How does one determine risk and safety when it comes to financial planning for the future? George Harrison’s Savoy Truffle lyrics from the Beatles’ White Album tell us “what is sweet now turns so sour,” aptly describing the plight of Ron, a 70-year old Pasadena, California man with his life savings of $200,000 invested in only bank CDs ¹ because he thought it was safer than the stock market. ² While it’s true he is protected from the risk of fluctuating dollar account value (except to the extent his account exceeded FDIC insurance coverage ³), he is nonetheless exposed to the risk of losing the value of his money.

George Harrison and the cover of the Beatles' "White Album"

What exactly is money? Currency is the answer that pops into most people’s heads if they’re asked for a definition of money. Greenback dollars (contacthigh.net/grodzilla/greenback%20dollar.html) hidden under your mattress can come in handy during the aftermath of a big earthquake when grocery store registers could be offline.

A greenback from around 1880

When it comes to investing for the future, however, a better definition of money is purchasing power. In this context, the risk versus safety question Ron could have asked, “what investment plan design is most likely to ensure my future purchasing power?”

Another example: Rosa and Jack’s entire $600,000 retirement account is invested in Certificates of Deposit (CDs).  As of this writing, the average one-year CD rate is 3.57%. ⁴ Historically CD rates have tended to follow inflation as measured by the Consumer Price Index (CPI).  The chart below shows how CD rates moving with inflation during the 1970′s, a particularly volatile period. ⁵

Past performance is no guarantee of future results

Utilizing a CD can be a logical choice when saving for a known short-term goal, such as a car purchase, or for use as a prudent reserve of six months to two years’ worth of income. But there is a surprising downside to this approach when only fixed income instruments are used for building long-term retirement goals. First, a bit about risk:

Risk comes in varied categories. Investments in the stock market have the risk of losing principal due to market ups and downs, also known as fluctuation or volatility. With stocks, the shorter the investment holding period, the greater the chance of loss.

Purchasing power risk (also called inflation risk) refers to the potential of an investment’s erosion in value due to inflation. People who rely upon fixed income investments such as bonds and CDs can be affected by this risk.  In addition to inflation risk, CDs may not provide the required growth over the long term in order to accumulate a nest egg goal, which is an example of the risk of running out of money before you run out of time.

When an artist no longer earns income and needs to live off of accumulated funds, the contribution phase ends and the distribution phase begins. If nest egg earnings offset inflation but nothing more, an accelerating downward spiral of principal depletion can result at such time the required withdrawal amount is greater than earnings. If the account value is sufficiently large, it may be some time before this occurs, if ever. But if principal is being withdrawn, in each successive period there will be fewer earnings. Yet withdrawals must increase to keep up with inflation. To keep up, each withdrawal will deplete an even bigger chunk of principal. And on it goes until the bottom.

If invested in a fixed CD earning 3.75%, Pasadena Ron could currently withdraw all of the about $7,500 in taxable interest from his $200,000 CD account without cutting into principal. ⁶ But in ten years he’ll need about $10,580 to buy what $7,500 pays for today, assuming annual inflation at 3.5%. If Ron depends upon that $7,500 today, where will the additional amount come from tomorrow? If he digs into principal, he will run out in about 25 years. If he needed $10,000 per year to start, his money runs out in 18 years. ⁷

In addition, 2009 will see medical cost inflation of nearly 10%, and it is older people on fixed incomes who are affected most. ⁸ Medical cost inflation is the projected increase in the costs of medical services assumed in setting premiums for health insurance plans.

This erosion of account value over time explains why relying only upon fixed income investments such as bonds ⁹ and CDs could be considered to have greater risk than the stock market. Again, let’s consider the two kinds of risk discussed above, inflation risk and fluctuation risk, in light of their suitability as long-term investments. Is there a strategy to tame market fluctuations and yet receive greater returns that more than offset inflation? That desire sounds like having your cake and eating it too, but consider what history tells us if our investment time horizon is long. There have been about seventy-four rolling ten-year periods between 1926 and 2008. The chart below shows that if you held an investment for ten years comparable to the stock market index shown, historically there was a 1% chance that a loss would occur. ¹⁰

Past performance is no guarantee of future results

The example below shows investment returns over a very long time frame, from 1801 to 2005. The chart shows the hypothetical result of $1 dollar invested in stocks, bonds, US Govt bills ¹¹ and gold. ¹²  All dividends are considered reinvested. “Nominal Return” means the effect of inflation is disregarded.

Total Nominal Return Indices from 1801 to 2001

The achievement of a written personal financial goal (and a plan for financial independence is not a plan without a written goal) depends upon three variables: how many years will you contribute, what amount will you contribute each year, and what is the rate of return of your investments? With these three we can estimate the potential future value of your nest egg, and plan accordingly. We can never predict the future rate of return, but the longer your holding period, the lower your chances of experiencing loss. Historically, it is apparent that utilizing only fixed income instruments for long-term investment goals can be riskier than equity investments such as a properly allocated portfolio of mutual funds.

I am not saying that bonds & CDs do not have an appropriate place in a retirement portfolio; What I am saying is that “safety” is not always what it appears to be, and that “risk” is not a singular definition that can be applied willy-nilly.

As in carpentry so does the truism hold for personal financial planning: choose the right tool for the right job. There is no such thing as one size fits all in life or investments. Financial products are simply tools. An individual’s or family’s plan, goals, and investment philosophy should drive the choice of specific investments within a well-designed, diversified portfolio. If you’ve got gazillions of dollars, then a mattress strategy might work for you. But most of us will need to address the conflict between living well today and taking care of our future self.

Michael Grodsky is an independent financial advisor for artists and collectors. He can be reached at 323-293-6800 or michael@aquariusfinancial.com
Registered Representative offering securities and investment advisory services through Independent Financial Group, LLC, a registered broker-dealer and investment advisor, member FINRA/SIPC. Aquarius Financial is not affiliated with IFG. This column is meant to provide general information, and should not be construed as providing investment, legal, or tax advice. Links are provided herein as a courtesy, and the referenced information is from sources we believe to be reliable; however, we cannot guarantee or represent that any are accurate or complete.

Image Credits

George Harrison composite image
•    Crop from: President Ford with George Harrison and Billy Preston in the Oval Office. December 13, 1974. Photographer: David Hume Kennerly. Public Domain.
•    Stanley. Photo by Michael Grodsky. Used by permission of author.
•    Chocolate Truffles. God knows where this one is from.
•    Psychedelic_dingbats, 07/23/2007 Author: Hendrike 21:20, 23 July 2007. Permission is granted to copy, distribute and/or modify this document under the terms of the GNU Free Documentation license.

The White Album
•    This image is ineligible for copyright and therefore in the public domain, because it consists entirely of information that is common property and contains no original authorship.

Clock face
•    Title: Gravure01.jpg Author: Postelwijn 2006-10-21 Description: Voorbeeld van graveerwerk op een wijzerplaat van een lantaarnklok. Permission is granted to copy, distribute and/or modify this document under the terms of the GNU Free Documentation license.

Footnotes

It can never happen to me is no way to look at the future.  If you knew that your home had a two-out-of-three chance of experiencing significant damage by fire, how would you protect yourself against that risk? Your first thoughts might be about moving to a different location! But what if all residences had that risk? Your options include accept the risk and do nothing, transfer the risk by purchasing insurance, or self-fund against the risk.

Taking Care of the Body Electric

When it comes to your future, make sure you see the big picture. After all, life is full of surprises: I was surprised to learn that more than 70% of us who live to “retirement” age will need long term care at some time in our lives. ¹

We don’t have to lose independence and control over our lives as we get older. Instead, long-term care planning is about living well as we age. Currently, 83% of long term care is provided in the home or community, while only 17% is provided in a nursing home. ² However, 40 percent of people over the age of 65 will need care in a nursing home for some period of time, and the average cost in Los Angeles is over $80,000 per year. ³

LTC is not just for the elderly:  Accidents and sudden illnesses can happen to anyone regardless of age or how well you take care of your health. 40 percent of people currently receiving long-term care are adults 18 to 64 years old. ⁴  Long-term care insurance can help protect against these potential financially devastating events. The key is to plan early, know our options, and to take action to ensure a good future.

Medicare doesn't cut it

Disability or health insurance do not provide long-term care, and in general neither does Medicare. In California Medi-Cal ⁵ will pay for long-term care, but a person’s assets generally have to be paid down to $2,000 or less in order to receive benefits. After death, Medi-Cal may recover costs of care from the estate. Steve Lopez’ article “State reaches Into grave for funds” describes one person’s discovery of this estate recovery program (Los Angeles Times, October 21, 2007).

Although Medicare may not cut it, the California Partnership can: The California Partnership for Long-Term Care ⁶ is an innovative program of the California Department of Health Services in cooperation with a select number of private insurance companies. These companies have agreed to offer high quality policies that must meet stringent requirements set by the Partnership and the State of California. It can take the guesswork out of selecting a high quality policy.

The Partnership’s mission is to provide affordable, quality long-term care insurance protection, so you won’t be forced to spend everything you’ve worked for on long-term care.

A unique feature of the Partnership policies is that it protects you from having to spend down your assets, should you use up your private long-term care benefits and need to apply for Medi-Cal assistance. The asset protection feature enables you to purchase policies with coverage equal to the amount of assets you want to protect from approximately $47,000 up to your total assets – with the assurance that these assets are protected for life, no matter how extended or expensive your long-term care needs may be. Without a Partnership policy, you could only achieve lifetime asset protection by purchasing lifetime coverage…something most people cannot afford. This added protection comes only with the purchase of a Partnership policy.

The bottom line: cost and eligibility.
Long-Term care insurance can be expensive because the costs it insures against are so high. The value is in spreading out possible costs over many years instead of having potentially massive expenses occur over a short period. If ltc insurance is an appropriate choice, there are powerful reasons not to delay purchasing: 1) If accepted, you’re covered from day one; 2) Unlike health insurance premiums that increase with a person’s age, long-term care premiums are determined by the age when you first obtain insurance. Rates typically rise after the age of 30, so it’s usually not cheaper to purchase than when you’re 30 years old, and 3) the cost of waiting exceeds the money you’d save by delaying—assuming that ltc insurance is eventually purchased.

Benefits need not be fixed, however, because of a policy feature called inflation protection. For example, a $310,000 lifetime benefit might cost a 48 year-old married person $2,000 during the first year of coverage. 30 years later at age 78, the lifetime benefit is now over $1,250,000 because of 5% annual compounding. The premium is still $2000 per year (It is possible that future rate increases may be approved by the State of California, affecting everyone equally. Individual rate increases are not allowed).

Regarding eligibility, there is no guarantee you will be accepted. The requirements vary based on an applicant’s age, medical history, medical follow-up, functionality, and cognitive awareness. Any change in your health increases your risk of being uninsurable. Below we’ll mention some other ways of planning for ltc expenses.

Upon whom are you counting for help if you need LTC?
Are you going to rely on friends and family? Whether they’re working or not, assisting you could be one of the most demanding situations your family and friends will ever encounter. Even if their intentions are good, will they be physically and emotionally capable of providing you with all the care you need? Could they afford the loss of income, and would you feel comfortable with the sacrifices your caregivers may have to make?

Q & A

What does LTC insurance cover?
It pays for a variety of services and supports to meet health or personal care needs over an extended period of time. Most long-term care is non-skilled personal care assistance, such as help performing everyday activities such as bathing, eating, dressing — even shopping, cleaning, cooking, and paying the bills.

What if I invest the premium cost myself instead of paying for insurance?
Because costs for long-term care continue to rise each year, not only do you need to consider the costs today, but also what sum may be needed in the future. By purchasing insurance you’re covered with the maximum benefit from day one. Here’s an example of the pot of money available from self-insuring vs. ltc insurance, courtesy of Metlife (Metropolitan Life Insurance Company).

How much can I afford to pay?
General guidelines suggest premium cost should not exceed 7% of income. You need adequate cash reserves and income to make sure you can afford the ongoing payments. The younger and healthier you are the better in terms of your premium cost. Long-term care insurance is not the right choice for every person.

What if I don’t need long-term care after all? Are there alternative ways of insuring the risk?
Most ltc policies allow a “return of premium” rider for additional cost. Other financial products include whole life insurance policies with a long-term care rider – if you need the long-term care benefits they are available to you, but if not you can use the account value yourself or pass to heirs.

Are there any options for those who are not insurable due to health conditions?
Some companies have a rider that allow an uninsurable spouse to receive benefits. Others specialize in insuring higher-risk people. Lastly, there are annuity products that include long-term care benefits. As with any insurance or financial product, there is no “one size fits all.” Financial suitability, needs and circumstances should determine the selection of any long-term care solution.

Summary
None of us want to be in a position to need long-term care. “It can never happen to me” can be a valid way to look at the future, as long as you have a plan for “If it happens to me.” But many people are simply unwilling to face up to the likelihood they will some day need long term care. Fully half of those surveyed agree with the statement, “long-term care is something I won’t need until I am older, and I don’t want to think about it now.” ⁷ According to the non-profit American Health Care Association (www.ahca.org), “Failure to prepare for the cost of a nursing facility stay or other long-term care is the primary cause of impoverishment among the elderly.”

For more information about the California Partnership for Long-Term Care visit http://www.dhcs.ca.gov/services/ltc/Pages/CPLTC.aspx

Michael Grodsky provides financial advisory (aquariusfinancial.com) and insurance services (www.aquariusltc.com) for artists and business owners. CA Insurance Lic. 0F43491. He can be reached at 888-777-2127 and at michael@aquariusfinancial.com

Registered Representative offering securities and investment advisory services through Independent Financial Group, LLC, a registered broker-dealer and investment advisor, member FINRA/SIPC. Aquarius Financial is not affiliated with IFG. This column is meant to provide general information, and should not be construed as providing investment, legal, or tax advice. Links are provided herein as a courtesy, and the referenced information is from sources we believe to be reliable; however, we cannot guarantee or represent that any are accurate or complete.

Image Credits

Ibanez_Studio_ST-200_electric_guitar_body. 2007. Photograph by Joko471. Released into the public domain by the photographer.

Scissors. Aug. 2005. Photo by Haragayato. Permission is granted to copy, distribute and/or modify this document under the terms of the GNU Free Documentation license.

Footnotes

“In recognizing that for-profit insurance is incompatible with a caring, a moral and a high-quality health care system that provides coverage for all, Senator Kuehl is leading the fight to break the industry’s death grip on our health care system.” –Michael Moore, filmmaker

Whoa! I thought you were Dale...

Many believe our healthcare system, especially with respect to insurance, is sadly lacking when compared to other countries. In fact, it’s sadly lacking when compared to practically anything else, from a radish to a doorknob.

Even though healthcare in the U.S. is both unimaginably costly and the least effective system in the entire developed world, there are some progressive changes underway:

“…since 2003 California State Senator Sheila James Kuehl has led the fight in the legislature to achieve true universal health care in California, and, in 2006, brought SB 840, the California Universal Healthcare Act, to the Governor’s desk, the first time in U.S. history a single-payer healthcare bill had gone so far. Although vetoed by the Governor, Senator Kuehl continues to work to bring universal, affordable, quality health care to all Californians. –Sara Rogers, 
Health Consultant (California Progress Report, February 20, 2008 (http://tinyurl.com/2vcvkn)

The Evil Spirit meets Francisco de Goya

Health insurance works creating a fund from pooled, ongoing payments by large numbers of people, which prevents an individual from having to bear the sudden expenses of unforeseen illness or injury. For example, suppose individuals within a group each knew that an expensive operation was inevitable, but did not know when in their lifetime the surgery would be needed. You might better manage your healthcare budget if you could draw from a collective fund, while making relatively smaller payments over the long term.

Competition among insurers has consumer advantages for home and auto coverage, but with health insurance—which insures against the cost of healthcare rather than against the loss or damage of material possessions—competition for profits can hurt the consumer. “It is actually against their interest for insurers to compete on giving us the best care. It’s not simply that they’re not doing it, but given the structure of the marketplace, they shouldn’t do it,” writes Ezra Klein in his illuminating article Not-Their-Fault Insurers. (LA Times, Sunday Feb. 24, 2008. (http://tinyurl.com/35t2gx)

Here’s why: Say insurer ABC comes up with a better way to treat cancer patients and advertises this fact. . Over time, a greater proportion of cancer patients will join this insurer and, to cover the additional costs, premiums are raised. Eventually, the healthier people will switch to lower-costing carriers, forcing ABC to again raise rates as a greater proportion of patients require increasingly expensive care. Competing on the basis of better care can mean lesser profits, possibly causing an eventual downward spiral ending in collapse of the insurer. We can certainly learn from other countries that have incentivised competing on the basis of delivering better care. See item #2 in the resource list for details.

If you’re not covered under a employer-sponsored plan, what’s the best way to go about finding an individual or family policy that fits your financial circumstances and needs? You may find it useful to engage the services of an independent insurance broker or agent as your guide through the maze of policy choices. Charging no fees, they earn a commission from the insurer whose plan they sell. Ask friends for a reference, or obtain a recommendation from a financial planner. You’re going to pay the same price for any given policy regardless from where you obtain insurance, so you might as well take advantage of an experienced agent’s knowledge. So-called “captive agents” can sell only one insurance company’s products, whether or not that is the best solution for you. In the first few seconds of conversation an agent normally will disclose if she works for an insurance company. If you don’t know, just ask. If they are a captive agent, ask what differentiates their product from others. It may turn out that it’s a good fit after all.

In order to talk to your broker or better make your own decisions, educate yourself in three areas. This is about learning how to take care of yourself, and you’re worth the short time it will take:

1. Learn the basics of health insurance:
   • Health Insurance Overview. This quick and easy-to-read guide will enable you to understand the essentials. (http://www.agencyinfo.net/iv/medical/medical.htm)
   • Access to Health Insurance / Resources for Care. A project of the Actors’ Fund of America. Click on your state of residence and read the insurance guide. If you want a more detailed picture, this is for you. (http://www.ahirc.org/)
2. Evaluate insurance company ratings
   • The National Committee for Quality Assurance issues a monthly report card, primarily on HMO insurers (http://www.ncqa.org/). Since you already read the Health Insurance Overview, above, you know what an HMO is, right?
   • Ratings by hospitals of various insurance carriers by national public affairs firm DAVIES (http://tinyurl.com/2tlgvk)
3. Determine what coverage you need and/or want by answering these questions. Which of these statements apply to you?

• I only use basic health care services, and I don’t want to pay a lot for my monthly health coverage payments. (You want a low premium, but you’re willing to take the risk of a high deductible in return.)
• I would like to pay as little as possible out of my own pocket before my plan begins covering my medical expenses. (You want a low deductible. Premium may be higher or lower, depending on the coinsurance amount and out-of-pocket max.)
• I want to cap the amount I spend on total medical expenses each year. (Who doesn’t? The question is, what is the cap amount you want?)
• I visit the doctor and providers’ offices often and don’t want to pay a lot for these visits. (You want a fixed office visit copay.)
• I take prescription drug medications frequently and want my plan to cover part of these expenses. (Look at the Rx benefits, and estimate your yearly costs. There may be separate deductibles for brand name Rx.)
• I would like my health care expenses to be tax-deductible even if I don’t itemize my tax deductions. (Then a Health Savings Account may be for you! You can even pay for aspirin, heating pads or acupuncture visits with tax-free dollars. Most HSA plans also include preventive care with deductible waived.)

Time for Q&A!

Q: My partner and I run our own business. Do we qualify for a group health plan?
A: In 1993 the California State Assembly passed AB 1672, which provides guaranteed access to health insurance by small employer groups from 2 to 50. You must have payroll & tax records, an employer federal tax ID, and eligible employees generally must be W-2 staff working 30 or more hours per week—but two owners count as well, including married couples or registered domestic partners, as long as they work a minimum of 20 hours per week.

Q: My application for private health insurance was declined. What can I do?
A: Insurance companies have the right to decline individual coverage. Errors can happen, so examine the letter you received describing the reason. If you recently have been covered under a group plan within the last 63 days, you may be eligible for a guaranteed-issue policy under COBRA, CAL-COBRA or HIPAA regulations. If you don’t qualify for any of these and have been declined, you can apply for the State of California Major Risk Medical Insurance Program (MRMIP). For more info visit the following link or talk to your insurance broker. http://www.dmhc.ca.gov/dmhc_consumer/hp/hp_cobra.asp

Q: Is there insurance that reimburses the cost of the deductible or coinsurance, so I don’t have any out-of-pocket expenses?
A: You can purchase an “indemnity” accident or cancer policy, which can supplement an existing health plan. You are paid cash when you incur expenses as a result of a covered event. Aflac is a well-known company that provides both individual and group policies. There are also group indemnity plans available by some carriers.

Q: I’m going to be traveling out of the country soon. Does my health plan cover me in other countries?
A: Generally, yes—read your Evidence of Coverage for details—but because the medical provider in another country likely will not accept your health plan for payment of services, you’ll have to pay up front and get reimbursed later. Medical travel insurance solves this problem, and HTH WorldWide provides inexpensive coverage that is recognized in most countries worldwide.

Q: Does Medicare pay for long-term care expenses?
A:  Medicare generally does NOT cover long-term care costs. The extent to which your costs will be covered depends on the type of Medicare plan in which you enroll (visit www.medicare.gov for eligibility rules). It’s no wonder that failure to prepare for the cost of a nursing facility stay or other long-term care is the primary cause of impoverishment among the elderly, according to the American Health Care Association (http://www.ahcancal.org). But it’s not just the elderly who need it: 40 percent of people currently receiving long-term care are adults 18 to 64 years old, and about 60 percent of individuals over age 65 will require at least some type of long-term care services during their lifetime. Long-term care is costly: A 65-year-old couple retiring in 2008 will need approximately $225,000 to cover medical costs in retirement, according to Fidelity Investments’ latest health care cost estimate. (Assuming a fully insured individual retiring in 2008 at his/her Full Retirement Age with a Social Security payment based on a final annual salary of $60,000. Also assumes a 3% Social Security annual cost of living adjustment and a medical inflation rate of 6.6% each year.) These facts highlight the importance of including long-term care expenses as one component of a personal financial plan.

Q: I’ve heard that hospitals are pretty dangerous places. What can I do to protect myself in case I’m hospitalized due to an accident.
A: The inpatient care you receive has its own set of risks: if you ever require hospitalization, enlist the aid of a friend to advocate on your behalf to guard against mistakes. I was surprised to learn that many more people are killed from hospital errors than from auto accidents—about 200,000 annually, according to HealthGrades, a healthcare quality research company (source: Health Grades Inc., “Patient Safety in American Hospitals,” July 27, 2004). See the resource section at the end for “How to Survive a Stay in the Hospital.”

Michael Grodsky is a financial advisor (aquariusfinancial.com) and insurance broker (www.aquariusLTC.com) who works with artists and business owners. He welcomes your questions, and can be reached at michael@aquariusfinancial.com. Registered Representative offering securities and investment advisory services through Independent Financial Group, LLC, member FINRA/SIPC. This column is meant to provide general information, and should not be construed as providing investment, legal, or tax advice. Links are provided herein as a courtesy, and the referenced information is from sources we believe to be reliable; however, we cannot guarantee or represent that any are accurate or complete.

Healthcare Information Resources

1. HELP: Health Consumer Alliance is a partnership of consumer assistance programs operated by community-based legal services organizations. “Our common mission is to help low-income people obtain essential health care.” (http://healthconsumer.org/)
2. PUBLIC POLICY: Every other industrialized nation has achieved universal health insurance. How do other countries do it? “National Health Insurance: Lessons From Abroad.” Century Foundation Press, 2/7/2008 (http://www.tcf.org/list.asp?type=PB&pubid=636)
3. PUBLIC POLICY: OneCareNow is a grass roots campaign devoted to educating Californians and building massive support for Senate Bill 840, “The California Universal Healthcare Act,” authored by Senator Sheila Kuehl. (http://onecarenow.org/)
4. RATINGS: America’s Best Health Plans is a collaboration between NCQA and U.S. News & World Report providing detailed ranking of over 600 managed care organizations (mostly HMOs) in America. (http://health.usnews.com/sections/health/health-plans/)
5. RATINGS: California HMO Ratings At-a-Glance. Report Card ratings concern medical care and services that affect most people. (http://www.opa.ca.gov/report_card/hmorating.aspx)
6. RATINGS: California Medical Group Ratings At-a-Glance. The information is for patients who were members of the medical groups in 2006. (http://opa.ca.gov/report_card/medicalgrouprating.aspx)
7. RATINGS: Doctors, hospitals, and nursing homes. (http://www.healthgrades.com/)
8. RATINGS: Find and compare hospitals near you. (http://www.calhospitalcompare.org/)
9. RATINGS: Insurance Company report card. The National Committee for Quality Assurance is a not-for-profit organization dedicated to improving health care quality. The NCQA seal is a widely recognized symbol of quality. (http://www.ncqa.org/)
10. RATINGS: Survey by Davis Public Affairs, a national public affairs firm for healthcare providers. The results were based on interviews with 113 executives representing more than 500 hospitals, or 10% of all U.S. hospitals. (http://tinyurl.com/2tlgvk)
11. SURVIVAL: How to Survive a Stay in the Hospital. Article at medicinenet.com (http://tinyurl.com/2apwg2)

Image Sources

Composite image: Skull in beer glass.

• Gold Skull. 29. April 2006, Ausstellungsstück im Museum für Hamburgische Geschichte Author: Michail Jungierek. Permission is granted to copy, distribute and/or modify this document under the terms of the GNU Free Documentation license.
• The official emblem of the International Committee of the Red Cross (ICRC).
• Fuck off Bush T-shirt. Federación Universitaria Argentina, 2006. Author: unknown. Permission is granted to copy, distribute and/or modify this document under the terms of the GNU Free Documentation license.

Composite image: doorknob/radish

• Doorknob. Hotel Russia. Moscow, 2005. Permission is granted to copy, distribute and/or modify this document under the terms of the GNU Free Documentation license. Author: Dsmack.
• Radish: 07.04.2007. Author: Felixphoto. Released by copyright holder into the public domain.

Composite Image: Evil spirit with patient.

• Yoshitsuya Ichieisai, The Evil Spirit, c. 1860. Triptych. This image is in the public domain because its copyright has expired.
• Francisco de Goya. Self-Portrait with Dr. Arrieta. 1820. Oil on canvas, 117 x 79 cm. The Minneapolis Institute of Arts, Minneapolis, MN, USA. This image is in the public domain because its copyright has expired.

If I have to be an idiot, at the least I’m a green idiot. I believe in clean air, corporate responsibility, community activism, licorice, pizza and Thai food. And healthy living, freedom, and of course freedom raisins.

Shiny happy raisins

I love trees, sky, and ah, the OXYGEN! But I’m worried about the dismal state of health care, education funding, the ozone hole, the Medicare donut hole, and your little dog too! Did you know the North Pole is melting? That really scares me. Plus I need to cut down on my Chunky Monkey intake.

In everything I do, in every move I make, it seems that I’m part of the worldwide web of production and consumption. So I pertly place my recyclables in the blue bin, our family uses reusable grocery bags, and I vote. What more can a light-switch thumping, gasoline-pumping 21st century fox do?

C'mon, baby, light my sri fire...

It was only a couple of years ago a friend remarked to me that real estate was the only investment that made any sense, as if his seat on the Ferris Wheel of investments, propelled by an invincible source, would forever be going up, up, UP! Instead, what happened was “up, up and away.”

The first Ferris wheel, from 1893 World Columbian Exposition in Chicago

The desire for a sure thing is hard to resist. Albert Einstein, succumbing to pressure to support the idea of a static universe, in his 1917 paper added an adjustment number called the “cosmological constant” to his equation for general relativity. In 1931 he publicly renounced this static cosmology and endorsed the Big Bang expanding universe model, ditching the cosmological constant and returning to his original equation. He later called his bowing to peer pressure the greatest blunder of his entire life. You can read about the adventure in author Simon Singh’s “Big Bang – The Origin of the Universe.”

Many philanthropic foundations have long drawn a wall between their socially conscious mission statements that drive grant making, and the investment holdings of their endowment. There is a truism that investing for social benefit results in lower returns. But just as scientific peer consensus eventually embraced the Big Bang theory, so has the thinking of philanthropic foundations changed. The reasons are twofold: A recognition that corporate responsibility and societal concerns are valid parts of investment decisions, ¹ and a growing number of academic studies have demonstrated that socially responsible investment (SRI) mutual funds perform competitively with non-SRI funds over time. ²

For example, according to University of Maastricht and Erasmus University Rotterdam economists in their prize-winning paper, “we find little evidence of significant differences in risk-adjusted returns between ethical and conventional funds for the 1990-2001 period.” ³

Foundation investment choices seem to be increasingly guided by effect upon society as a whole, not just financial gain, according to a recent Los Angeles Times article. ⁴ Fresh thinking in the nation’s largest foundations may be driving the impetus ever faster: The $8.5-billion William and Flora Hewlett Foundation (Menlo Park), the $6.1-billion John D. and Catherine T. MacArthur Foundation (Chicago), the $7.8-billion W.K. Kellogg Foundation (Battle Creek, Michigan) all have made recent changes to improve the social effect of their investments. ⁵

SRI assets are also growing faster than assets as a whole: according to the non-profit Social Investment Forum’s 2005 biennial report, SRI assets rose more than 258 percent from $639 billion in 1995 to $2.29 trillion in 2005. Over those ten years, SRI assets grew four percent faster than the entire universe of managed assets in the United States. ⁶

Some have already been on the SRI track: the nation’s second largest foundation, the Ford Foundation, along with others such as the F.B. Herron Foundation, the Jessie Smith Noyes Foundation and the Nathan Cumings Foundation, have for a long time aligned their charitable and investment practices.

What is Socially Responsible Investing?
Socially Responsible Investing (SRI) is a broad-based approach to investing that now encompasses an estimated $2.3 trillion out of $24 trillion in the U.S. investment marketplace today. ⁷ The release of the United Nations Principles for Responsible Investment–subscribed to by some of the world’s largest institutional investors, asset managers, and related organizations representing over $9 trillion in assets as of mid- 2007–underscores the widespread acceptance of the principle that investors cannot, in the long run, achieve their goals by investing in corporations that externalize their costs onto society. ⁸

How do I research SRI funds?
A good place to start is the Social Investment Forum (http://www.socialinvest.org). Look at the resource list at the end of this article too.

How do I start investing?
If you participate in an employer-sponsored retirement plan, there may be SRI funds already available to you. If you manage your own IRA or other plan, look into what’s available. But don’t just go adding a fund without considering the entire makeup of your portfolio.

The key to earning decent long-term returns and limiting overall risk is to have a proper asset allocation, meaning you don’t have all your eggs in one basket. For do-it-yourself-ers, check out the government’s website about asset allocation (http://tinyurl.com/2825hw), or purchase “All About Asset Allocation” by Richard A. Ferri ($13.57 at Amazon), a great introduction to the topic. Your personal financial advisor or company where you have your investment or retirement accounts can help.

How do I know which funds will produce the highest returns?
You don’t, you can’t, and you won’t, so just forget about it because past performance doesn’t predict future results. The day-to-day ups and downs of the market receive the media attention, but the daily, quarterly, or even yearly returns are largely irrelevant in constructing an individual’s portfolio whose objectives are long-range.  What you want to look for are funds that perform well over the long run within their particular sector, as compared to the appropriate benchmark indices. Various areas of the economy are always moving up and down and sideways, and so far no one has ever been able to know ahead of time what the pattern will be. Asset allocation, I’ll say again, may be the key to long-term success in building a financially secure future. Not panicking helps too!

What makes an SRI fund different?
If a prospective company is a fit according to a fund’s stated objectives, research is performed to determine whether or not it’s a good idea to buy stock at the current offering price. It boils down to the question “Within the guidelines of the stated objectives of the fund, will this purchase help to achieve the highest possible return for the fund’s shareholders?”

The three core socially responsible investing strategies are screening, shareholder advocacy, and community investing. Screening means a fund will include or exclude companies based upon criteria such as alcohol, tobacco, animal testing, and human rights, among others. These screens can be positive (e.g., including companies that treat employees well) or negative (e.g., excluding companies who do business with disturbed musicians).

Keep in mind that, as with all mutual funds, SRI funds have no guarantees of future return.

In any case, you'd better take this lad's offering of raisins!

If you use electricity, drive a car, and participate in many other activities of daily living, in a very true sense you are already investing in the companies that allow and encourage your consumption. In other words, you are part of the “market” whether or not you actually own stocks or mutual funds. Socially responsible investing can be a way to make your dollars work toward something in which you believe, and support those companies you believe have a vision in line with your own.

Resources and suggested reading
1.    “The Mission in the Marketplace: How Responsible Investing Can Strengthen the Fiduciary Oversight of Foundation Endowments and Enhance Philanthropic Missions.” Social Investment Forum Foundation’s resource guide for foundations to manage risk and leverage their investment assets more fully with their core philanthropic purpose, while creating lasting value. http://tinyurl.com/35t49h
2.    “10 best” list of companies. Corporate Responsibility Officer magazine rates the citizenship disclosures, policies and performance of large-cap, public companies in the following industries: Auto & Vehicles, Paper, Technology Hardware, Technology Software, Transport, and Travel & Lodging industries, Chemical, Energy, Financial, Media and Utilities industries. http://www.thecro.com/node/580
3.    Social Science Research Network. http://www.ssrn.com/
4.    United Nations’ “The Principles for Responsible Investment.” An investor initiative in partnership with UNEP Finance Initiative and the UN Global Compact. http://www.unpri.org/
5.    The Social Investment Forum; national membership association dedicated to advancing the concept, practice, and growth of socially and environmentally responsible investing. http://www.socialinvest.org/
6.    Social Investment Forum’s 2005 biennial report. http://tinyurl.com/258794
7.    Sristudies.org, a resource for quantitative aspects of socially responsible investing. Includes an annotated bibliography of studies of socially responsible investing. A project of the Moskowitz Research Program, which is affiliated with the Center for Responsible Business at the Haas School of Business, University of California, Berkeley.
8.    Socially Responsible Mutual Fund Charts of Financial Performance. http://www.socialinvest.org/resources/mfpc/
9.    SocialFunds.com, an advertising-driven website with information on SRI mutual funds, community investments, corporate research, shareowner actions, and daily social investment news.
10.    “Handbook on Responsible Investment Across Asset Classes.” For asset allocation junkies, individuals and institutional investors the Boston College Center for Corporate Citizenship created this work. http://tinyurl.com/2ffqbu

Michael Grodsky is a financial advisor (aquariusfinancial.com) who works with artists, collectors and business owners.  He can be reached via email at michael@aquariusfinancial.com. Registered Representative offering securities and investment advisory services through Independent Financial Group, LLC, a registered broker-dealer and investment adviser, member FINRA/SIPC.

This column is meant to provide general information, and should not be construed as providing investment, legal, or tax advice. There is no guarantee as to the accuracy or completeness of the information in this article. There are no guarantees of future return for any fund, nor an endorsement of any investment product. Mutual funds are sold by prospectus only. For complete information on mutual funds including sales charges and expenses, call your financial professional for a prospectus. Please read the prospectus carefully before investing. Links are provided herein as a courtesy, and no guarantees are made as to the accuracy of the content on the referenced websites.

Image credits

Sun-Maid/George Bush composite image
•    First Sun-Maid packaging to feature a likeness of Lorraine Collett as the “Sun-Maid Girl,” 1916. Designer unknown, incorporates painting by Fanny Scafford. Public domain in the United States.
•    Photograph of Bush speaking. Brazil, November 6, 2005. Agência Brasil, a public Brazilian news agency, produced photograph. Published under the Creative Commons License Attribution 2.5 Brazil.

Fox/Morrison composite image
•    Foxes by Franz Marc, 1913. The Yorck Project: 10.000 Meisterwerke der Malerei. DVD-ROM, 2002. ISBN 3936122202. Distributed by DIRECTMEDIA Publishing GmbH. Public Domain.
•    Jim Morrison portrait, 2007, by Amadeu.taradell. Released by author into public domain.

Ferris Wheel/Superman composite image
•    The first Ferris wheel from the 1893 World Columbian Exposition in Chicago. The New York Times photo archive. Public Domain.
•    Screenshot of 1941 cartoon Superman. Fleischer Studios. This work is in the public domain because it was published in the United States between 1923 and 1963 with a copyright notice, and its copyright was not renewed.

Musician holding Valentine’s Day raisins composite image
•    Photo of musician Jeff Hawley, 2007.  Manager, Marketing Content Pro Audio and Combo Division, Yamaha Corporation of America. Courtesy of Mr. Hawley.
•    Photo, August 3, 2005 by Mazbln. Halberstadt, Klosterkirche St. Burchardi, Ort des John-Cage-Projektes “As slow as possible.” Permission is granted to copy, distribute and/or modify this document under the terms of the GNU Free Documentation License, Version 1.2 or any later version published by the Free Software Foundation.
•    Original painting of Lorraine Collett by Fanny Scafford, 1915, later used on Sun-Maid raisin packaging. Public domain in the United States.

Footnotes

Although the slithy toves may endlessly gyre and gimble in the wabe, as the end of the year approaches your opportunity for setting up a new retirement plan is drawing to a close. When Lewis Carroll penned the line Beware the Jabberwock, my son! he might as well have been thinking of the IRS taking its tax bite from your behind.

The Jabberwock. Illustration by John Tenniel

When it comes to saving for the future, make sure you see the big picture. In my last column I waxed and whined over the concept of the Time Value Of Money, describing how compound interest can generate surprising results given enough time. This column goes one step further: If you can choose to defer spending today so you’ll have more tomorrow, what structures are available? One investment strategy is that self-employed artists can shelter income and defer tax liability through traditional retirement plans. Quoted contribution amounts and other numbers are based upon the 2007 tax year (all tax references sourced from http://irs.gov).

If you haven’t yet considered a plan, now is a good time to take action. If you already have one, bravo for you! If your finances have changed this year, check if your existing plan is still is the best fit for your circumstances. With increased income you may be able to increase contributions, and thus shelter more income from taxation. Contribution maximums range from $4,000 to $180,000 for 2007, depending on your income, plan type, and age.  Notice I didn’t consider that your income would be less? Hope springs eternal!

What are the benefits of setting up a tax-deferred retirement plan versus simply saving on your own in a taxable account?

First let’s consider what happens if you save on your own. Jill had a dream in which her future self wasn’t happy, not one whit, with her progress in building a nest egg.

Photograph by Nevit Dilmen, 2006

Miraculously, she found $4,000. If she’s in the 33% tax bracket, she had to earn $5,970 to get that $4,000 in her pocket. If she now invests in a CD or savings account she’ll continue to pay taxes on the interest earned each year. At least that’s better than nothing, but is there a more productive alternative?

The incentive for saving in a retirement plan is that contributions may be deductible from your income, and earnings grow tax-deferred. Maybe we should call it your “re-engagement account,” because the idea of retirement probably doesn’t apply to you. Point is, imagine a future day when you can choose whether to work, and yet maintain your lifestyle. Maybe you can get all the way there, maybe not, but with both a goal and a plan you can assess your progress along the way, make changes, and adapt. A tax-deferred retirement plan is a good place to start.

Let’s compare the result of saving $4,000 on your own versus saving in a pretax retirement account, assuming a single artist with taxable income of $50,000 from all sources, such as from both art production and teaching.

SAVING ON YOUR OWN
Taxable Income: $50,000
Tax Rate: 25%
Tax: $12,500
After Tax Income: $37,500
Contribution to savings account: $4,000
Result: $33,500 in pocket + $4,000 in savings account (net $37,500)

SAVING IN A PRETAX ACCOUNT
Pretax contribution to retirement account: $4,000
Taxable Income: $46,000
Tax Rate: 25%
Tax: $11,500
After Tax Income: $34,500
Result: $34,500 in pocket + $4,000 in retirement account (net $38,500)

Yes, that’s right, you’ve got $1,000 more in your pocket if you contribute $4,000 into a pre-tax plan. This example used $4,000, but you may be able to shelter considerably more per year or more if you are self-employed, have the required income level, and choose an appropriate plan. Now that you understand the benefit of tax-deferral, let’s move to an overview of the various plans.

Plans may be individual or employer-sponsored. First we’ll look at individual plans: the IRA and Roth IRA (http://www.irs.gov/publications/p590/index.html).

The IRA (Individual Retirement Arrangement) allows you to save while your investments grow tax-deferred until you withdraw them. If you’re eligible and under age 70 1⁄2, you can take a current tax deduction for all or part of your contribution. A full deduction is available ($4,000, or if over age 50, $5,000) if you aren’t covered by an employer-sponsored retirement plan. If you’re covered by a plan, you can still take a full deduction against your 2007 taxes if your AGI (adjusted gross income) is less than $52,000 in 2007 if you’re single, and less than $83,000 in 2007 if you’re married and filing jointly.

Also, if you’re married and filing jointly and either you or your spouse is covered by a retirement plan, the spouse who isn’t covered can make a fully deductible contribution as long as your combined AGI doesn’t exceed $156,000. The deduction is fully phased out at $166,000.

It’s a good choice if you qualify for a current tax deduction or you expect to be in a much lower tax bracket in “retirement.”

At the mention of the word “marriage,” I have to acknowledge the serious inequities regarding rights for same-sex partners. A 2004 General Accounting Office report found 1,138 benefits, rights, and protections provided on the basis of marital status in Federal law; gay and lesbian couples are excluded from all of these. Individual state laws afford a changing landscape of protections and benefits. Currently six states plus the District of Columbia now allow the registration of a domestic partnership. In the State of California, for example, new law requires RDPs (Registered Domestic Partners) to file a joint return using the married filing joint or married filing separate filing status. However, because Federal law does not allow RDPs to file a joint return, they must continue to file as unmarried individuals on their federal returns. Returning to the IRA…

You cannot take an early withdrawal without incurring taxes and a possible 10% federal tax penalty on some of your contributions and earnings unless a 72(t) exception applies. The 72(t) exception is for people who have a rare bone disease that results in a mouthful of multi-layered 72 tiny teeth instead the usual 32. A congressman’s daughter had the condition, so it became impacted into tax law.

Two Supernumeray Teeth At Premaxilla

OK, I made that up.  The real 72(t) explanation is at this link if you’ve really got to know:  http://tinyurl.com/2lbrq2    Good luck!

With the Roth IRA you pay income taxes up front and you never pay them on amounts withdrawn from the IRA again. Even though you can’t deduct contributions to a Roth IRA from your income taxes, it provides the most advantages for the most people, especially those with long time horizons. You’ll have more in the end than in a regular IRA, given enough time.

You can contribute the full amount ($4,000, or if over age 50, $5,000) to a Roth IRA as long as your MAGI doesn’t exceed these limits:
•    $99,000 if you’re single
•    $156,000 if you’re married and filing a joint return

The contribution amount is fully phased out at $114,000 if you’re single and $166,000 if you’re married and filing a joint return. You may be wondering what is a MAGI? It’s either the three wise men or modified adjusted gross income. Take your pick.

Three Wise Men depicted in a 6th century mosaic

Contributions can be withdrawn tax-free and penalty-free at any time. The earnings on your contributions can be withdrawn tax-free and penalty-free if your initial contribution to the account was made at least five years ago and you’re age 59 1/2. You may be able to convert other account types, such as an IRA or 401(k), to a Roth IRA, subject to rules.

Employer-Sponsored Retirement Plans
(http://www.irs.gov/publications/p560/index.html)

If you are in business for yourself, regardless of your business entity type (such as a sole proprietorship, LLC, or S-Corp) you can utilize an employer-sponsored plan. Plus you can have both a regular or Roth IRA and an employer-sponsored plan.

The primary benefit to these plans is that contribution limits are higher than in a regular or Roth IRA. The possible drawback (or benefit, depending how you look at it) is that if you do have employees, you may be required to make contributions to their accounts as well. I’m going to describe only some of the most basic plans, their maximum contributions and under what conditions you would be required to cover any employees. There is both flexibility and complexity in designing how to implement these plans, and following is a summary description of the major plan types.

SEP IRA (Simplified Employee Pension)
•    Maximum Contribution: 25% of participant’s pay or $45,000, whichever is less.
•    Who MUST be covered: Any employee who has worked for three out of the past five years and is age 21 or older.
•    Cost: very little to set up ($10 for example); minimal ongoing paperwork and expense.
•    Deadline for setting up a SEP: You can set up a SEP as late as the due date (including extensions) of your income tax return for that year.

SIMPLE IRA (Savings Incentive Match Plan for Employees of Small Employers)
•    Maximum Contribution: $26,000.
•    Who MUST be covered: Any employee earning $5,000 during any two preceding years and who is expected to earn $5,000 in the current year.
•    Cost: very little ($10 for example); minimal paperwork and expense.
•    Deadline for setting up a SIMPLE: January 1 through October 1.

401(k) or Roth 401(k)
The plan design may allow for employee to choose to make their contributions with after-tax dollars, and would then be characterized as a Roth 401(k) plan.
•    Maximum Contribution: 25% of participant’s pay or $45,000 whichever is less.
•    Who MUST be covered: Any employee with 1,000 hours of service within one year and who is age 21 or older.
•    Cost: Trust and recordkeeping fees (can be several hundreds of dollars annually).
•    Deadline for setting up a 401(k): To take a deduction for contributions for a tax year, your plan must be set up by the last day of that year.

PROFIT-SHARING PLAN
You don’t need profits in order to make contributions to a profit-sharing plan. Contributions to a profit-sharing plan are discretionary.  There is no set amount that you need to make. If you establish a profit-sharing plan, you can have other retirement plans, such as a 401(k).
•    Maximum Contribution $45,000.
•    Who MUST be covered: Any employee with 1,000 hours of service within one year and who is age 21 or older.
•    Cost: Trust and recordkeeping fees (can be several hundreds of dollars annually).
•    Deadline for setting up Profit-Sharing Plan: same as 401(k).

DEFINED BENEFIT PLAN
The lure of these plans for sole proprietors is that older employee/owners can pack in significant benefits in a relatively short period. If you are an older artist whose career is coming along nicely but you haven’t yet accumulated assets for your next “re-engagement” period, you may want to take advantage. Notice the high contribution limit. However, once they are set up, these plans have mandatory contribution amounts. If your income is not fairly predictable, and you aren’t able to contribute the required amount each year, you will be disqualified and owe a significant excise tax. Like the profit-sharing plan, you can have other retirement plans at the same time.
•    Maximum Contribution $180,000.
•    Who MUST be covered: Any employee with 1,000 hours of service within one year and who is age 21 or older.
•    Cost:  Most expensive, with trust, recordkeeping and actuary fees. The complexity of these plans generally requires a few thousand dollars to set up and maintain.
•    Deadline for setting up DB plan: same as 401(k).

Taking Distributions from Plans
In all retirement plans except for the Roth types you’ll owe tax on withdrawals at your then-current tax rate. With certain exceptions, if you make withdrawals before age 59 1/2, you’ll owe a penalty of 10% plus whatever tax is owed. You must begin taking distributions when you are 70 1/2 (again, except for Roths).

Conclusion
From the shy, patient IRA to the glam-rock Defined Benefit plan, there’s a choice for almost every budget and dream. All that glitters is certainly not gold, but are those gold coins in the image below? Toss a coin of love into your own bucket and make a wish for peace and prosperity. Today is the hardest day to invest, but it’s the only day we’ve got.

Electron micrograph of Avian influenza viruses, 1997

Michael Grodsky is a financial advisor (aquariusfinancial.com) who works with artists, collectors and business owners. Registered Representative offering securities and investment advisory services through Independent Financial Group, LLC, a registered broker-dealer, member FINRA, SIPC. This column is meant to provide general information, and should not be construed as providing individual financial advice. For investment, legal, and tax advice see your advisor, accountant, and attorney.

The S&P500 is an unmanaged but commonly used measure of common stock total return performance. It is composed of 500 widely held common stocks listed on the NYSE, AMEX and OTC markets. Investment return and principal value of stocks will fluctuate with changes in market conditions. It is not possible to invest directly in an index. Past performance is not indicative of future results. It is always possible to lose money when investing.

Image Credits

1. The Jabberwock. Illustration by John Tenniel (February 28, 1820 – February 25, 1914). Public Domain.
2. Golden Egg; Photograph 2006 courtesy of Nevit Dilmen; Permission is granted to copy, distribute and/or modify this document under the terms of the GNU Free Documentation License.
3. Two Supernumeray Teeth At Premaxilla. X-ray photograph courtesy of Albert. Public Domain.
4. Three Wise Men, named Balthasar, Melchior, and Gaspar. From a late 6th century mosaic at the Basilica of Sant’Apollinare Nuovo in Ravenna, Italy. Photograph 2006 courtesy of Nina Aldin Thune. Licensed under the Creative Commons Attribution ShareAlike 2.5 License.
5. Colorized transmission electron micrograph of Avian influenza A H5N1 viruses (seen in gold) grown in MDCK cells (seen in green). Photograph 1997 courtesy of Cynthia Goldsmith, Centers for Disease Control and Prevention. Public Domain.

© 2007 Michael Grodsky

You’ve gotten your act together, or are on the way to do so. You’re making money, but what do you do with it? What should you know?

Using the concept of the Time Value of Money (TVM), you can move towards creating a financially independent future. If you understand how it works, you’ll want to begin taking action sooner rather than later. What’s the secret? Because it requires a long-term perspective, most people will not focus upon the opportunity it provides due to the demands of daily living. So it effectively remains a ‘secret’ to many.

TVM and compound interest work hand-in-hand. Some believe that Albert Einstein answered “compound interest” when asked, “Hey, Einstein, what’s the greatest discovery of the 20th century?” The fact that he never wrote or said anything like that makes the effects of compound interest no less amazing, no less important to your future. But first, what is it? It’s simply the process of an investment earning a return, and that return is then added to the original investment. And on and on, over time. Why is that such a big deal?

In Kurt Vonnegut’s wonderful little book Cat’s Cradle a scientist creates a substance called Ice-9 that causes water to freeze at room temperature. Every ocean on the planet would instantly freeze if Ice-9 crystals touched a single drop in one ocean. TVM is kind of like Ice-9, but instead of working instantly it gathers steam slowly at first, but then watch out! The result, given enough time, is inevitable wealth and financial independence: a very big deal indeed.

Carlo, a young artist of 27, decided he wanted to throw away over $100,000. He didn’t put it that way, but that’s the reality. Perhaps he felt he didn’t deserve to take care of himself, or maybe he was just too busy. He told me he wanted to delay beginning his savings plan until he felt more “settled” in his life. It is true that he couldn’t afford to invest very much. So what harm could ensue from a few years’ delay, given the relatively small amount in question–$168 bucks a month, or 5% of his income? Maybe better to wait after all…

I used to be just like him, believing that the future will take care of itself, and me. I can’t speak for Carlo, but for me a lack of knowledge and inertia informed that wistful hope springs eternal attitude.

Where is that $100,000 my young friend so effortlessly threw away? It lives 38 years in the future, a distant tale of lost opportunity. For if he had saved $2000 each year for only two years in a row then stopped–only $4000 total, mind you–at age 65 that $4000 could become $169,000 (assuming an average annual return of 10.5%; the S&P500 ¹ average annual return for the period 1/31/1987 – 1/31/2007 is 11.17%). Look, there’s often too much month left at the end of your money, but I hope you’ll make a commitment to start saving now, after what you will have learned by the end of this short column.

What might my friend have accumulated by age 65 if he continued his $2000/year savings plan for 38 years, given the same assumption of 10.5% average annual return? A nice $914,000, thank you very much. Waiting two years, though, will have cost him $169,000. If he saved at a recommended 10% to 15% of income, he would of course have far more. And he’d need it, because 38 years of inflation means $914,000 might be worth only $300,000 in today’s dollars.

Here’s the show-stopper that really demonstrates TVM’s power: Imagine that at age 20 you started saving $2000 per year for ten years in a Roth IRA, then stopped. Your account would be worth about $36,000 at the end of those first ten years (assuming 10.5% annual return). Let’s say that over time you had a successful art career, partnered up with a loving someone, had kids (or a dog or elephant) and saved a bundle, but you left your original investment alone. A long time passes, and now you’re 70 years old. How much is that IRA worth, the one to which you contributed a total of $20,000? It’s grown to $1,860,000, and it’s tax-free to boot (because it was invested using a Roth IRA). How many 70 year-olds alive today do you imagine could use that kind of money? Does this sound like anything in which your future self would be interested?

Choosing the dollar amount to save, the institution at which you hold an account, the type of account (such as an IRA, Roth IRA, SEP, 401(k)), and the investment itself are important considerations. Investor education tools can be found at:
•    latimes.com (click on ‘Business’ in left hand menu, then on ‘Money Library’)
•    U.S. government website for investors (http://www.mymoney.gov)
•    The American Association of Individual Investors, a nonprofit organization that arms individual investors with the education and tools they need to build wealth (http://www.aaii.com)

There’s a saying: today is the hardest day to invest, but it’s the only day you’ve got.

Michael Grodsky is a financial advisor (aquariusfinancial.com) who works with artists, collectors and business owners. Registered Representative offering securities and investment advisory services through Independent Financial Group, LLC, member FINRA/SIPC. This column is meant to provide general information, and should not be construed as providing individual financial advice. For investment, legal, and tax advice see your advisor, accountant, and attorney. Email: michael@aquariusfinancial.com
© 2007 Michael Grodsky