How do investors become wealthy? Do they inherit a family fortune? Do they win the lottery? Yes, these situations do occur for some people, but the vast majority of wealth in America is earned through work, and grown through wise decision making. It sounds simple enough, but can be challenging to implement for most Americans.
Myth: Wealthy people do not need financial planning because they are already rich.
The wealthy stay wealthy, and grow their wealth, because of financial planning. Sound planning covers a myriad of different concerns, such as income generation, investing options, insurance, estate planning and taxes. A successful wealth accumulator has a plan that addresses these key areas, monitors results, and makes adjustments when necessary. Many financially successful people focus their time on making money while relying on a team of experts to implement and monitor plan progress. The sad truth is 68% of Americans do not have a trusted advisor that offers financial planning [i].
Myth: Wealthy people do not need insurance and just self-insure.
The concept of insurance is transferring risk from your household to an insurance company, which serves as a powerful financial benefit. The cost of insurance may feel unnecessary, until an unforeseen circumstance occurs, and you are thankful you have it. Some of these unforeseen circumstances may include unexpected health issues, a car accident, or the sudden loss of a loved one. Obtaining insurance will help to offset the financial burden of these circumstances, therefore, protecting the wealth of the insured. As a result, insurance continues to be a powerful tool used by the wealthy to guard their assets. Further, financial planning is also a helpful resource in making sure that people are adequately insured, and not paying for insurance they do not need.
Myth: Wealthy people do not need to pay attention to their cash flow situation.
It is important to get a full understanding of your cash flows, both in and out. This means monitoring what types of income sources you have coming in, and being honest with yourself about what your outflow or total expenses are-including taxes. Once you understand what your cash flow situation looks like, it is much easier to avoid falling into debt and to set up a regular, monthly savings plan. If you currently do not have an automatic savings plan set up yet, start small with a monthly amount that you can afford, and then increase the amount as your income increases. With these savings, you can start to build an emergency fund, and then focus on your immediate goals like buying a home, saving for education, and eventually, retiring.
Myth: Taxes are inescapable and cannot be controlled.
Part of understanding your cash flow situation is understanding what you are paying in taxes. Although taxes are paid when income is earned (whether through an employer or through investment returns), taxes can be monitored, controlled, and legally reduced. According to the US Census Bureau, the average American college graduate will earn over $2.1 million dollars during their lifetime [ii] . If a conservative tax estimate of 20% is used, this graduate will pay $420,000 in taxes over his or her lifetime. One way to effectively reduce these tax payments is to begin saving in retirement accounts. If you are under 50 years old, you can save $18,500 to a qualified retirement account each year. If you are 50 and over, you can save $24,500 each year. These savings are able to come directly out of your paycheck tax free, and grow tax free until these funds are eventually withdrawn from the retirement account [iii].
Myth: If you have enough retirement income, you do not need to plan for retirement.
Most Americans are very concerned about what their retirement will look like as this is their lifetime primary goal [iv, v]. However, at retirement, many Americans will have different types of income and assets with different tax characteristics, and it is important to know how this all comes together. For example, say a couple needs $152,000 of income per year to maintain their lifestyle. This couple has $32,000 in Social Security, $55,000 in qualified dividends, $10,000 in long-term capital gains and $55,000 from a pension or 401k. In California, this couple will pay $3,439 in state tax and $11,136 in federal tax, representing about 9.6% of their income for that year. Although this may sounds like a lot of money, this tax bill can increase significantly more by changing one variable. Let’s say that all of the money comes out of qualified retirement accounts. If this is the case, that same tax bill moves from $14,576 to $31,000-more than double the original example! Consequently, knowing how taxes factor into your retirement planning is paramount to take into consideration [vi, vii].
Myth: Estate Planning is only for the wealthy and serves no benefit while you are alive.
Many Americans believe estate planning is only for the wealthy, or only produces benefits after death [viii]. However, by establishing a living trust, healthcare directives (along with medical and financial powers of attorney) are established as well. In the event that you are incapacitated physically or mentally, these documents will ensure you still receive the medical care that you have authorized, and have your bills paid each month. Further, upon passing, these documents will also ensure your estate avoids the expensive and public process of probate-a process that often invites distant family members and creditors to contest your wishes. Additionally, estate planning will provide instructions regarding who will benefit from your accumulated wealth, and how they should spend it [ix]. For example, if you are concerned one of your beneficiaries may have a spending or addiction problem, you have the option to provide them with income for their life, but never provide them with access to the principal [x].
In conclusion, successful investors have financial plans that effectively address all of the areas covered in this article. They are honest with themselves about which of these areas they are good at and are willing to do, and what parts they are not or do not care to do. For the areas where they are deficient, they find talented people to help them address these needs. So, with this, I ask you to have an honest conversation with yourself to determine what you are good at, and where a team of experts may provide you the expertise you need to help you achieve your financial goals.