Many people jump right into investments without giving any consideration to how that fits into their money personality. You wouldn’t buy furniture for your home or wear clothes that you have never seen before purchasing without the careful consideration of your individual personality and needs, so why put your money in investment vehicles without the same careful consideration? Determining your money mindset will avoid unnecessary anxiety when it comes to investing!
The first step to leading your wealth is to begin by developing your “Money Mindset.” As you begin to set the parameters and guidelines for how you will invest your money, you must remember that this process is an art, not a science. You will no doubt change your philosophy over time and continually tweak your rules for years to come.
There is NO set formula for this process. The rules that you set are truly YOUR money rules. You must be comfortable with them and be willing to follow them consistently. As you establish these rules, remember that no one knows your financial background, situation, emotions and priorities more than you do. Therefore, this is a very personal exercise. This process may prompt emotions that you never imagined would come out over money. It may be that you just have a very difficult time making yourself do this exercise for some unknown reason. Or it may be extremely easy for you to rush through the process. In any event, I challenge you to really evaluate your thoughts and emotions about money and to set up your money rules according to a plan that you can get excited about.
The following are some points of consideration to assist you in determining what your “Money Rules” should be. And remember this is a dynamic process that will change over time with age, income, investable assets and market conditions. Take time annually to review and make the appropriate changes.
Before considering investment options, determine what your income needs are now and/or will be in retirement. If you don’t know what you need you will not be able to accurately plan for your retirement.
Ask yourself:
1. How much income do you need now to retirement and from retirement to the rest of your life, to support your lifestyle?
2. What percentage of your portfolio will be required to provide Income and what percentage to provide Growth? If you aren’t sure, have a monthly income number (a minimum and desired amount) of income you will need to support your desired lifestyle.
3. How are my assets and income currently protected?
a. Assets – Are they guaranteed and insured, and if so, by whom?
b. Income-Is the only source of your income dependent upon your job?
c. Are both your assets and income dependent upon your job?
1. PARTICIPATION: Active or Passive or Pactive (a little of both)?
Decide what percent of your portfolio you wish to be active vs. passive. Active means that you do the work. Passive means that you don’t. But, the reality is that most passive investments are really “pactive” investments. In other words, you must always drive your investment portfolio and be involved.
Ask yourself:
1. How much time per week can I devote to my investments?
2. Am I willing to do the due diligence that is necessary to make wise investments?
3. Am I organized enough to track my investments?
4. Do I enjoy managing my investments?
5. Do I have enough investment knowledge to do this myself?
6. Am I able and willing to learn about investments?
7. Can I detach my emotions from an investment if it goes bad?
8. Can I stay focused on using my money rules even if my friend gives me a “hot stock tip?”
2. INVESMENT OBJECTIVE: Cash Flow or Appreciation?
Decide what percent of your portfolio you wish to allocate to producing cash flow and what percent of your portfolio you wish to allocate to producing appreciation. Basically this means money now or money later.
Ask yourself:
1. Am I able to pay my monthly bills without using debt right now?
2. Do I have a sufficient emergency fund in case things go bad?
3. Do I know of anything in the next 12-36 months that will have a significant effect on my income or expenses?
4. Is my job stable and am I committed to staying at it for the next 12months or longer?
5. Do I have credit card debt or other debts (medical/school/other)?
6. For how long will I be satisfied with my current standard of living?
7. Have I considered cost of living increases?
8. Are there large purchases that I plan on making or that I am considering in the next 12-36
months?
9. Am I disciplined enough to start an investment program and stick with it for at least 5 years?
10. Am I an impulse buyer?
11. Am I patient when it comes to money growing?
12. Do I practice delayed gratification?
13. Can I emotionally handle the ups and downs of watching an investment fluctuate in value over
time if I believe that it will result in higher returns in the end?
14. Will I stick to my money rules even when I do not want to?
15. Is my personal life stable enough to invest for the long haul?
16. What is my preferred EXIT strategy?
3. TARGET RATE OF RETURN: Determine the minimum limits and the goals for your investment returns.
You can determine this by the “Annualized Rate of Return” or the “Overall Return on Investment” approach. You can set minimum limits and goals for each type of investment account or you can simply set overall minimum limits and goals for all of your investments. However you choose to do this, the important thing is that you know what you are trying to accomplish with each investment that you make and you know that it is reasonable to accomplish your goals with each investment.
Ask yourself:
1. How do I feel about the risk/reward relationship in investing?
2. Do I get nervous if my investment account balance goes down one month?
3. Can I accept temporary losses to make higher gains over time?
4. Am I willing to make unconventional investments to make higher returns? What if my family tells me that I am foolish?
5. Do I need investments that feel “safe” to sleep better at night? We call this “Sleep Equity”!
6. The formula for wealth is: time+money+rate of return. If you have a lot of one or two, then you can have a lesser amount of the other one. Which one do I have the least of? The most of?
7. Can I be patient to wait on my money to grow?
8. Do I need to see immediate growth in my money?
9. Do I need to feel in control of my investments?
10. Do I have “baggage” from past investment experience that will hinder me from investing wisely?
11. Have I had a bad experience with a specific class of investments? If so, can I get past it and
invest in that class again?
12. Do I consider myself conservative, average or aggressive as an investor? Does it really matter
what I am if the numbers determine whether or not I succeed in this area of my life?
13. Can I use the numbers, not my emotions, to determine my investment success?
14. Can I lose the money that I am going to invest and be O.K.? Can I lose any of it? How much of it can I lose?
15. Am I looking at my investment capital as my “pot of gold” that I am depending on? Or, am I
investing my capital and working on making it again?
16. What is the worst case scenario? Can I live with it?
4. RISK APPROACH: Determine how you want to handle RISK
According to Ed Winslow, author of the book “Blind Faith”, there are only four ways of managing any kind of risk.
· Avoid Risk – Investment strategies that do not place your principal at risk and normally would offer some type of guaranteed return, such as CD’s, savings accounts or traditional fixed annuities.
· Accept Risk – Investment strategies that place your principal at risk and do not offer any contractual guarantees only “promises” of “potential” high returns such as stocks, mutual funds or variable annuities.
· Manage Risk – Investment strategies that claim to manage risk in an effort to minimize it, such as asset allocation models, hedge funds and money managers. For example Wall Street guru’s proclaimed for years that a well diversified portfolio would minimize their client’s risk of investing in the stock market. Recent market corrections have shown that this management style does not address “systemic” risk or in other words, all traditional asset classes experiencing a simultaneous downturn.
· Transferring Risk – Investment strategies that transfer the risk of loss of principal to experts in exchange for contractually guaranteed principal protection and participation in market gains. These strategies typically trade off a small portion of the potential upside to have NONE of the downside or potential loss during downturns or market declines.
Ask yourself:
1. How am I most comfortable in handling risk?
2. What percentage of your portfolio should be in each risk handling category?
3. Am I able to categorize my current and future investment options in each of these risk handling categories?
4. Do you have a template or approach that will assist you in optimizing the risk/reward within each risk handling category. For example: I have 2 options that fall into the category of risk avoidance. Option 1, One year CD paying 3% per year, Option 2, a 100% liquid savings account currently paying 2% per year. Which one would be better for you? The answer will be a function of your individual circumstances in the areas of liquidity, rate stability and security of the financial institution.
5. What is the EXIT strategy I am most comfortable with?
5. LIQUIDITY NEEDS
You must decide how liquid you need to keep your investments. It is imperative that you seriously consider this matter. You do not want to end up badly needing funds that are tied up for a long term hold. So, decide how much money you can invest for the long term (over 2 years) and how much you can invest for the short term (under 2 years) and how much you can invest for really short periods (under 1 year). Only invest monies that you do not need for cash flow or other needs. It is always advisable to have a safe emergency fund that is easily accessible. Your Advisor can make a recommendation as to what he/she believes is suitable for your situation.
Be sure and evaluate the liquidity cost of any investment. For example; this may be directly addressed as a “surrender” value in an annuity or it can be hidden in investments such as stocks or mutual funds. For example; many brokers will tell you that your stocks and mutual funds are completely “liquid” and can be liquidated any time you feel you need money…HOWEVER, if they are “at risk” investments and you lose half of your investment, your money isn’t liquid, its VAPOR! This is undoubtedly the most unanticipated surprise that most people face when investing. Annuities get a “bad rap” from brokers because they say you have to tie your money up for some set number of years varying by contract, but you know upfront your surrender charges or cost of liquidity and most of the time it doesn’t exceed 10% of the total monies invested. Contrast this scenario by stocks or mutual funds in which you can lose half of your money during an unanticipated downturn or poor money manager.
Ask yourself:
1. Am I able to pay my monthly bills without using debt right now?
2. Do I have a sufficient emergency fund in case things go bad?
3. Do I know of anything in the next 12-36 months that will have a significant effect on my income or expenses?
4. Is my job stable and am I committed to staying at it for the next 12months or longer?
5. Should the need arise, can I purchase Health Insurance, Long Term Care Insurance etc…?
6. Do I have credit card debt or other debts (medical/school/other)?
7. For how long will I be satisfied with my current standard of living?
8. Have I considered cost of living increases?
9. Are there large purchases that I plan on making or that I am considering in the next 12-36
months?
10. How much money can I tie up for 5 years? 3 years? 1 year? 6 months?
11. Am I investing my retirement fund? What if I lose some or all of it?
12. Do I have time before retirement to make up money lost in investments?
13. Can I get to my money if I come across an investment that is secure and guaranteed to give me a great return in 6 months?
14. Can I get to my money should I have a short term or long term disability event?
6. TAX RAMIFICATIONS
You must consider the effects that taxes will have on all your investments and your regular income as well. Some investments create returns that impact the taxes you pay on your ordinary income. A great year in your investments could mean that your regular income is taxed at a much higher rate. Many people pay AMT or Alternative Minimum Tax, when there is an excellent strategy such as “fractionalized ownership of oil and gas wells, which will offset those taxes, and yield returns for generations!
You will need to consider using:
· CPA and/or Tax Attorney (recommended for significant wealth) to help you plan how to move your money in and out of investments over time to take full advantage of the tax code as it relates to investments.
· Strategies like using Real Estate depreciation or using IRA monies to make investments or using 1031 Transfers in Real Estate are all potentially very helpful strategies.
It is a must that you have a great tax strategist onto your team to help you in this area.
Choose professionals who are more successful than you and whose clients include high net worth individuals and other very successful business owners. Choose “specialists” not generalists. You wouldn’t go to an internist to get bypass surgery! When you work with a professional whose expertise is in very specific areas, they will know all of the subtle nuances of your taxes.
Ask yourself:
1. Will the IRS treat me or my spouse as a Real Estate Professional?
This term refers to the way the IRS treats certain investors-it does not mean that you are a Real Estate Agent or Broker. See your accountant for help if needed- it could really be worth it for you!
2. Will my investment returns cause my earned income to be taxed at a higher rate?
3. Do I understand the difference in long-term and short-term capital gains?
4. Am I self-directing my IRA investments into Real Estate, Promissory notes, businesses, etc…?
5. Am I using a Roth IRA?
6. Do I understand the tax benefits of cash flow real estate?
7. Do I know the most tax efficient direct investments?
8. Am I deferring taxes on the growth of my investments?
9. Am I planning on tax free income at retirement?
10. What is my EXIT strategy?
7. ASSET CLASS ALLOCATION PERCENTAGE: Develop an Asset Allocation Strategy with Diversification
Some examples of various Asset Classes are as follows:
· Businesses/DPP (Direct Participation Programs)
· Real Estate
· Gas & Oil
· Promissory Notes
· Cash on hand
· Gold, Silver & Precious Metals
· Insurance & Insurance backed Investments (Life Settlements, Fixed Indexed Annuities, Whole or Universal Life-Banking on Yourself Concept)
· Securities (Stocks, Mutual Funds, Bonds)
True “Diversification” is outside of traditional asset classes. You are not diversifying when you merely have large cap/small cap within a stock portfolio, because if/when there is a systemic downturn, they all crash! You should have at least some of your money in asset allocation vehicles that are either uncorrelated to market conditions or have protection of your principal safety built into the contract. An example of a “safe” allocation strategy would be the following:
· Fixed Indexed Annuities 20%
· Whole or Equity Indexed Universal Life Insurance: 20%
· Life Settlements: 30%-40%
· Real Estate: 20%
· Gas & Oil: 10% (Fractionalized Ownership)
· Gold, Silver & Precious Metals: 10%
· Cash on hand: 10%n(or whatever allows you to sleep at night!)
Your model may only include 2 asset classes, that is OK, just make sure you have made your determinations based on careful consideration of these 7 steps. Be sure and diversify at least 2 asset classes and have some of your investments in strategies where your principal is contractually guaranteed. The more money that is contractually guaranteed, the more comfortable you may be putting another portion in a more risky investment.
This model applies to your overall portfolio, not just your invest-able assets at any given time. You may need to re-balance your portfolio over time as certain asset classes get out of balance. Also, there are many other investment options not included in this model such as stocks, bonds, mortgage notes, collectibles, etc… Whatever asset class you come across in your search, be sure and determine what characteristics this investment is for ex. (active/passive/little of both) (safe/risky) or (cashflow/appreciation)
If your personal money rules exclude those characteristics of those particular investments….
DO NOT EVEN CONSIDER THEM!
Another very important point to consider is if you are a W2 Employee or in other words, depending on a company for your paycheck, your salary is “at risk money”. Outside of the obvious illegal or non-performance reasons, you have no control over your company and their decision to terminate your employment. Companies move, go bankrupt, and products lose their allure, so consider this when determining how “safe” your paycheck money really is. Also keep in mind that 401K plans are almost always strategies that put your entire savings at risk, and the mutual funds that are offered in a 401K plan are usually not the best choices on Wall Street. They have a “captive” audience so they bundle the funds that do not sell or perform well alone.
These are only models or examples. You must make these decisions yourself because you are the only one who truly knows you and because you must live with the outcome. This model is a working template that can be changed and applied to many different situations.
This is your financial formula that can help you achieve more than you ever imagined for yourself and for the good of others. Be sure and include anyone who will be affected by your investment decisions such as your spouse!
*Great Resources:
“Incorporate and Grow Rich” C.W. Allen, Financial Strategist
“Cash Machine” by Loral Langemeier, Financial Strategist
“Wealth Cycle Investing” by Loral Langemeier, Financial Strategist
“Blind Faith” by Edward Winslow, Investment Advisor, CPA, CFP
“The Millionaire Mind” by T.Harv Eker
“Rich Dad Poor Dad” by Robert Kiyoski
“Cash Flow Quadrant” (Rich Dad Poor Dad) by Robert Kiyoski
“Breaking The Rules” by Kurt Wright
*7 STEPS TO ESTABLISHING “YOUR” MONEY RULES is a registered trademark of Lead Your Wealth® © 2009