EP 6: Making Money Simple (Part III)

by Peter Lazaroff | Jul 28, 2021 | Podcast

In the final installment of a three part series, Peter walks through the third section of Making Money Simple: The Complete Guide To Getting Your Financial House in Order and Keeping It That Way Forever.

The first episode focuses on creating a system for financial success. The second episode describes how to successfully invest to maximize the impact of a good savings system.

This third and final episode focuses on big financial decisions at critical junctions in life. When major financial decisions come only once or twice in a lifetime, it’s important to get them right.

Listen now and learn about:

Considerations when starting a family
Everything you need to know about buying a home
Decisions regarding estate planning, life insurance, and disability insurance
How to hire an advisor

Episode

Outline

When I outlined Making Money Simple, I wanted to give readers a clear starting point, focus only on the most important decisions to make, and share my savings system that quietly nudges your finances in the right direction without regular effort on your part.

The book is broken into three parts:

The first section is all about goal setting and building a system for financial success,
The second section focuses on investing
And the third section is about big financial decisions that happen infrequently, but are important to get right

I covered the first two sections in the prior two episodes, so this episode is the third and final installment of this series.

Let’s dive right into those big financial decisions!

When major financial decisions come only once or twice in a lifetime, it’s important to get to them right.

Chapter 10: Family Finances

Even if you don’t have a family, DON’T SKIP AHEAD, this chapter still has something for you. There’s valuable information on buying a home, which certainly applies to a variety of people in different stages of life. The decision to rent or buy a home is one of the most important financial decisions you will make and it’s important to get it right.

Plus, maybe one day you’ll have a significant other…

When you are single, you manage finances in a way that is comfortable and that you understand—no one must approve or disapprove of your financial decisions.

Couples, however, must agree on a system for budgeting, paying bills, and saving for the future.

Everyone feels differently about their finances. Different money personalities and levels of income require unique strategies.

I offer three strategies that can serve as a starting point for combining your finances and can be customized to better fit your situation.

Before I share these strategies, one quick callout is that these different money models are intended for couples who are married or have committed to a life partnership.
For couples living together who have yet to lock it down, it makes more sense to keep finances separate and divvy up joint expenses as you see fit.

1. Keep it Simple: Joint Accounts for Everything

Using joint accounts is the easiest way to combine finances.
Good communication is essential, so it’s important to maintain an open dialogue about money. One way to accomplish this is setting a spending threshold that requires spousal notification.
For example, some couples agree to tell each other about purchases greater than $250.
It isn’t intended to be an approval process whereby the other spouse signs off on the purchase before it’s made. Rather it is a way to ensure the lines of communication remain open.

2. What’s Mine Is Mine: Separate Accounts for Income and Spending

The opposite of merging finances is maintaining separate accounts, which allows couples to divvy up joint expenses and enjoy total freedom over their own finances.
Although having similar incomes makes this much simpler, couples with different levels of income can separate finances by assigning more expensive items like a mortgage to the higher earner and utilities to the lower earner.
Where things get trickier is saving for retirement or paying down debt.

This is not a set-it-and-forget-it solution because life (and your finances) get more complicated over time.

This system requires regular assessments of different assigned expenses, particularly as children enter the equation or career growth creates greater income disparity between spouses.
If you prefer making financial decisions that require less ongoing maintenance, then this system might not be ideal for you.

The Hybrid Model: Allocate Income to Both Joint and Individual Finances

Hybrid models allow each spouse to have some money of their own while most everyday expenses are paid out of a joint account. There are two methods for employing a hybrid model.
The first is the Percentage Model.
Here’s how it works: both spouses put 80 percent of their income into a joint account and 20 percent into personal spending accounts they hold separately.
The joint account covers everyday expenses like mortgage, groceries, meals together, vacations, medical bills, and long-term savings. Personal spending accounts might cover items such as clothing, personal electronics, accessories, gifts, or trips without the other spouse.

When using a Percentage Model, the 80/20 split is a starting point that can be tailored your personal circumstances.

For example, large income disparities may result in one spouse having much more personal spending money. In this case, consider changing up the income split—one spouse might put in 80 percent of income while the other puts in 40 percent.

The second hybrid model is the Fixed Dollar Model, which allocates a specific dollar amount of each paycheck to personal spending accounts and the rest toward a joint account.

Say one person earns a monthly after-tax paycheck of $10,000 and the other brings in a monthly after-tax paycheck of $5,000.
In this case, both spouses might put $1,000 a month into their personal spending accounts and then pool the remaining $13,000 into a joint account.

The Fixed Dollar Model gives everyone gets an equal amount of personal spending money.

For some couples, this works better than the 80/20 Model and reduces the sense of inequality.
I’ve also seen clients choose a variation of the Fixed Dollar Model in which the higher earner from the preceding example puts an extra $500 a month into his or her personal spending account.

The worksheets on peterlazaroff.com/resources are perfect for exploring ways to combine finances and discuss other family money decisions, including the unique expenses associated with having children.

I have a section on What to Expect (with Your Finances) When You’re Expecting.

I go through some ideas for how to accommodate the higher expenses that come along with children.
For example, when you are pregnant, I think it’s smart to immediately open a savings account and start a monthly contribution that gets you prepped for the less discretionary income. Plus it gives you a little kid-specific rainy day fund for unplanned expenses.

Next I talk about how saving for your child’s education.

There’s no denying the benefits of a college education. There’s also no hiding from the cost.

As with all savings goals, the earlier you start saving, the better you can leverage the power of compounding.
I go into great detail about the best vehicles and strategies for college savings,
but for the purposes of this particular conversation, I want to focus on two things to keep in mind when talking about saving for college

The first and most important thing to remember is that your child can always receive financial aid or take out loans to pay for college, but there’s no such option for your retirement.

Postponing retirement savings means missing out on decades of tax-deferred compound growth, and it may be hard to catch up later.
As the father of two children, I completely understand the desire to give your kids everything they need to get the best education possible.
My plan is to pay for my children’s college expenses, but I will always prioritize my retirement savings.
I’m pretty sure that if my children had the choice of taking out student loans or having me live in their basement during my retirement, they would choose to fund their own education.

The second thing to keep in mind is that you don’t need to save 100 percent of your children’s college expenses by the time they graduate from high school.

A good target college savings amount is 70 percent and plan to pay the rest from your cash flow at that time. There are a few reasons why:
- You can’t know that your child will even go to college. The ideal vehicles for education savings have penalties if you withdraw money for purposes other than education.
- Your child may receive a scholarship. You might end up with a large sum of money that doesn’t need to be used for higher education expenses, but you will be penalized for withdrawing it for any other use.
- It’s difficult to predict the type of college your child might attend. Until your child is in high school, it’s impossible to know whether their tuition will resemble an in-state school, an Ivy League school, or something in between.

Now that you know to prioritize your retirement savings and only target to save 70 percent of the projected cost of college, I’ll let you refer to the book for the best accounts and strategies for education savings.

The final section of Chapter 10 focuses on Buying a Home

Owning a first home is an exciting prospect.

It has long been part of the quintessential American Dream.
While owning your own house comes with many intangible benefits that are difficult to quantify, there is a financial aspect you must consider.
A house and its mortgage will likely be among the biggest items on your Net Worth Worksheet, so the math needs to be taken seriously.

When Does Buying a Home Make Sense?

Whether a home purchase makes sense depends on several financial and emotional factors. I share a series of questions and exercises that, when answered truthfully and realistically, will help you make an informed decision.

Admittedly, the exercises largely overlook the emotional considerations in buying a home, but my goal for this portion of the book is to help you make the best financial decision for long-term success.

I understand the frustration of paying rent every month and feel like you are throwing money away. But buying a home is not always the answer.
Payments on a typical 15-year or 30-year mortgage mostly go toward interest costs in the early years and the upfront costs of a purchase are significant, too.
If you plan to own your home for less than five years, then lower your expectations of building equity and understand that home ownership may have a negative impact on your net worth.

You’ve Decided to Buy. Now What?

Throughout the home-buying process, there is a lot of pressure to spend more than what makes sense for you. The publisher really wanted me to come up with a sexy way to calculate how much house you can afford, and I think I came up with something somewhat reasonable, but I’ll be honest that there is not a perfect equation for every situation and, more importantly, every geographic market.

I like to generate the three numbers and use that range to inform the decision of how much you can afford.
The exercise in the book uses a formula involving gross monthly income, the total amount of monthly payments you are making to other debts such as student or auto loans, the mortgage rate, and down payment.
The 2^nd number is simply 2.5x your gross income
The third number is choosing a home that results in a mortgage payment equal to 25% of your monthly income

An important thing to keep in mind when thinking about how much house you can afford is that just because you can spend a certain amount on a house doesn’t mean you should.

Common Mistakes People Make When Buying a Home

I close out the chapter with common mistakes people make when buying a home.

The biggest mistake people make is not living their long enough for the finances to work out in their favor.
Other common mistakes stem from viewing your home as an investment rather than a form of consumption.

Chapter 11: Big Financial Decisions at Critical Junctions in Life

This chapter focuses on some decisions that impact you and your family’s well-being: estate planning, life insurance, and disability insurance.

I can’t possibly do these three topics justice by quickly summarizing them, so I promise to cover each of them in greater detail in a future episode and I’ll also link to some of my blog articles that give you more than a preview on what is covered in the book:

But here are the headlines of the various topics for this chapter:

With estate planning, I explain:

why you need an estate plan,
the primary components of a complete estate plan,
what happens after you create your estate plan,
and common estate planning mistakes.
FWIW, I have a relatively comprehensive blog post on this topic that I’ll link to in the show notes.

For life insurance, I explain:

When Life Insurance Makes Sense and How Much You Need
What to Consider Before Buying Life Insurance (including the differences between the types of available life insurance and some guidelines for choosing the right type of policy for you)
Common Mistakes People Make When Buying Life Insurance, which is actually one of my favorite sections of the book because I share a series of common one-liners that insurance salespeople give when trying to talk you into a policy that might not actually be in your best interest.

Finally, for disability insurance, I explain:

The importance of disability, which took me personally a long time to really wrap my head around.
- You are more likely to become disabled during your career than you are to die.
- Accidents can happen everywhere and illness can strike anyone.
- If you’re like me and delayed this coverage due to it’s expense, my hope is that this section of the book is the prod you may need to stop procrastinating and start protecting your most important asset (your earning ability).
I also have a section that explains why most people don’t get disability insurance
And finally, I go through Considerations When Purchasing Disability Insurance,
- which I think is really important because it can be very high cost,
- but it can also be highly customizable to your needs if you know how to navigate the features and risk tradeoffs – so I go through all of that to help you with your decision

The content of this chapter is the densest and most complicated in this entire book.

While many people can implement an efficient system for saving toward goals and investing those dollars in a disciplined manner, it is a far bigger task to sufficiently plan for an unexpected death or disability.
Consequently, you may eventually find yourself needing to hire a financial professional.
Before hiring a professional, you must understand the different types of advisors and how to identify the right one for you.

That takes us to the final chapter…

Chapter 12: How to Create Your Own Team of Professionals to Help You Succeed

Financial planning is more like an ongoing full-time job than a one-time task to tackle. Hiring a financial professional often makes implementing a comprehensive financial plan easier and more effective.

As a financial planner, I’m obviously biased, but allow me to share a quick story from the book to give more context to my suggestion to hire help.

When I bought my first home in May 2010, I was dead-set on having a big yard.

With that bigger yard came bigger responsibilities.
Devoting time and effort to maintaining the lawn required about 90 minutes a week, but I always felt the time commitment was manageable.

There were some occasions, however, when I didn’t have time to cut the grass.

Sometimes that was due to other commitments and, admittedly, sometimes it was just due to laziness.
In an ideal world, fitting in 90 minutes for lawn care would be no problem. But in real life, things happen. Stuff comes up. Other opportunities present themselves that sound better than doing chores.

Postponing my yardwork meant dealing with much longer grass when I did get around to mowing it.

Longer grass meant it took more time to cut the next time, and the lawn didn’t look as nice.
It was even worse when I put it off a day without looking at the weather, only to be surprised by three days of rain. Then cutting the grass really became a problem.
But all and all, I got by just fine. My lawn looked pretty good and I didn’t see a reason to do it any differently.

That all changed the summer I hired a guy named Leo to cut my grass for $35 a week so I could spend more time with my wife and newborn son.

Leo did little things I wouldn’t have thought about or known how to do properly.
He periodically changed the direction in which he cut the grass to encourage healthier growth.
He fertilized and seeded strategically.
He cut the grass a specific length depending on weather conditions or an area’s exposure to the sun.
He edged around our flower beds and plants.
The end result was a dramatically healthier and superior-looking lawn. Not only that, but hiring Leo created time for me to focus on more important things in life.

People who take a do-it-yourself approach to any job—be it landscaping or financial planning—do so to save money or because they enjoy the work.

Do-it-yourselfers are also okay with “getting by just fine,” as I was with my lawn, but the difference between “just fine” and doing well with your money is significant.
Much like Leo did a variety of things to improve my lawn’s health and appearance, a financial professional does things you would never think to do.

“Building and executing a financial plan is not necessarily rocket science, but not knowing what you don’t know can seriously limit growth. Plus, mistakes can cost huge amounts of money.”

Unfortunately, the mistakes and missed wealth-enhancing opportunities aren’t always obvious to do-it-yourselfers because they don’t possess the tools to accurately evaluate their financial life.

There is an ongoing Vanguard study that estimates financial advisors add “about 3 percent” in relative return to an individual’s investments.

The book outlines the best practices that contribute to Vanguard’s estimate of a financial advisor’s value.
Of course, the value of an advisor is not consistent over time, you shouldn’t expect that 3 percent to show up each and every year.
There are times when fear or greed may tempt you to deviate from a thoughtfully-crafted investment plan. In this instance, your advisor could add tens of percentage points by guiding you to stay the course and avoid losses—such valuable interventions can offset a lifetime of fees.
It’s also worth pointing out that the study doesn’t attempt to quantify the value of comprehensive financial planning because, as the authors noted, we don’t need to see oxygen to know it’s beneficial.

While I am biased in thinking that choosing a good advisor is one of the best decisions you can make, I’m not naïve to the fact that choosing the wrong advisor can do more harm than good.

So the next section in the chapter focuses on choosing a financial advisor.

If you are going to hire a professional, the biggest investment you can make is in the time you put into selecting the right person.
This starts by understanding some of the major differences between professionals in the industry.
Even when two professionals go by the title “advisor,” it does not mean they provide the same service or adhere to the same ethical standards.

Differences in Standards of Care

Most people don’t realize that different financial professionals are held to different standards of care. The fiduciary standard requires that an advisor put a client’s interest first. Registered Investment Advisors (RIAs) adhere to the fiduciary standard, and they are regulated by the Securities and Exchange Commission (SEC), which enforces the rules around what it means to be a fiduciary.

Link in show notes: https://peterlazaroff.com/fiduciary/

Meaning of Various Advisor Titles and Credentials

Another area of confusion for consumers is the wide range of job titles and professional designations that people use to convey their expertise.

While a job title might have some relevance to a firm’s internal hierarchy, you can start with the assumption that all job titles are a form of marketing.
There’s no reason to worry about whether your advisor’s title is Wealth Manager, Planning Associate, Financial Planner, Portfolio Manager,Financial Consultant, Financial Specialist, Director, Senior Vice President, President, Principal, Partner, and so on.
The title doesn’t matter in the context of trying to find the best financial advisor for you.

While it’s a challenge to understand the services someone will provide based on a title, the hundreds of professional designations are perhaps even worse.

It is very rare these days to meet a financial professional without some combination of letters after his or her name on a business card.
The problem is that not all letter combinations require the same degree of expertise, knowledge, or training.

There are three designations I highlight in the book as being more meaningful credentials in the financial advice profession.

All three require extensive knowledge, continuing education, and adherence to a strict code of ethics.
They are: CFP, CFA, CPA

Link in show notes: https://peterlazaroff.com/the-best-three-designations-for-financial-advisors/

Differences in Compensation

The way financial professionals are compensated can impact objectivity.

Fee-only advisors are paid only by their clients, which creates an incentive structure with the fewest conflicts of interest.

The most common fee-only advisor is paid a percentage fee based on the amount of assets being managed, with that percentage fee decreasing as the account size increases.
Other fee-only advisors charge by the hour or set fixed retainer fees for financial planning services.
Because a fee-only advisor’s compensation is not tied to a specific product or strategy, they can objectively provide advice without being swayed by personal benefits.
This makes it easier for fee-only advisors to adhere to a fiduciary standard.

At the complete opposite end of the spectrum, a commission-only advisor earns income on products sold to the customer such as insurance products and mutual funds.

They also earn income from transactions made and accounts opened for customers.
The more activity a customer has, the more a commission-only advisor earns.
Remember, a commission-only advisor works for his or her company, not you.
The recommendations they make are filled with conflicts.

One final subtle distinction to note is between fee-only and fee-based advisors.

Fee-only advisors are desirable because they always act as fiduciaries and their compensation closely aligns their interests with a client’s interests.
Fee-based advisors earn some their revenue from fees paid by their clients, but also earn commissions from selling certain mutual funds, insurance policies, or brokerage products.
Fee-based advisors adhere to the suitability rules, which means their financial recommendations may not be in your best interest and those conflicts of interest are harder to uncover.

How to Choose an Advisor

1. Make a list of firms or people you know that you would consider hiring

2. Visit brokercheck.org to check each prospective advisor’s record for misconduct

3. Visit prospective advisors’ websites – this is a bit like juding a book by its cover, but a website contains valuable information about a person’s background and capabilities. You might also consider checking out the firm’s blog to see if they have content that is relevant to you.

4. Narrow down your list to finalists

Structured Interview

Send two or three advisors an email requesting a discovery meeting.

They will undoubtedly have questions about you, but your questions are going to be more important at this stage. Equally important is how you ask those questions.
People tend to ask different prospective advisors different questions, which makes comparisons tricky.
You also must contend with the human brain—specifically, our memories are worse than we realize and our decision making is often biased by unimportant factors.
The way to combat these issues is to hold a structured interview.

The structured interview process was made popular by Nobel Prize–winning psychologist, Daniel Kahneman, to help reduce the impact of bias on our decision making. However, the first time I saw it applied to hiring a financial advisor was in a column by Jason Zweig of The Wall Street Journal.

I provide a list of the questions for a structured interview, along with some commentary to help you identify responses that are in your best interest.

I also included some follow-up questions you might want to ask.
After this list of questions are instructions for how to conduct and score a structured interview.

For your convenience, you can download a Structured Interview Worksheet from peterlazaroff.com/worksheets.

Robo vs Hybrid vs Human Advisors

“Robo advisor” is the industry term for a digital platform that automates your investments for a percentage fee based on your assets under management (see Figure 12.2). This growing segment serves a huge segment of investors who were previously forced to do it themselves, which opens most people up for a plethora of mistakes, or work with brokers who weren’t required to act as fiduciaries.

Hybrid advisors go beyond automated investment portfolios by also providing financial planning through a digital platform you can use to track progress, make adjustments, and manage various goals. On top of the digital experience, hybrid advisors also provide you with access to Certified Financial Planner (CFP®) professionals to help further hone and personalize your financial plan.

Resources

About the Podcast

Long term investing made simple. Most people enter the markets without understanding how to grow their wealth over the long term or clearly hit their financial goals. The Long Term Investor shows you how to proactively minimize taxes, hedge against rising inflation, and ride the waves of volatility with confidence.

Hosted by the advisor, Chief Investment Officer of Plancorp, and author of “Making Money Simple,” Peter Lazaroff shares practical advice on how to make smart investment decisions your future self with thank you for. A go-to source for top media outlets like CNBC, the Wall Street Journal, and CNN Money, Peter unpacks the clear, strategic, and calculated approach he uses to decisively manage over 5.5 billion in investments for clients at Plancorp.

Support the Show

Thank you for being a listener to The Long Term Investor Podcast. If you’d like to help spread the word and help other listeners find the show, please click here to leave a review.

Free Financial Assessment

Do you want to make smart decisions with your money? Discover your biggest opportunities in just a few questions with my Financial Wellness Assessment.