Excerpted with permission of the publisher John Wiley & Sons, Inc. from The Seven S.E.C.R.E.T.S. of the Money Masters by Robert Shemin and Peter Hirsch. Copyright (c) 2010 by Robert Shemin and Peter Hirsch.
By Robert Shemin and Peter Hirsch
Suppose we were to ask you, "What is the first thing you need to do in order to attain financial security and build wealth?" What would your response be? If you're like most people, you'd probably say, "Earn more money and invest wisely."
And you'd be wrong.
The first step in getting control of your financial life is ensuring that what you already have, regardless of how much or how little that may be, is protected. Many people are so focused on getting more that they forget to take the necessary steps to preserve their current assets until it's too late.
Protecting your money is even more important than making more of it, because once you get behind, it's very difficult to catch up. Let's look at a simplified example.
Suppose you buy 100 shares of Widgets, Inc. stock at $1 a share. During the first six months of your investment, Widgets' top competitor introduces a hot new product and the value of Widgets' stock drops by 50 percent. But there's good news on the horizon. A few months down the road, Widgets comes out with an even hotter product and the stock doubles in value.
Great, right? Not so fast. After the first hit, your stock was worth only $50, so your 100 percent profit only gets you back to your original $100. You're barely breaking even. That's why it's important to avoid loss if at all possible, because once you're in a hole, it's very difficult to climb back out.
Unfortunately, a no - risk investment simply doesn't exist, but there are ways to determine the level of risk before getting involved.
Investigate before You Invest
Don't make a move without taking the time and energy necessary to investigate the stability of the business itself, the person or people behind it, and the banks or other investors providing back-up at the next level. Remember that size isn't always an indicator of stability. You have to look no further than the Big Three U.S. auto companies to see that even very large, seemingly stable businesses aren't immune to devastating losses.
When we're making a business decision, we live by a simple principle and suggest that you do the same: Investigate, verify, and verify again.
We strongly recommend looking into the background of anyone with whom you're considering doing business. That might sound cynical, but we've seen far too many people lose enormous amounts of money by trusting the wrong person or business entity.
Just as leopards and other animals display patterns as part of their physical appearance, people develop patterns of behavior that we should be aware of in order to keep our businesses, investments, and relationships safe. Just as a leopard doesn't change his spots, someone with a history of nefarious business dealings or questionable financial practices is unlikely to change, so make sure you know who you're getting into bed with when your money is at stake.
Not so many years ago, it was relatively easy for people to hide a great deal about themselves, but that isn't the case today. Thanks to modern technology, it's no longer necessary to hire a private investigator to get basic information on someone. There are simple Internet tools that, for a very small fee, will allow you to verify almost any piece of information, from someone's driving record to credit history and criminal record. Before you hire a new employee, rent property to a new tenant, or go into an investment with a partner, it just makes sense to find out who you're dealing with. The information is out there, but you have to take personal responsibility for finding it.
How Volatile Is the Investment?
The stock market is a great example of extreme volatility, and yet 98 percent of financial planners have no qualms about putting their clients ' money, including their retirement accounts, into mutual funds despite the enormous risk involved. It should be illegal to have people nearing retirement exposed to full market risk. That is nothing short of financial malpractice.
We've all known people who have been sucked into investing large sums of money in the stock market based on tales of the huge profits being made by other investors. Around 1999, legends about dotcom millionaires and people who quit their jobs to find wealth as day traders, buying and selling Internet and technology stocks from their home computers, fostered the notion that the market was a modern-day gold rush.
These investors were riding high on confidence, convinced that they'd become money masters blessed with knowledge that would enable them to continue making huge sums of money indefinitely. We all know what happened next. As surely as night follows day, the dotcom bust followed the dotcom boom, and a lot of people lost a lot of money.
Then and now, it's easy to find people who will tell you they can predict the market. Brokerage houses spend tens of millions of dollars on advertising, ensuring you that they have specialized knowledge that will protect your investments and make them grow. Investment advisors will tell you they have found the key to timing the market and predicting which stocks will do well, and the financial programs on television love to trot out the latest wunderkind who has beaten the market and can tell you how it's done.
Make a note of that guy's name and keep watching. The chances are excellent that a year from now, he'll have faded away and been replaced by someone else. Some people do manage to beat the market, but hardly anyone is able to do it consistently. It's simply not possible to predict with regularity which stocks will go up and down, and when they will do it.
It's much like betting on the Kentucky Derby. You can study all the available information about how each horse has done in previous outings on a similar track in comparable weather conditions, but past performance is just that-- past. It can provide clues, but it is not an indicator of how a particular horse will run today. There are no more reliable systems for predicting the stock market than there are for predicting the outcome of a horse race.
How Expert Is Your Financial Expert?
The "investigate and verify" principle also applies to choosing a financial advisor. Our friend Jason enjoys fine dining and, because he travels a great deal for both work and pleasure, he has an opportunity to experience some of the best restaurants across the United States and around the world.
Before he leaves on a trip, he carefully combs the Internet and a stack of magazines, looking for new restaurants in the place he'll be visiting, or perhaps an old favorite he hasn't patronized for a while. Once he arrives, he studies the menu and the wine list meticulously and asks the wait staff several questions before deciding what to order. Good food is important to him, so he takes time to do his homework in order to get exactly what he wants.
When it comes to choosing a financial advisor, on the other hand, Jason is remarkably careless. He selected his first firm on the basis of an expensive brochure he received in the mail. Several months later, when he was dissatisfied and disillusioned, he switched to a guy recommended by a colleague at his office, although he had no idea whether the advisor was suited to his own individual needs or how well he was performing for his co-worker.
Now he finds himself with a portfolio that doesn't match his expectations and a broker who won't return his calls because he's no longer making money from Jason ' s investments. If he put a fraction of the time he spends on planning his dining experiences into researching his investment strategies and the people who are helping plan them, his budget for dining out would grow considerably.
If a trusted friend or family member recommends a broker or investment advisor, there ' s nothing at all wrong with considering the advice, but ask questions before you part with a single dime. Find out how much your friend really knows about this person's qualifications and track record. Is the broker just a golfing buddy or a fellow PTA member, or does your friend have concrete knowledge about his or her professional credentials? Is it possible that the person making the recommendation is inflating the success rate of his own investments in an effort to appear more prosperous?
Whether you're acting on a recommendation or your own research, when you sit down to meet with a potential advisor, treat that first meeting like a job interview, but be certain you're the interviewer, not the applicant. Don't be afraid to ask questions. You're considering entrusting this person with managing your money. You have every right to know what training the adviser has received, what type of financial licenses he or she holds, how long the person has been a stockbroker or an independent adviser, whether any written complaints have been filed against him or his firm, and whether you'll be dealing directly with him or be passed off to a subordinate. Many people are not aware that in today's world, virtually anyone can rent an office, get some business cards printed, and call themselves a financial advisor. Make sure you're dealing with someone with the proper training, licensing, and experience, and there are only two ways to do that-- ask questions, and then verify everything you're told. Someone who bristles at your questions, appears uncomfortable or as if his feelings are hurt, or simply tries to placate you with vague reassurances is not the right financial advisor for you, no matter how well your brother-in-law claims he's doing for him.
Another red flag to watch for during your interview is an advisor who tries to snow you with jargon. Financial dealings are intimidating to many people. The industry has a language all its own, and it's easy for someone with a bit of training to toss out terms like hedge ratio and earned surplus in an effort to appear knowledgeable, assuming that you won ' t ask questions.
Just as unscrupulous automobile mechanics test your knowledge of cars before giving you an estimate for repairs, some investment counselors subtly size up your knowledge of finance and investments, and they begin to salivate if they smell blood in the water. Certainly your advisor should know more than you do. Otherwise, why would you need him? But look for someone who takes time to explain the details, and be certain you're comfortable rather than accepting a "just trust me" attitude from the advisor.
Keep in mind that, first and foremost, most brokers and financial advisors are salespeople. Often they are hired by a large firm primarily because of their charm, confidence, and people skills. The job of such advisors -- the way they make money for themselves and their firms -- is by selling you investments on which they earn a commission or fee.
Are they all unscrupulous snake oil salesmen? Of course not, but they are in the business of sales, and part of their job is to sell you on the idea that you need their help in order to make the most of your money. It's important to become an educated consumer with the ability to decide for yourself who to trust and how much you need to be involved in your own financial decisions.
Remember that at the end of the day, after you've done your research and questioned a potential financial advisor about his or her credentials and experience, it's always best to trust your instincts. Most of us have a little voice that tells us if we're uncomfortable with someone, even if we can't quite put our finger on why. There is no shortage of people who want to help you manage your money. If everything looks good on paper, but something simply doesn't feel right, find someone else. You will sleep better at night knowing you are working with someone in whom you have confidence.
We talk more about this later when we give you seven questions (and a bonus) you need to ask your financial advisor.
Are All Your Eggs in One Basket?
Remember the spectacular collapse of Enron? In its wake, Congressional committees investigating the scandal heard heartbreaking testimony from a number of Enron employees, who had lost not only their jobs but also their life savings and any hope of a comfortable retirement. A retiree from Texas reported losing nearly $1.3 million. A 59-year-old lab technician who had devoted 25 years to Enron and its subsidiaries was just months from his planned retirement when the company collapsed, and he saw his 401(k) drop from more than $600,000 to just $11,000. A secretary watched with amazement as her 401(k) skyrocketed to nearly $ 3million, only to evaporate when the company filed for bankruptcy in December 2001. In all, some 12,000 Enron employees lost $1.3 billion, in addition to their jobs.
Why did this happen? Sadly, in many cases, it happened because employees believed so strongly in their company and the executives who ran it that they invested virtually all of their retirement savings in Enron stock. It seemed like a good idea at the time because the company matched their contributions, but as we now know, accounting fraud brought down the organization, its employees, and their life savings. Lesson learned, but too late.
To be sure, loyalty to an employer is a thing to be valued, but it's a very poor investment strategy. It's an equally bad idea to plow everything into any one type of investment, whether it's the stock market, real estate, or stuffing it into your mattress. There is no such thing as a sure thing, and there is no company or industry that is immune to financial ups and downs. Diversifying your investments is absolutely key to protecting your assets.
There are other strategies for scattering your eggs among several baskets. You might consider holding some assets in your own name, some in the names of businesses and corporations you've established, and some in trusts that you've created. In case of a major lawsuit or even a messy divorce, having more than one asset base can protect you from being completely wiped out.
Is Keeping Your 401(k) Costing You Your Retirement?
The Employee Retirement Income Security Act (ERISA) of 1974 was signed by President Gerald Ford on September 2, 1974, Labor Day, and this legislation made 401(k)s possible. The Act was passed to help protect employees' retirement money from abuse by owners of businesses.
While the ERISA was passed under the guise of being a benefit to employees, it turned out that the majority of the benefits were in favor of the employer. There is a good reason that 401(k) plans are so popular with employers. They transfer the risk to the employee, as opposed to employer-funded pension plans that provided a guaranteed retirement benefit for each participant. The resulting impact started by the ERISA is not only leaving millions of people without a retirement plan, it is also forcing people to trust their financial future to the stock market.
Another problem is the limitation of offerings that most companies provide their employees for their 401(k) or retirement plans. The control and direction is really in the hands of whoever decides what the company offers.
Direct investing in gold, commodities, real estate, art, and other vehicles typically is not available through a 401(k) plan, yet these are viable options that can be an important part of an investment portfolio. In order to make use of those vehicles, one would need a self - directed IRA or pension plan.
Furthermore, most companies do not take enough time to educate their employees about investing and the true nature of 401(k) investing. As a result, many employees simply choose a mutual fund or two in a method that ' s not far removed from blind man's bluff or pin the tail on the donkey. Then they go about their business and trust that the matter of saving for retirement has been handled.
We discuss the impact of the 401(k) -- and why it might not be the retirement panacea you've been led to believe -- when we talk about the sixth secret, tax efficiency, in Chapter 7.
If you have any lingering doubts about the importance of safety, consider not just yourself, but the other people to whom you're responsible. Almost all of us have others who depend on us -- spouses, children, aging parents, employees, investors, other stakeholders. The only thing worse than losing your own money is losing someone else's, so it's imperative to remember our responsibilities to others and take the necessary steps to keep our assets safe.
This book is available at all bookstores, online booksellers and from the Wiley web site at www.wiley.com , or call 1-800-225-5945.