What is a “fiduciary” and why do you care?
You may have been hearing or reading more and more about financial advisors being held to a “fiduciary” standard and you probably wondered why that mattered. Up until now, stockbrokers and other advisors at firms receiving commissions (e.g., wirehouses, insurance companies, banks, broker dealers) were held to a “suitability” standard, which meant that they simply needed to recommend investments that were suitable to each client’s situation from a risk and time horizon perspective. In other words, if an investor said that they were risk-averse, then the advisor couldn’t invest in high risk investments (aggressive stocks, high yield bonds) in their account.
To contrast that, Registered Investment Advisors and Certified Financial Planner professionals are held to a “fiduciary” standard meaning that when they advise their clients, they must put their clients’ best interests first. The difference is that if there were two comparable investments with the same objective, one with a high commission being paid to the firm (and the financial advisor) versus another low-cost, no commission fund, a financial advisor held to a “suitability” standard could legally recommend the fund with the higher commission because it was suitable for the client, even if it was not in the client’s best interest due to the high commission! A proposed law would require that all financial advisors be held to the same fiduciary standard. What is interesting is that an article in the Wall Street Journal (WSJ) on July 19th (http://online.wsj.com/article/SB124536973514629609.html) reported that these changes to put the client’s best interest first could “upend” Wall Street! I think most people working with a financial advisor already assumed their needs were being put first, even if that was not the case. Fascinating how this change to better the investor’s experience could cause such turmoil!
Another article more recently in the WSJ on August 29, 2009 stated “Wall Street finally has agreed to put its brokers under the tougher fiduciary standard for their dealings with customers. Now a fight looms over how tough that standard will be.” I vote to make it as tough as possible. Investors deserve to know that their interests are always put first.
Budgeting…a simpler way?
Budgeting…that dreaded word that conjures up images of grueling, detailed entry of every single purchase into software like Quicken that will result in a myriad of pie graphs that tell you…what? Why do we even do budgeting?
From a financial planning perspective, cash management, or budgeting, is the first step to get control of your finances. Where is your money going every month? Are you in the positive and saving, or are you relying on credit cards to get by each month and pay required expenses? If you’re newly married or starting a family, what are your future goals, such as purchasing a house or saving for your child’s college education? Budgeting can tell you what you can afford to pay in extra monthly expenses or savings, and how long it will take to reach those goals. If you’re approaching retirement, how much do you need to withdraw from your savings, investments or retirement accounts to meet your needs? It’s important to understand the difference between a “need” and a “want”, especially if you have to cut back, such as in this volatile economy.
Some financial experts will tell you that your first step is to take a notebook with you everywhere you go for a month, writing down every expenditure – specifically the cash ones – from your daily latte at Starbucks to the magazine at the store and other “luxury” items. Others will tell you that you need to buy software such as Quicken or Quickbooks and download or enter your bank, credit card, and investment statements into the software then categorize every expense in order to produce graphs that show you where your money is going. Both are good ideas, however, I think the idea of all that work scares a lot of people away from the concept of budgeting. Although keeping track of all of your expenses in a software would be good, truly only 9-10% of all people consistently keep up with it. Most of us don’t have the time or interest to keep it up.
So at a high level, what are the key questions to ask yourself first about cash management?
1) Are you putting away money each month for your future goals?
2) Are you avoiding accumulation of ongoing credit card debt each month?
3) Do you feel in control of your finances?
4) Do you have a good idea of where your money is going every month?
Where do you go from there? When you want to get into the details, there is a great budgeting article written by Liz Pulliam Weston, a personal finance writer, that is available on MSN Money: How Much Should You Spend On… (concept based on a book written by Harvard bankruptcy professor Elizabeth Warren and her daughter Amelia Warren Tyagi called “All Your Worth: The Ultimate Lifetime Money Plan”) The gist of the article is that you need to review your current expenses to determine if they fall into the 50/30/20 budget.
The basic idea is that 50% of your total after-tax expenditures should go towards your “must haves” or your required monthly commitments, such as mortgage payments/rent, utilities, minimum loan and credit card payments, insurance, child care and transportation.
Then 30% is your “wants”, which includes vacation, clothing, eating out, and entertainment. This is the area that can be cut back, if necessary, when times get tougher.
Finally, the 20% should be savings towards goals and debt repayment.
I’ve seen a lot of budget guidelines over the years and this seems to be a simpler way to make sure that you are spending prudently and putting away money to meet future goals. As Liz Pulliam Weston says, “It’s simple, if not easy.”
If your “must haves” far exceed 50% or you’re having trouble keeping to your personal monthly budget, then it makes sense to take a closer look at your budget and at that point one of the more in-depth budgeting tracking tools could be used for awhile to assess your spending habits. If needed, there are other methods of budgeting to control the spending of your “wants” through withdrawing that designated amount in cash each week or moving those funds to a separate account to make sure you stay within your budget.
Obviously, we all go through life transitions where we can’t stick to our long term plan, whether it’s a job change, illness, disability, or debt has accumulated to the point of necessitating drastic measures such as debt consolidation or bankruptcy. The 50/30/20 budget gives us some guidelines to follow when we aren’t dealing with those extremes.
I’d love to hear your comments about your experience with budgeting or what you think about the 50/30/20 budget.
