Build Your Money Machine To Last Life Time
Let’s see how the file cabinets work for other women — the three file cabinets that show you how you would be taxed, with three drawers for investment choices.
June Mendoza, the Michigan housewife, called me one day with the sad news that her father had died. She was bereft with grief, of course, but she also faced the burden of helping to manage the assets her father had left for her seventy-three-year-old mother. These included $125,000 from a life insurance policy, $18,000 in stocks and bonds, a coin collection, and a small income from the pension plan her father’s company had given him. June’s father also left June an investment nest egg, although it was smaller than the one he had left her mother.
True to the pattern she had established—and accepted—in her marriage, June thought she could simply dump the responsibility of her father’s estate on her husband, Steve. After all, he took care of all her financial needs; why shouldn’t he also invest and direct her mother’s cash?
Sure enough, when June sat down to talk to her husband about taking on financial duties for his mother-in-law, he readily agreed to do so. But then June asked him what he was going to do with the funds. His response: Put them in the bank!
“Joan, I have never before in my life questioned Steve’s judgment with these things,” she said. “But it just doesn’t sit right with me. That seems like an awful lot of money to give a bank.”
“You’re right. There are much better choices,” I offered.
“I don’t know what to do. It’s my mother, and I want the best for her,” June said.
“I’m sure you do. But before we work out some strategies for your mother, tell me something, June. What is your money invested in?” I asked.
There was an embarrassed silence.“I don’t know,” she finally replied.
“What if you were in your mother’s situation today—if something were to happen to Steve? Where would you be financially? Do you have any idea what your financial future looks like?” I continued.
“I’m in trouble, aren’t I? And I guess my mother is, too, if I don’t do something,” she said.
June had finally caught up with the women’s revolution. She was ready to start the process of financial self-discovery. But I sensed that it would be best for me to pull back a bit and let June proceed at her own pace.
I encouraged her to sit down with Steve and find out what their money picture looked like. I also suggested that she figure out who would assume stewardship of her mother’s inheritance, and that she give some thought to what strategies she’d like to explore. I gently pointed out to her that, at seventy-three, her mother could live another ten, fifteen, or even twenty years, and that she’d need income to cover that time and to pay for any medical needs or long-term care not covered by her insurance. Recalling the money she and Steve had shoveled out for various treatments for their daughter Ellie’s eating disorder, June could relate to that. I urged her to take some time to sort through what we’d discussed.
June called me back at the end of the week. Her voice was crisp and businesslike, and I detected a strong note of self-assurance. Could this be the same woman who, at the Ranch, had shown so much disinterest in money matters?
Her mother’s dilemma had galvanized her into action. She’d finally sat down with her husband to talk money. Steve works for a pharmaceutical ﬁrm, and he earns $55,000 a year, plus bonuses. They manage to pay their bills and indulge in some simple pleasures, but their financial margin is thin because of the cascade of cash that went to help their daughter and to educate all of their children. However, they do own a condo and a small cabin in the country, where they go on weekends to unwind. June learned from her talks with Steve that he had never really aggressively invested any of their money because he never trusted brokers. What cash they had accumulated went into savings accounts or CDs with low yields. In short, Steve hadn’t grown much cash. Because of their shared cultural mind-set, it never occurred to Steve to discuss finances with June. After all, Steve had always thought, “I’m the breadwinner—it’s my right and my responsibility to take care of money matters. Why should I burden June?” And to the extent that June had thought about it, she’d agreed. But now her assumptions about male and female roles were changing.
June accepted some of the blame for the poor state of her family finances, but, more important, she realized there was a lot of work to do. First, she had her mother’s money to think about. Then, she had her own nest egg to consider. June’s father left her an investment portfolio worth $30,000, which has the potential to grow nicely.
My first question was, how protected was June? I asked her whether Steve had any life insurance policies.
“I really don’t know, but I’ll find out,” she responded.
Steve needed insurance, I explained, to ensure that if he were gone, June would not suddenly be left without a home because she could not keep up the mortgage payments.
I also asked her about their country home. Could they really afford this second house in their current financial situation? Perhaps, I suggested, they were putting the cart before the horse by placing more priority on enjoying their summer vacations than on setting up their long-term financial futures. The house has potential value, I told June, because she and Steve could rent or sell it and add the cash to their Money Machine. But to build wealth they’d need to begin thinking about their cabin as a possible source of cash ﬂow, not just a personal luxury.
June promised to talk to her husband about using the house to generate a little income. She also said they’d call me back— together—to discuss strategies for growing June’s mother’s cash, and that she would find out exactly what was in the stock portfolio her dad had bequeathed her. After a lengthy discussion with Steve, June went through all the bank accounts and sent me copies so I could help her interpret them. She decided to close the bank accounts and to not renew the CDs when they mature. Instead, June and Steve will use the money to invest $15,000 a year in a private pension plan and create some lie insurance for Steve, who is forty-seven years old (three years younger than June).
Why create the plan for Steve and not June? June does not work and has no income; Steve does. Putting the PPP in Steve’s name will give them both a steady income in his nonworking years and will provide June with protection in the event of his death. The cost of the term insurance portion is about $110 a month, or $1,320 a year. June and Steve will invest the balance, or $12,700, in mutual funds that they will select after she receives information about them. Their money will grow in these mutual funds until they’re ready to use it.
There’s no limitation, after the first year, on when they can withdraw money. But June and Steve plan not to touch the money. They want to leave it all in to grow, as in the game of golf, for their future. If we project that this money will grow at 10 percent per year, the stock market’s historic rate of return, we see that Steve and June will have an annual tax-free income of about $60,000 from the time that Steve is sixty-five until he is eighty-five. They’ll have a stream of income, driven by the engine of the stock market and protected from taxation by the insurance in their PPP and insurance protection.
Linette Atwood also plans to contribute $10,000 a year to a PPP. She’s now thirty-eight, so her money has more time to grow than Betty’s or Steve and June’s. Assuming her investments will earn a 10 percent average rate of return, Linette projects that she’ll have an annual tax-free income of $120,000 from age sixty-five to age eighty-five. Plus, she’ll be able to tap into her PPP’s cash before she is sixty-five if she needs to help pay for her daughter’s college education. She’ll also set up an education IRA for her daughter.
You can look to your other investments as the sole source of your future income, or you can combine them with the income from a qualified plan, such as an IRA in your Money Machine.
What About an Annuity?
If you’ve been investigating your financial options, you may have heard about annuities, an investment choice I haven’t mentioned until now. But if you have never really understood what an annuity is, don’t worry—you can scratch it off your list of possible investments. An annuity isn’t a wealth-building strategy. The marketing line for annuities is that they shelter investments from taxation. They do, but not effectively, because an annuity protects your money in only one out of three cases. Annuities protect only the growth of investments. If you invest in an annuity, you won’t get a deduction when you put your money in as you do if you invest in an IRA. And you won’t be able to withdraw your money tax free as you can from a private pension plan. When you withdraw money from an annuity, you pay the regular income tax instead of the capital gains tax. Also, an annuity, like a qualified plan, ties up your money until you are fifty-nine and a half.
As you can see, annuities are not a great investment option. By the time you pay annuity charges, annual expenses, and income tax on the money you withdraw, it could take from ten to fifteen years to earn more than you would have if you had chosen a similar investment in File Cabinet No. 1.
One more thing about annuities that really raises my hackles. Sometimes, I see a broker invest someone’s money that’s in an IRA in an annuity. This makes no sense. After all, like any qualified plan, an IRA already shelters the growth of investment income from taxes, so why would you need to pay additional charges to have an annuity shelter it as well? That’s what I call malpractice, and investing in an annuity that’s already inside an IRA is clearly not a strategy for a Money Machine.
If you own an annuity, make a point to find out how it’s performing—maybe some of its mutual funds are doing better than others. If your annuity is inside your IRA, check to see how much it would cost to get out of it, and then continue to invest the money in your IRA.
Simiplifying Your Investments
Let’s consider the woman whose investments read like a road map of the world. Intent on financial security, and perhaps overly mindful of the value of diversification, she has invested in many different things, but now she has become frustrated because her investments all seem like such a jumble, and managing them is so time consuming.
That’s the case with Sadie Chung, the petite fifty-nine-year-old poet and author we met at the Ranch in Mexico. Over the years, she’s accumulated three IRAs—one in a bank and two at different brokerage ﬁrms. She also has investments in her former employer’s company pension plan, an annuity her late husband purchased for her, stocks in an account at one brokerage ﬁrm, and bonds in an account at another brokerage ﬁrm. Her husband also left her a batch of individual stocks and mutual funds, $750,000 in cash from his life insurance policy, some commercial property in Hong Kong, and a condo on Fisher Island in Miami. She invested in a limited partnership, and she recently set up her own company and a company-sponsored retirement plan. And with all that, she still finds time to work part-time as a poet and lecturer in creative writing.
“How does this all add up in my Money Machine? Remember, my broker made me sell my mutual funds and move to bonds. How do I know what to do?” she asked in utter frustration.
For Sadie, I immediately prescribed the KISS theory: “Keep It Sleek and Simple!” Sadie is out of control—or at least her investments are. She’s buried under a mountain of financial statements, which give her lots of information presented in ways she can’t decipher; she’d have to take courses in accounting, investing, economics, and law to figure it all out.
Sadie will have to do some major reorganization before she can clearly see what all her investments will mean to her financial future. And while she’s out of control, she might be missing a good investment opportunity because she’s relying on someone else’s judgment rather then her own.
Here’s how Sadie’s money management can be simplified. For starters, her three IRA accounts can be rolled together into one IRA. Two securities accounts can be rolled into one. And the pension money from her former employer can be rolled into her new IRA account. These steps require only a few phone calls and a form or two, and they take Sadie from six statements to two—one for her IRA account and one for her regular brokerage account. Next, she can look inside each account and see what’s in them and whether the investments are performing well. She can also diversify within each account by investing in different stocks, types of funds, and mutual fund families.
Turning to Sadie’s annuity, I noticed that it was held by a major bank. But it didn’t look very good to me. It appeared that the annuity had a guaranteed rate of 5 percent until an anniversary date. We looked a little further, and I suggested to Sadie that she call the bank and obtain more specific information. She found out that, yes, the 5 percent rate was guaranteed until the end of the month; then the rate would drop to 3 percent!
We were astounded. Three into 72 meant that it would take twenty-four years for her money to double! That same year— 2013—was an exceptional one for the stock market, as the S&P 500 returned nearly 30 percent. Clearly, the bank, not Sadie, was beneﬁting from Sadie’s annuity. The bank was taking Sadie’s money, investing it in the stock market, paying Sadie her 5 percent return, and pocketing the difference! We made a quick decision to roll right out of that annuity and into another one that allowed her to beneﬁt from the higher returns of the stock market.
It is important to simplify your financial life wherever possible so that you can fully understand and take charge of what you have. If an investment is too complex for you to manage, don’t buy it. Simplifying your holdings will make it easy to determine how much cash your investments will pay you in the future so you can monitor the growth of your Money Machine.
By taking control of her financial life, Sadie is well positioned to be financially free. When her investment picture looked like a spilled jigsaw puzzle, she was frustrated; she even considered quitting all other pursuits to deal with her financial life full-time. Now she has some peace of mind. She is enjoying building her financial future, even while she continues the other areas in her life that mean so much to her.
Sadie’s so excited about her Money Machine that she’s teaching its principles to her nieces. Erica and Danielle came by with baby-sitting money in hand, and they’ve each set up a brokerage account for themselves to put in their money. Both girls have been tickled to watch their Money Machines grow.
Danielle was so excited that she told a sixteen-year-old friend, Karen, to come see me so that she, too, could start a Money Machine. Karen visited me, and we talked about growing money, the game of golf, the Rule of 72, and the many years Karen has to develop her financial resources.
When I was finished, the young woman said: “I have to tell you that my parents advised me not to see you. They said that to invest money, you have to pay too many commissions and stuff. But I just wanted to tell you that I’ve learned a lot. Thanks.”
That I might have opened up her thinking was all the thanks I needed.
It’s wonderful how taking on life’s challenges truly strengthens us. The results can be positively joyful. That’s what I see in the faces of women—like you!—who are taking charge of their financial lives. It’s such a good feeling to inspire and encourage.