A Financial Revolution 


January 31, 2006
Boosting Yields with Royalty Trusts
Earlier this month I posted about boosting yields with preferred stocks and the diversification benefits of real estate investment trusts. I'd like to explore another tool for boosting returns – royalty trusts. Royalty trusts are not technically companies. They are legal structures – special-purpose financing vehicles – to hold assets for another company or shareholders. Generally, royalty trusts purchase the right to royalties on the production and sales of a natural resource company (e.g., timber, oil, natural gas.)

Unlike a normal company, trusts must distribute all cash flows to the shareholders, usually in the form of a dividend. As a result, these trusts often provide high yields, sometimes in the double digits. I looked at five mid-cap royalty trusts: BP Prudhoe Bay (BPT), Cross Timbers (CRT), Hugoton (HGT), Provident Energy (PVX), and San Juan (SJT). Reviewing these five trusts, there are two things that stand out: 1) the returns over the past twelve months averaged over 30% and 2) the trusts yield an average of 11.4%. Four of the five trusts are focused on energy extraction so it’s not surprising that they performed well last year. Over the past five years, the group is up more than 200% while the S&P 500 was flat. They also outperformed the Energy Select ETF (XLE) during that period.

It’s easy to see how royalty trusts can boost income. It is also, however, important to understand some of the major issues associated with royalty trusts. The issues include:
  • Dividend payout: the dividend is based on a percentage of income. If income rises, dividends rise. If income falls, dividends fall. Price volatility can play a big role in the dividend payout. For example, the price of a barrel of Brent crude oil in 2005 ranged from approximately $40 to $67. This may be partially hedged through long-term contracts.
  • Tax implications: trusts are treated much like mutual funds and must pass earned income to shareholders. As a result, the earnings (and their tax treatment) retain the form when distributed to shareholders. This includes depletion tax credits.
  • Depletion: The earnings of a royalty trust come from depleting the asset. Eventually, the asset will be depleted and the trust will be worthless. It is important to read the information on these trusts to monitor how much of the asset remains. As the assets are depleted, the value of the shares is at risk.

I was first introduced to royalty trusts in a Paul Strum article in Smart Money magazine in 2002. And while I don’t generally follow the stock recommendations of magazines, this is one piece of advice that I’m glad I followed.

For more information:



January 30, 2006
Cash Back Credit Card Calculator
A post from last month compared the rebate percentages for eight popular cash back credit cards. The post included an Excel spreadsheet that calculated the cash back rebate for each card based on spending patterns. I’ve now created a JavaScript calculator to replace that spreadsheet. Simply enter your monthly charges and the percent of those charges that are Every Day Purchases (e.g., groceries, gasoline, drug store purchases, or postage). The calculator displays the rebate from the eight cards.

Let me know if I’m missing any no-annual-fee cash back cards.

Cashback Credit Card Comparison Calculator
Total Monthly Charges (US $):
Everyday Purchases (% of Monthly Charges):
Annual Cash Back
Discover Platinum Card
US Bank Cash Rewards Platinum Visa
CIBC Dividend Card
National City Cash Builder Elite Visa
American Express Blue Cash Card
Citi Dividend Platinum Select Card
MBNA Cashback Platinum Plus MasterCard
Capital One No Hassle Card



January 28, 2006
Top 10 Investing Scams
MSN has an article about the top 10 investment scams. Here's the short version:
  • Ponzi/pyramid schemes that promise huge returns, but only pay off the "investors" who got in early.
  • Fake promissory notes from companies or that are little known or don't exist.
  • Immoral financial managers that charge for services not provided or conduct unauthorized activities (e.g., frequently trading without permission.)
  • Con artists scamming people with similar interests/backgrounds (e.g., non existent "gifting" programs for a church.)
  • Unlicensed agents selling products/investments that promise high returns with little risk (and pay very high commissions.)
  • "Prime bank" schemes that promise to let you invest in the same secret investments of the ultra rich.
  • Internet fraud such as phishing scams where a web site that looks legitimate is really a front for a thief. Another is the Nigerian 419 scam. If you've ever received an email asking you to help someone move their money to a US bank account for which you will receive a nice multi-million dollar commission, you've seen the Nigerian 419 scam.
  • Mutual fund improprieties.
  • Variable annuities with big surrender charges (cash out fees) and high commissions.


Seven Factors to Consider When Developing a Financial Plan
When developing a financial plan, whether it be investing in mutual funds, Exchange Traded Funds (ETFs), or individual stocks and bonds, it is important to think about the following eight factors:
  • Financial Goal: What do you want to achieve?
  • Risk Tolerance: How much risk are you willing to accept? Generally, the level of risk you are willing to assume affects the level of returns you can achieve.
  • Diversification: This is related to risk tolerance. Having a diversified portfolio can reduce the risk level of a portfolio. If you hold only one investment and the price falls 50% your portfolio is down by half. If you have two investments of equal value and one falls 50%, your loss is limited to one-quarter. Diversification reduces the effect of any one winner or loser in your portfolio.
  • Time Horizon: When will you need to access the money? Over the long term, stocks provide a higher return than bonds and cash vehicles (e.g., CDs, money markets). However, in a given two or three year period, stocks may underperform. Therefore, if you think you'll need the money in one or two years, stocks or stock mutual funds may not be the best investment.
  • Liquidity: This is related to the item above. Do you need quick access to the cash and preservation of principal? If so, you should consider cash vehicles.
  • Tax Consequences: Do you have a high marginal tax rate? If you do and you invest in mutual funds, you might want to invest in tax efficient funds (see Turnover and Fund Returns) or municipal bonds or funds (as an added bonus, most are structured to avoid the Alternative Minimum Tax (AMT).)
  • Management Effort: How much time can you invest in managing your assets? How much time do you want to invest?
  • Interest Rate Cycle: What is going to happen with interest rates? While you probably don't know what the Fed plans to do with rates, by watching the direction of movement (i.e., increasing, decreasing, or flat), you can determine whether long- or short-term bonds provide the better risk-adjusted returns.

For more information about financial planning, see TD Waterhouse's Planning Suggestions and Financial Planning Tools.



January 26, 2006
Mortgage Insurance? Fuggedaboutit!
During that exciting evening ritual of going through the stack of junk mail (there was a bank statement mixed in to make it interesting), I skimmed a letter offering insurance for my mortgage. The insurance would pay off my mortgage if I die and make payments if I'm disabled. Is this a good deal? Nope. I took a look at my paycheck and noticed my employer's life and disability insurance plans are cheaper. I would expect the same would be true for life and disability insurance through a private plan. In addition to the lower cost, the money from life and disability insurance can be used to pay any expenses (e.g., food, utilities, credit cards), not only the mortgage.

Let's add that letter to the pile in the recycling bin...

The About network has a FAQs page on disability insurance and TMF has an insurance center with several good articles.


January 25, 2006
JNJ Reports Earnings and Fails to Throw Money Down a Hole

Following up on my analysis of JNJ, there were three important events today. First, JNJ reported mixed earnings for Q4. Compared to Q4 2004, earnings increased 9% but revenues decreased by 1%. For the year, earnings increased by 12% while revenues increased 6.7%. The decrease in Q4 revenues was due to currency effects (approximately 2% of revenues.) The consumer segment and medical devices segment led the growth – 9.2% and 13.1% revenue growth for the year. The pharmaceutical segment increased by only 0.9% for the year. The result: investors fled and the stock reached 52-week lows, falling by 3%.

In other news, it looks like JNJ will lose the bidding war for Guidant (GDT). Boston Scientific (BSX) has probably overreached and is overpaying for Guidant. BSX management estimates that the deal will dilute earnings for more than 5 years. JNJ will wind up with $705 million if GDT walks away from the deal. Expect JNJ to look for another candidate – St Jude Medical (STJ) – or possibly a cooperative agreement with Medtronic (MDT). [Update: STJ's shares are down almost 7% on Wednesday due to lower earnings resulting from acquisition expenses.]

Finally, the FTC approved JNJ’s purchase of Animas, a maker of insulin pumps and diabetic supplies. The Animas deal will be a boost to JNJ’s product mix and bottom line. (Diabetes afflicts 7% of the US population. Unfortunately, the numbers are growing.)

While I believe JNJ was a good long-term deal at last week’s prices, I think it’s even better today. It might, however, be a good idea to wait for the price to stabilize before jumping in.

For Additional Information:



January 23, 2006
Turnover and Fund Returns

The February issue of Smart Money has an informative article about how a mutual fund’s turnover affects performance. Turnover represents the percentage of a fund’s investments that are sold each year. For example, a turnover rate of 84% – the average for large cap mutual funds – means that 84% of the stocks or other assets in the fund were sold during the previous year. A fund’s turnover rate can be greater than 100%. Rydex Large Cap Growth Fund (RYAWX) has a turnover rate of 2,018%, meaning it holds an investment for an average of 18 days.

When evaluating a fund as a potential investment, I usually look at turnover only because it has tax consequences – the more often a fund sells, the more potential to realize taxable capital gains that are distributed to fund holders. The Smart Money article points out that tax efficiency is not the only benefit of low turnover – low-turnover funds perform better than high-turnover funds. A study by Kevin Laughlin grouped all mutual funds into quartiles based on their turnover rates. Over 10 years, those funds with the lowest turnover rate returned an annualized 11.49%; those with the highest turnover rate returned 9.78%. Over 10 years, that's 197% return vs. 154% return. In addition, low-turnover funds had lower fees (less trades to pay for) – 24% lower than high-turnover funds.

The article argues that fund managers with low turnover are generally focused on the long term and look to invest in high quality companies. The average turnover rate of the low-turnover funds is 13%. That means they hold investments for an average of 7 years. 7 years! That takes conviction in your decisions. Hopefully these managers invest a great deal of time and effort to analyze the companies (would Rydex's managers invest time researching a stock that will only be held for three weeks.) Perhaps because of the effort required to find good long-term investments, these funds generally own fewer stocks, allowing the managers to focus on their best ideas (it’s easier to find a handful of stocks than 100 good stocks.)

If you want to follow this strategy, find funds with low turnover, low fees, and a limited number of holdings. The first two are easy – most mutual fund screens include them – the number of holdings is usually located in the prospectus or fund summary.

For Additional Information:



This Week's Carnivals
There are some excellent posts on this week's carnivals.


January 22, 2006
Obtaining State Tax Forms
While we're on the subject of tax software and tax forms, the Federation of Tax Administors has links to tax forms for all 50 states (even states with non-income taxes.) As you would expect, federal forms are available on the IRS web site.


January 21, 2006
Free Tax Preparation Software
H&R Block, TaxACT and the IRS are offering free standard-edition federal tax preparation software. In states with income taxes, use the data from the Federal return to prepare the state return manually.

H&R Block TaxCut Standard - Federal edition only (the optional State add-on costs $24.99 - the price of TaxCut Deluxe + State.)

TaxACT Standard - Federal edition only (the optional State add-on costs $12.95.) This includes a free e-file.

The IRS has a list of companies that offer free online tax preparation and e-filing for taxpayers with an Adjusted Gross Income (AGI) of $50,000 or less. The list includes TaxCut and TurboTax.

If you need State software or the features from the Deluxe edition, you can work it out to get the TaxCut software for only a few dollars after rebates. Here's how it's done:
  1. Order TaxCut Deluxe + State for $29.99 ($19.99 after price match/coupon code)
  2. Order Microsoft Money Deluxe 2006 for $39.94 (free after rebate)
  3. Order Cosmi Perfect Attorney for $19.99 (free after rebate)
  4. Enter coupon code 61959 ($5 off)
  5. Contact Staples customer service (preferably via online chat or phone) to request price match with Target ($19.99) [Note: Tell them that the software is available in your local store so they shouldn't deduct shipping.]
  6. Complete the rebate forms for TaxCut, Money, and Perfect Attorney
You don't need to buy both MS Money and Perfect Attorney, but if the total is over $50.00, shipping is free. The final price is approximately $18.00 and you'll receive a $10.00 (after January 21) or $15.00 (through January 21) Staples gift card.


January 20, 2006
JNJ: The Right Prescription for Your Portfolio?
Background

If you have a toddler, you know the power of a Band-Aid. It appears that these are the body art of the under-5 crowd (can’t wait ‘til we get to the piercing stage!) Band-Aid is not Johnson & Johnson’s (JNJ) only stellar brand. When you think of JNJ, what brands come to mind? Johnson’s Baby Shampoo? Neutrogena? Aveeno? Tylenol? Would it surprise you to know that these powerhouse brands and their cousins in JNJ’s consumer products segment are responsible for only 18% of revenues at the world’s most comprehensive health products company? Did you know that JNJ is also the world’s second largest biotech company?

JNJ has three business segments – consumer products, pharmaceuticals, and medical devices. Pharmaceuticals is by far the largest segment with 47% of revenues. While the pharmaceutical segment is seeing some pressure from generic competitors – three blockbusters with sales of more than $2 billion/year each are now off patent protection – there is a stable of strong products in the regulatory review process. JNJ is planning to acquire Guidant (GDT) – a maker of medical devices – which would allow it to enter new markets in the cardiovascular field while complementing their current products lines. The deal is currently in question (JNJ and Boston Scientific (BSX) are in a bidding war.) [Note: GDT has suffered a number of recent recalls and is probably facing some major lawsuits.] [Update: See JNJ Fails to Throw Money Down a Hole.]

While there is pressure from competition and governments trying to control skyrocketing health-care costs, JNJ has done well by moving into high growth areas with new products. In 2004, new products introduced since 2000 accounted for more than 35% of sales.

The results for 2004 were impressive. JNJ posted record revenues, earnings and cash flow, with sales reaching $47.3 billion and earnings of $8.5 billion. Relative to 2003, revenues grew by 13% and earnings by 18%. That’s two decades of consistent double-digit earnings growth. In addition, JNJ increased the quarterly dividend for the 42nd year in a row.

Financials

JNJ’s financials look strong and steady. It isn’t a growth stock, but it is reliable.

Averages for the last five years

JNJ's free cash flow is rising by an average of 16% per year. The P/E ratio at 21.5 is near its average lows during the last five years (average low P/E = 20.4, average high P/E = 30.0).

JNJ reported satisfactory 3rd quarter results - sales increased 9.6% from Q1-Q3 2004 and earnings increased by 12.1%. [Update: JNJ's 4th quarter results are in. See JNJ Reports Earnings.]

Environment

JNJ is a leader in many environmental areas:

  • Largest corporate consumer of renewable energy in the U.S.: 18% of JNJ’s global electricity was from renewable sources
  • Corporate Leader” in EPA’s Performance Track (PT) – a program to encourage “beyond compliance” behavior: 87% of JNJ’s U.S. facilities report to PT
  • Extensive “design for the environment” program: 99% of new products and packaging were reviewed in 2004 to minimize environmental impacts
  • Charter member of EPA’s Climate Leaders – a program to measure and reduce greenhouse gas emissions: goal of reducing emissions by 14% between 2001 and 2010.

JNJ has made great progress in reducing water use and hazardous and toxic substances. They have also made progress reducing their packaging and raw materials per unit of sales. Between 1995 and 2000, JNJ’s toxic emissions fell by 63%. Between 2001 and 2004, toxic emissions fell by another 36%. One black mark on JNJ’s record is noncompliance events. This number has steadily increased over the last five years. Looking deeper, however, the numbers show that most of the violations are for two sites. For those two sites, the vast majority of violations were due to excess temperatures in equipment that did not lead to excess emissions. (For details on the environmental metrics, see Environment Worldwide Results.)

Overall, JNJ’s environmental progress is impressive. There is still significant work to be done to reduce air, water, and waste emissions further, but they have demonstrated a serious commitment to addressing these issues. JNJ is even working with its suppliers to encourage environmental stewardship.

For more information on other socially responsible investing (SRI) criteria see the company's Social Responsibility web pages and its 2004 Sustainability Report. FL Putnam and Calvert have posted profiles of JNJ on their web sites.

Assessment

JNJ is a good company with a strong record of earnings growth. The stock's price is trading a bit high relative to the overall market, but well within its historical price/earnings range. Standard & Poors gives JNJ a “Buy” rating with a 12-month target price of $72. Their estimate is rosy, but then again, everyone loves an optimist.

The company pays a solid dividend yielding 2.1%. While that’s only a little better than a money market account, JNJ has raised its dividend every year for the past 42 years. There is no reason to believe they won’t continue to raise it by at least 12% for the next few years (over the past ten years, the dividend has increased by an average of 15% per year.)

Let’s play with that yield number a bit... If JNJ raises the dividend for the next ten years at the same rate as the past ten years, what would today’s buyer yield on the stock? A $60.80 investment will buy $5.10 in dividends per year in 2015 – a yield of 8.4% from the cost basis.

My thoughts: A good, safe buy for a long-term holding. An investor won’t double their money overnight with JNJ, but the investment won’t lose half its value either.

Additional Info on JNJ:



Trying A New File Host
I haven't had much luck with free file host sites. I've created a number of tools and templates for myself and readers of A Financial Revolution. However, the first hosting site shut their doors and the second deleted the file after a couple weeks. I'm trying again with Badongo.

I've updated the following tools/links:

If anyone has had success with a free file hosting site, please let me know in the comments.



January 17, 2006
Estate Planning: The Importance of a Durable Power of Attorney
After a will and a living will/healthcare proxy, a durable power of attorney (DPA) is probably one of the most important documents every household should have. The DPA gives another person or institution the right to act on your behalf.

The DPA comes in handy if you are incapacitated (e.g., an accident) and someone else must pay the bills or sign legal documents. Even if everything is held jointly, a DPA would allow a spouse to sell joint assets if necessary.

If you’re concerned about granting so much power to another person, a “springing” DPA might be the answer. It takes effect only under specific circumstances (e.g., if your physician or two other Doctors agree that you’re incapacitated.)

According to Lynn Brenner’s Smart Questions to Ask Your Financial Advisers, a normal power of attorney is not sufficient because it expires if you become legally incompetent. A DPA doesn’t expire until you revoke it or die.


REITs Offer Diversification Benefits
Ibbotson and Associates recently published a study comparing two portfolios – one with 20% invested in Real Estate Investment Trusts (REITs) and one with no REITS. These are typically funds or individual stocks of companies that lease apartment or commercial office space. The study found that since 1972, the account with 20% invested in REITs increased annual returns by 0.7% compared to a portfolio with no REITS (11.6% vs. 10.9%.)

While the 0.7% may not be much (less than a typical actively-managed mutual fund charges), the more important finding is that REITs have a low correlation to stocks, especially small stocks. That means if you plotted the share price of REITs and small stocks you wouldn’t see patterns or relationships between the two.

REIT stocks and funds had an amazing few years, but things cooled off last year as we started to see the air coming out of the housing bubble. I wouldn’t move much money into REITs right now, and certainly not 20% of a portfolio, but this is one strategy to remember when it’s time to rebalance the portfolio.


January 16, 2006
Creating a Custodial Account for a Minor
It’s once again time for that January ritual, funding our Roth IRAs and Coverdell Education Savings Accounts for the year. This started me thinking about a Uniform Gift / Transfers to Minors Act (UGMA / UTMA) custodial account. These accounts are owned by minors but managed by an adult custodian. One upside of a custodial account is that the gains from the account are taxed at the child’s rate. The downside is that once the money has been deposited, it can’t be taken back – it’s a permanent gift to the minor. The money can be spent on the child’s behalf (e.g., education expenses, travel), but the child gains control as soon as they reach legal age – generally 18 or 21 depending on the state. The money will also factor into college financial aid applications as part of the child’s assets.

Perhaps the biggest concern is what happens in 15 years when that toddler turns 18? Will he or she be responsible enough to make “appropriate” decisions when they learn they have $50,000, $100,000, or more in the bank? I hate to think about what mistakes I would have made if I had been given $50,000 when I was 18.

While parents can describe a custodial account as an account earmarked for college, a first home, or retirement, the child is legally free to spend the money as they wish once they are of legal age.

I’ve read about some parents that simply keep the accounts a secret from the children until they are 30 or 40 years old. While that’s always a possibility, I don’t understand how the taxes are handled (the accounts are not tax deferred so the children would have to report the gains on their income taxes.) Perhaps the best course of action, whether a child has a custodial account or not, is to educate children about finances and prepare them to make the “appropriate” decisions.


January 15, 2006
Leaving Tracks on the Internet

This month’s Money magazine has an interesting article about online profiles and their possible effect on job applications. The head of World Privacy Forum says that employers routinely Google job candidates and their findings can affect whether or not your hired.

Information related to questions that employers cannot legally ask can be found on the Internet for all to see – information about political views, psychological state, sexual preferences, and social habits. Employers are free to use the information when they make their decisions.

The article focuses mostly on children, but the advice is general enough to be useful for everyone. They suggest:

  • Limit the information in your web identity;
  • Create a pseudonym or disguise; and
  • If personal info is already posted, remove it.


January 14, 2006
The Wisdom of Charlie Munger
Charlie Munger is Warren Buffett's right-hand man. While he's largely remained out of the spotlight at Berkshire Hathaway, last year he co-authored "Poor Charlie's Almanack". It turns out, however, that most of the speeches presented in the book are available for free on the web.

Chapter 2: A Lesson on Elementary, Worldly Wisdom
Chapter 6: Investment Practices of Leading Charitable Foundations
Chapter 7: Philanthropy Roundtable
Chapter 8: The Great Financial Scandal of 2003
Chapter 9: Academic Economics
Chapter 10: The Psychology of Human Misjudgment

For more insights of the duo at Berkshire Hathaway, check out Buffett's letters to shareholders and Munger's letters to Wesco shareholders.


January 13, 2006
"Hot" Stock Tips
I got back to the office this morning after a week-long trip to Europe and I noticed a couple faxes touting the latest investment in a company ready to "change the way we live." According to the faxes, investors in the company are poised to make a fortune.

The faxes reminded me about Joshua Cyr's experiment. Joshua created a hypothetical portfolio of stocks touted in spam emails. The result: after six months the portfolio was down 52%. Six stocks rose, 16 fell more than 75%, and 15 fell by a lesser amount.

I guess I'll just recycle those faxes.


Four Ways to Reduce Taxes on Mutual Funds
  1. Don't write checks on your fund account. Each time you write a check, you're selling shares in the fund and realizing a loss or gain that must be reported on your tax return.
  2. Don't trade frequently. Moving money from one fund to another creates a taxable transaction.
  3. Don't buy mutual funds in November or December. If you buy a fund before a fund distributes its capital gains, you will be taxed on part of your investment. For example, if you put $1,000 in a fund priced at $10/share and it subsequently pays out $1 in capital gains, the price will fall to $9. If you reinvest the gains, you'll still have a $1,000 investment and a taxable gain of $100.
  4. Invest in ETFs or tax-efficient funds. Tax efficiency is based on the trading frequency of a fund manager. Look for funds with low investment turnover. For more info on tax efficiency, check out Money's Ask the Expert.


January 07, 2006
Are You Subject to the Alternative Minimum Tax?
All Things Financial links to a nifty IRS tool to determine if you're subject to the AMT. You need to do a preliminary 1040 in order to use the tool.


Boosting Investment Yields with Preferred Stocks
During the market meltdown in late 2000/early 2001, we started looking for alternative investments that would give us a more stable return. We decided to move about five percent of our portfolio from common stocks to preferred stocks. Preferreds generally pay a guaranteed, relatively high dividend, but the appreciation potential is limited. One of the preferreds we purchased was Royal Bank of Scotland. We paid $25.19 per share. The stock is currently trading for $25.45 – a whopping 1% return over five years. However, during that time we received $10.00 ($2/year) in dividends – a 7.9% annual yield. The S&P500 ETF (SPY) returned -2.6% with an average annual yield of 1.3%.

When the market is flat, preferred shares are a good way to boost yields. However, as with any investment, it’s important to research the stock. I usually look for the following when researching preferred stocks:

  • Companies with good credit ratings from Moody or S&P.
  • Higher trading volume of the preferred stock.
  • A call date of at least two years in the future.
  • A dividend eligible for the 15% dividend tax rate.

By moving a small portion of our portfolio to preferred stocks we’ve boosted our overall returns over the long term. However, because of their limited appreciation potential, preferred stocks can drag down a portfolio in a surging market like 2003.

Additional Resources:

Linked at Outside the Beltway.



Financial Plan Step 3: Set Goals
“If you don't know where you're going, you might wind up someplace else” - Yogi Berra

The next step in the financial process is to set financial goals. Defining goals is a key part of the strategic process – it offers something to dream about at night, and to work towards during the day. Unfortunately, we hadn’t given much thought to our specific financial goals. Sure we had a general idea of what we wanted – to be financially secure, fund our children’s education, retire in comfort, and so on – but we muddled through our financial lives focusing on the day-to-day expenses, not whether we were properly preparing for our future. Fortunately, we still have plenty of time. That's a major advantage because of the power of compounding.

To get started, we answered the following questions:

  • If, at the end of the year, we were to look back at the past twelve months, what were the highlights (e.g., home, career, school, vacation, community, family and friends)? In three years? Five? Ten? Twenty?
  • What portion of the kids’ college education should we provide?
  • How and where do we want to spend our retirement?
  • What are our key values?
  • What are our key issues and concerns?

These questions can kick off a discussion about each family member’s hopes and dreams. They can also help identify non-financial actions that are necessary to accomplish those hopes and dreams.

After answering the questions, we were able to prioritize and estimate the resources necessary to achieve our goals. For example:

  • Paying off our mortgage by Jan 1, 2010 will require an overpayment of $800/month. (We already pay $750/month extra so this shouldn’t be difficult.)
  • Taking two family vacations per year – one international and one domestic - will require about $3,000 - $4,000/year. (We can probably do this for less, but I’d rather over budget.)
  • Retiring in 25 years will require about $2.2 million in assets.
  • Paying for the kids’ college expenses will require about $200,000.

Our list is much longer (and more expensive!) The next step is to compare what we need against what we already have and develop a plan…

Additional Resources



January 02, 2006
Online Banks Offer High Rates and Signing Bonuses
My Money Blog has a nice comparison of online banks, including opening bonuses.


Financial Plan Step 2: Assess the Situation
"You can't get where you want to go if you don't know where you are" - Anonymous

The second step in the financial planning process is evaluating our current financial picture. Without an understanding of the current situation, I couldn't assess what steps to take to meet the financial goals.

Because I'm "detail oriented" with regard to entering transactions into Microsoft Money, this next step is very simple - I used the "What I'm Worth" and "Where My Money Goes" reports. I then transferred the data into custom net worth and cash flow statements. (Why? you ask. The spreadsheet includes some financial ratios.)

This exercise was very educational. I learned, for example, that we spend a lot of money dining out and improving our home. Theoretically, the home improvement expenses increase the value of our home or at least make it more comfortable for us. That seems like a worthwhile use of our money. Home improvements aside, I've identified several ways that we can reduce spending to save a few hundred dollars a month. If I can cut down on taxes, I might be able to squeeze a few more dollars to apply toward savings or retirement.

With step 2 finished, it's time to begin the real work - identifying goals and objectives.

Additional Resources:


January 01, 2006
Financial Plan Step 1: Get Organized
As our family’s chief financial officer, I try to organize our records, balance the accounts, and employ our assets to maximize returns. And while my family has regular discussions about our finances, if something unexpected happens to me I want it to be easy for them or another family member to know exactly what financial accounts we have, where they are located, and how to access them.

Key documents are kept in a locked file cabinet, a fire-proof safe, or, in the case of receipts for the current tax year, an expandable file folder. Keeping the documents organized aids in tax preparation and insures that we can find documents on short notice. This system has worked well, but there is still opportunity for improvement. Step one of my financial plan was adding two three-ring binders for important documents and updating financial data in Microsoft Money.

The first binder includes:

A copy of the document locator was also given to a trusted family member.

The second binder has brokerage statements and trade confirmations in chronological order organized by account.

All financial data, including transactions for bank accounts, investment accounts, and credit cards, is managed in Microsoft Money (I really need to back up that file!) This makes my daily recordkeeping much simpler and should help with the next step in the process of creating a financial plan.

Additional Resources:



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