Post on 25-Dec-2015
transcript
The 3 Phases of Life
Happiness
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l _____________ l ______________ l _____________ lPreparation Growth Preservation
Phase 1: Preparation
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• Explore options
• Develop Skills (Earning Power)
• Practice Balance
Income & Expenses
The key is to maximize income (through earning power) and minimizing expenses
(using self-control).
Income is directly related to 3 things:
• Level of Skills developed
• Demand for those skills
• How easily you are replaced
Points to Remember
• In the long run no one is really overpaid!
• Your income is always tied into you Productivity
• If you want to make more money, develop more Skills
Expense Control
• Most Bankruptcies are caused by uncontrolled spending, NOT low income.
• Distinguish between Wants & Needs.
• Carefully watch small monthly bills (cell phones, internet, cable, etc.)
• Closely monitor Debt (Type and Amount)
5 Valid Reasons for Debt
• Home
• Education (think Earning Power) – no more than 1 year of Earnings
• Emergencies - medical, etc.
• Building Credit (careful)
• Investments when Appropriate – small business and real estate
Once your income and expense picture is stabilized you should start a program of moving from
income from Work to income from Wealth.
What is an Investment?
An investment is a vehicle to take you from where you are financially to
where you want to go.
(BIG Question: Where do you want to go?)
X
X
5 Elements of All Investments
• Rate of Return
• Safety / Risk Profile
• Liquidity
• Tax Implications
• Passive / Active
What is Interest?
Interest is the rental charge for using other peoples’ money.
Remember: It is better to receive than to give!
What makes compound interest so powerful?
Time
Compound interest is earning interest on previously earned interest.
Simple Interest vs Compound Interest
40 Years
$50,000
$250,000
Simple Interest
$2,599,000
Compound Interest
$50,000 initial investment earning 10% per year for 40 years in a tax-deferred account.
5 Ingredients of a Good Credit Card
• High Credit Limit (unless you have self-control issues)
• Low Interest Rate
• No Annual Fee
• Grace Period
• Perks (cash back, air miles, gifts, etc.)
Investment Categories
• Stocks
• Bonds
• Real Estate
• Small Business
• Collectibles • Specialty (Commodities, Metals, Notes, etc.)
Retirement Considerations
• Remember, in true retirement all income is derived from wealth.
• Big Picture Hint: If you have chosen a career wisely you may not be in a hurry to retire!!!!
• The retirement landscape has changed substantially over the last 20 years.
“Old School” Retirement
The Social Security Act of 1935 was created as an “income stabilization” program to provide Retired
American (over 65 years old) an income until death.
In 1930: At Birth At 65
Life Expectancy – Male 57.7 yrs 3.2 yrs
Life Expectancy – Female 60.9 yrs 4.8 yrs
Modern Retirement
Current Life Expectancy at 65 years old:
Male 15.4 yrs
Female 19.2 yrs
On average, Americans are living 5 times longer in retirement than their grandparents.
With longevity, come some distinct challenges!
Retirement Challenges• Longevity: Making the accumulated funds last
(traditional principal withdrawals of 5 - 6% per year may be too much).
• Inflation: (at 3 to 3.5% per year) over a 20 – 30 year period can wreak havoc on a portfolio.
• Bear Market: Especially within first 5 years of Retirement
• Retirement is now divided into two phases: Active (65 to 80 yrs old) and Passive (over 80).
• Many experts now say that the Active phase requires 100% (or more) of pre-retirement income (traditional 60% no longer applies).
• Longevity = Pensions or Annuities
• Inflation = Growth-oriented Investments
• Bear Market = Guaranteed Return• Investments ( Money-Market,
• Dividends and some Annuities)
Assessing Risks
Retirement Income Components
• Inheritances (often not received until close to retirement!)
• Social Security• Pension• Tax-advantaged Investments (401K, 403b, Roth
IRA, Traditional IRA, etc.)
• Taxable Investments (Stocks, Bonds, Real Estate, etc.)
• Home and other Assets
The “Perfect” Retirement Plan
The perfect plan would be:
•100% of pre-retirement income is earned each year from all portfolio components.
•Principal portion of the Investment Portfolio is never diminished by withdrawals.
•Overall portfolio and the yearly income increases each year by at least the inflation rate.
How to Calculate Your Retirement Needs
Step 1: Paint a precise Picture of your perfect Retirement in todays’ dollars (with Specific Income needed per Year.)
Step 2: Determine overall Income Needs factoring in a 3.5% inflation rate as follows:
10 years to retirement: add 40%
20 years to retirement: add 100%
Step 3: Calculate the expected yearly Income from Social Security and your Pension.
Step 4: Subtract the total Income received from Social Security and the Pension from the yearly Income needed for the “Perfect” Retirement to Determine the “Short-fall”.
Step 5: Assuming a 5% yield on your Investment portfolio in Retirement, multiply the yearly short-fall by a factor of 20 to determine how much you will need in your investment portfolio to provide your required monthly income.
(Your portfolio includes all funds in cash, 401Ks, 403bs, Roths, IRAs, taxable accounts, and investment real estate. Your home is not included unless you plan to down-size. Also, other assets are not counted unless they produce a sustainable income).
Step 6: Calculate the total current value of all your investment accounts and subtract the result from the total portfolio needed.
Step 7: Congratulations! Now you know how much your portfolio needs to grow in order to fund your retirement program.
(Your overall portfolio will grow by the combination of compounding yields from your current portfolio and systematic contributions until
retirement.)
Example for an Active Retirement
Bob is 45 years old and has been teaching for 5 years. He plans on retiring at 65 years old with 25 years of service.
During the Active phase of his retirement he has calculated that he will need $75,000 (in todays’ dollars)
per year to fully fund his plans for travel, golf and the theater.
Since Bobs’ retirement is 20 years away, he has factored in an inflation rate of approx. 3% per year. Therefore, Bob realizes that when he retires he will need an income of
$150,000 per year
Bobs’ Expected Income
According to the Social Security department, if Bob retired today with full benefits he would receive $15,500 in yearly benefits.
Bob assumes that these benefits will keep pace with inflation. Therefore, when he does retire he will receive $31,000 per year.
Bob expects to be earning $80,000 as a teacher in 20 years. With 25 years of service he plans to receive approx. $40,000 per year from his pension.
Yearly Income from Social Security & Pension = $71,000
Short-fall Calculation
“Perfect” Retirement Income $150,000
Social Security & Pension Income - $ 71,000
Yearly Short-fall $ 79,000
In order for Bobs’ Investment portfolio to produce this much income each year, it will need to be worth a total of:
$ 1,580,000 ($79,000 x 20)
Bobs’ current investment portfolio includes the following:
• Cash for Investments $ 6,000
• Roth IRA $17,000
• 403b $64,000
• Current Equity in Tri-plex $48,000
Total Value of Investments $135,000
The Bottom Line
Over the next 20 years, Bob needs to turn his investment portfolio of
$135,000 into $1,580,000.
(Ouch!)
Here is What Bob Must Do
At a 10% return (historical average) Bobs’ current portfolio will be worth $908,000 at retirement.
An inheritance of $100,000 when Bob is 58 years old will be worth $195,000 at retirement.
The balance needed of $467,000 must come from contributions made between now and retirement.
In order to accomplish his goal, Bob must find a way to contribute
$7,500 per year.
Over 20 years, an investment of $7500 per year earning a 10% return will become
$473,000
If Bob can only invest $3000 per year for the next 20 years then this part of his portfolio would be worth $189,000.
Bob would be $288,000 short of his goal.
Bob would have to do one of two things:
1. Reduce his yearly income by $14,400
2. Liquidate 1% of the principal value of the
portfolio in the first year (each year this % would increase)
The Power of Time
Bob BettyYears 1-10 $10,000 / year 0
Years 11-35 0 $10,000 / year
Total Investment $100,00 $250,000
Value After
35 Years $1,71,477 $789,544
* Based on an 8% ROI.
* Effects of taxation not included.
Question: When assembling an Investment Portfolio what is the
single most important consideration?
Answer:
DiversificationAsset Allocation is another name for diversification.
Many studies have concluded that 90% of a portfolios performance is a result of diversification!
Do NOT Consider…
• Trading Commodities
• Trading Currencies
• Investing in Oil Wells
• Day-trade Stocks
• Depend on Cash-based Investments
Basically, do not invest in anything you do not understand!
Historical Returns 1925 - 2004
• Stock 10.4%
• Real Estate 9.9%
• Bonds 5.4%
• Treasury Bills 3.7%
• Inflation 3.0%
Cash-Based Investments(Savings Accounts, CDs, Treasury Bills, Etc.)
These investments do not provide enough returns to truly outpace
Inflation over time.
Always have an Emergency Fund in Cash
(2-3 months of expenses)
Bonds
Bonds are conservative, income-producing investments suitable in or near retirement.
During the Growth phase they should represent a relatively small part (if any) of
an investment portfolio.
Real Estate
Investment Real Estate should be a part of every truly diversified investment portfolio.
It has a number of unique and powerful advantages over other types of
investments.
Some advantages include Preferential Tax treatment, Immunity from “Bear” markets and LEVERAGE.
401k & 403b
• Operate essentially the same. 401k is used in “For profit” companies and 403b is used in “Non-profits”.
• Major advantages are Pre-tax contributions and tax-deferred growth.
• Disadvantages include limited investment choices, administrative fees and withdrawal restrictions.
• In 2006, max. contribution is $15,000 ($20,000 if over 50 years old).
Traditional IRA
• Contributions are pre-tax dollars
• Growth is tax-deferred
• Much larger selection of potential investments than 401k and 403b.
• In 2006 maximum contribution is $4,000 (over 50 years old can contribute $5,000)
Roth IRA
• Contributions are after tax
• All growth is tax free
• Greater flexibility in Retirement than the Traditional IRA
• In 2006, the maximum contribution is $4,000 ($5,000 is over 50).
Which IRA is better?
Depends on:
• Importance of current tax savings
• Anticipated Tax Rate in Retirement
Taxable Accounts
• All contributions are after-tax dollars
• Account growth is taxable (using Capital Gains rules)
• Complete freedom in choosing investments
• Very flexible in Retirement
• No maximum contribution
Effect of Tax-deferralSally and Sue both have $4,000.00 per year from earnings
to contribute to their retirement.
Sally decides to use a taxable account . Therefore, she invests $3,200 (20% tax rate) each year into stocks. She also pays 15% (long-term Capital Gains tax rate) on all gains each year.
Sue decides to use a 403b program. The full $4,000 gets invested each year and all gains grow tax deferred.
If Sally and Sue both earn 10% per year on their accounts and continue to invest for 35 years, how much will each have?
Suggested Order of PreferenceRetirement Programs
1. Employer Matching Programs
2. IRAs (Either Traditional or Roth)
3. 401k / 403b
4. Taxable Accounts
What to Invest In
• Mutual Funds
• Exchange Traded Funds (ETFs)
• Individual Stocks• Bonds (if conservative)
Mutual FundsAdvantages:
• Instant Diversification (if done right)
• Professional Management
• Low initial Investment
• Low (or no) Commissions
Disadvantages:
• Administrative Fees
• Questionable Performance
ETFsAdvantages:
• Same diversification as Mutual Funds
• Trade like stocks
• Low Administrative fees
• No “hidden” Capital Gains
Disadvantages:
• Purchase and Sale commissions
Individual StocksAdvantages:
• Ultimate Flexibility
• Employ a Variety of Investment Strategies
• Invest in “Special Situations”
Disadvantages:
• No Diversification (minimum 100K required)
• Purchase and Sale Commissions
Prior to assembling an investment portfolio you MUST determine your tolerance for risk. Are
you:
• Aggressive – Can live with substantial market fluctuations in order to receive higher returns
• Moderate – Some fluctuations for average returns
• Conservative – Market fluctuations would cause sleepless nights and ulcers
How to DiversifyDivide your portfolio into the following segments of
the stock market:
• Large Cap – Growth
• Large Cap – Value
• Mid Cap
• Small Cap
• International
• Bonds (if Conservative)
At various times each of these segments will “lead the market” while others will lag. By diversifying you will always achieve a blended return.
Over time this approach will always produce better returns than a concentrated portfolio.
4 Rules of Stock Investing
• Don’t try to “Time” the Market
• Never Chase Hot Stocks or Sectors
• Develop a Strategy and Stick to it.• Rebalance your Portfolio at least
Annually.
Suggested Aggressive Portfolio
Large Cap -Value
Large Cap -Growth
Mid Cap
Small Cap
International
20%
20%
20%
20%
20%
Suggested Moderate Portfolio
Large Cap -Value
Large Cap -Growth
Mid Cap
Small Cap
International
Bonds
20%
20%
20%
10%
15%15%
Suggested Conservative Portfolio
Large Cap -Value
Large Cap -Growth
Mid Cap
Small Cap
International
Bonds
Cash
20%
10%10%
10%
25%
10%
15%
Advantages of Real Estate Investing
• Stable Returns over Time
• Independent from the Stock Market (Diversification)
• Tax Advantages (Depreciation)
• LEVERAGE
My favorite type of Properties to invest in are Apartments because:
• Values are subject to less volatility than other types of Real Estate (Over-building)
• Often Priced more Attractively
• Generally more liquid in Nature
• Vacancies are less “painful” and turnover much faster
Example of the Power of Real Estate Investing
Scenario:
Sam is 38 years old and has just received an inheritance of $75,000. He has heard that real estate can be an excellent investment.
After some research, he decides to purchase a small apartment building and hold for the long-term.
This example will use my “favorite”
size property. It has the following attributes:
• 12 x 2 bedroom units• Tenants pay electric and gas for their unit• Building has a pitched roof• Extra land in back is a BIG plus• Property is on a quiet street in an excellent area of the city
Sam finds 3 fourplexes on a cul-de-sac in the great part of town. The owner is asking $840,000 for all three properties ($280,000 per fourplex).
It has everything he’s looking for so, after some intense negotiating, they agree on a selling price of $825,000. The seller agrees to the following terms:
• $75,000 cash down payment
• Seller will “carry-back” $90,000 @ 6.5%
• Sam will obtain a 1st mortgage for 80% of the purchase price ($660,000)
Income & Expenses Characteristics at Purchase
Income:
12 units @ $675.00 each per month
Total Monthly Income (GSI) $ 8,100.00
Less Vacancy Factor (4%) - $ 324.00
Monthly Income after Vacancy $7,786.00
Monthly Expenses:• Water & Sewer $300
• Trash 50
• Property Taxes 630
• Property Insurance 400
• Maintenance / Repairs 250
• Miscellaneous Expenses 100
Debt: 1st Mortgage of $660,000 @ 7% for 30 yrs
Monthly payment = $4,400.00
2nd Mortgage of $90,000 @ 6.5% of 15 yrs
Monthly payment = $ 785.00
Summary of Income & Expenses
Income:
Rental Income (after Vacancy) $7,786.00
Expenses:
Operating Expenses $1,730.00
Debt Service $5,185.00
Total Expenses $6,915.00
Net Monthly Income $ 871.00
Sam is motivated to maximize the potential of this property. Therefore, he decides to do the following:
• He applies $700.00 of the cash flow per month to the 1st mortgage to accelerate the principal pay-down.
• Each year he increases the rent by 3%
• He also applies the yearly rental increases to the principal
• After 5 years of operating the property Sam hires his favorite tenant as a resident manager and pays him half rent (Prevents “Burn-out”)
Assuming Sam sticks to his plan over the years here is what will happen:
• In 14.5 years of operation Sam will pay off the 1st mortgage
• In 15 years Sam will pay off the 2nd mortgage
• Sam will have received a tax write-off of approx. $25,000 per year in Depreciation ($700,000 / 27.5 years)
• Sam is 53 years old
Property Income & Expense Profile15 Years
Annual GSI ($1,050 per unit) $151,200
Operating Expenses (3% inflation) $ 32,000
Debt Service $ 0
Free Cash Flow $119,200
Based on the Purchase Cap Rate, the Property will be worth $1,275,000!
The Bottom LineIn 15 years Sam will have turned $75,000 into $1,275,000 and the property will be
generating cash flow of approx. $120,000 per year.
Sam has harnessed the Power of LEVERAGE by letting his tenants pay off his
mortgages!
This represents a ROI of 1,600%!!! (over 20% yield per year)