure out your short-term, mid-term, and long-term goals. Short-term goals are those things that you want to achieve within the next three to five years (say, paying off debt or setting up an emergency account), mid-term goals are those six to ten years away (like saving for a larger expenditure, say, a car or a house), and long-term goals are those that you want to achieve in ten or more years (focusing on retirement and aspirational purchases, for instance).
In order to identify your goals, you need to think seriously about what makes you happy, what you want your life to look like, and what you want to get out of it. This requires honest, thoughtful, and truthful reflection. There's no point here in trying to fool yourself, because you are the only one to whom this is vitally important. And be prepared to encounter a little emotional upheaval. You may not have ever thought carefully about where you're going and how you plan to get there, and, as with any long journey, getting started can be a little scary.
As I said before, you can't have it all. But at this early stage of setting up your financial plan I want you to ignore that truism and think not so much about goals as about dreams. It doesn't matter, at least for the moment, how practical your dreams are. We'll come back to reality fairly soon. Right now I want you to list, either on a piece of paper or on your computer, your wildest dreams, the things you most want to do, the places you most want to go, the things—clothes, cars, homes—that you most want to own.
For many of you this may be an easy exercise. For others, perhaps not. Take me, for example. When I first sat down to determine my goals, I freaked out and had to go straight to the cookie bag. My "freak-out" was on two levels. First, it was a commitment thing. Just having to think about what exactly I wanted to do five, ten, and even twenty years out was overwhelming. I remember screaming at the paper, "I can't commit to what I'm having for dinner tonight, much less what I'm going to be doing in twenty years!" Once I got through that little crisis, I realized that the second issue was the fact that I didn't know what I wanted. "Oh, no," I thought, "I'm goalless!" If you're like me, don't despair. There are ways to overcome your commitment issues.
Fortunately, I was able to put on my professional hat and realize that the point of the exercise was not to commit to a life sentence, but to give myself goals to work toward. My goals may change over the years, but at least I'll have the ability to choose twenty years from now which job I take or whether to retire early. Keep in mind that what you articulate now may change over time, but the goals you set now act as a road map for your life's financial journey. We all know, too, that working toward something helps tremendously to keep us focused, disciplined, and engaged.
Excerpted from Does This Make My Assets Look Fat? by Susan L. Hirshman.
Copyright © 2010 by Susan L. Hirshman.
Published in September 2010 by St. Martin's Press.
All rights reserved. This work is protected under copyright laws and reproduction is strictly prohibited. Permission to reproduce the material in any manner or medium must be secured from the Publisher.