CHAPTER SEVEN
MAINTAINING CONTROL OF OUR FINANCIAL FUTURE

THE PROTECTED INVESTOR

THE ARMADILLO protects itself from its predators with armor made of small plates of bone. When attacked, it rolls itself up and becomes practically invulnerable. Since there are so many predatory risks in the investment world, like the armadillo, we need a protective shield to keep us invulnerable to them. We need to examine our goals and objectives and have reasonable expectations for returns on our investments. But before looking at possible sources for a return on our investment, we need to assure that there will be a return of our investment. We have to be constantly aware of the worst possible outcomes and of new defenses that we can use to protect ourselves while thriving in this harsh environment.

Setting Your Goals and Objectives

The first step in constructing a Protected Plan is to take a current inventory of how you shape up financially. This is basic and entails constructing a personal statement of net worth (balance sheet). List everything you own (assets) and its value in one column. List everything you owe (liabilities) in another column. The difference is your personal net worth.

When you are constructing a Protected Plan you don’t need to fret over how much risk to take. Your objective is to minimize118 risk and achieve a reasonable return over time. If you want to take on some risk with a portion of your portfolio, I suggest that it be a relatively small amount. Stay away from individual stocks unless you want to set aside some play money for gambling. Decide in advance the maximum amount you are willing and able to lose.

Once you have listed all of your assets and liabilities, list the rate of return, if known, next to assets that generate interest, and the interest rate you are paying (Cost) next to your liabilities.

The format of your balance sheet should look something like this:

See Table

What you are earning on your fixed rate investments and what you are paying on your debt are vital statistics. If you have a retirement plan through your employment, know all of the investment options and be up-to-date on how you are invested. If the return is uncertain because it depends on unpredictable price movements such as the value of your real estate or your stock portfolio, note this on your statement.

Once the inventory is complete, you can think about financial goals and objectives. It’s difficult to draw up a plan unless you have identified these. For many people this is the hardest part of the process and is something they have never considered. This part of the process deserves some serious introspection. Ask yourself questions like this: At what age do I want to retire? How will I fund my children’s education? How much income will I need at retirement? And, what happens in the event of my death? All need to be carefully considered.

Quality of Life

Most people dream of reaching the point where they no longer have to be concerned about money issues. This means that we can meet our expenses and have arrived at the place where we can reduce or eliminate the time spent working and worrying about money.

Americans are spending more time on the job than they did twenty years ago. Our quality of life is diminishing. According to the book The Overworked American: The Unexpected Decline of Leisure, we are working about 170 more hours a year. We have bigger homes, more cars, and record consumption, yet our quality of life has decreased by over 50 percent since 1970, as measured by the Index of Social Health.¹ Americans use 30 percent of the earth’s resources yet make up only 5 percent of the world’s population. In other words, all this stuff we work so hard to acquire, much of it financed with debt, hasn’t made us any happier.

Money in and of itself doesn’t make us happier either. The highest income earners in the United States are doctors, yet they are among the professions that have the highest percentages of unhappy people, along with lawyers.

The average time spent shopping each week by Americans is six hours. The average time spent playing with children is forty minutes per week.² It has been estimated that during a person’s lifetime he or she will have watched the equivalent of a year’s worth of television commercials.

When we set our financial goals we need to step back and determine what we really value in life. In 1967, 83 percent of college freshmen felt that it was essential to develop a philosophy of life. In 1987 this figure dropped to 39 percent.³ As a society we’ve become focused on the generation and consumption of material wealth at the cost of our own self-actualization and happiness.

And what’s to keep these trends from continuing? The American people are like willing pawns in a giant economic chess game. Our children are born into a world where they are exposed to over 360,000 advertisements by the time they graduate high school.⁴ Experts in marketing and psychology design ads that shape our personal needs and desires, creating the most prolific consumers in the world. We are willing to subordinate time spent with our families and our personal long-term happiness to buy whatever Madison Avenue directs.

In a Protected Plan the goal is not the attainment of a certain amount of money within a predefined time frame. This isn’t a competition to see who gets there first or who can buy the most toys. Simple intermediate goals such as getting the house paid off or saving enough to help the kids with college are the primary focus.

If expenses are kept under control and we avoid the social disease of rampant consumerism, it becomes much easier to achieve the ultimate goal—financial freedom.

The Protected Plan is much more than being cheap or frugal; it’s about learning to want less. It is a realization of the belief that time is much more valuable than money. More time is generated to nurture relationships, acquire insights, and experience the joy of having total freedom and control of our lives.

With the Protected Plan, our assets don’t fluctuate wildly based upon a stock market that can change on a whim. Our financial well-being doesn’t depend on such nonsense. We are inoculated against the emotional disease of severe depression or despair that can overtake the person who agonizes over financial issues.

Managing Expectations

At the peak of bull markets, investors believe that the gains will continue indefinitely. Surveys during the bubble of the late 1990s indicated that expectations of future annual returns soared to greater than 30 percent.

In the Protected Plan, slow and steady growth is acceptable. We avoid direct investments in the markets that put the achievement of our goals at risk. We focus on shielding our principal and finding alternatives to the traditional approach of buying individual stocks and mutual funds. We know that time-honored methods of dealing with market risk, such as diversification, asset allocation, and market timing, do not provide us with the level of protection that we need.

There is reasonable comfort in a U.S. government-backed security that pays a fixed rate of interest. But when it comes to the stock market, there is complete uncertainty. Even though we are constantly reminded to keep our long-run vision, history tells us that bear markets can wipe out years of gains in a very short time. We are not willing to shoulder this risk.

Control of Spending

The frustrating part of investment planning is that the future is unpredictable and out of our control. Choosing the appropriate122 way to allocate investments and selecting the particular investments to achieve our goals is more of an art than the science it sometimes appears to be. Ask 1,000 different investment plan professionals what to invest in, and you’ll probably receive 1,000 different answers.

It’s desirable to maintain as much control as you possibly can over the variables that affect your financial returns over time. This begins with maintaining control over spending. The amount you expend each month should on average be less than the amount of your after-tax disposable income. The difference is savings and goes right toward increasing your net worth. If you can’t live beneath your means, and you depend upon credit cards and other loans to make up financial shortfalls, you will never attain financial freedom unless you receive a windfall such as a large inheritance or lottery jackpot.

Paying off Debt

One of the first things to consider in a Protected Plan is paying off personal debt. Paying off a credit card debt charging 14 percent interest gives you a guaranteed 14 percent return on your investment. Once completely paid down to zero, make sure credit cards are paid off monthly in the future, or don’t use them at all. Credit card interest isn’t even tax deductible and should never be used to finance spending.

Next, look at the interest rates you are paying on your mortgages and other loans. Can you earn more in a risk-free investment? If not, by paying down the mortgage or other debt, the risk-averse investor makes a guaranteed risk-free return of the percentage of interest that would have been paid on the debt.

Debt is not always a bad thing, and it doesn’t always make sense to pay it down. There are times when we may end up with very low interest loans, even as low as zero percent. For example, automobile dealers frequently offer low- or no-interest loans as incentives to purchase a new car.

In order to determine whether the interest rate you are paying on your debt is too high, I suggest comparing the loan rate to the current inflation rate. If the loan rate is higher, the interest on the loan is costing you real dollars. If the loan rate is the same or lower than the inflation rate, you have a favorable debt that is actually beneficial to your financial health.

Gaining Control

Here is immediate action you can take to gain more control over your financial future:

1. Checking accounts pay very little or no interest. Keep the balance just over the amount to cover service charges. Some banks will look at a combination of checking and savings accounts for service charge calculation.
2. Use savings to pay off debt. Assure that there is a backup plan in the event emergency funds are needed. This can be in the form of an equity line of credit secured by your principal residence. Many banks offer this to their borrowers at the prime-lending rate.
3. Eliminate the stock portfolio if there are no immediate severe tax consequences.

By shifting toward paying down debt, protected investors are much more in control of their finances and are receiving a guaranteed return that is not possible to get elsewhere. Avoiding interest on the loans that have been paid off reduces expenses. The plan is simple. You pay down high-interest debt and pay the minimum toward favorable low-interest debt. Sometimes credit cards offer introductory rates with low or no interest. These can be used to pay off higher interest rate debt, but you must pay off the balances or roll the debt to another favorable card before the rate increases.

The other financial assets to consider are retirement investments. We all know the value of setting aside money today for use in the future, yet as a society, we are not doing very well at this. Chapter 10 is devoted to retirement investments.

The beauty of the Protected Plan is its inherent simplicity. Financial investments are made outside of our retirement plans only after all of our high-interest debt has been eliminated. Once this has occurred, we consider only those financial investments that are insured, guaranteed by the U.S. government or U.S. government agencies, and other alternative protected investments.

Notice I use the word “financial” investments. Other investments, such as owning a home, fit into the plan, even though it’s not possible to insure that the market value will not be less when we try to sell it. Ownership of a rental home may also be a good investment, especially if you are handy and can fix up a place to increase its curb appeal and market value. Again, you don’t have control over the market value, but you do have control over important factors such as determining the location of your purchase, approving qualified renters, and maintaining the property so that it continues to be attractive as both a rental and an investment.

Compare this to the amount of control you have when you buy stock in a company. Virtually none! There could be all kinds of things going on in “your” company that you are clueless about. Yet you are one of the owners. And when you buy a managed equity mutual fund you’ve lost what little control you do have. You’ve delegated your right to choose the investment to someone else.

Ongoing Plan Maintenance

Once a plan is put into action it needs to be continually updated for life-changing events that may occur. The birth of a child will probably generate a new desired goal: building a college education fund. An inheritance could create a huge 125windfall, or on the other hand, you might incur unexpected expenses from helping an ailing relative.

The plan can always be modified, but its basic principles remain the same. Getting out of unprotected investments should be top priority regardless of what the market is doing. This also applies to uninsured corporate bonds or corporate bond mutual funds. If you must hold stocks, check with your investment consultant about buying put options. These will act as insurance and protect you against massive decreases in the stock price. It does cost some money to protect yourself, but consider that we insure far less valuable items (such as automobiles) for possible unforeseen losses of value.

Review your list and ask yourself if each asset is insured against loss. The FDIC insures bank accounts up to $100,000. Government-backed securities are guaranteed by the U.S. government or agency. An insurance company guarantees insurance company annuities. Your house, rental house, and auto should be insured for loss against a number of potential hazards, including fire and theft. Every material asset you possess should be protected if at all possible. It would be a worthwhile exercise to do this not only when first implementing your Protected Plan but at least once per year.

Don’t make the mistake of falling in love with your stocks or mutual funds. Remember, when the market is going down you’ll be advised not to panic because “the market always goes up over the long run.” This might have been true in the past, but as long as there are alternative protected investments available, why take the risk of being subject to market losses, unless your intention is to be a gambler.

The Protected Plan eliminates the problems associated with trying to time the market and all of the psychological issues relating to stocks discussed in Chapter 2. Also remember that individual investor performance is dismal relative to actual market performance, and even the professionals can’t beat the market, as discussed in Chapter 1. That’s why indexing has become so popular.