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5 Most Important Financial Concepts a Fiduciary Must Teach

5 Most Important Financial Concepts a Fiduciary Must Teach
January 30
00:05 2018

A fiduciary must always act in the best interests of the beneficiary (or client). It may surprise you to learn one can apply the term “best interest” to any number of factors. We tend to associate it most with investments and the general handling of money. Given all the publicity surrounding the DOL’s Conflict-of-Interest (a.k.a, “Fiduciary”) Rule, it’s not surprising many focus the term “best interest” on matters dealing with the movement of monies within retirement plans. But there’s more to “fiduciary” than what the DOL says.

The concept of fiduciary duty dates back centuries. It applied to both property and to relationships. Since the founding of America, however, it’s orbited around trusts and trust law. The best way to think of this eighteenth/nineteenth century idea of fiduciary is the old-time bank trust officer. Back then, trust officers found themselves not only guarding the assets of young beneficiaries, but often acting as guardian of those young beneficiaries. Their role as parental proxy tasked them with the obligation to help mold these unripe children into model citizens. This didn’t merely benefit the community, in the long-term it benefited those children once they matured to adulthood. In other words, it was in the best interest of the beneficiaries to learn, understand, and embrace fundamental concepts that would allow them to succeed as they got older.

In this same sense, a good fiduciary will always look for opportunities to teach – and test for understanding – clients and beneficiaries. For this reason, we’ve asked financial experts from around the country what they felt it was important to convey to retirement savers. Here are the top five most important financial concepts a fiduciary must teach. (Please note: We will consider the top five economic concepts in a later article.)

#1: Compound Interest
Compound interest represent the basis for all personal financial matter – both good and bad. Unfortunately, few people learn of it until it’s too late. Even if they do grasp this notion at a young age, they may not fully appreciate the Yin/Yang nature of its being. Time is the greatest ally of the investor, as time allows for compounding,” says Robert Johnson, President and CEO of The American College of Financial Services in Bryn Mawr, Pennsylvania. “None other than Nobel laureate Albert Einstein is rumored to have said that ‘Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t… pays it.’ Compound interest works to the advantage of the investor and to the detriment of the debtor.”

Tammy Johnston, author and President and CEO of The Financial Guides in Calgary, Alberta, says it’s important for everyone to understand “how compound interest works for investments. This is one of the fastest and simplest ways to build up money over time and the sooner you start the easier it is.”

Alas, compound interest has an underappreciated Dark Side, one that young retirement savers might just now be discovering. “Early in their career,” says Johnson, “someone who graduates with a great deal of student debt will have to budget for a large percentage of their earnings to go simply to extinguishing that debt. That debt will serve as a weight and will not allow individuals to pursue other financial goals like saving for retirement, purchasing a car or a home, etc.”

College debt is just to beginning of a potential vicious cycle of compounding. Johnston says, in addition to the benefits of compound interest, people need to know “how compound interest works for credit cards. This is the fastest way that kids/young adults can get into serious financial trouble.” She says its essential they understand “how quickly the interest costs add up so they don’t end up paying $80 for a game or a sweater that originally cost $50 because they put it on credit and didn’t pay it off.”

#2: Budgeting (Tracking and Setting Goals)
Many usually place budgeting at the top of the list because it’s critical to integrate it into everyday activities and decision making. Kristin Peterson, Marketing, College Raptor, Iowa City, Iowa, says “To have a clear understanding of the money you earn and how it is put to use a budget framework is important. Budgeting allows you to take a proactive approach to managing your money. By budgeting monthly expenses set aside not only for immediate needs but future goals as well.

Peterson alludes to the two components of effective budgeting: tracking and setting goals. “A budget is the foundational piece to all financial success,” says Johnston. She says it’s critical you track “how much money you have coming in (job, dividends, interest, etc…) and how much you have going out (rent, tuition, food, transportation, entertainment, etc…).”

Determining what your going to do financially is just as important as keeping track of your finances. J. Brewer, president of Arkad’s Lesson, in Indialantic, Florida, says you must “set and commit to relevant money goals so you don’t give in to temptation. Small achievements lead to confidence, which leads to larger goals and cumulative successes.”

#3: Increase Income
This may seem like an obvious objective, but life contains too many distraction (we’ll be talking about these next) for people to keep they’re eye on the ball. Brewer says, “Pay yourself first. Save!” He feels this is the first step “to help avoid dependency on government/social/family/friend services, which are already stressed, and help prepare for a wealthy future.” He suggest these three steps: “1) Work for earnings beginning as soon as practical; 2) Reserve a reasonable percentage for savings/investment/retirement without fail; and, 3) It is never too early to prepare for the future – you’ll be spending a long time there.”

Full-time students aren’t exempt from implementing this approach. They can get in the game, too. “Even if you are subsidized by your parents,” says Peterson, “taking a paying job when available is a great way to earn extra cash. Working 10 hours a week not only improves your financial situation but helps you learn time management which in turn could even contribute to stronger academic focus and performance.”

#4: Decrease Costs
OK, in many ways, this is the key idea, for it contains the popular strategy of “winning by not losing.” Alas, as alluded to in the previous points, spending often represents a too tempting distraction. It causes you to veer from your true goal. It’s where most mistakes are made.

And it’s tricky. It comes in many disguises. Don’t be fooled into thinking you’re doing well by avoiding the most obvious spending blunder. That false confidence just makes you more vulnerable to a more deceptive error. Let’s tackling this in ascending order.

The first tactic is “to curb impulse spending,” according to Johnston. She suggests “to ask the question before every single purchase, large or small, ‘Do I really want this?’ Buying clothes that you only wear once and then sit in your closet collecting dust until you throw or give them away. Spending money on fast food just because. How many hours did you have to work to buy something you don’t use, like, or remember? What other more valuable things could your money have gone to if you had been more deliberate and conscious in the moment you were paying?”

Of course, the simplest thing to do is to not buy, especially if the motive for buying is something other than need. Brewer, says to “defer material gratification. Lean times will come to everyone. Learning how to be lean from the beginning versus chasing/buying every shiny object in front of you helps a person to keep their personal priorities in perspective. Frivolous spending would likely prevent one from larger or more important purchases or expenses such as a home, car, education or unforeseen obligations down the road.”

Look for alternatives or substitutes rather than purchasing. “Money doesn’t grow on trees and with limited earning potential making the most of the dollars earned allows students the ability to stretch funds further,” says Peterson. “Less is more – always be looking for ways to cut unnecessary costs. Making your own coffee instead of a Starbucks run save you on average at least $3 a day or $1,100 a year.”

If you have no choice but to make a purchase, Peterson says, “Take full advantage of discounts, deals and freebies. Looking out for your best financial interest includes spending dollars as wisely as possible and getting a good deal allows you to keep more money for yourself. You can buy quality workout clothes from Old Navy instead of buying Nike or Lululemon and in the long run you’re still getting things you need but you’re saving by choosing the cheaper option.”

A good purchasing strategy can go a long way. Brewer says to “buy used/‘like new’ (versus new) for cash, and avoid payments with interest on things that lose value. Paying interest on depreciating possessions is plain foolish. Why make others wealthy from foolish buying habits? Thrift/second-hand store purchases (clothes, sports equipment, electronics) save a lot of money and will likely not require one to go into interest bearing debt.”

Ultimately, the best way to control spending falls under our “Budgeting” category. “Keep track and stick to your budget and forget impulse purchases,” says Peterson. “Resist the urge to deviate from your plan. A good plan should allow you the freedom to make some want not need purchases, albeit in line with your goals. Do not splurge on the latest Kylie Jenner make-up. In the end, no one knows if you’re wearing designer make-up.”

The punishment for uncontrolled spending is uncontrolled debt. That’s an albatross very difficult to remove. Corey Vandenberg, a mortgage banker in Lafayette Indiana, says people really need to understand “credit cards and general debt and interest and how it works. It appears that most people believe by making the minimum payment that they are getting somewhere on paying off debt. But the reality is they have an up to 25-year payback by paying just the minimum. This is assuming you don’t use it again. It appears to me that most people are digging that hole of debt deeper instead of getting out of it. We as Society need to teach basic financial education in school to prevent a for profit institution from later having to do it for us and after we are in the debt or overdraft trap.”

One of the most frequent money pits involve sunk costs. In fact, the term “money pit” comes from the habit of throwing good money after bad. It’s most commonly used when talking about used cars. These objects are well past their “use by” date. It’s simply cheaper to buy a new car than continue to pour money into a lemon. “People take sunk costs into consideration when making decisions all of the time,” says Dave Barr, a CPA in Pittsburgh, Pennsylvania. “It is important, both from a business and personal perspective, to take sunk costs out of the decision-making process. The cost or consequence of that thing is already going to happen, regardless of the final decision.”

The final cost trap is ironic because it actually involves the cost incurred in not spending money. It’s the opportunity cost. It occurs when people avoid undertaking something because they focus on the near-term cost rather than the long-term benefit. Barr says many people “only think about the immediate consequence of an action, but often there are many things that happen indirectly based on a decision. It is important to widen their viewpoint when making decisions.”

#5: Always be Learning, Talking, and Asking About Money
No one has all the answers because the world is forever fluid. Today’s correct answer is soon made incorrect, and a new correct answer emerges. Life changes. The economy changes. The markets change. With these changes come changing answers. “Knowledge is power,” says Johnston, “and if you don’t know the rules of the game chances are good that you are going to lose. Learn about money, talk about money, and question everything. Talk to your parents, a trusted and financially successful family friend, relative, community leader, business owner about money and what they have learned over the years and mistakes they have made. Read financial books, blogs, and websites. Listen to podcasts. Be comfortable asking questions about financial matters (for example: at ‘x’ interest rate and ‘$y’ payments, how much will this cost me in total to pay off the debt?). The more you know and the more comfortable you get on the subject of money the more financially successful you will be.

And, as any above average fiduciary will tell you, it’s in your best interest to be successful.

Christopher Carosa is a keynote speaker, journalist, and the author of  401(k) Fiduciary SolutionsHey! What’s My Number? How to Improve the Odds You Will Retire in Comfort and several other books on innovative retirement solutions, practical business tips, and the history of the wonderful Western New York region. Follow him on Twitter, Facebook, and LinkedIn.

Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada.

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Christopher Carosa, CTFA

Christopher Carosa, CTFA

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