A believer in continuing professional development, Eric Dostal obtained the CERTIFIED FINANCIAL PLANNER™ Professional (CFP®) designation, and graduated with a JD from St. John’s University School of Law. Eric recognizes the challenges investors face when planning their retirement and therefore he helps clients retire when and how they would like. Eric focuses primarily on providing affluent and high net worth individuals with expert, comprehensive and impartial financial planning advice to help those individuals achieve their unique life goals.
After joining Sontag Advisory in 2013, Eric has worked extensively with clients over the past 4+ years to create and implement their unique financial plans. Eric has demonstrated a high degree of skill developing and overseeing the investment, insurance, retirement, tax and estate planning strategies of his clients.
Eric currently lives in Merrick, New York with his wife Jamie and daughter Madeline. When not in the office, you can often find him spending time with family and friends. He also recharges by sitting down with a good book and honing his culinary skills.
JD, St. John's University School of Law
B.A. - History, SUNY Geneseo
You are missing the time value of money. Let’s assume you purchase the UL policy when you are 40 years old for $50,000. You have an outflow in year one of $50,000. If you were to pass away the next year, at age 41, the internal rate of return (IRR) of the policy would be 276% – a great rate of return!
However, it is highly unlikely that you will die at age 41 and the insurance company knows this. What’s more likely to happen is that you will live until you are ~93 years old. If you do, the IRR for the policy drops from 276% to 3%. All the insurance company needs to do to make money is out-earn a 3% annualized return on your dollars.
Additionally, $188,000 in today’s dollars adjusted for an annualized inflation rate of 2.1% would have the purchasing power of ~$59,000 fifty-three years from now. In essence you would be paying $50,000 today to give your kids $59,000 in inflation-adjusted dollars about fifty years from now – an IRR of 0.31%. That is the time value of money.
Instead of buying the insurance policy, let’s assume you invested the $50,000 in a moderately aggressive portfolio comprised of 60% equities and 40% bonds, earning an annualized 5% return. In the same 53 years, the initial $50,000 you contributed would have grown to ~$660,000 or $215,000 adjusted for 2.1% annual inflation. So, would you rather leave your kids $59,000 or $215,000?
The same analysis applies to the $20,000 initial outlay policy with the $1,056 annual premiums, except that it’s worse. If you were to live to age 93, the IRR of the policy, unadjusted for inflation, would be 0.83%, and the $100,000 would have the purchasing power of ~$32,000 today.
Life insurance policies should rarely, if ever, be viewed as investments. They are a way to transfer the risk of your untimely death away from your loved ones by providing a means for their support and well-being. A well-diversified portfolio will serve you much better in the search to leave behind a legacy for your children.
I will give you three pieces of advice. First, pay yourself first. Before you spend any money on food, clothing, housing, entertainment, vacations, whatever you can think of, be sure you have put aside something for yourself. It is best if you set up an automatic transfer that corresponds to your paycheck deposit. Even if the amount is small, get into the habit of saving regularly and consistently at the beginning of your career. This habit will reap huge dividends for you in the future.
Second, invest your savings prudently. As your savings balance grows, many individuals will come to you with ideas of how to invest your money for the future. Be sure to take a critical eye to all of these proposals. Ask as many questions as you can. Decipher how the person you are speaking with is paid. Ask them to explain their underlying assumptions, go beyond the materials presented to you and dig into the details. Ask if they invest their own money in this way, and if the answer is no, ask why. Many individuals are highly experienced in personal finance and have the tools and the knowledge to guide you on the right path. It is your responsibility make sure that the person you are working with is one of these individuals.
Third, appreciate your greatest asset, time. Right now, the most powerful force you have going for you is time. The dollars you invest today will work and grow for you for the rest of your life. Those dollars will earn more dollars, which will, in turn, earn more and more. This phenomenon, known as compound growth, is extremely powerful, but it takes time. Know that this is a lengthy process, do not get discouraged, and enjoy the ride.
First, congratulations on graduating! I’m going to take your questions one by one:
-Where do I find a financial adviser?
If you choose to work with a financial advisor I would recommend using a CFP® Professional. As outlined on the website: “Certified Financial Planner™ professionals have completed extensive training and are held to the highest ethical and educational standards. CFP® professionals understand the complexities of the changing financial climate and will make financial planning recommendations in your best interest.”
-How in the world do I pick the right one if I go this route?
You need to find someone you are comfortable with and who has the knowledge to help you. You should choose someone who has a fiduciary responsibility to you, meaning they must put your interests ahead of their own. I would look for someone who is a fee only Advisor, does not get paid on commissions, and who is employed by or registered as a Registered Investment Advisor (RIA). These factors are not the only thing that matters, but it is a good starting point for interviewing advisors to see who would be a good fit for you.
-Does a financial adviser help with investments or is that left to wealth managers?
A comprehensive financial advisor will help you will all aspect of your financial life, from setting up the investments in your portfolio, to creating a financial goal plan to meet your needs, to providing insurance and tax advice.
-Taxes- (I know next to nothing about taxes) would a financial adviser help with taxes?
Yes, a financial advisor should help you with tax planning. The level of planning necessary will vary depending on the client’s particular situation. Some financial advisors prepare tax returns for their clients, others work closely with the accountant to provide the information necessary to prepare your return. Generally, it is the financial advisor’s responsibility to understand their clients’ individual tax situation and to recommend actions that will benefit them.
-I always seem to hear about more and more investment tools beyond the simple 401(k) or IRA/Roth IRA, what are the ones I need to know about and utilize?
You have mentioned several types of “retirement” accounts. These accounts are tax-advantaged plans that derive their existence from the Internal Revenue Code. There are other types of retirement plans, (Simplified Employee Pension Plan (SEPP), Cash Balance Pension Plans, 403(b), 457(b), 457(f), Keogh, etc.), which you might have access to. Generally, these types of plans are only available through an employer or if you own your own business.
-I own a decent car. Should I sell it, put the proceeds to work in the markets and take on a monthly payment?
What you would essentially be doing is leveraging your portfolio, which can be a risky move. You would be borrowing money to make an investment, at historically low interest rates, which could lose value. I would not recommend selling your car to invest in your portfolio. Now, if you decided to trade in your car for a cheaper model, I would suggest you put the excess you received in an emergency fund until you have about 6 months of living expenses saved.
-If I did something like that, should I buy or lease?
I always recommend buying a car rather than leasing, but that’s generally because I try to keep cars until the transmissions falls out of them. If you like to change your vehicle often, don’t drive very much and don’t want the responsibility of ownership, than leasing can be a good idea. Very often though it works out to be more expensive to lease a vehicle than to own one.
-I want to diversify my investments outside of the stock market, but it seems like that's the only readily accessible vehicle to do so. How and what else should I look into?
There are many asset classes outside of the US stock market that you can invest your dollars in. A well-diversified portfolio should be constructed out of an asset mix that uses both US and International Equity, Fixed Income (Bonds) and Alternatives. However, the asset allocation of an investment portfolio (the percentage invested in stocks, bonds and alternatives), is far more important in driving your returns and volatility than any individual security or fund selection is. When selecting a proper risk profile we look at two primary components; risk ability and risk willingness. Risk ability is focused on your ability to achieve your financial goals based upon a certain allocation. Risk willingness is focused on your emotional level of comfort with volatility throughout different market cycles.
-Is there an entry level way to take advantage of the incredibly low interest rates currently available?
We talked about leverage already, any amount that you would borrow to invest would be using leverage. I would recommend looking at possibly refinancing any student loan debt you may have. There are many companies out there that are offering competitive refinance opportunities.
-What % of my take-home pay should I save, invest on my own, put into a 401(k), etc.
First, you need to establish an Emergency Fund in cash to cover 3-6 months of non-discretionary spending. Once you have this established, you should contribute to your 401(k) an amount equal to your company match. If after that you are still able to save more, I would generally recommend increasing your contribution to your 401(k) until you reach the maximum. This can change depending on your individual goals. For example if you wanted to start saving for a down payment for a home or to start a business those funds should be saved outside of retirement accounts.
-What should I do to earn and improve my credit?
You need to open credit lines (credit cards), use them to make purchases and pay your statement balance in full when it is due. By establishing lines of credit, using that credit wisely and paying on time you will improve your credit score.
-How many credit cards should I have?
Generally I would recommend having between 1-3 credit cards to build up your credit score.
-What % of my available credit line should I spend?
You should aim to keep your outstanding credit between 1-9% of your total amount available. Again, you should pay off the full statement balance each month.
I hope that I have been able to answer some of your questions. I understand that taking on these items is a large undertaking, especially when you don’t have a background in the subject matter. Keep asking questions, it’s the best way to make sure you are getting the right answers.
The thing you are going to need to pay attention to is the “Kiddie Tax." The net unearned income, (income earned from something like a required minimum distribution), of a child under the age of 19, or age 24 if a full-time student, is taxed at the parent’s marginal rate. Net unearned income does not include: 1) the standard deduction of $1,050 (2016); and 2) the next $1,050 (2016) of income which is taxed at the child’s marginal rate (typically 10%). This means the Kiddie Tax applies if a child’s unearned income in a tax year is greater than $2,100.
Given the market value of the inherited 401(k) of ~$25,000 and your daughter’s age, the required minimum distribution from the account should be around $350. As outlined above, you could withdraw up to the standard deduction amount of $1,050 without paying income tax and another $1,050 while typically paying a 10% tax rate. Anything above $2,100 would be taxed at your marginal rate, the highest rate applied to the last dollar you earned.
Unfortunately, to be able to contribute to a Roth IRA an individual needs to have earned income during the year. Earned income refers to income derived from things like wages, salaries, tips and other taxable employee pay. Income derived from retirement accounts does not count. As such, your daughter would be ineligible to contribute to a Roth IRA unless she has another source of income.
Your best bet is likely to leave the funds in the former 401(k) and withdraw only the required minimum distributions each year. This will allow the 401(k) to continue to grow tax deferred. You can then place the distributions into a UGMA/UTMA account for your daughter’s benefit or use them to pay for some of her expenses.
It is easy to get caught up in the daily media coverage about rising interest rates and bond returns, forgetting why you own bonds to begin with. Fixed Income serves two equally important roles in a balanced portfolio: 1) to provide return, and 2) to manage portfolio risk. With rates as low as they are, the expectations for future returns from fixed income are quite low. However, this is not a good reason to shift assets away from fixed income and into riskier assets as it ignores the risk management and diversification benefits of bonds.
Investors tend to succumb to two major mistakes during periods of low expected bond returns:
- Mistake 1: “Reaching for yield”
- Many investors have taken on excessive interest rate risk and/or credit risk in order to generate high streams of current income in today’s low interest rate environment.
- I believe this is a dangerous, short-term oriented way to invest.
- Mistake 2: Letting short-term, mark-to-market losses impact long-term asset allocation
- We should not let short-term market sentiment drive the long-term asset allocation decisions of our portfolios. It is a given that when rates increase, bond prices generally fall. However, trying to predict exactly when this will occur and making top-down changes to a long-term allocation because of short-term fears can be far more harmful to your portfolio than a single period of negative bond returns.
For diversified portfolios, a high quality and diversified bond allocation plays a critical role in managing portfolio risk, regardless of the prospects of future returns. Predictions of interest rate movements are no better than stock market predictions. In 2014 the market consensus was that interest rates would rise and just the opposite occurred. I prefer a consistent, diversified, long-term allocation that can weather different types of interest rate environments. If interest rates rise quickly, the value of a high quality bond portfolio will decline. However, assuming that the bond issuers do not default and that coupons are reinvested, the losses stemming from a rise in rates are not permanent. As monies are continually reinvested at the new, higher rates as coupons are paid and short-dated bonds mature, the momentary decline in value should be recouped over time. History has had very few multi-year holding periods of high quality bonds with negative total returns. Even during a historical period of skyrocketing rates, high quality bonds have still been far less risky than stocks.
Given your age and the fact that you are currently in retirement, an investment portfolio comprised mainly of stocks does not seem to match your risk ability, even if you are willing to have a higher equity allocation. I would advise you to seriously consider adding a fixed income allocation to your portfolio to reduce some of the risk you currently have.