Budgeting: Putting the Pieces Together


Budgets are like a puzzle. You have a finite amount of money, regardless of how much you earn. You need to figure out where each piece of it is, and should be, allocated. It’s an honest look at your spending and saving rates. Many people have a negative attitude towards budgeting, thinking that it’s restrictive, time consuming, or unnecessary, but a budget is really something positive. It’s a tool to help you get where you want to be one day.

DWM works with clients to create custom financial plans. Why is that so important? The CFP website says it perfectly: “Creating a financial plan helps you see the big picture and set long and short-term life goals, a crucial step in mapping out your financial future. When you have a financial plan, it’s easier to make financial decisions and stay on track to meet your goals.” These plans help you define and quantify your goals. They’ll help you identify how much you will need to save to make these goals.

To create a realistic plan, one needs realistic numbers. One of the most important figures in all of this is the amount of money you spend, since the more you spend the less you have to save. Remember, you have a finite amount of money. Some people like to know exactly what they are spending, and we have clients that have created Excel budget spreadsheets that detail their spending down to the penny. On the other hand, some people don’t think about their spending (or live in denial about it) and have no clue. But burying your head in the sand doesn’t change reality. The money is still being spent whether you’re aware of how much you’re really spending on discretionary items vs saving for goals like retirement, or not. It’s better to face things now when you still have a chance to change your spending habits, and save to meet the goals that are important to you.

For DWM to provide you with a meaningful plan, we need solid numbers on your spending. So if you’re not currently tracking where your money goes, here is some advice to get you started:

  1. Take a look at your current spending. This is the part where many people stop before they get started because many budget worksheets contain 50+ categories. Trying to classify and tally everything into that many categories is daunting and time consuming. Instead, download a full year’s worth of transactions from your bank accounts’ and credit cards’ websites to an Excel spreadsheet, and sort by category or description to get an idea of where your money is really going. Label each category as Fixed, Goals, or Flexible according to the guidelines below in step two, and figure out what percentage of your take-home income each of the three composes. For some people there will be surprising or depressing revelations, but don’t be dismayed. You can take control of your spending habits. Now you’re ready for step two.
  1. Set goals and adjust your current spending accordingly. A good, easy to follow guideline is to divide your total take-home income 50/20/30:

–  Fixed expenses such as home, student, and car loans, utilities, insurance, memberships, and other expenses you are committed to and don’t vary much should make up 50% of your budget at the most.

–  Financial goals such as retirement, saving for college or a down payment on a vacation home, building an emergency fund, and paying off credit card debt should total at least 20%. (Note that you may be saving more towards retirement goals than reflected in this number because it only includes take-home income, and 401k contributions are deducted before your paycheck is deposited. For more on the ideal saving rate, see Brett’s recent blog.) For our clients, this is where a financial plan from DWM really helps you to know how much to allocate each month to meet your goals. Of course, we also review and offer our advice on fixed expenses and flexible spending as part of our comprehensive financial planning process.

–  Flexible spending makes up the other 30% (or less). This includes things that usually vary month to month like food (both grocery shopping and dining out), hobbies, medical costs, entertainment, shopping, gifts, etc. This portion may be spent on whatever you want or need, as long as you stay within budget.

This guideline is proportional (it uses a percentage of your income for each of the three categories), so it is scalable for all income levels.

We strongly suggest setting up automatic payments/contributions for the fixed expenses and financial goal categories. You will save time, avoid missed or late payments and contributions, and it can help keep your flexible spending portion in line. If 50/20/30 is a big change from your current spending and you are having a hard time cutting your fixed or flexible spending, start with adjusted percentages and continue to make small changes until your budget is in line with your goals. Monitor your actual-vs-budgeted spending monthly to see if your actual percentages are in line with your budget. Once you are consistently finding your percentages are where they should be, you can move on to step three.

  1. Re-evaluate as circumstances change. For example, if you receive a raise or bonus, your mortgage increases, decreases, or is paid off, you buy a new car or pay off an existing loan, when you are no longer saving or paying for college, etc. Otherwise, if you are making all your fixed expenses and financial goal payments/contributions without running up debt from flexible spending expenses, you know you’re doing fine and don’t have to track expenses each month.

So, look at how your income is being spent and be honest with yourself. With DWM on your team, you can develop a budget and make sound financial decisions that help you meet your short and long-term goals. Please contact us to update your plan or learn more about budgeting, saving, or our comprehensive financial planning process. Your future self will thank you.

Tax Tip: Choosing the Right College Savings Plan

529This time of year, everyone is looking to find ways to avoid large tax burdens. Contributions to your child or grandchild for college savings may be a great way to plan for the future and get some tax relief right away. As a college savings tool, 529 plans are the most popular choice to maximize tax-free growth of your investment, as long as it is used entirely for qualified secondary educational expenses. An individual can contribute up to $70,000 and a couple up to $140,000 to one beneficiary in a single year, as long as they count it towards their annual gift tax exclusion over a five year period. Many of the 529 plans allow for maximum account values of over $300,000. The 529 contributions are considered an asset of the custodian, allowing for flexible financial aid qualification for the student and transfers of the funds between accounts for other beneficiaries. Each state has its own plan and investment module and many offer tax benefits for contributions by residents. If your state does not offer tax incentives, then you are free to invest in any of the top-performing 529’s in other states, as most plans do not have residency requirements to participate. DWM can help find the best direct-sold plans with low operating expenses and good allocation menus. South Carolina’s direct sold plan ranks in the top 10 and Illinois in the top 15 for the last 5 years and both offer tax incentives for residents.

Before the 529’s were created, the investment choice for many was the Uniform Gift to Minor Acts (UGMA) or Uniform Transfer to Minors Act (UTMA) custodial accounts. These plans offer the advantage of allowing for non-qualified educational expenses without penalty. For example, if you want to use the funds to buy a car for your teenager. The UGMA/UTMA accounts also offer a full range of investment options with the ability to choose allocations and make changes as you would with any other investment account. There is also no limit on the maximum contribution amount. UGMA/UTMA accounts are taxed on their growth and mandated by the rules of the “kiddie tax”. This tax provision allows for the first $1,000 of unearned income of the minor to be tax-exempt and then the second $1,000 is taxed at the young account holder’s lower tax rate. Any gains from investment growth, dividends or interest above that $2,000 unearned income limit will be taxed at their parent’s higher tax rate. This tax provision affects all account holders under 19 or dependent full-time students between ages 19-23.

So what happens if you are the custodian for a UGMA/UTMA for a minor child or grandchild and you want to move it to a 529? 529’s can only accept cash deposits so the account will have to be liquidated and the custodianship terminated. The irrevocable provisions of the beneficiary arrangement in Uniform Minor acounts, however, must still be maintained, even in the 529. The 529 will ask for the source of the funds, and, if coming from a UGMA/UTMA, some 529 plans will register it as a Custodian 529. This simply means that the beneficiary rules designate the account holder be given control of the asset at age 18. The same Uniform Minor laws apply regardless of what kind of account these funds transfer to because the original asset was in an irrevocable account. Funds cannot be transferred or used by siblings or other family members without a penalty.

Is it prudent to move the funds into a tax-exempt 529? The biggest consideration are the taxes created by the liquidation of the UGMA/UTMA account and/or the annual taxes owed by the minor during its operation. After evaluating the potential gains to be made during the life of the account, you must consider what the tax on those gains will be. You can choose to liquidate the account in pieces over time or all at once, depending on the tax burden created. The tax must be paid at some point, so perhaps sooner rather than later will prevent it from increasing. Another choice is to leave the assets where they are and put any additional contributions in a new 529 for the beneficiary. This will avoid causing a taxable event while creating a beneficial 529 account. There may be a tax benefit to transferring the funds into a state-sponsored 529 plan because of tax breaks offered by some states, like South Carolina and Illinois. The tax owed on the gains may be offset by the tax incentives offered. You will have to weigh the implications of the long-term tax-saving benefit of transferring into a 529 against the tax burden created by liquidating the account.

While it’s true that the 529 is an excellent college-saving tool, there can be advantages to using the Uniform Minor accounts as well. And a conversion of a UGMA/UTMA account to a 529 can be a complex decision. At Detterbeck Wealth Management, we can help you evaluate your situation to determine the best option.

Diversification Means Some Leaders and Some Laggards

eggs in one basketCommon sense tell us: “Don’t put all of your eggs in one basket.” Investment professionals give it a fancier name: “Modern Portfolio Theory (MPT)”, first articulated in 1952 by Nobel Prize winner Harry Markowitz.

The concept is that, regardless of what all the financial pundits and media people say and write, we can’t predict the future. So, we spread our bets across a variety of investments. The trick, mathematically, is to consider how the price of each investment varies in relation to the others. We use the term correlation and recognize that there is a benefit to non-correlation. That is, when some are zigging, others are zagging. The objective with diversification is that for the same level of risk, we can earn higher returns and/or lower volatility.

Here’s the catch: a truly diversified portfolio will almost always have a portion of the portfolio that is underperforming. Behaviorally, all of us hate to lose. Worse yet, we often fixate on the negative, drum up feelings of regret and develop “if only” thoughts.

Let’s take a look at some leaders and laggards over the last 20 years:

Investment returns-2014_Page_1

There’s a lot of data in this chart. Click on it for a full size image. Each color represents a different asset style. Last year, the S&P 500 growth (maroon) was the top dog. MSCI EAFE (grey) was at the bottom of the list. Yet, follow the colors from year to year. Leaders one year often don’t repeat the next year. In fact, sometimes, like “chutes and ladders,” they go from top to bottom. If you have a diversified portfolio, you can be assured you’ll have some leaders and some laggards.

The key is how the elements of your portfolio work together. Let’s look at the first two months of 2015 as an example:

In January, the S&P 500 came back to earth. In fact, it was down 3%, as were small caps. International and emerging market stocks were down about 1%. So, a diversified equity portfolio in January was likely down 2%. On the other hand, a diversified fixed income portfolio was up perhaps 1-2%, and a diversified liquid alternative portfolio was up almost 2%. So, even though domestic stocks were down 3% in January, a diversified portfolio could have been close to break-even.

In February, things changed. Stocks got hot again. The S&P 500 and small caps were up almost 6%. International and emerging markets were up about 5%. Fixed income and alternatives were just about unchanged. So, a diversified portfolio might have been up 2-4% in February.

In each month there were leaders and laggards zigging and zagging. And the big leaders one month were not the same the next month. The key is the non-correlation benefits between the various holdings that can produce higher returns and/or reduce volatility.

We need to focus on the whole portfolio, not the laggards. We have to fight the bias of “fallacy of composition” which causes us to reflexively assign the attributes of one piece to the whole. In investment terms, that’s noticing one asset style doing poorly and concluding, incorrectly, that the portfolio overall is flawed.

Finally, we all suffer in some measure from the phenomenon of “if only.” The “science of regret” is quite complex. A key point is to setting appropriate benchmarks. For example, our clients know that their Investment Policy Statement (IPS) gives us our “marching orders” for managing their portfolio and includes a targeted long-term net rate of return for their portfolio. That’s the appropriate benchmark. Comparing performance results for all your investments to the top performer in the year is not only an inappropriate benchmark, but can be damaging if the result is rebalancing your allocations to chase recent performance.

Focus on diversification- use of all three asset classes: equities, fixed income, and liquid alternatives, and appropriate diversification of asset style within each asset class. You’ll have leaders and laggards. The real key is avoid our behavioral instincts to focus on the laggards and, instead, to celebrate your overall long-term performance and the fact that diversification is working for you.

Developing and Maintaining Superb Long-Term Business and Personal Relationships

relationshipsI attended NAPFA’s South Symposium in Atlanta last Monday. Wonderful event. The focus was on “Communicating Excellence to Clients.” Horst Schulze, co-founder and past CEO of The Ritz-Carlton Hotel Company was the featured speaker. We all know about the service culture at the Ritz-Carlton- the only company to ever twice win the Malcom Baldrige Quality award. His remarks were simple, yet tremendously powerful for anyone who is interested in providing exceptional service and/or developing superb long-term term business and personal relationships.

The three key elements are:

  • No defects
  • Caring delivery
  • Timeliness

People want service without defects. The service needs to be designed so it can be expected to function perfectly within foreseeable boundaries. Sure, sometimes things will go wrong due to unpredictable circumstances. However, as Dr. Schulze said, “Sloppy or incomplete service design is, from a customer’s standpoint, intolerable.”

The perfect service also requires caring, friendly people to deliver it. This may sound simple, but, frankly, caring, friendly people seem to be in short supply these days. For example, think of how you are generally treated at the airport, the doctor’s office, or on the phone before and after you get to speak with a real human being. Communicating is huge in this regard. Every. Word. Counts. Body language is also a big key. Lastly, Dr. Schulze implored us to “cool our jets/passions” and make sure we make listening a primary component in all business and personal conversations.

A defect-free service delivered by caring and friendly people if delivered late is the same as a defective service. In today’s fast-paced world, delivery standards and expectations continue to get tougher all the time. The key is to learn your customers’ definition of time and obey their definition, not your own. Dr. Schulze gave us an example of an attorney who received a client question by voicemail. The attorney started the research and after four days, submitted a carefully crafted, well-researched opinion by e-mail only to find that the client was irate. The attorney didn’t realize this information was needed earlier than that and hadn’t called or emailed the client to get a better understanding of the client’s expectations before diving into the project.

Dr. Schulze also gave us some excellent pearls of wisdom relative to these three goals. “When we say it’s deadly to cut costs that cheapen your product or service in ways that matter to your customer, we mean it.” “When we say you need to take the customer’s position quickly, or you might as well not take it at all, we mean it.” And, “when we say that you serve but you are not a servant, we mean it.” Although Dr. Schulze’s comments were presented primarily in a business context, it is easy to see how important the three key elements are in personal relationships as well.

I encourage each of you to think about these concepts and how they relate to all of your relationships. At DWM, we strive for client loyalty, employee loyalty and great long-term business and personal relationships. Ours is not a “job,” it’s a passion to help people understand and meet or exceed their financial goals, of all kinds. We’re always looking to improve our service and welcome new valuable input and suggestions from team members, experts such as Dr. Schulze, clients, friends and others so we can update our processes. If you have any suggestions for us, please let us know. We’re all ears, as is my grandson Henry:

Henry's ears

Women and Money

woman-and-calculatorWe hear so much about a ‘gender gap’ in incomes between women and men. Patricia Arquette received a standing ovation during her Academy Award acceptance speech for her rallying cry for wage equality. But when it comes to women and money, it seems what we really have here is a ‘confidence gap.’ We are all perhaps influenced by the many stereotypes about a female’s approach to money. Women are sometimes characterized conversely as bargain-shoppers or shopping addicts. Maybe this comes from the idea that men are the hunters and women the gatherers, a “Men are from Mars and Women Are from Venus” explanation for different behaviors by the sexes in regards to personal finance. In a Real Simple article by Geraldine Sealey, one quoted survey found that “90% of women identify themselves as the chief bill-payer and shopper for the household”, yet 60% think their investing and financial planning skills are below average. This might be where we need to boost equality!

Many women are identified as anxious and conservative about investing and more concerned with frugality and saving. In a DailyWorth.com survey, 83% of men are interested in investing while 79 % of women are more interested in saving. Consumer spending is arguably driven by the chief household purchaser. So, in that context, a woman is highly influential in budgeting for the real costs of the goods and services needed for her family – she may be the gatherer, researching purchase decisions carefully and bargain-hunting. Women are the caretakers, generally, and achieving their financial goals may be tailored to consider the needs of others – like children or parents. The other side of that coin is the aggressive and confident hunter. Men tend to be more interested in achieving goals through investing or entrepreneurship, and so focus on macro goals of higher salaries, retirement planning and investment portfolio growth. Again, these are perhaps outdated stereotypes and certainly many women are savvy investors and confident entrepreneurs and many men are care-takers and thorough purchasers. However, as financial planners, we do see some of these issues played out with our clients. Men tend to be more confident that they understand the issues of different investment vehicles, stocks and bonds and retirement planning. Women are sometimes intimidated by Wall Street jargon and tend to be overly risk-averse and cautious with investing.

Women face some unique challenges as well. 80% of American women will find themselves as the sole keepers of their personal financial situation at some point in their lives. However, most women feel that they are financially insecure, in spite of the fact that they have more education, control more wealth, and are more involved in making financial decisions than ever before. Women’s careers are often interrupted by family needs, both for childcare and eldercare. This can limit their potential for income growth and prevent them from saving adequately for retirement. In fact, many women who leave the family finances up to their husbands may become widows who are in need of financial guidance and someone who they can trust to advise them. For these reasons, it is important for women to take charge of their own financial future.

So how do we close this gap and give women the same confidence in their personal financial situations as men? One very important way is education. At DWM, one of our most critical tasks when working with clients is to help them understand all aspects of their financial plan. Our weekly educational blog last week focused on financial literacy for our kids. Education on successful financial management is a good goal for all of us, adults and kids! There are many great resources to help with this such as seminars, books, and many internet sites. One example is the Women’s Institute for a Secure Retirement (WISER) that specifically addresses women’s issues. We also recommend the National Association of Personal Financial Advisors (NAPFA), to which we belong. NAPFA offers many informative webinars on their website on all financial basics, like Money 101, Investments: The Basics and Women and Money. Let’s close the gap!