Over a span of almost 30 years in private practice, I discussed personal finances in painstaking detail with thousands of individuals and families in my capacity as an estate planning and elder law attorney. What intrigued me was the financial disparity that existed among people in similar circumstances. This wealth gap likewise exists among attorneys who have had similar opportunities. Class reunions make this quite apparent. Some people in your law school class are well off while others struggle. Obviously, the professional choices that we make dictate our income potential. Yet there are those who have made lots of money while accumulating meager assets and there are those who have earned significantly less but are well on their way to retirement.
Many factors influence the amount of wealth that one accumulates. Certainly, luck can play a part. Some acquire wealth through inheritance or marriage; however, they do not represent the majority. Sixty-nine percent of respondents to a 2008 poll conducted by PNC Wealth Management accumulated the bulk of their financial holdings through work, business ownership, or investments, whereas a meager 6 percent acquired wealth by inheriting it. An additional 25 percent have prospered through a combination of inheritance and personal earnings.
By and large, I have observed that people who have “done well” and are “living the dream” share three common characteristics: First, they are financially literate, having committed to an ongoing education with respect to investment and money management principles. Second, emotional maturity and wisdom guide them in their decision-making process. Third, they heed advice given to them by financially astute mentors.
The principles outlined in this article are geared toward those who do not have a sizable inheritance on the horizon or who are not yet financially independent. Although many will find the following six suggestions to be familiar, most have not applied them with persistence and consistency to their own lives.
1. Assess Your Financial Health
An analysis of financial health begins with a determination of net worth and a review of your credit report and credit score. Although the bleak or disappointing truth may be difficult for those who have experienced setbacks, facing objective reality is indeed the first step to taking control of the reins of your personal economy.
Worksheets to determine net worth are readily available. Although the calculation is simple (financial assets less liabilities equals net worth), the “legwork” requires an investment of a little time and effort, which is an obstacle to some. Recalculating the figure on a quarterly basis is indeed a proactive approach. As your net worth increases, your confidence builds and you will be inspired to continue with your positive course. A decline in a given quarter may evoke negative feelings, but you will be in a position to quickly adjust your course if the current strategy is not proving effective.
Your credit report and credit score are relied on by lenders, landlords, insurance companies, and even employers to determine your credit worthiness. The adverse consequences of a poor credit rating include denial of loan applications, increased interest rates, and higher car insurance premiums.
Most credit scores (commonly referred to as FICO scores) are calculated by software developed by Fair Isaac Corporation and range between 350 (extremely high risk) and 850 (extremely low risk). The factors used to arrive at the FICO score include payment history, amount of debt, and length of credit history. Credit score can be improved over time by making payments on time and reducing debt.
Under the Fair Credit Reporting Act (FCRA), each of the three major reporting companies (Equifax, Experian, and TransUnion) is required to provide an annual free copy of a consumer’s credit report upon request. Reports from all three can be obtained through the website www.annualcreditreport.com. Errors on credit reports may be disputed by contacting either the credit bureau or the organization that provided the incorrect information to the credit bureau.
2. Set Specific Financial Goals
Whether the objective is to fund retirement, get out of debt, buy a vacation home, or send the kids to college, it must be set forth in writing with specificity. First, project the exact amount that you need. Second, determine the date by which you must accumulate the required resources. Third, establish benchmarks and concrete criteria so that you can measure your progress on a quarterly basis. Fourth, adjust along the way as necessary.
In the words of the French writer and aviator Antoine de Saint-Exupéry, “A goal without a plan is just a wish.”
3. Develop Budgetary Discipline
Some agree with Oscar Wilde that “Anyone who lives within their means suffers from a lack of imagination.” On the other hand, meeting your savings goals requires you to live below your means.
The budget process seems simple; yet, according to the 2012 Consumer Financial Literacy Survey, more than half of the adults surveyed had not established a household budget (tinyurl.com/bne3gll). Information regarding the mechanics of setting up a budget along with basic budget worksheets are readily accessible through a number of Internet resources. The process involves recording all sources of income and listing all expenses (whether incurred monthly or otherwise). The expense side should include the amount needed to be set aside to meet long- and short-term financial goals discussed above. After subtracting expenses from income, there will either be a deficit or a surplus. If you have a deficit, you need to either make more money (a topic beyond the scope of this article) or reduce expenses. Enhancing net worth by adjusting lifestyle can pose a huge challenge; however, it becomes more palatable when you maintain the perspective that the long-term financial goal is more important than short-term gratification. If you have a surplus, save it!
4. Do Not Carry Balances on Credit Cards
Credit cards offer a convenient method by which to make and keep track of expenditures. Besides, it is fun to cash in on the accumulated points. However, their double-edged allure is apparent to those who use them to live an otherwise unaffordable lifestyle. Responsibility for monthly payments can continue for years after the items purchased are discarded or extravagant restaurant meals are enjoyed.
Example: Joe Lawyer and his family decide they deserve a vacation. Because he is barely making ends meet, he charges $5,000 on his Visa card knowing that he can squeeze $150 per month out of the budget to pay the debt. Presuming an 11 percent rate of interest, he will make his final payment about three and one-half years after the vacation, and the actual cost of the trip will be $6,000 (the interest payments total $982.62).
As a general rule, if you can’t pay the credit card bill at the end of the month, don’t incur the charge. If you have already incurred significant credit card liability, commit now to a plan to satisfy the debt no matter how overwhelming it may seem.
A number of online calculators are available that will assist you in establishing realistic goals. Tempting as it may be, I do not recommend taking out a home equity loan to consolidate outstanding credit card debt.
Example: Presume that Sally Barrister has an outstanding balance of $35,000 in credit card debt at 15 percent interest. If her goal is to eliminate the debt in four years, she would need to pay $974.08 every month.
5. Minimize Investment Mistakes
Having money to invest for the future presents its own set of challenges. The objective is to enjoy reasonable return on the asset (whether through appreciation or income) as opposed to losing your proverbial shirt.
Make sure that you get your education from an unbiased source. Many financial planners look out for the client’s best interest and make recommendations accordingly. However, some present biased information to guide the client into a product from which the planner will receive a high commission.
Along these same lines, beware of doing business with people who suggest that you invest in deals that will generate a huge return on your funds in a relatively short period. Remember, “If it sounds too good to be true, it probably is.” Living by this precept can save you some headaches.
I have personally witnessed several clients and friends who were persuaded to mortgage their homes to invest in ponzi operations, highly leveraged real estate deals (now underwater), and risky tax shelters. Many of these “opportunities,” if not most, went south and sour. The investors were saddled with the sting and burden of expensive mistakes. If you do not understand how the investment works (including the purported tax benefits), keep your money for another opportunity—which will certainly come along.
6. Establish Open Financial Communication in Relationships
It’s difficult enough to accomplish financial success on your own without taking into account the values and expectations of a spouse or significant other. Ideally, you will be in harmony in all aspects of your relationship—including financial. However, the chances of finding a romantic partner with whom you are in complete agreement on money issues is highly unlikely, if not impossible. According to a recent survey conducted by Harris Interactive on behalf of the American Institute of Certified Public Accountants, American couples argue about financial issues more than any other issues, including child rearing and division of household chores (tinyurl.com/92blucg).
Although some couples opt to live separate financial lives, most are intertwined—at least to some extent. Establishing a strong communication process with respect to finances will go a long way toward preventing relationship discord as a result of financial disagreements. Money discussions may not be romantic, but money disagreements are even less so. The following tips should prove helpful:
- Strong relationships are founded on full disclosure with respect to all aspects of life. Before the marriage or other commitment, make sure that you exchange information regarding your respective incomes, assets, and liabilities. (Couples entering into prenuptial arrangements are required to exchange this information.) The thorough couple will compare credit reports and credit scores. It is better to reveal a poor credit history now rather than later, when you are trying to make a joint purchase with your partner.
- Clearly allocate responsibility with respect to the administrative aspect of money management and accumulation goals.
- Have a regularly scheduled “business meeting” (at least quarterly) to discuss short- and long-term goals, savings, cash flow, and spending issues.
- Do not deceive your mate about finances. The Harris Interactive survey cited above revealed that three in ten adults who are married or living with a partner admit to potentially deceitful behavior about money.
So Take Charge
No matter your current circumstance, you can improve your economic status—over time. A bright financial future is attainable by lawyers willing to form and consistently follow sound financial habits like those outlined above. If you wish to learn more about these principles (and many more), see my upcoming book, The Lawyers’ Guide to Financial Security, scheduled to be published in 2013 by the American Bar Association Solo, Small Firm and General Practice Division.