Independent, Fee-Only Financial Advisor

Independent, Fee-Only Financial Advisor

Tuesday, May 23, 2017

How to make an emergency savings fund

Creating an emergency savings fund/account/plan should be the first step in your financial plan. I've written about its importance before, but never actually dedicated a post to the topic. It is fairly straightforward, but here are some important considerations.

What goes in an emergency fund? Money. Cash. The thing is, we don't know what an emergency will look like so it is important that your emergency fund can cover all sorts of weird situations. Cash is king, as they say, and barring the end of the world, cash should still be good in your local jurisdiction.  It may still even be good after the end of the world if nobody is quite sure what else to do.

Where do you put this cash? Lets think about what an emergency might look like. A fire. A devastating robbery. An accident whilst hiking in the Himalayas. You want cash, but don't leave it in your wallet, mattress or in a jar underneath a tree that only you know where it is. If it were under a tree that only you knew where it was, it would be rather difficult to pay a hospital bill in Nepal. Can you imagine trying to explain to the billing department there how you planned on satisfying the bill? Even more nightmarish is if you were hiking without a permit - that $11,000 fine would not be satisfied by the laughter you would evoke from the friendly park rangers.

Put the cash in a bank account. I generally advise having an online savings account that is reasonably out of reach, sight and mind. You can probably find one that does not charge fees as long as you maintain a certain balance. Set it up so that you can transfer money back and forth from your checking account and go ahead and set it to auto deposit until you have built up a reliable reserve.

I recommend online bank accounts for a few reasons. You can typically get lower fees and a better possibility of an interest rate online. Also this means your money will be accessible wherever you are. If this is separate from your other banking activity, this keeps it out of sight and out of mind - exactly where an emergency account should be.

How much do you need to put in there? This is the trick. Start with $1,000. Why? It is a nice number. It has several digits and if you're just getting started with this frightening world of imagining the worst, it is a comfortably round place to be. From there, stash 3-6 months of living expenses. Think about all of your must pay costs - mortgage/rent, utilities, loans, food and a modicum of entertainment. If you are particularly worried, stretch that out to 12 months. Once you have three months expenses put aside, however, breathe a little sigh of relief and bake yourself a cookie or five dozen.

Are we done yet? No, not quite. Losing your job for economic or motivational reasons is one thing. If that happened, the aforementioned emergency account would tide you over for 3-6 months. You would have time to figure out how to make that stretch a little longer too. But emergencies can get much worse. You can have a car wreck, a tornado could hit your house or you and your family could come down with a mysterious, new and expensive disease. For these sorts of things, you'll need to have cash to cover insurance deductibles and out of pocket medical expenses. Add up these and add them to your monthly expense sum.

Say you have living expenses of $2,000/mo with $1,000 deductible on your home and $500 on your car insurance plus a modest $2,500 deductible on your health insurance. To cover yourself for plowing your own car into the side of your house in the sort of way that hospitalized you for 5 months, you would need:

  • $2,000 x 5 = $10,000 for the bills that keep rolling in the door.
  • $500 to get the car fixed and ready to go upon your release.
  • $1,000 to keep your house from collapsing further.
  • $2,500 to stay pay the good people keeping you alive.
  • Or a total of $14,000.
  • Add in another $2,000 to get yourself back on your feet one you get out and you need $16,000.

Does it have to be this way? This much money? In an account earning next to nothing?

Kind of.

That much cash sitting in an account can be very boring when it does not earn any interest. It can also be hard to forget about if you are tempted to spend elsewhere. You may get antsy about the returns you are missing out on elsewhere. Remember that cash has value besides just the interest that it earns. There is value in that money being readily available and value in the assurance that it will be there.

That is a very large amount of money for most people. Emergencies are, by their nature, rare. It is unlikely that you will need this money. Picture the total figure as a goal, the most conservative, totally covered amount. You're not going to start day one with all of this saved up. You should keep this number in mind as a goal, a way to restrain yourself from spending too much elsewhere.

Here are some other financial accounts that can help you in a real emergency.

A Health Savings Account. If you have a high deductible health insurance plan, you can have an HSA, or health savings account. Money going into the account reduces your taxable income, and money coming out is not taxed so long as you spend it on medical expenses. For 2017, you can set up a health savings account that allows you to contribute up to $3,400 for an individual HSA or $6,750 for a family HSA account.

Investment Accounts. Investment accounts have money in them. You can use this money! The tax consequences will depend on what type of account it is. Typically your taxes and penalties will be highest with a traditional, deferred income account like an IRA or 401(k). A taxable investment account will have the most flexibility but a Roth IRA may not have tax consequences for withdrawals depending on your age, what the expense is and how long you have money in the account. Investment accounts are best for longer term, predictable expenses, so they may not be ideal for an emergency situation. This could be an interesting option if you had plenty of money to invest but did not want to have your cash doing nothing in a savings account.

Credit Cards. This one is tricky because an emergency could very well cut off your access to credit, or could have stemmed from poor usage of credit in the first place. Assuming that you have managed your credit well, and modern commerce is still going on in the world around you, you can probably still use your credit cards to tide yourself over when money is tight. Ultimately, in an emergency you should be looking to cut your expenses, so credit card spending should be considered a last resort. Always make a plan to pay off high interest credit card debt as soon as you can.

Remember, a healthy emergency savings account is the first step in any financial plan. Make sure your account can cover likely expenses in an emergency, and put it out of reach. If you don't have a huge stash, remember that you may have other sources of cash to protect you if the worst happens.


Twitter is a wonderful place. While it can be a mess at times, it gives you access to follow the thoughts of a huge variety of people. One who I have been paying attention to lately is former Navy SEAL and leadership trainer Jocko Willink. While a lot of his exhortations center around exercise, the lessons are meant to be taken and applied to other areas. Naturally, I started seeing how to apply them to personal finance.

Decisions decisions indeed. Small decisions can have a huge impact on your financial situation. Here are three decisions you can make to have a positive impact on your finances.

  1. When faced with a large expense, are you going to take a hard look at your options and get the best deal you can or are you going to just accept the easiest option? Housing and transportation are huge and complex expenses for most American's budgets. Faced with huge and complex decisions, many people are at an information disadvantage. Considering how much money is at stake, when contemplating a move or purchase of a new vehicle, you need to take a step back for a good overview, and lean on unbiased advice when you are not sure. Take a step back and get an unbiased opinion. Locking yourself into large financial decisions may be unavoidable, but getting the best deal here will make the biggest impact on your savings.
  2. When the market declines, are you going to continue to invest or pull everything out? If you have an investment account, watching the price decline during a market pullback can be difficult. If your account is appropriately allocated, and your time horizon is still long enough, no action may be the best action when the market declines. In fact, if you are young and still adding to your portfolio, you may be setting yourself up for outsized gains in the future.
  3. Will you commit to making saving a habit or will you put it off until "next month"? Saving is a habit. Even when you can only start with a small contribution to your savings account, it matters. $10 each week may not seem like much, but raising that regularly translates to a lot saved over time. There is no real magic to financial security - you need to spend less than you make, and putting away a little bit at a time is a worthwhile habit to get into.

Getting your finances into shape takes discipline, regardless of your starting point. If you don't feel you have enough to make ends meet now, but know you are in for a raise or a windfall later, you may put off getting started on a financial plan. We all know what happens next, the raise or windfall comes and it gets spent amidst a flurry of justifications. If you start good habits early on, you will be in much better shape as your income rises. Develop a payment plan for your bills that keeps you current and avoids late fees, look for better deals on regular expenses like phone and internet bills, stash some money in an emergency savings account and then take advantage of payroll deductions for a retirement plan if your employer offers it. Do the work to set yourself up for financial success - even when you don't feel it is possible.

People work, earn money and spend money for a large part of their lives. If you do not get yourself in good financial habits, you will be in poor shape for a long time. Motivational tips like these from Jocko can be easily applied to your financial life - just get to it!

Wednesday, May 17, 2017

Fiduciaries and Fees

The DOL Fiduciary Duty Rule has been the talk of the asset management industry for... quite some time now. This rule would require anyone who gives advice/manages money in a retirement type account be a fiduciary. A fiduciary is one who serves your best interest. If you are paying for advice or asset management, this makes sense. Your advisor works for you and places your interest above their own.

In general, fiduciaries should be transparent about any conflicts of interest that they have and work to reduce those conflicts. When conflicts do arise, a fiduciary should put their client's interest above their own. Often, conflicts are seen when an advisor is paid by commissions on various products. Mutual funds often have multiple share classes, some pay large up front commissions to the salesperson and some have extra fees built in to compensate them over time. If your advisor stands to make more money recommending you one product over another, and both are appropriate for you, they are incentivized to recommend you the one that pays them more.

Because of this clear and simple example of commission, a lot of the talk around the fiduciary Rule has been around cost. As the financial industry becomes more transparent and efficient, costs have come down for investors. Index funds have built up the expense, cutting momentum to a public battle in the pages of popular financial media. For the most part, this is a good thing! Reducing costs is one of the surest ways to boost returns. As I often say to clients, a dollar that you don't pay in expenses is a dollar that you keep in your account.

In the context of the fiduciary rule, this focus on fees may be an oversimplification.

Criticism of the rule from large brokerage houses like Morgan Stanley rightly pointed out that a fee based account might be more expensive in the long haul than a commission based account for someone who did not need to interact with their broker that often. While this is a little disingenuous (they could always lower the fee), they had a point if you were only talking about the dollars paid. The point is that the source of those fees brings about an inherent conflict. If you pay a fee to an advisor, they work for you. If they are being paid by a brokerage firm, they work for that brokerage firm. The amount matters less than the potential for conflict.

Importantly, Fiduciary does not have to mean rock bottom fee! While yes, lower fees will generally be more in your best interest than higher fees, good advice and guidance can still cost money! A fiduciary should be paid in a way that does not bring a conflict of interest between you. That is the point.

The pervasive focus on fees has everyone in a frenzy! In todays newsletter, Matt Levine asks what have we gained if the fiduciary rule doesn't lower fees.
If the fiduciary rule pushes investors from high-cost mutual funds recommended by commission-based advisers to medium-cost mutual funds recommended by expensive fee-based advisers -- and if investors' all-in costs aren't any lower -- then what have we gained?

While a broker being incentivized to put you in a higher fee version of the same mutual fund is a problem, it is not the most costly problem that the DOL rule can solve. Looking at client's outside accounts, I see cases all of the time where they could move to a lower cost fee structure to save a few basis points, or even reallocate to passive funds to drastically reduce costs and eliminate an active manager that isn't adding value. Those are not the egregious cases though.

The biggest conflicts of interest that I see are in insurance products. Variable annuities are much more convoluted products than plain mutual funds in an investment account. Annuities are often attractive because the salesman can tout a guaranteed rate of return, or a promise that the product will never lose money! The conflicts are huge, however, when commissions approach 10%. I see products that are so convoluted I am almost certain that the salesperson did not understand what they were selling. They can focus on the bullet points in the pitch book that say GUARANTEE! and not dig any deeper.

I have seen conflicts of interest lead to churn in accounts that cost clients dearly even if the returns of the actual investments were positive. I have seen products that purport to give S&P 500 linked returns with a guarantee of no losses deliver no returns in periods that the S&P 500 was up 50%.

While many people in the financial industry are hard working, intelligent and hold themselves to high professional and ethical standards, many are not. If you have an advisor who may be good, but does not have the highest standards, and has a conflict of interest, you may well be getting very bad advice! It is not just the headline, or even underlying fees that you are charged, it is the whole body of advice and service you receive. You can pay no fee just by putting your money under your mattress, but that does not mean your mattress has a stronger fiduciary relationship to you than an excellent advice manager who charges above average fees for their service.

Bad advice has no regard for your financial well being. Bad advice takes sales points that make a product seem appropriate and turn it into profit for the advisor and losses for the client. Good advice might cost money, but in the long run, will be MUCH less expensive than bad advice.

While a fiduciary advisor will probably try to to lower your fees, that is not all they serve to do. They serve to give you excellent advice that will better your financial position. Eliminating conflicts of interest is not about eliminating a few basis points of fees. If you need good, personal advice, you will still need to pay for it. Working with a fiduciary is the best way to ensure that you will be getting advice that is truly in your best interest.