Financial Lessons Learned

With another tax season behind us and some hopeful economic signs appearing on the horizon, I've taken an opportunity to reflect a bit on the past couple years. There are some lessons that have been learned or relearned by myself and many of you out there. If you haven't learned any lessons then this post might give you some more financial insight.

1. "Good Times" can't last forever. Although we are blessed as Americans to have a unique form of government that has fostered much success and prosperity throughout our history, we are still subject to the economic ups and downs of a free market economy. If anything, we are subject to these even more than some more socialist or heavily regulated economies.

2. Freedom isn't free. Somewhat related to my previous point, we have to pay a price for the "ups" in our economic cycles with the "downs" that inevitably follow. More government involvement in our economic lives my flatten these cycle out a bit, but the price of more government is less freedom.

3. There is a cost to everything. The recent downturn has brought out a sort of panic reaction which says we need to pull ourselves out of this downturn--quickly and at any cost. The cost of some of the recent government legislation is very significant. It might not be immediately apparent, but we are burdening our future generations with more taxes without giving them a say in the decision. There are also costs to the substandard moral behavior which brought on much of this crisis. The cost has been severe and not just to those who acted unethically.

4. Economic cycles are beneficial. Although this recent recession has caused much financial pain in many people's lives, changes are often made which will pay future dividends. Companies have improved processes and removed excess costs. Families have reevaluated purchasing decisions and paid down debt. Governments have been forced to provide services more efficiently or in a more need-based manner. Many of these changes will strengthen our country to allow for future growth cycles.

5. Despite the financial challenges, we should be grateful. We are blessed with families, friendships, freedoms and opportunities that many people in the world could never imagine. Let's not forget those things because of some short-term disappointments and surprises.

Emotional Buying

I recently attending a church fundraising auction which was an enormous success. Considering that $$ and purchases were involved, the evening gave me some food for thought about how people buy things. The auctioneer was very talented and humorous and made the evening enjoyable for everyone. His performance, along with the fact that the bidding got a bit competitive all led to the success of the evening. The upbeat emotions of the evening led people to have fun and spend money. I have been involved in several charity auctions and this is often the case.

So how does this relate to our everyday and not so routine purchasing decisions? We often head into a store to buy something and come out with something else or more than we intended to buy. Our mood and the presentation of the store affect our purchasing behavior. This might be common sense to most, but it is often forgotten, especially when larger purchases are involved.

As a financial planner and as a rational consumer, I try to have a plan in place before I am in a situation to spend money. This doesn't always work and isn't always necessary with small, insignificant purchases, but is recommended behavior for the big decisions in life. Next time you are choosing a home, car or large appliance, keep this in mind. I would also recommend a plan or a referral in choosing important services providers, like doctors, dentists, financial advisors and the like.

Are You Wealthy in More Ways Than One?

Wealth is often measured by money in the bank, real estate, cars or other material possessions. The traditional way to measure one's wealth or personal net worth is to add up all the assets, subtract the liabilities and the difference is the net wealth of an individual. Although I do these calculations as a professional, I also like to consider things like time commitments, stress levels and appropriateness of debt, among other things.

Have you ever considered if you are "time affluent" as the online columnist Laura Rowley has observed? Do you have all the time you desire to be with friends and family and enjoy the material possessions that you have acquired or do you find yourself spending all your time acquiring the material possessions?

Do you have unnecessary stress in your life? Is some of this stress related to financial decisions and burdens that may have been unintentionally placed upon yourself or your family? Do you make other poor decisions because of the stress that you are feeling?

Finally, are you comfortable with the amount of debt you have taken on? Have you ever considered the appropriateness of your debt? Even if you can afford the payments is debt always necessary to acquire what you really need in life?

I don't want to sound like a psychologist, since I'm not trained as one, but finance definitely involves more than a net worth statement or debits and credits. In addition to preparing professional financial statements and using institutional money management techniques, I like to assess how balanced people are in their lives and how financial decisions are adding to or detracting from ones total "wealth" in life. I think this is something we can do better with, especially as Americans in an economy that seems to be all about acquiring things.

What's Ahead for Taxes?

As tax time comes around, many people are wondering what the future holds for taxes in the United States. If President Obama gets what he wants, tax rates will go higher for higher-income Americans. His recently proposed budget has the Bush tax cuts going away at the end of 2010 for individuals making $200,000 or more and couples making $250,000 or more (sounds like a marriage penalty to me).

The budget proposes that the top two tax rates would go from 33 to 36 percent and 35 to 39.6 percent. Capital gains taxes are also proposed to go from 15 to 20 percent for this same group of high-income Americans. It is also expected that the estate tax will be reinstated retroactive to January 1st at a 45 percent rate.

No one likes to see tax rates increase, and these changes aren't a sure thing, but we do need some fiscal changes at the Federal level in order to protect the future generations in America. As opposed to playing political games with tax policy, I would prefer that the President and Congress enact fair tax policy for all Americans so we all have "some skin in the game," as opposed to deciding who is rich and who is poor and who should be rewarded or punished for his or her political leanings. I would also appreciate greater consideration of the spending side of the equation. Consistent, increased spending seems to be a given, despite the economic ups and downs that American households face. We would all be on a path to bankruptcy if we increased household spending year after year without considering where the income was coming from.

All this being said, these tax changes can be managed and muted somewhat by staying informed of what's ahead and working with a licensed financial professional, when needed. We should do our best as citizens to influence the policies in Washington and then stay informed to deal with the good or bad consequences of those decisions.

What a Difference a Year Makes!

Although unemployment remains high and the media may continue to focus on the negatives of the past couple years, things have turned around dramatically in the stock markets. For example:

S&P 500 (Large U.S. Companies)

Down 38.49% in 2008

Up 23.45% in 2009

EAFE Index (Large International Companies)

Down 45.09% in 2008

Up 27.75% in 2009

MSCI Emerging Markets Index (International Companies from Developing Nations)

Down 54.48% in 2008

Up 74.50% in 2009

The trend is quite similar for many other stock indices in 2008 and 2009 and the positive returns are even more dramatic from the point the markets bottomed on March 9, 2009.

Pessimists might say that although we have seen positive returns in the markets of late, we still aren't back to the 2007 peak and we don't know where we're going from here. Both of these points are valid, but a more positive view would be that we've made great progress in coming back and the markets (which typically forecast 6-9 months forward in the economy) are forecasting significant economic improvements.

A couple conclusions from this short analysis would be that markets are volatile (2008-09 were an extremely dramatic example) and that investing is a long-term proposition with bumps along the road. This recent period once again confirms the need to have a realistic, diversified investment plan and to stay disciplined through the ups and downs.

The Economics of the Holidays

Most people are probably aware that more money is spent around Christmas time than any other time of the year. One estimate by Joel Waldfogel of the Wharton business school at the University of Pennsylvania concluded that $66 billion was spent by Americans on gifts in 2007. It is also estimated that 135 million Americans participated in Black Friday (the day after Thanksgiving and first day of the traditional Christmas shopping season) in 2007.

Considering the dollars spent and the enormous number of people involved, there are some significant economic lessons that can be learned. I love the holiday season, but like many things, I try to take a practical, analytical view at times and see what I can learn about human behavior.

1) Much of the holiday spending is unnecessary, or at least unappreciated. I don't recommend that everyone think selfishly, but Waldfogel also estimates that $12 billion of the $66 billion spent each year is inefficient spending, or money that the recipient wouldn't have spent on themselves. Gift giving is a wonderful tradition, but gift cards, cash or more educated purchasing can result in a more economically effective Christmas.

2) Consider giving to those who are truly needy instead of excessively giving to those who aren't needy at all. The percentage of GDP produced at Christmas time has actually decreased over time, so maybe we are improving our behavior a bit here.

3) Think about the long term value of Christmas gifts or decorations. Many products are designed for the "wow" factor, but are expensive or underutilized over a longer time period. Artificial vs. real Christmas trees and regular vs. LED Christmas lights have various costs and benefits that should be considered.

4) Certain gifts and traditions are not critical to a good Christmas. The most meaningful things are time together with family and friends and traditions that promote giving, peace and harmony amongst people.

Despite my tendency to focus on the economic side life, I love the positive, uneconomic parts of the holiday season. Like many significant events in life, Christmas provides an opportunity to think about the costs and benefits of various financial decisions and how they fit into a sensible long-term financial plan.

Tax Rates - Where are They Headed?

A pretty strong consensus exists that tax rates are going up. The massive deficit spending and entitlement programs of our government make this a near necessity. Different political parties will express different solutions to our current fiscal crisis, but rising taxes is included in many of these. Although most people don't like paying taxes or the prospect of increasing tax rates, awareness can help us plan and be prepared for these impending changes.

Personal Income Taxes - It is unlikely that personal income tax rates will change in 2009 or 2010. The Bush tax cuts will expire at the end of 2010 and the top tax rate at that point will revert back to 39.6% from a 35% rate today. A surtax for high-income individuals has been proposed in various health care proposals, but this should not take effect until 2011. A higher capital gains tax rate and other tax increases would likely also take effect then.

Estate Taxes - The current estate tax is set to expire at the end of 2009, with no estate tax being due in 2010. It is extremely doubtful that Congress would let this revenue source go away. Various proposals are being debated in Congress right now. The current estate tax rate of 45% and the current estate tax exemption amount of $3,500,000 per individual could change, but this should become clearer in the next several weeks.

Business Income Taxes - Business income tax rates have not changed much recently, but Congress has implemented various bonus depreciation deductions and additional loss carryback provisions to try to give businesses tax breaks in recent years. A more comprehensive business tax overhaul is possible in the next couple years, but these changes are unclear at this point.

Taxes are a significant part of all individuals and families' financial situation. Although the tax impact of various financial decisions should not be the primary consideration, awareness of current and future tax rates and deductions is an important part of any financial plan.