The top 15 rules for Special Needs Finance

When clinical psychologist and author Jordan Peterson released his book 12 Rules for Life he created a sensation.  The book grew out of Peterson’s hobby of answering questions posted on Quora where he sought to answer the question “What are the most valuable things everyone should know?” His twelve rules were distilled down from an original list of 40 different topics.  His book immediately jumped to the top of Amazon’s best seller list, where it has remained since.  Whether you love him or hate him doesn’t really matter.  I think what we can all agree on is that we inherently love the concept of a list of things!

Don’t believe me?  Lists are everywhere these days.  You can’t go a day without seeing some kind of list populate on social media.  There’s lists of every kind.  Here’s a list of the top 10 illegal exotic pets, and here’s one for the top 10 most expensive fountains! Even in the financial blogging world, everyone has a list.  Take for example Lifehacker’s 10 Good Financial Rules of Thumb, or The Simple Dollar’s 60 Simple Rules of Personal Finance. You get the picture.  Why do we like lists?  Well…here’s a list.

  1. They make us more productive.
  2. They make our lives easier to manage.
  3. They calm us down.
  4. Our brains love lists!

Since lists are seemingly virtuous,  I thought it appropriate to create at list of important rules for finance for special needs families.

The top 15 rules for Special Needs Finance

  1. Make Sure You Need it….You Probably Don’t.

There are truly very few things we actually need.  If you subscribe to Maslow’s hierarchy of needs, you have a ready-made list of priorities.  According to Maslow at the bottom of the list is the basic fundamental needs that have to be met for human survival (e.g. water, food, etc.). Once a person’s physiological needs are met, focus then turns to safety.  Once you can survive naked and afraid, you can focusing on developing a tribe and human connections.  Belonging to a group provides you love and affection.  With love and affection, you can derive esteem from others and yourself.  Once you have esteem you are finally able to achieve you individual potential. heirarchy

So how does that translate to finances?  Well, there is a financial hierarchy of needs as well.  First you must be able to provide enough income for the basic necessities (eg. Rent, utilities, groceries).  You then earn enough income to provide your necessities and pay off your debts.  Next on the hierarchy is the accumulation phase; the debts are paid off, and you’re earning enough extra to save for the future and your inevitable retirement.  The fourth goal is to be self-sustaining and wealthy enough to live off of your savings and reach financial independence.  The final self-actualization phase at the top of the pyramid where you can focus on giving back to your community and achieving your life calling.

As you lay out your needs, you will quickly notice that buying that new TV, or leasing a new car doesn’t seem to necessarily fit in your hierarchy.  If you compare the joy of the near term purchase, to the joy you could attain from being independently wealthy and being able to give back to society….it doesn’t even compare.  Perhaps that “need” is really a “want”.  So make sure you truly need it….you probably don’t.

  1. Stop Worrying

We all worry.  Living a life of a Special Needs Family is cause for worry.  I get it; it just isn’t all that helpful to spend time worrying.  There is a real benefit to a positive outlook.  It makes you healthier and helps you to develop grit.  In turn, grittier people perform better in life and are more likely to achieve their personal goals.  Having a positive outlook will allow you to focus on what’s truly important and make good decisions as it pertains to your life choices.  So stop worrying, and spend your mental and emotional energy on tasks that actually help you achieve your life goals.  Stop worrying, and get gritty instead.

  1. Focus on You, Every Life is Different

Don’t get caught up with the Jones’.  Their life has little reflection on your life.  They can’t possibly know what you are going through.  They have their own problems, you just may not be able to see them.  It’s easy to wallow in self-pity and put our own problems on a pedestal.   It’s easy to look externally and see how other people are living and get jealous of the choices they have made.  It’s human nature.

You have your own values and goals.  Your values drive YOUR decisions.  The way you invest your time and money should align with those values.  Because values are intrinsically personal, your choice of how you spend your time, and what you invest your money in will ultimately reflect what is important to you and your family.  Do a budget.  What do you see? Are your values and actions in consonance with your goals?

  1. Instant Gratification Isn’t Gratifying

Humans are predisposed to instant gratification.  We live in an instant society.  Microwaves, Netflix, Amazon Prime, iTunes, Facetime, and food delivery services are all examples of how life has become more instant.  If we want it we can have it, and we can have it now.  Life is pretty great in 2018!

Regrettably, there is a real danger with instant gratification.  Achieving your financial goals is not an instant endeavor.  Sure, some people can get rich quick.  But they also can get poor even quicker.  It’s not about the numbers, rather, it’s about the life choices you make along the way that reinforce your behaviors.  It’s about a deliberate plan to invest over the long-term to achieve your goals and your willingness to sacrifice in the near-term for something great in the long-term.  It’s also about the discipline to stick to the market when you’re living through a signficant downturn.

Studies have shown those who can focus on the longer term outcome and develop the will to withstand short-term temptations tend to have better life outcomes.  Focusing on your future and limiting your impulses in the present may even help you keep off extra weight! Sleep on it overnight, or two or three. You’ll be glad you did.  You will stave off the impulse purchases, and you will develop positive savings habits.

  1. Only Focus on What You Can Control

There is a lot outside of your control; government benefits, Social Security solubility, healthcare and housing trends, interest rates, and the stock market just to name a few.  In your life you may not control the prognosis for your child, the advancement in medication and treatments, or the availability of school aides and therapists.  Because there is so much outside of our control….it is a waste of time and energy to focus on what you cannot effect.  Rather, spend the time focusing on what you can control.  You can control the way you treat your family and neighbors and the relationships you develop.  You can’t control your market return, but you can control your spending and your savings rate.  You can control your discipline and effort.

  1. Everyone Has Baggage…It’s Ok to Move On

If you’re like me, you’ve made some bad financial decisions in your life.  I bought a Janus mutual tech fund back in 2000 at the height of the tech bubble.  It was a total loss.  Janus isn’t even in business anymore.  I followed the herd and paid for it.  There was also that very expensive whole life policy I purchased when I was 23.  I couldn’t afford the premiums and let it lapse.  You might have some baggage too.  Perhaps you were burned badly by a poor investment, or someone masquerading as a financial planner.  Maybe you panicked and sold your stock portfolio during the 2008 downturn while it was at the bottom.  I’m here to tell you, it’s ok.  Time to move on.  You can’t achieve your objectives without a little risk.  With risk sometimes comes loss, but also the potential for great reward.  You’ve gained wisdom through experience; Learn from it.   Time to get back in the game.

“There are no secrets to success. It is the result of preparation, hardwork, and learning from failure-” ― Colin Powell

  1. Invest Early and Often

Harness the 8th wonder of the world….compound interest.  By beginning to invest at a young age you can reap the advantage of having a long time to compound the return on your investment and will develop the benefit by establishing a savings habit.

For example.  Say beginning at age 25 you are able to save $500 per month and earn a return of 7% compounded monthly.  You would have $1,235,771 at age 65 when you finally retire [Figure 1].  Now what if you didn’t start saving early.  Instead you waited until life conditions where more optimal.  When you try to catch up and save $1,000 with the same 7% rate of return beginning at age 45, you would only have $507,536.38 at age 65 when you retire [Figure 2]. You’ve invested the same $20,000 with the same growth rate in both scenarios.  However, in the first scenario, your money has twice as long to grow and you end up with more than twice as much at retirement.  The benefit of saving early and relying on the power of compounding is it doesn’t take a lot of money to get started. Even small amounts invested regularly can make a significant difference to your retirement portfolio.

  1. Make Good Risk Decisions and Diversify

“No one can predict what the stock market will do or which mutual fund will outperform in the future. This is why we diversify — so that whatever happens we will not have all our money in losing investments.”- Bogleheads’ Guide to Investing

Choosing a mix of different kinds of investments (stocks, bonds, REITs, etc.) and maintaining that mix are among the most important ingredients in your long-term investment success. This means creating an investment plan based on your goals, risk tolerance, financial situation, and time available.  The goal is to select an asset allocation that gives you enough peace of mind that you can sleep at night, and avoid the urge to sell when the market plummets and prevent the tendency to sell low and buy high while still taking enough risk to achieve your objectives.

There are some general rules of thumb you can use to determine the appropriate mix of assets.  It essentially comes down to how much risk can you take.  If you are young with plenty of working years ahead and can generally count on a steady stream of future earnings, you can assume a little more risk.  If you’re a bit older and closer to retirement you may want to be a bit more conservative.  Stocks typically provide more long-term growth, but they can also be unpredictable and subject to the whims of the market. Bonds, on the other hand, are usually more stable but offer less of a return.

asset allocationSo back to the rule of thumb.  Subtract your age from 100. The result is the percentage of your savings that should be invested in stocks. The remainder should be in bonds. For instance, if you’re 40 years old, you should have 60 percent of your funds in stocks and 40 percent in bonds.  This is the basic model.  For those who are ok with risk and have a stable income, use 110 as your base instead (eg. 110-40=70 percent stocks and 30 percent bonds).

At least once a year, you’ll want to “rebalance” your portfolio because your returns will throw your ratio out of whack over time.  If stocks perform well and bonds poorly your percentage of stocks in your portfolio will have grown too big in relation to your bonds.  To rebalance you can either sell the stocks and purchase bonds which essentially allows you to sell high and buy low, or you just add to your bonds with your subsequent contribution.

Want to learn more about asset allocation?  Read this, this, this, and this.  Also here are some examples of properly allocated portfolios.

  1. Never Try to Time the Market

“The only value of stock forecasters is to make fortune-tellers look good.”- Warren Buffet

Instead of market timing, use routine and automatic investing instead.  Each month set a fixed amount to invest.  That fixed amount will purchase shares at the then-current prices. As share prices decline, the fixed amount will purchase a higher number of shares. On the other hand, when stock prices increase, the fixed amount buys fewer shares. By following this method you don’t need to worry about investing at the top of the market or trying to determine when to get in or out of the market and thus avoid the urge to time the market.  Rather, overtime you are averaging the number of shares you purchase.  The highs and the lows are dampened with enough steady contributions.

  1. Always Take the Match

Ever heard that there is no such thing as a free lunch?  Truth…except when it comes to your 401(k). If your employer is providing you a match…you take it. A match is when your employer will match whatever contribution you put towards your 401(k) up to a certain amount. For example, if you choose to put 3% of your salary into your 401(k), your employer will put that same amount in as well, in effect doubling your contribution.  I like free money…and I bet you do to.  If you empoyer offers it, take the match.

  1. Use Index Funds and Keep Costs Low

The less you pay, the greater your share of the returns you keep.  Low expenses mean that you get to keep a greater portion of market returns where they can continue to compound rather than being siphoned off by a mutual fund manager.  Studies have shown Indexing’s consistent low costs result in greater than average relative performance over the long-term.  A higher expense and/or actively managed fund would essentially have to beat the Index by the cost difference, year after year to even match its performance.

As for performance, Rick Ferri conducted some extensive analysis that captured the value of index investing over active management. He found that Index funds have a higher probability of outperforming actively managed funds when combined together in a portfolio.  A diversified portfolio holding only index funds in all asset classes is difficult to beat in the short-term and becomes more difficult to beat over time. An investor increases their probability of meeting their investment goals with a diversified all index fund portfolio held for the long-term.

Say you saved $100,000.  Your mutual fund manager charges you a 1% fee to manage the fund.  1% of $100,000 is only $1000 after all.  Seems reasonable doesnt it? However, you don’t just lose the seemingly small amount of fees you pay, you also lose all the growth that money might have had for years into the future, compounding over and over. Over 20 years the difference between a 7% return  and a 7% return minus a 1% fee  is $72,853! The good news is there a several mutual fund companies that offer low cost Index funds.  Fidelity is one.  Vanguard is another.  Vanguard’s average fee is only .11%. Save yourself a headache and a significant amount of money.  Go with Index funds and keep costs low.

  1. Minimize Taxes

Intuitively we know how powerful compound interest is over time.  Taxes drag on your performance because you are losing the compounding game every time you have to pay taxes on any of your capital gains.  For example, say you have the same $100,000 invested in a mutual fund.  After 20 years at 7% appreciation your account is worth $386,968.45, having gained a whopping $286,968.45 in interest.  Great news for you….even better news for the Government!  The IRS wants a slice of those gains.  Because you held onto your investment for over a year you are subject to long-term capital gains tax.  If you are married and make between $77,400 and $480,050 you will owe 15% of your gains to the IRS.  That equates to a tax bill of $43,045.  Not awesome.  Wouldn’t you prefer to keep that money working for you instead?

While an investment strategy shouldn’t be based solely on taxes, it should still consider any opportunities to manage, defer, and reduce taxes so you can keep more of your earnings and keep harnessing the power of compound interest.  The easiest way for the average investor to blunt the effect of taxes is to defer them and let your gains compound without interference.  You defer taxes by the use of tax-deferred accounts offered by retirement savings accounts such as 401(k)s, 403(b)s, and IRAs.  The two most familiar tax friendly accounts are the Traditional and Roth IRAs.

Traditional IRAs may reduce your current taxable income (if income eligibility requirements are met), and any investment growth is tax-deferred. The downside is that after age 70½ there are required minimum distributions (RMDs). So not ideal if you have plans on passing part of your retirement savings to your beneficiary.

With a Roth IRA or a Roth 401(k) you contribute after-tax dollars and investment gains are tax-deferred.  Withdrawals in retirement are tax-free, provided some conditions are met. Unlike Traditional IRAs, a Roth has no RMDs during the lifetime of the original owner so they are useful for estate planning.

If you hold funds outside of a retirement account you can still limit the effect of taxes by “tax-loss-harvesting.”   A loss on the sale of a stock can often be used to offset an equal capital gain up to $3,000 in taxable income annually. This is usually done during rebalancing your allocation.

  1. Stay the Course

You, not the market, is the single most important factor in how your investment performs.  Humans are emotional beings, and as such, investor behavior tends to be illogical.  This does not lead to wise long-term investing decisions.  We tend to buy high and sell low because of fear, panic, or hubris….the complete opposite of what we want to do.  Every time you have the urge to tinker, or change course, listen to noble laureate Eugene Fama instead:

“Your money is like a bar of soap. The more you handle it, the less you’ll have.”

  1. Don’t Let Life Take What You’ve Earned

So you’ve been a diligent saver and you’ve done all the right things.  Early in your career you started investing, you’ve socked away a portion of your income each month into a low-cost index portfolio, you allocated properly and you’ve taken the company match.  And then life happens.  Perhaps you get laid off and can’t find a job for a period of time.  Maybe there is an extended hospitalization for your child.  Or worst case scenario maybe you or your spouse pass away.  Life is going to happen at the most inopportune and unexpected times.

Don’t let life take what you’ve earned.  Build a solid emergency fund to help you weather these unforeseen events.  Purchase an appropriate amount of life and disability insurance.  The last thing you want to have to do is deplete your retirement savings when you have to account for the unforeseen.

  1. You Won’t Know Everything and That’s Ok….Find Those That Do

You don’t know everything.  I certainly don’t.  Special needs financial planning is just too complex.  It’s nearly impossible to keep up on all of the changes to state and federal law.  The tax code is constantly tinkered with by Congress.  Government benefits fall prey to budget cuts and rule changes.  You’re busy.  Busy caring for your family and progressing your career.  Busy with life.  And that’s ok.

Recognize that you don’t need to know everything.  You just need to be willing to ask for help.  Seek out and develop professional relationships that can benefit your family.  Find a good attorney to draft your Special Needs Trust and estate planning documents.  Develop a relationship with an insurer who you can trust to provide you just the right amount and right type of insurance for your unique situation.  Find a CPA who understands the complexity of trusts and tax impacts.  If you are uncomfortable with many of the concepts in this post, find a good financial advisor who can help you along the way.  It’s ok to get help.

 

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