Seven Benefits of Financial Literacy with One Bonus!

 

If you are thinking about hiring a financial adviser, you might be wise to read my experience of unethical “advisers” who took full advantage of my naivete to impose perfectly legal hideous commissions and high costs.

My financial story is remarkably simple. I have always given people the benefit of the doubt, even though I was taken advantage of when I was younger, which cost me $6000. I call this the youthful “tuition” of getting wiser and knowledgeable about everything financial, and now helping others. Some may regret this negative and costly experience for the rest of their lives. I do not. I did something about it—my suggestions about what I do now are contained in this blog post.

I started saving for retirement when I was a young teacher. A few years later I eavesdropped on two gentlemen talking at a party about annuities. One said to the other that “annuities were not a good plan.” No other investigation or reading was required to motivate me to find out about my annuity. I investigated what I had in my portfolio, and he was right. My annuity contained a surrender cost for retrieving my money, so I asked my “advisor” to put me into a plan with no surrender costs. She nodded in agreement and put me into another plan. A few years later I found out the second plan also had a surrender fee! I was so livid, I decided to become financially literate, so I’d never be taken advantage of again.

After years of managing my nest egg without a financial adviser, I noticed that friends, colleagues, and relatives were not interested in the basics. Many of my teacher colleagues seem not to mind about their money in annuities. Others wanted handholding but didn’t know how to find an adviser. So, I came up with the following seven benefits. You do not have to be a full-blown financially literate investor to benefit. As you read about my current experiences, you might realize that you know more than you think. Second, I boiled down the potentially complicated search for that financial adviser so that you could make an educated guess on what you wanted from him or her as you prepared to interview potential advisers.

Gain an understanding of the investment process (financial literacy). Investors can confidently:

1. save on taxes,
2. protect your assets,
3. set up an estate plan/will/trust,
4. save money for education,
5. save money on insurance premiums,
6. be financial literacy role models,
7. live a stress-free life by practicing frugality.

But the bonus benefit is saving money by paying a certified financial planner (CFP) only by the hour when such services are needed. If you want to acquire a financial adviser or change the one you have, this post will help you prepare. Without preparation, you will pay more than you should, and doesn’t take a lot of your time.

Financial advisers that I personally know or read about have informed me that they do all the above, and more. Further, they wanted to make it clear that financial professionals do much more than construct a diversified portfolio with low-cost funds and manage it from then on. I agree. Constructing a diversified portfolio is what fiduciary advisers do with their eyes closed: it’s so simple for them.

But the point of this chapter is to convince you of the ensuing benefits by first knowing the investing process and then construct your portfolio. All seven benefits listed above magically appear as a byproduct. It is amazing! They look so straightforward and comprehensible that you will quickly gain the confidence to begin to manage your finances without an expensive adviser, or be prepared to hire one more efficiently.

Let us discuss each benefit point by point. I will share my decision-making process of which professionals I hire to do a specific task and what I pay them.

1. Save on Taxes: Taxes are complicated, so let’s only discuss how to prepare your investment portfolio before filing your IRS return. When we sell a capital asset (real estate, bonds, stocks, jewelry, precious metals) and you make more than you paid, that profit is a capital gain. The same tax principle applies to our after-tax retirement funds (IRAs, 401k, 403b, and 457b are tax-deferred until taken out and taxed as ordinary income, not capital gains). IRS wants to know. When we trade a stock or a fund, all mutual funds and brokerage firms must report the capital gains on Form 1099 to the IRS.

Passive Strategy. Not trading is the key to keeping capital gains taxes low. So, I introduce the index fund. Index funds are naturally tax-efficient by lower turnover compared to actively manage funds (Many studies and books support this). With minimal trading, the investor would get tax-efficient investments by lower capital gains taxes.

Long-Term and Short-Term tax rates. The other benefit is holding the index fund for a year or longer. Long term capital gains are usually lower than short-term. Buy and hold your assets for a year or longer to qualify for the lower capital gains taxes. All I can report is that any time I distribute money from my investments, I occur long term capital gains or sometimes harvest a tax loss. For the record, I also must distribution from my IRAs because I am over 70.5 and that money is taxed as ordinary income (I let my taxman figure this out and I suggest that you also consult a tax professional. My Vanguard rep shows me how to harvest a tax loss).

By investing in index funds for many years you automatically get a low turnover. When you eventually take out your money for retirement, as I currently do, you will pay long term capital gains. How cool is that?

However, the decision to hold it for a year or longer is up to you. I have most of my money with the indexing capital of the world, Vanguard Group. Vanguard discourages excessive trading, with restrictions on trading built into their system. All I do is hold my index funds for a year or longer. If you do so and then sell it, you will capture the long-term capital gains tax rate. I feel confident with my long-term buy and hold habit because my fellow Vanguard investors also employ many years of long-term thinking.

Hiring a Tax Expert. For my annual IRS 1040 filing of taxable income from a pension, social security, and investments, I pay $485.00 to a tax professional for that specific (and complicated) task.

As we discuss each benefit, carefully notice which professionals I hire and pay for a specific task. I hire specifically for household, mechanical and medical assignments and these professionals are paid by the hour or the project. My problem is addressed, and the professional walks away, fully paid. Both the professional and I are satisfied.

2. Protecting your assets. Fiduciary advisers have been recommending a vital balance between stocks and bonds for a long time. For decades, pensions, endowments, and foundations construct balanced portfolios with stocks and bonds. This balance is nothing new, but it is the basis for protecting your assets when markets crash. For example, I am 72 years old, so I hold about 70% in bonds and 30% in stocks. This simple asset allocation is also called the “stock-bond split.”

This split protected my portfolio from huge losses during stock market crashes in 2008 and 2020. In 2008 I only lost 11.8%, and in 2020, my portfolio declined quickly by about 8%. Just as quickly, it rebounded within three months.

Unfortunately, financial advisers reject this “based on age” split because it is too simplistic and is a broad-brush approach to a complicated asset allocation with protection. In my opinion, they are categorically wrong for two reasons. First off, it is that simple! How do we come up with an appropriate stock-bond split that protects our assets as we age? They argue that you need equity exposure to keep up with the standard of living during our retirement years. I agree again. Of course, we need equity exposure. I want a return on my investments which will keep my portfolio growing for the rest of my life.

According to the Vanguard Portfolio Models, the 30% equity/70% bond allocation returned 7.3%. That’s plenty of return for my needs as a retiree. Of course, others’ needs may be different from mine, so it is flexible enough to adjust. Yet many respected professionals recommend a higher allocation than 30% to stocks for somebody in my age bracket. I disagree vehemently. I am risk-averse, and I need this money for retirement. I refuse to put my portfolio at any more equity risk.

Target Date Funds. What is laughable is that most financial experts and employees love the popular target-date funds in the employer’s retirement plans. The same stock/bond split principle applies. Target Date Funds are managed for you and do the rebalancing out of stocks and into bonds as the employee ages! They are offered by most fund companies.

3. Set up an estate plan/will/trust: If people knew the investing process, they would know who in their family could handle a lump-sum inheritance and who could not. And take immediate precautions for those that cannot. In addition to my tax man, I hired two additional professionals. I paid them a onetime fee for their expertise:

1. a financial adviser to take over my plan when I become incapacitated. He is not getting paid now, but he will get an asset under management of 1.0%* (AUM) when I can no longer handle my affairs.
2. I hired an attorney and paid him a single fee of $1,900 to set up a trust (@ $450.00 per hour).

The attorney and my financial adviser knew each other. I explained how I wanted three of my descendants to be given their share over time, rather than a lump-sum. For the rest of my descendants, I instructed them to set aside their share for their children’s college tuition. If I become incapacitated, the financial adviser will start getting paid at 1.0% assets under management to tend to my financial needs while I am still alive. When I die, my financial adviser will manage my estate as detailed in the trust.

4. Education Planning: Parents, grandparents, or other relatives may be motivated to help pay college tuition for their younger family members. By knowing how to invest, you will find the money to plan for your retirement AND plan for your young relatives’ college (529 college saving plans). Since I do not have children, my estate plan is to provide money to several family members for tuition purposes (My seven grand nieces and nephews). The real legacy for your children, grand, and great-grandchildren is more than college tuition and is next.

5. Be a financially literate role model: I would think many adults want their younger relatives to be financially literate. But first, you must learn some investing basics. People who are living below their means and investing wisely are, by definition, setting a role model for their younger relatives, and friends.

For my great 9-year-old niece and 11-year-old nephew, I set up a custodial account with Vanguard Uniform Transfers to Minors Act (UTMA) Brokerage Account. Their mother and I act as the custodians. My idea is for the children to learn about Vanguard and let them choose the investments. We hope they will experience, firsthand, how money grows using the stock and bond market. At age 18, it is their money. They can continue to leave it invested or use it for another excellent investment—education.

6. Save money on Insurance: Keep insurance coverage and investments SEPARATE. Do not try to be cheap when it comes to insurance protection (umbrella, autos, home, long-term care, and earthquake) No matter what your age bracket, take your insurance protection seriously.

I gladly pay the premiums. I spend annual total premiums of about $5000 for all my insurance protections. Paying for insurance for my investments (a.k.a. annuities) is not a good idea. Annuities are incredibly complicated, expensive, and the returns are pathetic. Thus, I save on insurance by keeping my investments and insurance separate. My stock/bond split, diversified portfolio, and my conservative asset allocation is my “insurance plan” for my investments, at a huge cost elimination.

7. Live a stress-free life through frugality: This is the best benefit of all. So much has already been written and said about the benefits of frugal living. There are thousands of financial blogs and podcasts, but you can start reading the super-frugal living guy on the planet, Mr. Money Mustache. He alone started the 21st-century youth movement called Financial Independence Retire Early (FIRE) or just Financial Independence (FI).

These investors are not only financially literate at a young age but amazing, anti-consumers who get it! They saw the mistakes their parents made, and suffered from it, during the 2008 financial crisis when their portfolios were not balanced and unnecessarily lost much of their savings. Many millennials were forced to go back home because of job losses, and no emergency funds. Plus, the older generations’ excessive spending chained them to a job they do not like and a stressful life with chronic monthly mortgage and auto payments for big homes and new cars.

The F.I.R.E. millennials want a different life, and to be financially independent at a much early age than older generations. Additionally, they want to be prepared, and immune, for the next financial crisis. When anybody, not only the F.I.R.E. community, begins their retirement nest-egg, the money must be found. Cutting costs in living to save and invest for the long term has a long and colorful history. Many people who lived modestly still acquired millionaire status.  What you do with your income is more important than your income level.

Intuitively, financially literate people know how to cut the costs of three primary life expenses: home, auto, and investment. Read their blogs and listen to their podcasts. They are everywhere with insightful personal stories that are inspiring to all of us. I am proud of their anti-materialistic principles and opting for quality of life.

The Bonus! By simply knowing how to construct an indexed, diversified portfolio, you can save a ton of money on financial advice. 

My seven benefits cover much ground in the financial literacy curriculum, and some details have been left out for brevity. But I hope you get motivated to take advantage of the benefits. It is your money. Your adviser does not need to be your tax man, trust attorney, or your insurance agent. Most of us already employ these professionals. Your adviser’s job is keeping you and your portfolio on track to reach your goals, whether in the working years or in retirement. If you use my example, you will have those parts of your financial planning covered with set fees to those specific professionals.

You can discuss the same standard of fees I illustrated in this article with your financial adviser. Garrett Planning Network requires that their advisers sign fiduciary oaths and accept hourly payments, but you must request this arrangement. Inform the potential adviser that you already have a rough draft of a diversified portfolio, insurance protection, have set up a will or trust, and you have a tax-efficient portfolio with a tax professional for your annual IRS reporting. You want the adviser to look at the portfolio, adjust as needed, and stick with your plan.

Unfortunately, not all advisers accept hourly pay. After explaining what you will bring to the table and the adviser explicitly refuses the hourly fee, report the adviser to Garrett immediately (Read this blog post for an unfortunate story of an adviser I reported to Garrett).

Hiring a financial adviser can be almost as complicated as becoming financially literate. But by reading this post, you have started to “believe it or not” that you can achieve a level of confidence that you might not have known before. In the final analysis, financial advisers can do three things that genuinely add value:

1. They can help you set up your portfolio and lead you in the right direction: long term thinking, reasonable returns, no mixing of insurance with investments.
2. After your portfolio is constructed, they can assist in rebalancing between stocks and bonds, making sure your beneficiaries are current, and harvest a tax loss. If you are retired, they can assist in setting up cash flow with taxes in check and purchase a low-cost immediate annuity. Yikes! Yes, I said that! (This is ONLY for retirees who do not have a traditional pension).
3. Finally, according to many financial adviser experts, the most impactful benefit is behavioral coaching. This is defined as helping clients stick to their financial plan.

But ONLY hire them by the hour, as you do with all those other professionals. Two insights you will gain by your financial literacy:

1. You understand and agree that your financial adviser needs to be paid by you writing a check.
2. Being financially literate is where the joy pays off, knowing that you are helping yourself and your loved ones to live a financially independent and stress-free life.

Now, save some money and be a financial role model for your entire extended family!

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Steve’s BIO

Stephen A. Schullo, Ph.D. (UCLA ’96) taught in the Los Angeles Unified School District (LAUSD) for 24 years and UCLA Extension teaching educational technology to student teachers. Steve wrote investment articles for the United Teacher-Los Angeles (UTLA) union newspaper for 13 years. He has been featured and quoted in many mainstream media articles about 403(b) plans, including the Los Angeles Times, NY Times, and U.S. News and World Report. He co-founded an investor self-help group 403bAware for teacher colleagues and wrote 7,500 posts in three investment forums since 1997. He testified at California State legislative hearings and honored with the “Unsung Hero” award by his teacher’s union for his retirement planning advocacy.

For the last 14 years, he serves as a volunteer on LAUSD’s Investment Advisory Committee as a “Member-at-Large” and former co-chair. The committee contains collective bargaining reps from the unions and monitors the district’s tax-deferred retirement plans, 457b/403b, of 55,000 former and current LAUSD employees, worth $2.8 billion in total assets.

He started this blog in 2012 to help all PreK-12 public school educators nationwide, especially his Los Angeles Unified School District colleagues. He belongs to a small national group of 403(b) advocates (mostly teachers) who want to bring closer attention to the 403(b). During the last 25 years, 40 newspaper articles have been published and each one says the same thing, TSAs (Tax Sheltered Annuities) are terrible 403(b) plans and the salesperson gets the benefit from lucrative commissions and high-costs. Nobody in educational leadership reads these articles NOR talk about the proper place for annuity products publically. We come together at 403bwise.com and 403bwise Facebook page https://www.facebook.com/groups/349968819000560/ Come on over if you want to join us so we can help our colleagues avoid these self-conflicted and high-cost Tax-sheltered Annuities (TSAs).

Steve is the author of two books, Late Bloomer Millionaires and Fighting Powerful Interests: Educators Challenge Tax-sheltered Annuities and WIN!, a story of how a handful of LAUSD educators struggled for years to improve the 403(b) to no avail. But we never quit! We were instrumental in LAUSD’s implementation of the new 457(b) plan and earned a very rare, but very precious “Plan Design” award. 

For a copy of both books, email Steve at steve.schullo@latebloomerwealth.com and he will happily email you both books, FREE with no obligation except to read them and get informed, in a pdf file format.