When was your last financial check-up?

By Larry Simon, CPA

Nearly everyone has heard their doctor preach, at one time or another, about the need for routine check-ups. Yet, how often do you consider the need for a review of your personal finances? Finances are one of the biggest triggers of stress for both individuals and families, causing lost production at home and work. The time for a financial check-up is now!

Do you have financial goals? If so, are they in writing and do they include deadlines? Goals, both short and long term, are the road map to achieving good financial health. Your goals must address your saving and spending patterns. Your goals should include a retirement age goal, and a time frame for achieving financial security. They may include, among others, goals for education, large purchases, vacations, wealth transfer and charitable giving. These goals serve as a reminder of what you need and want and each goal should be measurable.

Is your debt under control? Do you pay off your credit cards each month? If you are among the 30 percent who pay off all their purchases every month, you probably have your spending under control. Look at your credit card statements. Can you remember what you bought with each charge? If you can’t remember what you bought, there is a good chance that you did not need it. Did you buy things that you really needed? Or was it for something that you just wanted at the time? Have you used all those things since you purchased them? Look at it this way: for every $1,000 you owe on your account, you could be paying $200 each year in interest payments. Do your math to see how much is flying out the window every month in interest.

Have you started a retirement fund yet? If so will your current rate of savings provide an adequate fund to meet your future retirement needs? Tax laws allow and encourage personal savings for retirement in various tax-favored accounts. They allow you to invest a considerable amount of money each year, which starting early and saving on a regular basis, will allow you to accumulate several million dollars in benefits. Review your needs, determine the amount you can put away and then determine which type of plan(s) will best suit your needs and goals.

Have you started a savings program to meet the cost requirements of your children’s college education? If so, will your current savings rate be adequate given the effects of inflation and rising tuition costs? College education costs, similar to health care costs, tend to rise much faster than the traditional consumer price index. In fact, the average increase in college education costs runs close to six percent while the long term average increase in the consumer price index is roughly three percent. What this means for parents who plan to support their children’s college education costs is that plans need to be made as early as conceivably possible in order to achieve this vital task.

By way of example, let’s assume, in today’s dollars, the cost of a private college, room, board and books currently cost $30,000 per year. With this cost, a rate of return of eight percent, after tax, and a regimented plan of savings which begins the year of the child’s birth, $6,800 would need to be saved and invested for college education each and every year, including the years while in college. These savings would yield, based on the hypothetical, a college fund of approximately $305,000, to support four years of education. (This is a hypothetical illustration and is not intended to reflect the actual performance of any particular security). If you consider a state university rather than a private college the needs and savings might be half of the foregoing example. Still a sizable annual savings goal, college savings is quite a challenge and one that requires early thought and consideration.

In today’s world, one of the most efficient ways to save for college education costs is to establish a Section 529 College Savings Plan for your child or grandchild. These plans, under current tax laws, enable earnings to grow un-taxed for both federal and state purposes and withdrawals utilized for qualified college expenses to be removed from the 529 College Savings Plan without federal tax consequences. Without making use of the tax efficient program such as this, the task becomes more daunting as any tax burden simply increases the amount which must be saved. In order to plan for this most important expense, parents or grandparents should develop a game plan and approach to funding these costs immediately, before the challenge becomes insurmountable. As with other investments, there are generally fees and expenses associated with participation in a Coverdell ESA or a 529 savings plan. There is also risk that these plans may lose money or not perform well enough to cover college costs as anticipated. Most states offer their own 529 programs, which may provide advantages and benefits exclusively for their residents. The tax implications can vary significantly from state to state. Note that 529 savings plan withdrawals are free of federal tax only through December 31, 2010, unless Congress acts to extend the current tax law.

Have you reviewed your life insurance and disability coverage recently? In the event of an untimely death or incapacitation, will your current policies provide adequately for your spouse and/or children? Are you one of the many individuals who have purchased a life insurance policy or disability policy years ago and never reviewed the policy or your needs again? In the case of life insurance, with increasing income and obligations for children, including their future education, insurance needs typically follow a pattern of increasing through most of your working life then possibly leveling off or decreasing as you approach and enter retirement. The reason is that, during this period of time, many individuals create adequate retirement savings, which eliminates the need for life insurance to provide financial resources to a surviving spouse and family. Where large taxable estates are created, the need usually continues to rise with time. Besides changes in needs, advances in medical science have prolonged typical life spans and generally made life insurance less expensive today than in the past.

In addition, a variety of life insurance policy design innovations have changed the landscape from a world of annual renewal term policies and whole life policies to a world of level term policies and guaranteed universal life policies, to name a few. If you have a variable universal life policy where the longevity and performance of the policy is directly impacted by the underlying investments, like mutual funds, which you selected, it is absolutely critical to review those policies, especially in light of the several difficult years in the stock market, to make certain the policies will provide the protection that was originally anticipated.

In the case of disability income policies, regular changes in income and frightening statistics which identify the likelihood of a disability event make it critical to regularly review your needs. It is not uncommon for older policies to be maintained and additional coverage added to them, if available, or new policies layered on top in order to provide for increased needs.

Other considerations as a result of a review of insurance could be structural in nature where policy ownership or beneficiary designations should be modified based on circumstances. As well, if the need for life insurance has dissipated, in past years it was common to stop paying the policy and cash it in if there was a cash value available. In today’s environment it is possible to sell insurance policies to an investor who may place a much greater value on the policy based on age and circumstances. For all of these reasons, it is critical for a periodic review of your policies to take place.

How do you make investment decisions: based on your personal interest and hunches or do you have one or several advisors? Are you comfortable with the level of risk associated with your current investments? Unless you are a sophisticated investor or someone regularly assists you with asset allocation decisions, it is likely an investment portfolio review will prove of value. All too often, investments are made on hot tips or selecting investments with the highest return last year. These strategies often fail on several fronts. First, in advance of coming up with a long-term investment strategy, it is crucial to identify the investment time horizon, individual investor risk parameters and goals for investment returns. Many factors weigh into the results, including: the purpose of the investment – which could be buying a car, a home, funding college education or retirement, the length of time to achieve that goal; the investor’s risk preference, be it conservative, aggressive or somewhere in between; the investors age; and total financial resources.

As a result of carefully considering these items, an asset allocation strategy should be developed making use of diversified asset classes. Over time the best performing and worst performing asset classes will constantly change and studies have shown that asset allocation is the largest contributing factor to successful portfolio performance. Contrasting an appropriately allocated portfolio to the hot stock selection method, what is typically found is that a well-allocated portfolio is much less volatile in overall performance than the performance just before a hot stock was purchased, followed by abysmal performance once the stock or asset class falls from favor. Going with the hot tip or looking the rear view mirror is certainly not the tried and true way to create serious wealth over time. It could prove to be more like a wild roller coaster ride than an investment plan.

For these reasons it is important to seek out appropriate advice if you do not consider yourself a sophisticated investor.

Larry Simon, CPA, is a Managing Director with Margolis Financial Services, LLC and a Financial Advisor with Raymond James Financial Services, in Bala Cynwyd.