Financial focus for the new year

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James Gould ’85 (accounting, M.S.) is president of Alesco Advisors in Pittsford, N.Y. He is a Certified Public Accountant. He wrote this with help from Jody Rossiter ’98 (finance), a portfolio manager at Alesco Advisors. They say the key to personal financial planning is recognizing that your plan is indeed personal. Below are a few tips.

Don’t be a hero

Most people do not prepare their own tax returns, drill their own teeth or fix their own car. Yet many people believe they can build their own financial plan. Chances are you will be far better off by working with a professional adviser. We strongly recommend a fee-based adviser versus an adviser who gets paid a commission.

Think ‘balance sheet’

Many view financial planning from an income statement perspective versus a balance sheet perspective. Looking at one’s income and expenses is important, but it can lead to a false sense of accomplishment. Your balance sheet is made up of your assets and your liabilities. If your assets are greater than your liabilities, you have a positive net worth (also known as equity). If your liabilities are greater, pay close attention to this article.

Begin with the end

What are your expectations for retirement? What are your plans for leaving money to your children, your alma mater or other charities? How will you fund your children’s education? While these questions may seem daunting, they are your reality. The sooner you make plans to address this reality, the more likely you are to meet your goals. By the way, these goals are also liabilities. They are your future liabilities.

Use ‘opposite arrows’

How can you possibly pay for these liabilities? The answer is a concept known as “opposite arrows.” If I want to get in better physical condition, I can diet or I can exercise, or I can do both. Doing both is the implementation of “opposite arrows” for one’s physical health. The dieting equivalent for your fiscal health is called a budget. Budgeting is actually very easy to do—it is all about portion control. You only have a certain amount of income, you have to build wealth to meet your financial goals, therefore you need to save. This means controlling your expenditures. You must also get your savings to work hard for you by investing them properly. The opposite arrows are spending less of your income and making more on your investments.

Thank you, Uncle Sam

The best options for saving money for most people are tax-deferred investments. These would include employer-sponsored retirement plans (particularly if there is some form of employer matching contribution), IRAs and 529 Plans (for funding a college education). Retirement plans, IRAs and similar investment options are attractive because you can invest pre-tax dollars. The long-term impact of tax-deferred compound interest is spectacular. If you don’t believe me, just run the numbers on compounding annual savings of $5,000 at 7 percent per year for 30 years. (Hint: It’s more than $472,000!)

Understanding your debt

Using debt to buy an asset that will appreciate in value at a rate that is faster than the cost of debt could make great sense. For example, it would be reasonable to incur a mortgage with a fixed cost of 4.25 percent per year to buy a property, which is expected to appreciate at 5 percent annually. Where debt is bad is when it is used to acquire items that depreciate in value: boats, televisions, furniture. When it comes to credit cards, it is imperative to keep your purchases at a level that can be paid off each month. Pay down other forms of debt (car loans, student loans) as quickly as possible.

Don’t just save, build wealth

Building wealth requires a basic understanding of investments. Investing effectively requires the matching of your investment assets to your liabilities. What this means is for your long-term liabilities (for example, you’re 35 and funding your retirement at age 65) you can invest in the best performing long-term assets (equities and real estate). However, if you are putting money aside to buy a car in two years, the stock market is probably not a good idea. This process of matching your investment assets to your liabilities is one of the most important components of building a financial plan.

Know the basic investment flavors

There are only two things you can do with your money. You can own something (equity markets), or you can lend it (credit markets). Broadly speaking, the equity markets would include stocks, commodities and real estate. The credit markets would include bank deposits, treasuries, municipal bonds and corporate bonds. Equity investments generate far greater returns than investments in the credit markets over long-time periods. However, the profile of the returns for equity investments is much riskier than for most credit investments. Beware of anyone who tries to sell you a high-returning, low-risk investment.