The Financial Planners Plan: Emergency Funds

If I received a nickel every time someone asked me for financial advice, I would be rich. Around the cooler, in the grocery store, and at family gatherings are just a few of the places where people seek information. “What should I buy?” or “What is hot in the markets these days?” When I explain that financial planning yields better results than just managing an investment portfolio, people quickly agree and follow up with “What is the outlook for the economy?” Most advisors enjoy these conversations because of exciting gains or “knowing the most about capital markets.”

I, however, think it is time for a different post. This blog post outlines the realities of the Carmany household and how we deal with the challenge facing us. Now we must rebuild our emergency fund.

Basics of an emergency fund

While studying for the Certified Financial Planner designation, potential certificants learn about the importance of an emergency fund. “Save three to six months’ worth of expensesEmergency fund in case an emergency happens.” This cornerstone is usually one of the first steps in a financial plan. Often, I find people misusing the fund for nonemergency conveniences. What is an emergency? The web defines an emergency as “a serious, unexpected, and often dangerous situation requiring immediate action.” Buying a TV or taking a last-minute trip to get away from stress are not emergencies.

I will admit, my own past demonstrates abuse of earmarked emergency funds. For example, we bought our last car out of convenience rather than to meet a need. See, my family was getting ready for one of our annual trips to visit family. Our normal hustle was under way for our departure the next morning. The yard needed to be mowed, and our SUV needed to be pulled out of the garage so that we could access the mower. As soon as I started the car, I noticed it was running funny. My first thought was to deal with it after mowing the lawn. Once I looked over the SUV and completed my research, I found two bad sensors to replace. (We were going to take the SUV on our trip.) I had no idea how to deal with this riddle. I thought about it as we closed up the house for the evening. Amazed at the string of bad luck (the washer and window also broke the same evening), I quickly went out and bought a new SUV for my wife (one she likes) on credit the next day using part of our emergency fund as a down payment, all because I did not want to slow down and deal with the situation.

We recovered and have since moved on from the car buy.

My current situation

Currently, as I write this, my family faces our second and much larger emergency fund depletion. This time, however, it is real, as in “not having water turns the household upside down.”

We moved three years ago to a bigger house as our family expanded with my youngest daughter. I did not plan to move at first, but a couple of months after my wife, Yvonne, found out she was pregnant, she set a hard date. July 15 became our deadline and we had four short months to find a home, get our current home ready to sell, and move.

We made the deadline with time to spare and have been happy with the choice we made. There have been large outlays. The largest one so far is getting 85 percent of the house Billreplumbed. The water pressure from our well had been slowly dropping, so a plumber suggested that we replace our well pump and a few other items. The total cost: roughly one month’s expenses. After getting the work done, the plumber took the time to discuss with us the problems present in our current plumbing. He explained that his current fix may last a short while or longer. Guess which one it was? Two weeks later, here we are, getting the home refitted with new plumbing. The original pipes were not up to code and cheap material had been used. (I experienced personally how cheap it was, as one of the pipes cracked in the wall.) Total cost: several months’ worth of expenses.

The good news is, the house will be updated and our family will be able to get back to business as usual. Or will we?

Now what?

I now remember starting the emergency fund a long time ago. “Saving at $XX/ month, it will take T months to get back to the correct reserve amount” runs constantly through my mind. Additionally, the time taken away from funding other luxuries for the family will be put on hold. “Why did we buy THIS house? Why do WE have to wait to fund these other goals (which are luxuries)?” Sound familiar? It feels like starting at square one.

But I am not starting at the beginning. We now have the experience of dealing with a real emergency (having no water for the family). No credit card debt, no hassle over how to pay for it.

Transparency

I hope sharing this post shows: 1. Financial planners are subject to the same pitfalls and challenges as the families we help. In many cases, the planner does not practice the sameTransparency techniques he preaches. 2. Many articles discuss the importance of an emergency fund, but do not discuss the next step after it has been used.

In my family’s case, the second family trip for 2016 will be placed on hold. We will get back to the practice of building the fund to a suitable level by cutting costs. In the back of my mind, I do wonder about another emergency taking place. What will we do with no emergency fund?

In this case, we will start moving down the line of liquidity. We have additional investments in taxable accounts which are accessible.

As we make progress in building our emergency fund, I will share updates. When you meet with your advisor, ask him about emergencies he has experienced and how they were addressed.

If he does not practice the same techniques he teaches, you may need to look for another advisor. I believe a great advisor practices the same techniques that his client does. In this case, I know firsthand how the process works (the bucketing system) and I help people maneuver through the emotional turbulence of the situation.

If you have questions about building an emergency fund or about the bucketing system, or if you just want to share your story, please feel free to contact me at ncarmany@thewatermarkgrp.com or 317-805-0840.

 

Sources

  1.        https://www.google.com/webhp?sourceid=chrome-instant&rlz=1C1AVNE_enUS679US679&ion=1&espv=2&ie=UTF-8#q=emergency%20definition

Working in Higher Ed and Planning for Retirement

Leveraging higher education retirement plans yields great value if done correctly. However, many complicated questions need answers. Should you save in a 403(b), 457, or IRA? Do the plans have different features? What about Roth choices? What if I lose my job?

Here, information will be shared to help make the complicated world of retirement planning simple.

Retirement plan choices.

Choices403(b) – Scott Dauenhauer notes in his book, “Wild West: Providing Fiduciary Advice to Public School Employees”: “The 403(b) was codified into law with the Technical Amendments Act of 1958 and was more of a pre-tax, tax deferred ‘program’…” (1). This took place before the Revenue Act of 1978, setting up the 401(k) (2) and the Employee Retirement Income Security Act (ERISA) of 1974 establishing the IRA (3). The 403(b), also called a tax-sheltered annuity, is for “certain employees of public schools, employees of certain tax-exempt organizations, and certain ministers” (4). The IRS notes (4):

Individual 403(b) accounts will be opened up as one of the following types.

  • An annuity contract, which is a contract provided through an insurance company.
  • A custodial account, which is an account invested in mutual funds.
  • A retirement income account set up for church employees. Retirement income accounts can invest in either annuities or mutual funds.

As with its cousin, the 401(k), participants may contribute up to $18,000 for 2016, plus another $6000 if over the age of 50.

457 – The 457 is a special plan available to local and state employees (and other 501(c) groups). The 457 has the same contribution limits as the 403(b) and 401(k). A few key differences as noted by 403bwise.com are:

  • Assets in a 403(b) are held directly by employees, while 457(b) assets are held in a trust for the benefit of employees.
  • There is no federal 10 percent premature distribution penalty imposed on withdrawals from a 457(b) plan when separating from service.

Additional catch-up contributions accompany the plan (5).

  1. Two times the current year’s normal retirement contribution limit, or
  2. Underutilized limits from past years. Note: Not all employers make this additional catch-up option available, nor are they required to do so. Check with your employer for details.

401(a) – Investopedia notes, “A 401(a) plan is a retirement savings plan normally offered by government institutions rather than by corporations. These plans are usually custom-designed and are only offered to key government employees as an added incentive to stay with the organization. The contribution amounts are normally set by the employer and are mandatory” (6).

Normally, each of the listed plans allows the participant to save money on a tax-deferred basis, with the tax benefit being realized now by seeing a reduction in income for the contribution amount. However, the new Roth provisions allow participants to put away money which has been taxed now and allow the money to grow tax-free. In this provision, tax diversification may be incorporated into a portfolio where the benefactor creates flexibility by hedging future tax rate changes. (Click here for a better understanding of tax diversification.) The Purdue plans allow for the Roth option on the 403(b) plan (7). Additionally, participants can save in multiple plans.

By creating a tax-diversified and investment-diversified plan, retirement planning will now be flexible.

Next StepsTIme for action

  1. Review your current plan for opportunities to improve your retirement picture by
    creating additional flexibility.
  2. Call me at 317-805-0840 or email me at ncarmany@thewatermarkgrp.com with questions or to review options.

 

Sources:

  1. “Traditional IRA.” Wikipedia. Wikimedia Foundation, n.d. Web. 22 June 2016.
  2. “Your 401(k): When It Was Invented-and Why.” LearnVest. N.p., 3 July 2013. Web. 22 June 2016. <https://www.learnvest.com/knowledge-center/your-401k-when-it-was-invented-and-why/>
  3. “Traditional IRA.” Wikipedia. Wikimedia Foundation, n.d. Web. 22 June 2016. <https://en.wikipedia.org/wiki/Traditional_IRA>
  4. “Publication 571 (01/2016), Tax-Sheltered Annuity Plans (403(b) Plans).” Publication 571 (01/2016), Tax-Sheltered Annuity Plans (403(b) Plans). Interna Revenue Service, n.d. Web. 22 June 2016. <https://www.irs.gov/publications/p571/ch01.html>
  5. Otter, Dan. “Wise Information for K‑12 Employees.” Other Plan That May Be Available: 457(b). 403bwise, n.d. Web. 22 June 2016. <http://403bwise.com/k12/content/18>
  6. “What Is the Difference between a 401(a) and a 401(k)? | Investopedia.” Investopedia. N.p., 2015. Web. 22 June 2016. <http://www.investopedia.com/ask/answers/060215/what-difference-between-401a-and-401k.asp>
  7. Snapshot of Purdue University Retirement Programs. West Lafayette: Purdue U, n.d. <http://www.purdue.edu/hr/Benefits/currentEmployees/retirement/pdf/Snapshot_Retirement_programs.pdf>

Where do I start the financial planning process?

Starting lineMost advisors today have clients start the planning in one of two places.  The most common approach with asset managers begins with a thirty- to sixty-minute conversation creating an outline of the investing history, philosophy, and experiences. An investor questionnaire and account paperwork soon follow.

Holistic financial planning, the second starting position, focuses on your goals.  Retiring at 65, sending three grandchildren to college, leaving a foundation, and philanthropic giving are a few examples. After understanding your goals in a ranked way, the advisor creates a funding plan for those goals.  The partnership continues with overseeing and execution of the plan.  While this approach includes more facets than the investing approach outlined above, the process still falls short.

Many of the goals become numeric representations of a resource pool instead of an understanding centering on the person’s unique needs.  Research shows that people create higher levels of happiness by focusing on living a virtuous life versus our current hedonistic tradition (1).

Knowing your core values yields the best results in creating a financial plan.  (Click here to find your core values.)  Not only will it allow a decision-making framework to develop, it will often make the decision-making process easier.  When promoting values take center stage, the correct course shows itself.  Note, though, that as people age, values change. Typically, transitions happen every two to five years.

Finally, knowing your values helps set up the two main ingredients for financial success: behaviors and managing expectations.

Behavioral finance and economics have expanded exponentially over the past ten years.  Fifteen years ago, economics classes taught that the prudent man acts in a reasonable and logical fashion.  Now we know that emotions drive most decisions and influence behavior.  Denial head inthe sandThe key to finding financially friendly behavior starts with removing as much emotion as possible by automating one’s finances.  For example, set up auto journals, transfers, and payments to important accounts. Set up mortgage payments to automatically pay more than the minimum. Emotion is removed and little recurring effort is needed to create a favorable financial setting.

Many times we prefer to not recognize changing circumstances and rising undesirable emotions. If we change our orientation to ask what the most likely outcome is, what the most desirable outcome is, and what the worst-case scenario is, we better adapt to changing environments. The element of surprise is removed, or at least reduced, lessening the impact of irrational reactions.

How does one manage the complex world of multiple accounts and taxation?

First, the focus should be on what NOT to do.  Financial planning for most people means earning the highest returns while avoiding market volatility.  Yet when these same people complete investor questionnaires, they recognize that the more return one wants, the more risk is built into the portfolio.  Also, other investors focus on avoiding taxes, leaving behind more fitting opportunities.

Establish a simple yet effective method using financial buckets to help navigate the complex financial world of today. Understanding how and when to access funds for specific events from a portfolio will not only help reduce stress, but allow you to create a better plan because you know how the bucket basics work. (Look at this series to better understand how to set up a bucketing method.)

Wrap Up

TIme for actionComplete a core values exercise to better understand what motivates you.

Examine your calendar and checkbook; can you see the core values represented in the time and money spent? If not, focus on what needs to change and align the two.

Develop goals and an action plan.

Automate your finances.

Check your progress.

Helping educators through this process supplies a high level of satisfaction.  If you have questions or concerns about your plan, contact me at ncarmany@thewatermarkgrp.com or at 317-805-0840.

 

Sources:

  1. The Pursuit of Happiness. The Pursuit of Happiness. N.p., n.d. Web. 07 June 2016. http://www.thinkadvisor.com/2011/11/28/the-pursuit-of-happiness