Are you new to the concept of financial planning and wondering where to start? Do you have an advisor but only ever discuss investments? This post will be helpful in educating you on four key pillars in every solid financial plan and will serve as a guide on where you should focus your attention. We want to help you begin the process of bringing your current financial life to order while also securing your financial future.
You can click on any of the terms/concepts in this post with blue text to learn more about that term/concept. You can also click on any of the underlined elements in the table of contents below to jump to that section of the post.
The four pillars covered in this post are:
Plus, a 5th bonus topic: Working with a Financial Planner
1. Adequate Insurance
No matter what your balance sheet or cash flows look like, there are always risks that need to be hedged. The general insurance types that you need to consider are liability insurance, disability insurance, and life insurance (other types of insurance that need to be considered but are not part of this blog post, are insurance types such as health[i], long-term care[ii], and property and casualty[iii]).
Disability insurance[v] (long-term): Disability insurance is more important for younger workers than for older workers with a shorter working life. If you add dependents to the mix, it becomes even more important. If you are the sole breadwinner for your dependents, it becomes an absolute necessity. Disability insurance typically covers 60-80% of your income (depending on your policy). If you have a long-term disability insurance policy from your employer, and your employer is paying the premiums, the benefits from your policy would be taxable as income to you, in the unfortunate event you receive payments from your policy. If you pay the premiums yourself, the benefits would be tax-free to you. If you are a young worker and/or have dependents who are supported by your income, disability insurance becomes imperative. If your income increases, you should make sure your disability insurance increases commensurately. Another important consideration is whether or not your disability insurance policy is Own-occupation[vi] or not. An own-occupation disability policy will pay benefits if you are unable if you become disabled and are unable to perform the tasks of your specific job versus the tasks of any job. This type of policy is commonly owned by professionals such as doctors, who have a very unique skill set and are highly compensated for those skills. It is a superior level of coverage as it typically requires a lesser degree of disability before paying out and allows the insured to gain employment at a different job (that he or she can do) while still receiving benefits. Statistics show that it is more likely for workers to become disabled at some point in their working life than to die prematurely. So, not only is disability more likely than a premature death, but it might also be more expensive. In both situations, income stops, but with a disability, there might be added medical costs or the need for a spouse to stop working to care for their disabled partner. Long-term disability insurance is arguably the most important insurance to have, however, many people are under-insured or uninsured altogether.
Life insurance[vii]: Life insurance can get complicated fast. For that reason, we will focus on term life insurance in this post. Term insurance is as descriptive as you might think – it is life insurance that is only valid for an agreed-upon term, which is usually between 10 and 30 years. If the insured dies within that period, the policy will pay out. With most term policies, both the death benefit and premiums are level for the life of the policy. Like disability insurance, life insurance is more important for younger individuals who have dependents. A 30-year-old parent who is the sole breadwinner in his/her young family can purchase a 30-year term life policy that would cover the costs of living life and raising kids. One of the ways to calculate how much insurance one should purchase is called the Human Life Value[viii], which is essentially the present value of the future earnings of the insured. Your advisor should be able to help you determine the type and amount of life insurance that best fulfill your unique needs.
Liability Insurance:
Umbrella Policy[iv]: This type of insurance is usually issued by your property and casualty provider and covers the insured from any lawsuit over and above what is covered by your existing auto and home insurance policies. It is ultra-cheap and almost always a good idea to tack onto your existing property and casualty policies.
Industry-Specific Insurance: Do you have industry-specific liability insurance? If so, is it adequate to cover any potential lawsuits or claims of malpractice? For example, a doctor needs to have malpractice insurance, and a financial advisor needs to have errors and omissions insurance. Without these protections in place, their income and their assets can disappear in a hurry.
2. An Updated Estate Plan
There is a common myth that you only need estate planning if you have a large asset base… that is simply not true. Another myth alleges that your estate/beneficiaries will be taxed when you die… again, that is usually not true. Everyone needs estate planning, and rarely is anyone’s estate taxed by the federal government at death (some states do assess their own estate taxes[ix]).
Why does everyone need estate planning?
Estate planning is more than just deciding who gets your stuff when you pass - it is also appointing guardians for your minor children, stipulating if you would like life-saving measures taken if you were to suffer a medical event, deciding who gets to make financial and medical decisions for you in the event you are incapacitated, and much more. Below are the key documents most people will need to ensure their family members are not left to navigate a mess while mourning the death of a loved one:
Will[x]: This is the most basic document that outlines who will administer your estate (executor), who will inherit the assets within your estate (beneficiaries), and, if you have minor children, who will raise them (successor guardian). It is important to note that if you die without a trust, and your assets do not have proper beneficiaries or transfer titles, your estate will be subjected to probate[xi], that is, a probate court[xii] will preside over your estate’s administration. Probate is a public and potentially expensive process that allows creditors, family members, or anyone else who feels they were shortchanged to contest your estate and should be avoided if at all possible.
Revocable Living Trust[xiii]: This is a trust that doesn’t do much for you in your lifetime. Many think it will offer them creditor protection, protection from a divorce, or will “hide” assets from social security, Medicaid, etc. In reality, the reasons one would want to utilize a Revocable Living Trust is so that they can:
Avoid probate. Avoiding probate is a huge benefit of utilizing a “Rev Trust.” As covered in the previous section, probate can be an expensive, long, public process that is a burden to those trying to settle your estate (likely the same people who are already in grief at your passing). A Rev Trust can help alleviate that burden.
Have certainty that their estate will be administered exactly as they desire. Rev Trusts provide certainty that your assets will flow according to your wishes because your death triggers the Revocable Trust to become an Irrevocable Trust – a separate entity from you and the remainder of your estate that is not able to be altered. The Trust document would appoint a trustee[xiv] (a person you hand-picked ahead of time to administer your trust) to administer your trust according to the document and its instructions. Because the trust becomes irrevocable, it is the most certain way to ensure the assets within it pass to the people and entities you want.
Pour-Over Will[xv]: The pour-over will is the kind of will that commonly accompanies a trust and to ensures that any asset not assigned a beneficiary or owned within your trust is placed into the trust at your death and is administered according to the terms of your trust. It is a safety net for any asset that is inadvertently left in your estate (rather than your trust) at your death. These assets must still go through the probate process, but the probate court will have specific instructions to administer these assets as your trust dictates. This is a great fail-safe in case you forget to title an asset in the name of your trust or assign a beneficiary.
Living Will/Medical Directives[xvi]: This document explicitly states what care, including life-saving measures, you would like taken in the event you are incapable of communicating your wishes. Your medical power of attorney (covered below) should be familiar with this document and understand your wishes.
Powers of Attorney (POA):
Health Care Power of Attorney[xvii]: A medical or healthcare power of attorney is someone you entrust your medical decisions to in the event you are incapacitated. For dire, life-saving situations, your medical power of attorney should communicate the wishes you lay out in your living will to medical professionals, so make sure they have access to both documents. A medical power of attorney is also important for your family members who are ages 18+. Without one, they will not have an advocate to make their medical decisions on their behalf in the event they are incapacitated. This need is especially overlooked by young adults and their parents.
Financial Power of Attorney[xviii]: A financial power of attorney is exactly what it sounds like – someone you appoint and authorize to make financial decisions for you in the event you are incapacitated.
You just completed a full estate plan... now what?
Make sure your POAs, executor(s), trustee(s), etc. all have a copy of any necessary documents and understand/accept the role you have appointed them to.
If you have a trust document, you still have to “fund” it, which means you need to title the proper assets in the name of the trust, or at least name the trust the beneficiary of your assets so that it owns your assets at your death, ensuring they are distributed according to your trust document and not at the discretion of a probate court.
Ensure all beneficiaries are up to date.
To avoid probate, ensure all assets either have a beneficiary or Transfer on Death[xix], or are owned in the name of your trust. Avoiding probate will save your estate substantial fees and will provide your estate and family privacy as probate proceedings are public. Most importantly, doing this will ensure your wishes are honored even after you are gone.
3. Cash Flow Mapping/Saving
Most folks know the basics of traditional budgeting – like a diet, it is one of those things that is simple, yet difficult. It is important to know what is coming in and what is going out (especially if you are working with an advisor who is building a forward-looking financial model for you). But mapping cash flows becomes less important if saving becomes the priority vs the after-thought. Mapping cash flows is one thing, actually saving and investing is another. It is fairly easy and straightforward to track calories, but it's hard to refrain from eating the extra piece of cheesecake you have sitting in the fridge. To help with this challenge, you can employ a tactic referred to as Reverse Budgeting[xx]. Reverse budgeting makes the process of aligning your cash flows with your goals much easier and is a better way of saving/investing than attempting to track and pinch every penny.
In a traditional budget, one first analyzes where costs can be cut to save more/invest more/pay off more debt. Reverse budgeting flips that around by making saving/investing/paying down debt the priority, and forcing cash flows to fall in line accordingly. The benefits of reverse budgeting are:
It does not necessitate tracking every penny
It can be automated
For many, it allows them to stick with it better than a traditional budget
It allows you to spend without guilt
What should my savings goal be?
The goal should not be saving as much as possible at the expense of enjoying life. Too many people have deprived themselves of life experiences so that the number on a computer screen or statement grows as large as possible without ever enjoying the fruit of that sacrifice. As with everything else in life, this is a challenge of finding balance, which makes it hard to give a concrete answer on how much you should save. However, a qualified financial planner should be able to help you find the savings rate that provides that balance now while also ensuring you are prepared for the future.
4. Portfolio Analysis
God, grant me the serenity to accept the things I cannot change,
the courage to change the things I can,
and the wisdom to know the difference.
This is the beginning of the Serenity Prayer, but it should also be the motto of anyone who invests in capital markets (especially non-professionals). Far too many investors try their hand at out-trading and out-thinking markets when managing their portfolios. However, we are strong believiers in harnessing the collective knowledge and efficiency of an entire market rather than attempting to outperform the market's ability to gather and accurately price all current information, all future permutations of the current information, and price in future, unknown events.
Additional challenges individuals have that markets do not are emotions (fear, greed, FOMO) and biases (cognitive dissonance, confirmation bias, recency bias, and many more). Because of these challenges, our firm chooses to prioritize things we can control, such as simplicity, costs, and risk. Instead of doing a deep dive into investments in this post, we will focus on those three concepts. Examine your portfolio by asking the following questions:
Does the risk in my portfolio align with my time horizon?
Does the risk in my portfolio consider my personal and unique tolerance for risk? (tolerance for risk can be defined as your need, ability, and willingness to take risk)
Is my investment strategy simple and do I understand it?
Are the costs within my portfolio being kept low?
Are the tax ramifications of my investments being managed properly?
If your answer to any of the above questions is no, or if you don’t know the answer to one or more of those questions, then it is likely time to consider working with a financial planner...
5. Consider working with a financial planner to see how all these items interact with one another. A qualified professional will not only be able to help you address each of these pillars (and many more) but will do so in a way that is complementary to all other areas of financial planning.
Click this link to read our post on questions to ask your current or prospective financial planner.
If you are in need of professional help with any of the elements mentioned in this post, please reach out to us at hello@genwd.com
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
Foster Capital Management Inc. dba Generations Wealth Design (“Generations Wealth Design”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where Generations Wealth Design and its representatives are properly licensed or exempt from licensure. For additional information, please visit our website at www.genwd.com.
References:
[i] . Julia Kagan, “Health Insurance: Definition, How It Works,” Investopedia, December 16, 2023, https://www.investopedia.com/terms/h/healthinsurance.asp.
[ii] Julia Kagan, “Long-Term Care (LTC) Insurance: Definition, Costs, Alternatives”, Investopedia, July 30, 2023, https://www.investopedia.com/terms/l/ltcinsurance.asp
[iii] Alexandra Twin, “Property Insurance: Definition and How Coverage Works, Investopedia, July 3, 2021, https://www.investopedia.com/terms/p/property-insurance.asp
[iv] Amy Fontinelle, “How an Umbrella Insurance Policy Works”, Investopedia, April 21, 2023, https://www.investopedia.com/articles/personal-finance/040115/how-umbrella-insurance-works.asp
[v] Jason Fernando, “What is Disability Insurance? Definition and How It Protects You”, Investopedia, February 21, 2021, https://www.investopedia.com/terms/d/disability-insurance.asp
[vi] Julia Kagan, “Own Occupation Policy: What it is, How it Works, Example”, Investopedia, March 4, 2021, https://www.investopedia.com/terms/o/ownoccupation_policy.asp
[vii]Amy Fontinelle, “Life Insurance: What it is, How it works, and How to Buy a Policy”, September 21, 2023, https://www.investopedia.com/terms/l/lifeinsurance.asp
[viii] Julia Kagan, “Human Life Approach, Definition, Value Calculation, Example”, Investopedia, March 15, 2021, https://www.investopedia.com/terms/h/humanlifeapproach.asp
[ix] Janelle Fritts, “Does Your State Have a Tax or Inheritance Tax?”, Tax Foundation, June 21, 2022, https://taxfoundation.org/data/all/state/state-estate-tax-inheritance-tax-2022/
[x] Julia Kagan, “Last Will and Testament: Definition, Types, and How to Write One”, Investopedia, April 17, 2023, https://www.investopedia.com/terms/l/last-will-and-testament.asp
[xi] Julia Kagan, “Probate: What it is and How it Works With and Without a Will”, Investopedia, December 18, 2023, https://www.investopedia.com/terms/p/probate.asp
[xii] Julia Kagan, “Probate Court: Definition and What Goes Through Probate Court”, Investopedia, April 19, 2023, https://www.investopedia.com/terms/p/probate-court.asp
[xiii] James Chen, “What is a Living Trust?”, Investopedia, February 8, 2024, https://www.investopedia.com/terms/l/living-trust.asp
[xiv] Adam Barone, “What is a Trustee? Definition, Role, and Duties”, Investopedia, September 18, 2022, https://www.investopedia.com/terms/t/trustee.asp#:~:text=A%20trustee%20is%20someone%20who,as%20income%20after%20you%20pass.
[xv] Julia Kagan, “Pour-Over Will Definition and How it Works with a Trust”, Investopedia, July 11, 2023, https://www.investopedia.com/terms/p/pour-overwill.asp
[xvi] Julia Kagan, “Advance Directive, What it is, How it works”, Investopedia, November 17, 2020, https://www.investopedia.com/terms/a/advancedirective.asp#:~:text=An%20advance%20directive%20is%20a,the%20end%20of%20one's%20life.
[xvii] Carla Tardi, “Health Care Power of Attorney: Definition and How to Set Up”, Investopedia, September 21, 2021, https://www.investopedia.com/terms/h/hcpa.asp
[xviii] Adam Hayes, “Financial Power of Attorney: Definition, Required Forms, Example”, Investopedia, August 16, 2020, https://www.investopedia.com/terms/f/financial-power-attorney.asp#:~:text=A%20financial%20power%20of%20attorney%20is%20a%20legal%20document%20that,after%20the%20principal%20becomes%20incapacitated.
[xix] Cory Mitchell, “Transfer on Death (TOD): What it is and How the Process Works”, Investopedia, October 15, 2022, https://www.investopedia.com/terms/t/transferondeath.asp
[xx] Lauren Schwahn, “Pay Yourself First: Reverse Budgeting Explained”, Nerdwallet, February 20, 2019, https://www.nerdwallet.com/article/finance/pay-yourself-first-reverse-budgeting
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