So many choices, so many voices, so little clarity
21st century technology offers infinite financial possibilities. With a single click from their home computers, individuals can buy shares on a foreign exchange, get competitive quotes for insurance, analyze years of financial data, receive up-to-the-minute reports or on-the-spot prices of precious metals, and execute hundreds of other financial transactions – all by themselves. For those with an Internet connection, there are no restricted areas, no products that can’t be purchased, no places that can’t be reached.
However, expanded choices also necessitate more decision-making. It causes us to ask what can financial planning be used for? With so many financial products and strategies available, how does the consumer determine which ones fit their objectives and circumstances? In this open access environment for financial products, institutions recognize they must differentiate themselves from their competitors; companies can’t simply present and explain their products and services, they must market them. Thus, unlimited choices are accompanied by advertising that features attention-grabbing curiosities like talking-baby stock traders, animated green lines for retirement, and profound (yet utterly fictional) e-mail conversations about the financial future.
While this type of advertising may help consumers remember the name of the company or its products, it is questionable if marketing actually provides consumers with any clarity regarding their financial decisions. Instead, they are inundated with a combination of emotional images and conflicting financial perspectives, which offer little guidance or education. In the end, most mainstream financial “information” delivered by mass-media outlets does little more than add new voices to the cacophony of opinion and hype. Infinite choices and multiple messages equal consumer confusion.
One approach that always makes sense
Making sense of the multitude of messages and endless array of financial products requires a unifying financial objective, one that provides a context for evaluating all the possibilities available. To that end, here is arguably the best financial strategy, one that addresses the most pressing financial challenges, yet allows room for opportunities:
It’s all about income.
It is not about total return, or net worth, or risk tolerance, or financial ratios – it’s all about income. With this strategy, most financial issues can easily be filtered, understood and resolved by answering one question:
“How will this decision affect my income?”
Perhaps this sounds too simplistic. But try it.
How will buying a new car affect your income? (If the monthly payment is more than what you were paying, your income will be negatively affected. Is it worth it, or would you be better off finding reliable transportation for a lower price?)
How will investing in a qualified plan affect my income? Long-term the hope is your investment will compound greatly to increase future income. On the other hand, money set aside in an account meant to remain untouched until age 59½ reduces your current income. Considering your personal circumstances, which is more important, income now or income later?
If you make good decisions based on increasing your income benefits, your financial life will make steady progress.
The compelling case for income
Most Americans do not function in a closed, self-sufficient economic system where we meet our material needs and desires by growing our own food, making our own clothes, generating our own electricity, etc. In order to acquire both the necessities and luxuries of life, we use money. Since maintaining our material world is a daily, weekly, monthly and never-ending task, the need for spendable money (i.e., income) is daily, weekly, monthly and never-ending, providing income is the essential and foremost financial priority in everyone’s life.
The financial priority of income cannot be overstated. A major portion of our tax structure centers on income. With every election cycle, politicians of every stripe inevitably tout “jobs creation” as one of their legislative priorities. (Is this because more people want to work? No, it is because people want – and need – the income that comes from having a job.) Similarly, the debates about Social Security, Medicare and health insurance are ultimately concerns about providing and preserving income, and the costs of doing so. As a nation, we are obsessed with income.
For our discussion, income is any financial gain that puts spendable dollars in your hand. A paycheck is income, as are payments received from loans and rental agreements. Interest and dividends are also income. A stock that grows in value to $10/share from $5 has experienced appreciation, but there is no income until the stock has been sold at a profit. Similarly, homes and other real assets, while they might be listed on your net worth statement, are not income until their value has been converted to spendable dollars.
The 4 facets of income planning
As the number one financial priority in everyone’s life, income activities can be categorized in four distinct actions.
1. Generating Income
The foundation of every good financial program is the ability to manage assets to generate income. If you are employed, your ability to work is one of the assets you manage. Interest from a savings account, certificate of deposit or other financial instrument is income. The profits from a rental property can be considered income. (In contrast, a personal residence, while a financial asset, is not usually a source of income; the house may appreciate in value, but that appreciation doesn’t deliver spendable dollars.)
For most, the default option for income generation is a job, i.e., getting paid for services rendered. While this is undoubtedly the predominant form of income generation, it is not the only method. A narrow focus on employment for income generation is a shortcoming of many financial strategies. Many people could benefit from using financial assets under their control to generate more immediate income, instead of focusing exclusively on accumulating for retirement.
2. Accumulating Future Income
In the simplest sense, “accumulating future income” is simply saving today to provide income in the future. But just as income generation may mistakenly overemphasize just getting a good job, saving can also be over-simplified to amassing the largest possible number on a balance sheet. As Barry J. Dyke puts it, “a major problem in financial planning today is that 401(k) and mutual fund marketers have successfully blurred the difference between ‘saving’ and ‘investing.’ When one saves, money is safe and liquid. When one invests, 100 percent of your money is at risk 100 percent of the time.” Some assets, while highly valued, are not always good sources of income. For example, a rare collectible may be appraised at $1 million, but this asset only becomes income when it is sold, which requires finding a buyer and relinquishing the asset.
3. Protecting Income
Since most income generation comes through work and employment, it makes sense to protect both the generating asset (i.e., the individual) and its income potential. One of the reasons health insurance is such a prominent political issue is because almost everyone’s income is affected by their health, and the cost of maintaining it. The same rationale extends to obtaining both disability insurance and life insurance: when individuals stop generating income, everything else usually grinds to a halt.
Income protection is more than protecting the individual’s ability to earn income. As recent history shows, sudden changes in markets can turn profitable investments into sizable losses. Given this volatility, individuals may consider it prudent to “move” accumulated future income to various insured accounts to “lock in” their income-producing potential.
4. Distributing Income
In industrialized Western economies of the late 20th century, the template for income success was long-term employment during one’s working years, followed by pension incomes (from government and private plans), supplemented by personal accumulation.
In this model, the emphasis in personal accumulation was on maximizing valuation because all assets were assumed to be easily convertible to income at a later date. If you owned a home, it was assumed you could sell it for a profit. If you held stocks, future share prices were projected to be higher, and dividends consistent.
In considering employment and pensions, recent experience suggests the 20th century model for income may be outdated. In the Information Age, lifetime employment is less likely, private pensions are disappearing and government programs appear statistically unsustainable in their current formats. This puts a greater income burden on personal accumulation. Since much of the guaranteed income sources of previous generations are either disappearing or diminishing, individuals must place a greater emphasis in income generation from their personal savings.
Financial professionals, such as attorneys, accountants, insurance agents, and stockbrokers, may have knowledge in tax law, estate planning, portfolio selection, risk management, and other specialized areas. These specialties are important and necessary, but the over-arching purpose of these professionals and their specialties should be to enhance the income positions of their clients. If the four aspects of income planning are properly addressed, financial success will inevitably follow. For more financial strategies, read our Ultimate Guide to Financial Planning Myths.