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Boosting Parents’ Retirement Income

Many retirees have had their incomes devastated because of low interest rates. Historical returns for five to ten year bonds have been 4.5% to 5.5%. Today 10-year treasury bonds yield a paltry 2.6% and the average money market account is paying less than one percent. One of the primary drivers behind low interest rates is the Federal Reserve who has set and maintained the fed funds rate at near zero percent in an effort to stimulate an anemic economy. This past week, Federal Reserve Chairman, Ben Bernanke, indicated that the Federal Reserve will continue to support low interest rates for the foreseeable future. This leaves many retirees who depend on interest income in a financial tight spot with no relief in sight. Many retirees are finding it necessary to invade their principal just to pay their monthly bills.

In some cases, adult children are in a financial position to help…but what’s the best way to do this? First, let’s examine how a reverse mortgage can turn a non-income producing asset into a cash flow machine.

With a reverse mortgage, instead of making payments to a mortgage lender, the mortgage lender makes payments to the homeowner. And instead of paying down your mortgage over time, as you receive payments, your mortgage balance increases over time. At the point that you no longer live in the house, the home is sold and the loan paid off. Additional options include receiving a lump sum or having a loan that operates like a home equity line of credit. Some of the disadvantages of reverse mortgages are that you have closing costs that can be from three to seven percent of the loan amount; the interest rate attributed to the mortgage is typically two to three percent higher than a conventional mortgage; and you have to be at least age sixty-two to qualify. Lenders will also restrict loans to around 50% or less of market value.

One of the most often comments I get from retirees is that they don’t want to be a financial burden to their children. Translated, this means they would be very reluctant to take a financial handout even if you could easily afford it. However, they would likely consider a financial transaction that is mutually beneficial such as a ‘private’ reverse mortgage. With this strategy, the adult child becomes the mortgage lender but can do so without the closing costs; can use a lower interest rate; and could offer a loan greater than 50% of market value. You would need to formalize the transaction with a written promissory note and federal law requires that a minimum interest rate, called the Applicable Federal Rate, must be charged in order to avoid potential gift taxes. To avoid potential future conflict, be sure to make all siblings aware of the details of the arrangement before implementing.

Ultimately, when the parent is no longer living in the home, it can be sold and the loan, plus interest, repaid. The private reverse mortgage is an excellent way to partner with a parent to provide additional monthly cash flow during what may be an extended economic downturn.

Teaching Children about Work & Money

I was twelve years old when my father drove me to an unfamiliar neighborhood and let me out with a case of aerosol-size cans of fire extinguishers and said, “Son, when you finish selling this case, I have two more cases!” So I went door to door, ringing door bells, selling my wares. My first day I had limited success so I went home and pondered how I could become more effective and hit upon the idea of a ‘live’ demonstration. The next day I was armed with a small pan and lighter fluid. When the lady opened the door I squirted lighter fluid in the pan, lit it and asked, “If this was a stove-top fire, how would you put it out?” She ran and got some baking powder and attempted to dowse the fire. When it continued to burn, I handed her one of my fire extinguishers and she instantly put out the fire. My sales went through the roof!

Here’s what I learned:

I learned not to give up. Within every obstacle is an opportunity. In this case I used poor sales as an opportunity to try a different approach.
I learned how to interact with adults whom I had never met. After doing this over and over I found I quickly became more at ease in conversations.
I overcame the sense of rejection. Every presentation did not result in a sale. I’d take a moment to think if I could have done anything differently, learn the lesson and move on with the intent to constantly improve…try new approaches.
I learned that ‘work’ can be fun! Certainly making my own money was a new experience for me and it felt good! It gave me a sense of confidence. Maybe, just maybe, I could make my own way in the world!

Children learn the concept of work best at an early age. It’s not taught in school but through experience. As soon as you feel your children are old enough, encourage them to get a job. It could be babysitting, mowing lawns, a paper route.

Don’t pay children to do things that are part of family responsibilities such as taking out the trash, mowing the lawn, cleaning up their room or making good grades.

Do give them an allowance but include some ‘money rules’ to go with it, otherwise the only lesson they’ll learn is how to spend money….and my experience is that this lesson they learn without any help! Money rules might include:
The first 10% goes to helping others through a charity or gifts to their religious organization.
Twenty percent should go towards long-term investments. Yep, even at an early age, children can begin to learn about investing. Help them choose stocks they are familiar with such as McDonald’s, Wal-Mart, or Disney.
Another ten percent should go towards long-term savings…call it ‘the unexpected’ fund.
They are free to spend the rest as they choose.
They should be responsible for balancing their checkbook.
These money rules apply to both their allowance and job earnings.

Think of the mistakes you made as a young (or older!) adult and figure out how you can help your children learn the needed lessons before they are on their own. It will be one of your greatest gifts.

Where to Invest Now

As I was leaving the TV station earlier this week, I was stopped by a friend who asked for my thoughts on the markets. He had recently upped his contributions to the retirement plan and indicated his intention to invest 100% in bonds based on his dismal outlook for the economy. Hmmm. At first blush, this seems like a perfectly reasonable and conservative approach. It’s hard to argue that the outlook for the economy doesn’t paint a bright picture, at least in the near term. And setting up a systematic savings program is one of the most basic keys to accumulating wealth. However, I suggested he consider a slightly different approach to his investing strategy.

First let’s look at the stock market. For the decade ending 2009, the stock market has delivered negative returns and this year continues to disappoint investors. Could it be that much of the downside risk is already wrung out of the stock market? Sure, it could go down further but for someone who is systematically putting fresh money in each month, I’d say the stock market is a very good bet if you don’t plan to touch your money for at least five years. At this point, the greatest risk to the stock market may be ‘event’ risk…something like Greece defaulting on its sovereign debt. There is a small risk of a double-dip recession, but that seems unlikely. The good news is that corporations have used the economic downturn to take dramatic steps to cut expenses and improve systems. In short, they are lean and mean! Once the economy perks up, increased revenue will quickly accrue to their bottom line…think profits!

Now let’s take a moment and review the bond market. We are in the midst of the worst interest rate environment that I can remember. The Federal Reserve has set interest rates at zero percent and is actively pursuing policies that continue to keep interest rates low. It’s a disaster for retirees who depend on interest income to pay their bills each month. Investors, afraid of the stock market, continue to pile money into bonds and bond mutual funds, and in many cases, are buying longer maturities and lower quality just to get any kind of yield. What this creates is a kind of bond market ‘bubble’. Eventually, the Federal Reserve is going to take the lid off of interest rates and we’ll likely see them rise dramatically. At that time, bond holders, especially holders of longer maturity bonds or bond funds, will see values drop dramatically. Worse, it may be years before bonds recover from the bursting bubble.

What’s an investor to do? Since the stock and bond market future is never predictable, consider a mixture of high quality dividend-paying stocks (examples: AT&T, Southern Company and Eli Lilly) with bonds having medium to short maturities (example funds: VFSTX, PTTOX). You’ll want to own a basket of at least 20 stocks. Keep a close eye on your bond funds and be ready to shorten maturities when the Fed begins raising interest rates. An allocation of 60% stocks and 40% bonds should allow you to capture much of the stock market return with significantly less volatility.

Pre Marriage Financial Advice

Last week I discussed ways to reduce the financial strain in the event of a divorce. It occurred to me that a better strategy is to head off a future divorce by starting out a marriage on a sound financial footing. So if you or someone you know will be getting married in the near future, help them out by passing along these tips:

Commit to financial responsibility. First, start by realizing that even though you believe your marriage is ‘special’ and not at risk of a future divorce, the reality remains that one out of every two marriages will end in divorce. Of equal importance, realize that while financial issues may not always be the primary reason for a divorce, in most cases it’s a major contributing factor. So if you can get your finances squared away from the beginning, your chances of being in the 50% who stay married go way up.
Pull and share your credit reports. You’re about to combine your finances so it’s best to get a handle on where each of you stands on your credit score. If there are problems, you’ll have more time to resolve them before you join financial forces. Remember, when you get ready to buy your first home, lenders will review both of your credit histories.
Set short, medium and long-term goals. Let’s face it. The vast majority of couples are made up of one person who is more of a ‘spender’ and the other more of a ‘saver’. This is the perfect mix for frequent disagreements about money. “Honey, let’s go out to dinner (again) tonight.” “No. We’re saving for the down payment on a home, remember?” With finances, there’s a constant ‘dance’ between immediate and delayed gratification. Work it out together in advance and ‘automate’ saving for your goals wherever possible.
Divide the responsibilities. Someone has to pay the bills and handle the family finances. Often, the one who controls the money wields uneven control in the marriage. The best solution is to share the responsibility by paying the bills together. This way you both have a handle on where your finances stand.
Meet regularly. At least monthly, set aside time to review your goals; review last months expenses versus your budget (yes, you should have a budget); review your expected expenses for the upcoming month; and look ahead for any non-periodic expenses. This should not take you more than a couple of hours per month and is vital in order to keep your finances on track.
Understand the costs of affluence. In my experience, most couples have pretty lofty financial goals and expectations regarding their future lifestyle. Building a big financial future often comes at a cost in the form of long hours at work for at least one of the marriage partners. Be sure to discuss how you, as a couple, intend to balance work, money and family time.

Marriage is a wonderful institution where two people commit to intertwine their lives for the purpose of building a future together. All marriages face the spectrum of both bliss and challenges. By joining forces to solve your financial puzzle, you’ll likely find that the moments of bliss far out way the moments of challenges.