How to handle sudden financial windfalls

Is there such a thing as getting too rich too soon? At a time when the economy continues to make a shaky and uncertain recovery from a sustained recession, “sudden wealth” might seem like a pretty unlikely–and not entirely unwelcome– problem to have. The reality is, however, that financial windfalls are fairly common (typically as the result of an inheritance), and far too many families and individuals squander that wealth and waste a valuable opportunity to make a lasting positive impact on their long-term financial security. While the all-too-familiar cliché of fabulously wealthy high-profile celebrities who end up losing it all might be an extreme example, the average Joe doesn’t have a great track record in this regard either: T. Rowe Price did a study a few years ago that found that the average inheritance in the U.S. lasts just 72 days!

Here are some basic reminders to help you avoid missteps in the event that you are fortunate enough to come into some money:

• Take your time. Like the recent winner of a $336 million Powerball jackpot who remained anonymous for weeks–understand that there is no rush to make decisions.
• Carefully evaluate your finances, assess your debts, your tax liabilities, and the final dollar amount you are likely to be left with once your obligations have been met.
• Don’t be a sucker! Take the advice of the professionals, and be wary of the family member with a great business idea or the friend who suddenly needs a big loan.
• Plan your estate. Think about trusts and other financial instruments, look closely at things like power of attorney and determine where you want your money to go (charitable giving, inheritance details, etc.).

Only after you have done all of that can you relax. Have some fun! Take a trip, treat yourself, enjoy your good fortune. Just remember to do so within your means.

Tags: estate planning, inheritance, windfall

Social Insecurity?

This is not your parents’ Social Security Program; literally! In fact, the fundamental economic dynamics impacting savings and retirement planning with respect to the most talked-about strand of the social safety net are dramatically different today than they were even a decade or so ago. In 2000, the average monthly benefit to Social Security recipients was $840 per month. With a 5-year treasury yield of just over 6%, it would have taken a little less than $163,000 to generate that equivalent monthly sum. Today, however, yields are at around 1%, and with the average monthly benefit now $1,181, it would take about $1.4 million to get that kind of return. That is an enormous change from just 12 years ago, and the implications for retirement planning are profound. It has become more important than ever to maximize income streams. It is not necessarily about simply finding the highest yield–it’s about income planning: taking a strategic approach that involves what might have been considered some unorthodox decisions not too long ago. One of those decisions might be to defer Social Security payments until the age of 66. Everyone always takes Social Security as early as possible, simply because they can; but that doesn’t always make sense. If you defer payments for 4 years, perhaps making up the difference with funds from your IRA, you will then be entitled to the $2,000 monthly payment that comes with full retirement age. The $800+ monthly difference could make a significant difference over the long haul. And in times like these, the long haul is where you want to devote your retirement and financial planning resources.

 

Tags: financial planning, IRA, retirement age, social security payments, social security program, treasury debt, treasury yield

Uncertain Times

Unfortunately, while there have been a few lonely bright spots with regard to macroeconomic news, the overwhelming majority of the latest data continues to paint a pretty grim picture. Notably, the Federal Reserve is now forecasting that economic growth will be slower through 2012 than previous estimates, and that unemployment will be higher than earlier forecasts had predicted. The news was underscored by statements from Federal reserve Chairman Ben Bernanke, who said that “the pace of progress is likely to be frustratingly slow” and that there “are significant downside risks to the economic outlook”. Bernanke cited worries about European debt and volatility and generalized uncertainty in what are increasingly interconnected global financial markets. While this big-picture stuff can feel somewhat removed from the day-to-day concerns of the average investor, the result is that slower growth will likely mean weaker market returns. Investors, particularly those individuals approaching retirement age, should proceed with caution. Because, taken together with the recent string of news stories about the seeming inability of the debt and deficit “Super Committee” to come up with any real or lasting solutions, the climate of uncertainty and pessimism regarding our national (and your personal) finances is not particularly confidence inspiring. The best way to counteract that kind of uncertainty is with certainty. Control what you can control. Make and stick to a plan that reduces your exposure but still provides for your retirement needs. You can’t control global finances, but if you establish a strategic plan for yourself that deals with known factors and doesn’t rely on unknowns and uncertainties, you can certainly control your financial future–no matter what scary headlines hit the paper tomorrow.

Tags: ben bernanke, economic growth, european debt, federal reserve, global finances, macroeconomics, retirement, unemployment

Basic(s) Training

One of the frustrating ironies of a recessionary cycle is the way in which very natural and very human–and in some cases very necessary–responses to lean economic times can have an adverse impact. Actions that would be questionable investment decisions even in a booming economy can be particularly harmful during a downturn, and therefore it is always a good idea to take the time to remind yourself of the basic bedrock rule of investing: Buy Low and Sell High. Because when you pull money out of a struggling market to live off of in a downturn, you are engaging in behavior that is precisely the opposite of what would be recommended under buy low/sell high fundamentals. It is also important to remember that while long-term trends are important, what those trends mean for you is all that matters with respect to your financial well being. If you look at a chart of stock market performance throughout the 20^th Century, things look great: some ups and downs, but an overall climb. Here’s the problem though: you aren’t going to be retiring for 100 years, and you don’t want to be caught out in one of the 20-year cycles where there is a dip in the trend line. If you are close to retirement, the simple facts are that your options are also more limited, as you just don’t have the time to make up a big loss. Just as you should remember to buy low, sell high, and avoid overreacting, it is also important to remember to reduce your exposure and get more conservative with your investing as retirement age approaches.

 

Tags: booming economy, buy low sell high, economic downturn, investing, recession, recessionary cycle, retirement, stock market performance

Ex marks the spot

Beware of the ex-dividend date! No, it’s not some kind of evil creature from a childhood fairy tale, but the results on your tax bill might be pretty scary in their own right if you fail to exercise some basic–but unfortunately often overlooked–planning. The ex-dividend Date is relevant for anyone who is mulling the purchase of a mutual fund. With plenty of investors likely looking to take advantage of a market dip during these volatile times, that kind of reallocation can be a popular choice. But if you aren’t careful, you might wind up with a costly and unexpected tax bill if you are not careful. The ex-dividend date is defined by the IRS as “the first date following the declaration of a dividend on which the buyer of a stock is not entitled to receive the next dividend payment”. That’s a backhand way of saying that the ex-dividend date is the official cutoff point where owners of record are both eligible for dividends on their holdings and liable for tax payments on those same holdings. The popular phrase is that you want to try and avoid “buying the tax liability”. What that means for new investors is that if you purchase shares in a fund before they pay these out, you might be saddled with a tax bill and see the value of your per-share investment reduced. If you buy 1,000 shares at $25/share…and the fund declares a distribution of $1.50/share, you will get more shares, sure, but you also might get a 1099 for $1,500 in the mail. Not an appealing trade-off. The ex-dividend date for many funds is toward the end of the year, so do your research and be smart about timing. When it comes to investing, Caveat Emptor–buyer beware–always applies.

Tags: dividends, investing, IRS, market dip, mutual fund, tax liabiity, tax payments

Political Drama and Economic Paralysis

We are currently about a month and a half out from the 1^st of August, a date that seemed to start a chain reaction of political debate and legislative gridlock surrounding the debt ceiling controversy. While a last-minute compromise was eventually reached, the national and international fallout from two political parties’ very public struggle to agree on terms to raise the national debt limit has had a significant impact on the financial markets. The political struggle was followed by the S&P ratings downgrade, and a subsequent stock market nosedive. While we have gained back some of what we lost in the marketplace since then, the volatility has been noticeable. One of the things I have noticed over the years is that when the markets take a dive, people tend to fall victim to a kind of deer in the headlights paralysis. There is a general sense that if you simply wait things out, things will improve over time as the market recovers. Unfortunately, we have been essentially saying that same thing since 2001. The lesson for savvy investors is that the uncertainties of the current political and economic climate mean that a “wait and see” attitude might not do the trick this time. The consequences of inaction, particularly for those families and individuals approaching retirement age, can be damaging, and, with more uncertainty on the horizon, a failure to protect yourself could be very costly.

Tags: debt ceiling, economic climate, financial markets, national debt, political debate

My Big Fat Greek Debting

Unfortunately, the news from across the pond seems to continue to get worse. Europe, already mired in a deep economic slump related to uncertainties surrounding debt crises in Greece, Ireland and Spain, got more bad news as Italy, one of the Eurozone’s largest economies, saw their credit rating downgraded by Standard & Poor’s. We have already seen significant public unrest across Greece, and it has begun to spread to Italy and other countries. The markets are already basically pricing in a 100% certainty of a Greek default: short-term interest rates on Greek debts are close to 100%. Greek’s national debt, currently at 140% of GDP, will be at 180% by the end of the year. They simply cannot make their interest payments. Without some form of a significant and ongoing series of bailouts, Greece will default. The big question is not if, but when…and what. Because a default would do serious damage to the Greek economy, there is serious discussion about Greece exiting the Euro and devaluing its currency; an option that would accelerate a pan-European financial crisis and is generally considered to be even less desirable than a large-scale bailout package. The bottom line is that this is not going to end well. And while many Americans might believe that European financial challenges are remote and will not impact them personally, the unfortunate reality is far from the truth. European and American economies are intimately connected, and a crisis over there will increase the chances of a crisis here at home.

Tags: debt overseas, financial crisis, Greece economy, short-term interest rates, standard & poor's, turmoil overseas