DISCLAIMER: The information contained herein is for educational purposed only. Consult an investment advisor and/or a CPA for tax and investment advice prior to investing. The author and or his affiliates are as such not responsible for the reader’s tax disposition/liability or the merits of any investment strategies.

This chapter is primarily focused on those Veterans who will not have military careers which result in military retirement pay that will support their retirement lifestyle. A large majority of our servicemen and women will not receive any retirement pay (or qualify for any VA disability benefit) to support themselves after their discharge. You’ll have to plan for your retirement in the same way civilians do!

If you have ever had money problems, or just can’t seem to save and invest much, you are not alone. Unfortunately, financial literacy is not usually taught in school, not taught in most homes, and not taught in depth in the military.

Financial discipline, the act of deploying financial literacy, is a “muscle group” that you must discover, explore and exercise on your own. Like most subjects, the school of hard knocks is the teacher.

Fundamental financial planning is really just financial common sense mixed with some easy to learn information and discipline in your investing habits. There are three easy steps to create financial well-being and even wealth. It’s not what you earn it’s what you save!

One way to quickly and easily begin to save and invest may be to utilize your VA loan benefit to buy a home. YOU have this amazing tool at your disposal! You have the unique advantage of being able to purchase or “leverage” real estate at 100% of the price of the home because you can get real estate financing with a VA loan.

As a homeowner, you are building equity because as you make loan payments, you are reducing your principal balance. Assuming your property value doesn’t decline, you are building value each month in your investment. (Equity equals the value of your home or property minus whatever remaining loan balance you have.) Your house is, in essence, an automatic savings program (as long as properties aren’t depreciating). Your “real estate” savings program is increasing in value every time you make a mortgage payment. It’s literally a forced savings plan, creating wealth through your home.

As an owner you can also build wealth through appreciation, a common investment strategy. Of course, in most cases, there are tax advantages from your mortgage interest deduction and your property tax deduction. All of the above are tremendous benefits that you should take advantage of, if you are in the right spot in your life to be a property owner, not a renter.

Be aggressive with your savings amounts. If you are a terrible saver, you are not alone. Americans typically save somewhere between 2% and 6% of their gross income. That may not get you the kind of retirement you want. Following these fundamental financial planning “Golden Rules” will earn you the “golden ticket” to the “golden years!”

Let’s demonstrate some examples of why it’s important to begin saving as early as possible and remain consistent in your savings discipline.

INVESTOR 1, starting at age 20, contributes $200/month @ 8.00% annual yield* for 20 years. The total accumulation value of this investment would be = $117,804. This investor then stops contributing and lets it “ride” for 20 more years. This investment then grows to a total value of $580,397. I can’t emphasize enough how important it is to begin saving early in life. A $580,397 retirement nest egg was accumulated with only $200/month x 240 payments for a total of $48,000. Compounding returns over a long time period is what produces the greatest results.

INVESTOR 2 contributes $200/month @ 8.00% annual yield* for 40 years. The total accumulation value of this investment would be $698,201.

INVESTOR 3 contributes $200/month @ 10.00% annual yield* for 40 years. The total accumulation value of this investment would be = $1,264,816,

INVESTOR 4: contributes $200/month @ 12.00% annual yield* for 40 years. The total accumulation value of this investment would be = $2,352,954.

Note: The previous examples demonstrate the need to be aggressive in search of higher yields. Small incremental changes in yields produce HUGE results when compounded over time!

INVESTOR 5 contributes $458/month @ 12.00% annual yield* for 40 years. The total accumulation value of this investment would be = $5,392,187. This demonstrates the necessity of saving and investing a significant portion of your income.

*Yields are compounded monthly with tax deferred growth, as in an IRA or 401k. In 2014 – 2015, IRA contribution limits were set at $5,500 or $458/month and $6,500 if you’re age 50 or older. Tax “advantaged” growth is always an objective.

“Average Stock Market Returns,” are supported with lots of data. Without debating methods of calculations and possible inconsistencies, the data suggests that average stock market returns or “yields” fall somewhere between 7.5% - $12.00%. Without making an investment and letting it appreciate for decades, or without consistently adding to your investment, you won’t experience “averaged” returns of the long haul. Again, time and consistency are your friends here, and a technique called “dollar cost averaging” is achieved by utilizing both time and consistency.

This is simply a mathematical argument for achieving consistency in investment purchase prices over time. By consistently investing the same amount, at the same time intervals, you avoid the typically futile attempt of “timing” your purchases of mutual fund shares or another investment. It can be nearly impossible to guess “market lows,” hoping to buy at low points and then sell at high points. Don’t bother guessing! Many smart novice investors make consistent monthly contributions, “dollar cost averaging” their share price of their purchases, by investing every month at a “low” price or a “high” price. Over time this can produce a very satisfactory “average” purchase price as the general stock market rises.

The message from these examples and simple mathematical data is intended to prove only one single point. You can get rich and retire wealthy…ANYONE CAN. It just takes executing the fundamentals of investing early and staying consistent.

Making a commitment to save a significant percentage of your income every payday, right off the top of your paycheck, is how you pay yourself first. Saving BEFORE you make purchases for living expenses or discretionary items is the only strategy that absolutely ensures you’ll meet your savings goals. Paying yourself first makes YOU and your long term financial health the top priority! The highly disciplined person can divide his or her earnings into emergency funds and investments. Others who are not as highly disciplined can set up automatic deposits from payroll or even automatic drafts from your checking account into an investment every month. Buying a home using your VA benefit could be considered an easy application of this concept because your mortgage is paying down principal loan balance every month. Paying yourself first is challenging, we know, but the discipline equals success, stability and wealth.

As investment professionals, we often hear counter-arguments to the concept of paying yourself first such as, “Yeah, right!” Reluctant savers spew resistance as strong as bitter coffee, “Which do I sacrifice in order to save? My baby’s food? Or shelter?” We understand such worry, but stand by the savings mantra. You CAN save, even if you have to “find” money to save. Here are a few ideas to get you started.

Having an emergency fund is so important. Not to shock you, but a health crisis or a single trip to the ER could wipe you out financially and could drive you into bankruptcy. You need to start and continue to grow an emergency fund for “rainy days.” Other, non-medical emergencies will come up and you’ll need immediate cash to fix the problem, and you won’t be able to just draw from funds you’ve earmarked for rent and other necessities.

How much should you plan to have in your emergency fund? It depends on your situation. If you net 5K a month after your payroll deductions, you really should have at least 15K in the bank for emergencies. Say you get sick and can’t work, or you lose your job and can’t find a new one. What then? What if your skills are highly specialized and you need to cover a whole year’s worth of expenses because it will take that long to find just the right new position? In this case, you should have 60K in the bank!

The less stable your career or the less consistent your income is such as a commissioned income, the more you should save. On the other hand, if you have a secure job, such as a government position, or have longevity at a successful corporation, you might only need the equivalent of three month’s pay as an emergency fund. Regardless of your scenario, create an emergency fund and then start investing for retirement. Starting with the creation of the emergency fund first is important. You don’t want to start a tax-qualified investment and then raid it because of an emergency. Now that that the “unplanned” is planned for, let’s talk about the end game – retirement planning.

It’s very important to learn how to invest your savings. Investing is not only for the wealthy. It is for everyone who hopes and plans to be fiscally stable, even rich. You need to begin investing NOW, so you can make money and live off of your investments later, as opposed to still trying to work at the end of your productive years in life. If you start young, you now know the amount of wealth you can build over a lifetime.

Based on your investment goals, you must make choices regarding investment categories such as stocks, bonds, mutual funds or real estate. You can then break down your decisions further into investment vehicles. In the stock market, you might consider a portfolio of individual stocks, where each stock is your “vehicle” to achieve your goal. Or a particular mutual fund concentrating on smaller, high growth companies could be your vehicle in the market. Or if you like real estate, perhaps your vehicle of choice is a real estate investment trust or REIT. These are professionally managed funds that invest in commercial real estate for you.

Some mutual funds have created heroic returns for their investors! One of the most popular mutual funds in history is called Fidelity Magellan. The world renowned money manager Peter Lynch managed this fund for twenty three years. During his tenure, Peter Lynch reportedly averaged an amazing 29.2% average annual return for his fund shareholders. Incredible! And now I have to add a plug for my dear ‘ole dad. In the January 1997 issue of Forbes magazine, my father Van L Brady of Presidio Management was compared to Peter Lynch. My dad was a great professional investor who performed exceptionally well for his limited partners of Presidio.

As you are making your investment decisions, it is very advantageous to implement strategic tax planning by placing those “vehicles” into a tax qualified status or “tax advantaged” status such as a 401k or IRA. The tax qualified plan is like the garage that you park your investment vehicle into. For almost all of your investment choices, you could open an IRA (Individual Retirement Account) with a custodian or directly with a company such as Fidelity Investments as your custodian. You should nearly always choose a tax qualified account to start with until those account options are exhausted. Because of IRS limits on the total amount you are allowed to contribute, you might have more money to invest than the account limits allow, and THAT’s the position you want to be in!

Now let’s discuss some convenient investment plans you can look into right now. The first one, that you want to take maximum advantage of, is your company retirement plan, especially if they match your contributions. A 401(k) plan might be offered by your company and administered by a party outside the company, and the funds are managed by a fund company such as Fidelity.

Employer matching programs exist to provide incentives to the employee, as a bonus for a job well done. They build employee loyalty, and allow the company to get certain tax breaks.
If your company says, “You put in 6% of your gross income, and we’ll match you dollar per dollar and also put in 6% of your gross income into your 401(k).” That’s HUGE! You have to take advantage of that. There are some 401(k) programs where employees can put in as much as 15% of their gross income and their company will match 7%. THAT’S phenomenal! It’s FREE MONEY! So if you can max out your 401(k) contributions and have your company match it, do it! Maximize that retirement contribution!

When you’ve earmarked funds to invest in retirement planning and wealth building, you’ll need to educate yourself on various investment category options and decide where to place your hard earned money. To make it simple, mutual fund investments of stocks and bonds could be categorized into three types of funds:

Growth typically means more “growth oriented stocks” that are focused on re-investing the earnings and not paying dividends to shareholders. Higher returns are expected by shareholders because they are willing to accept more price volatility and risk.

Income typically means a basket of corporate bonds, municipal bonds and or mortgages that generate income to pay out to their shareholders. Lower returns are expected by shareholders and they are willing to accept less price volatility and less risk.

Balanced (Growth and Income) are typically a combination of growth stocks, divided-paying stocks, and a mix of corporate bonds and mortgages. Investors interested in this category are typically in transition from their productive earning years to their retirement years. They are transitioning from assuming more risk to accepting lower potential returns and less risk.

As you approach retirement, hopefully your income will come less from salary and more from some type of income generating instrument, such as bonds. As you approach age fifty five and have ten to fifteen years left in the workforce (based on the traditional idea of retiring at age sixty five), any financial planner will suggest that your portfolio mix be more balanced, such as a mix of dividend paying stocks and bonds.

If there isn’t a 401(k) program you can participate in through your company, then you need to start looking at other tax qualified programs on your own. Individual Retirement Accounts are the most popular choice. There are two types - Traditional IRA and Roth IRA.

A traditional Individual Retirement Account, or IRA, is a tax deductible AND a tax deferred investment account. You are allowed to contribute “pre-tax” dollars into the account (certain income limitations may apply) which means that your contributions are deducted from your gross taxable income. This saves on the tax bite, and then the contributions grow tax deferred. You pay income taxes when the funds are withdrawn in your retirement years. Tax deferred growth is a HUGE advantage when compounding returns over a lifetime. If the taxing authorities were extracting funds to pay taxes along the way, your account value would not grow at nearly the rate it will when taxes are deferred. Also, there are mandatory withdrawal schedules once you hit a particular age, currently age seventy and a half. The IRS MAKES you withdraw the funds so they can receive the tax revenue.

There are many other “tax advantaged” accounts available to the interested investor. Some include: SEP-IRA, Simple-IRA; Solo 401k and a Keogh plan. Most of these plans are geared toward retirement planning for the self-employed. Nearly all investment vehicles can be placed under or into an IRA or Roth IRA, especially using custodians that specialize in “self-directed” plans. It is not uncommon to invest in real estate, gold or other alternative investments with the help of these custodians.

I’m not a big fan of bundling investment products with insurance products in the same strategy, but sometimes a case CAN be made to do so. Traditional bundled insurance products began with “whole life insurance” more than a century ago. Prudential and New York Life built massive businesses with these products as their foundations. In the seventies and eighties, as interest rates skyrocketed, these companies created new products such as “variable life” and “universal life” insurance. I’m still not a big fan. “Buy term (life insurance) and invest the difference” is a common mantra for folks who would prefer to separate insurance needs from investment needs. History has proven that investment yields inside insurance policies differ from that of traditional investment products not offered by insurance companies. Additionally, life insurance premiums are far less expensive when buying term insurance.

However, if you have exhausted all your tax-qualified possibilities and opportunities, the only other potential vehicle to grow income tax-free is inside an insurance policy. Insurance agents offer what they call “investment grade” insurance policies where an investor can grow their money tax-free. When the face value (of the life insurance benefit) is low and contributions are high, little is applied to the payment of the insurance premium and most of the investor’s cash is applied to the investment inside the policy. This “investment grade” structure produces a product focusing on the merits of the investment and much less on the insurance benefit.

There exists limits on the minimization of the life insurance benefit vs. cash contributions to maintain the definition of “insurance,” and thus, the beneficial tax treatment. With traditional whole life insurance, or cash value insurance, there’s a life insurance component and a cash accumulation component bundled together. Whole life insurance is structured to focus on the insurance benefit. But within an investment grade insurance policy, the opposite is true. You’re minimizing the insurance component and maximizing the cash component to focus on the anticipated investment results. Use these tax-free policies to your advantage if you have exhausted all other tax-free growth and investment options.

Investing in insurance products like life insurance and annuities inside the tax qualified status of an IRA, Roth IRA or other tax qualified plan is a waste of resources. Insurance products already have “tax advantaged” status. Keep these insurance products away from your retirement plans!

For assistance in fundamental financial planning, contact a financial planning professional, or let So Cal VA Homes help. Call us at 949-268-7742.