Knowledge is power. We all know teaching someone to read will change their life. That’s true in the financial world too. People are reluctant to admit what they don’t know. But as financial advisors, we have a passion for helping others follow their dreams. Part of that is education. Part is really listening to what people want and need. Part is reading between the lines to see with our hearts as we help others articulate and plan for what they find truly meaningful.

There’s a difference between financial literacy and financial planning literacy. Financial literacy is what we desperately need to teach in the schools so that people know how to balance a checkbook or live within their means or, most importantly, save so that they can move forward with their goals. Financial planning literacy, at least the way I’m using it here, is how you put these building blocks of literacy together to create strategies, to understand the context of how to make financial decisions and to increase your knowledge about practical topics you’ll need throughout life.

We’re just starting to see more of an emphasis on financial literacy in the schools. That’s long overdue and will have a major impact on making effective decisions about money matters and life choices. But what about everybody that’s already through school and already immersed in life? Financial planning literacy will focus on life events, understanding terminology about sometimes complex concepts so that you can find the right answer for you.

So while it’s important to organize your financial records and do some analytical work, it’s just as important to get out in nature, immerse yourself in art, music, sports—whatever you love, and surround yourself with what brings you joy. Think about why that’s important. Think about what you want more of and what you want less of. Now let’s go figure out how to change your life for the better. That’s financial planning literacy.

The Dreams of WealthTM series of books helps you navigate the world of personal finance. Sometimes knowing what NOT to do is just as important as knowing what to do. Here’s a sneak peak from Financial Planning Literacy to help you get started dreaming your own dreams of wealth.

1. Asset Protection

It’s not going to do you much good to build up your wealth if you let it slip through your fingers. Any number of catastrophes can occur along the way. Have you really protected yourself and your family?

Do you have adequate life insurance? If you died tomorrow, would your spouse or loved ones have money to pay some of their biggest expenses like college or paying off the mortgage? Would they be able to stay in your house and still be able to pay the bills?

Life insurance can help protect the assets you’ve built up by sheltering them from estate tax and providing income replacement for your family. This is especially important when you have young children, a non-working spouse and/or a big mortgage. You’ll want to consider these needs as you weigh the cost of life insurance.

Another potential wealth destroyer is the dizzying cost of medical care in your later years. Have you considered long-term care insurance? According to the U.S. Department on Health and Human Services, almost 70% of people age 65 and older will need some type of long-term care in their lifetime. Many people are in denial about long-term care. If you don’t have a family friend or relative who has gone through this type of treatment, you may not have given it much thought at all.

For those of you who have experienced it first-hand, you know the physical, mental, and financial strain it can bring to the whole family. Does everyone need long-term care insurance? No. The very rich can self-insure and the very poor won’t be able to afford it. They may be eligible for Medicaid. For everyone else, it’s worth taking a look. There are traditional types of policies and hybrid policies that combine life insurance or an annuity with long-term care insurance.

Finally, consider how you are protecting your personal property. Is your home protected from fire, weather disasters, theft? Take a look at your home owners insurance to be sure. You should also have adequate coverage on your auto. If you or someone in your family had an accident, would your insurance company pay for the damage? What about law suits that could arise from an accident? Check to see what the underlying liability coverage is for both homeowners and auto insurance.

Protect yourself from property lawsuits by purchasing an “umbrella” policy. These policies build on the underlying liability levels in your homeowners and auto policies and take your coverage up to the $1,000,000+ range. The more wealth you’ve accumulated, the more umbrella coverage you should carry.

2. Managing Cash Flow

The financially literate know that they must be disciplined in their spending. It’s so easy to let expenses creep up as you make more and more money. If you’re not careful, those expenses can kill your chances of capitalizing on that wealth. The first rule of any good financial plan is to pay yourself first. Make sure you are putting away a healthy portion of your income and investing it. Don’t trip over the pitfall of living beyond your means.

Another aspect of managing cash flow is reducing taxes. As your return gets more and more complex, you may need to find professional help to take advantage of deductions you’re entitled to. Your accountant or financial advisor can also help identify other opportunities like additional retirement funding vehicles, mortgage refinancing strategies and/or estate planning techniques. If applicable, you should be discussing ways to use capital loss carryforwards (from past investment losses) to your advantage.

During your working years, it is critical that you carry disability insurance to protect your income stream. Many of you can purchase this coverage through your employer. Take advantage of the opportunity to protect your income should something prevent you from working. It’s far more probable that you’ll have a disability claim than a life insurance claim, and yet many people ignore this important coverage.

3. Debt Management

A well-run company knows how to manage its debt. You need to think about debt management in your personal life too. Look at your shorter-term debts first—things like credit card debt, car loans, bank loans (other than mortgages), student loans, etc. Examine the interest rates you are paying on each loan and try to consolidate your debt at a lower interest rate.

Mortgages can be a good way of managing debt. You get a tax break and rates are at a historical low. But even with your mortgage you should exercise some caution. Taking on more debt makes it harder to adjust should you find your circumstances change (i.e. you lose your job). Many people are finding that they can shorten the length of their mortgage (i.e. refinancing from a 30-year to a 15-year) while interest rates are low.

And don’t forget to consider the best way to cut mortgage costs: buy a less expensive house in a less expensive area. Now that COVID-19 has many of us working remotely, this has become a reality for many more people.

4. Investment Strategies

Even if you’re able to generate a considerable amount of income, you have to know how to protect and preserve that capital. I can’t tell you how many new clients come in saying they had fun buying their securities, but they have no idea when or how to sell. You need to make sure you’re in the right place for your goals in life and your ability to handle risk. And don’t forget to consider taxes!

One pitfall a lot of people have experienced in the past few years is misjudging risk tolerance. When the market keeps going up, it’s easy to think you can handle the risk. But after seeing significant drops in your portfolio, some of you may be re-thinking how much risk (or loss) is acceptable. If your mix of stocks, bonds and cash (your asset allocation) makes you uncomfortable, you need to think about repositioning your portfolio so that your asset allocation is in line with your ability to handle risk.

If you have incurred realized losses in the course of managing your portfolio, you can try to make the best of it by being tax-savvy. No one likes to lose money, but those losses can be a benefit at tax time. You can use $3,000 a year to offset ordinary income. You can net out an unlimited amount of capital gains and losses against each other. Any losses you can’t use right away can be carried forward indefinitely. This is just one of many techniques you can use to create a tax-efficient portfolio.

Behavioral finance is a hot topic today. Basically it’s the study of why people act irrationally. There are patterns that can be quantified of why we make stupid mistakes over and over. One of those is overconfidence when it comes to choosing investments. Of course we want to think we have superior knowledge and insight when it comes to choosing the next great stock. But studies show again and again a passive—or index—approach works better over the long-term for most people.

5. Managing Windfalls

Sometimes life hands you a little something extra. Maybe it’s stock options or an inheritance or some other once-in-a-lifetime event. Now that you’ve got that money, what do you intend to do with it?

Many of you will benefit from professional advice in these types of situations. There are almost always tricky tax implications. For stock options, you have to understand what type of tax you may trigger upon exercise or sale of your shares: ordinary income tax, capital gains tax, alternative minimum tax or all of the above. Careful planning can help you keep more of your windfall.

Over the next ten years, $15 trillion will pass from generation to generation. Make that $68 trillion in the next 30 years. Most heirs have no idea how to integrate that wealth into their own portfolios. You’ll need to give careful thought to which inherited securities are appropriate for your own situation and which securities should be sold and re-positioned.

The Secure Act makes this even trickier if you inherit an IRA. You’ll have to take that money out over ten years.

6. Getting the Most from Your Retirement Plans

Sadly, the majority of participants in company retirement plans don’t put away anything close to the maximum contribution. For 2021, you can contribute $19,500 ($26,000 if you are over age 50 and your plan allows it) to 401(k) plans, 403(b) plans and 457 plans. If you have a Profit Sharing Plan, you may be able to sock away as much as $58,000 a year ($64,500 if over age 50).

If you are at the executive level of your business, in addition to the “qualified” types of plans discussed above, you may be able to take advantage of “non-qualified” plans. These plans allow you to put away money and defer paying tax on the income until a future date when you take withdrawals. They have fewer restrictions than qualified plans on how much and who can contribute. The downside is that you cannot rollover these plans (in general) to an IRA. When you take distributions, they are immediately taxable. Good planning can help you make the most of these opportunities.

7. Retirement Drawdown

One of the biggest fears retirees have right now is running out of money too soon. Poor market performance just heightens that anxiety. You need to spend time thinking carefully about what you’ll have coming in during your retirement years as well as how much you expect to spend. You should seek professional help to quantify the probability of whether your assets will provide the type of retirement you’ve envisioned.

Even with careful retirement planning, there’s always going to be change. You’ll need to revise your plan as time goes by. A healthy dose of common sense goes a long way. In times when the economy is sluggish and the stock market is gloomy, you can at least control your own expenses. This can mean voluntarily tightening your belt by spending less as well as choosing investments with low costs.

All too often I see retirees make the mistake of thinking they can spend whatever their portfolio returns. When you factor in taxes, inflation, required minimum distributions and investment costs, that can be a major miscalculation. Run a financial independence analysis or, better yet, have a financial professional run one for you. This is an especially vulnerable crossroads for most people.

8. Estate Planning

The estate planning arena is loaded with financial literacy pitfalls. Many of you may not have any plan in place at all. That’s your biggest pitfall. The best way to care for your family if something happens to you is to put an estate plan in place. Procrastination is probably the biggest enemy of financial security.

Other potential pitfalls include setting up a plan but forgetting to fund your trusts, forgetting to change your beneficiary designations on life insurance, company benefits, IRAs, annuities. Your planning should include considerations for disability as well as death. Powers of attorney for health care and property can help if you are disabled. So can living trusts. A good estate attorney or financial advisor can walk you through what’s appropriate in your situation.

9. Educating Heirs

One of the biggest concerns for families who have been successful with financial accumulation is how to teach their heirs how to responsibly manage that money when they eventually inherit. You can set up children’s trusts within your estate documents that stagger the ages for access to the money over time. For example, instead of giving the children all of their inheritance at age 25 when they may not be emotionally ready for it, you can give them part of it at age 25, another portion when they are 35, etc. If they “blow” the first installment, there is still a chance they can make the most of the remainder of the estate.

Having family meetings during your lifetime can also go a long way towards educating your loved ones on how to manage that wealth. It can also head off potential family squabbles over what your intentions are with respect to your assets.

10. Making Time for Your Financial Life

Perhaps the biggest mistake I see people make financially is just not paying attention. Life gets busy and it’s easy to lose track of what’s happening with your money. Once a quarter, carve out an hour or two to go over your financial diagnostics: your mind map, your net worth statement, your tax situation. If you’re within ten years of retirement (or in retirement), then take time to review your plan. Ask yourself:

  • How much are my assets worth? Is that more or less than one year ago?
  • How much is my overall debt? How much have I repaid over the last year?
  • What savings goal am I working on now? How much progress have I made?
  • How am I doing on my spending versus my budget? What changes do I need to make?
  • What’s next to accomplish with my personal finances? Review taxes? Set up estate plan? Fund the kids’ college? Run a financial independence projection?

Whenever possible, automate your savings and debt-repayment goals. If you are saving for a particular goal, set up monthly asset transfers from your checking account to your investment account. One of the real secrets of building wealth is to just slowly and consistently save and invest. The same principle works in paying off debt. Just commit to at least a certain amount that you will pay off each month and have the money moved from your checking account to whatever you are repaying. You’ll see steady progress in the right direction if you commit to doing this (and refrain from adding to your debt!).

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Now that you know what you’re up against, it’s time to take action. The rewards are well worth it. Half the battle is avoiding the worst pitfalls that everyone worries about. Understanding the issues and taking action will set you on your path to your dreams and greatly elevate your financial planning literacy.

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Disclosures
The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.