Foundations for Financial Security

(Financial Planning made Easy)

We at Cornerstone Investment Management & Consulting believe that everyone needs to be aware of their investment and retirement needs from an early age. This bulletin will explain both how to get started and how to stay on task with this critical mission. Often, this process is confusing and the language of people who operate in this business is difficult to understand. We are here to help.

Balance Sheet vs. Income Statement

Often, a household considers finances only in terms of the Income Statement. By that, we mean that revenues (household income) are considered, and expenses are itemized into different categories (home, auto, insurance, education, etc.). At the end of the period, the balance is either positive if income is greater than expenses or negative if the opposite is true. What happens from there affects your personal balance sheet in the same manner that a net profit or loss does for a company. Controlling the bottom line of the Income Statement is critical to building wealth, but it does not stop there. The household Balance Sheet lists both Assets and Liabilities. Assets include all accounts (checking, savings, retirement, investment) as well as property and personal possessions. Personal liabilities are the debts incurred to pay for the assets; these can be both short- and long-term (examples are credit card debt, student loans, and mortgages). The difference between these two categories is known as "Owner's Equity" in accounting terms and is the net worth of the household as an entity. This is the number that must continue to increase over time. If it is not doing so, there are some personal finance issues that must be addressed.

The challenge is to convert the positive total from your Income Statement into a line item on the Balance Sheet. Often, when there is a positive bottom line on the Income Statement, it becomes discretionary income used to purchase possessions or intangibles such as vacations. Although these have value, we believe that they should be incorporated into the Income Statement's anticipated expenses so that surplus can be saved and invested. Investing these assets is the only way to ensure that, over the long term, the Assets on the Balance Sheet grow--leading to higher Household Net Worth. When you commit to doing this, you are well on your way to building wealth.

How much cash do you want to have set aside for any type of "rainy day" fund? Also, what are your intermediate-term cash needs (are you buying a house, funding education or parent's health care, etc.)? The answers to these questions will determine how much cash you need to have set aside in savings accounts before you get started investing.

The advantages to saving for retirement are numerous. The primary advantage to doing so is Tax Deferral. This means that savings that you have invested can grow tax-free in your account. We've all seen the graphs of the difference between funds saved before taxes and those saved after taxes; put this advantage to work for you early and an even greater difference is made. If you have the opportunity to save through an employer plan, this is a way to enhance the benefit by Tax Avoidance. When you invest through an employer plan, your contribution is withdrawn from your account prior to being taxed personally. In addition, many employers provide some type of incentive to invest by matching (up to a percent) your contribution. Not only is that "free money", it is not taxed as well. In addition to investing through your employer plan, you can also contribute to a Roth IRA (up to $4000 per year based on your income levels, with the limit gradually increasing through time). This option also provides for growth of assets tax-free, and the ultimate withdrawals will not be taxed themselves. In addition, you have control over the investment of your assets in this account (unlike the employer plan, where you select from their menu of options).

If you have children for whom you are funding a college education, state 529 plans are fantastic arrangements. Although the investment options are limited by the plan themselves, the assets grow tax-free and are not taxable upon withdrawal. The plans have a high maximum level and are transferable from one beneficiary to another. A forthcoming information bulletin will provide more information on how these plans work. It is important to note that we believe that it is important to fund your own retirement as well as funding your child's education. There continue to be tremendous scholarship and loan opportunities for students, but there are only government services for retirees who don't have the ability to pay.

Above and beyond your savings plans for specific needs, you should also be striving to build wealth through a personal investment account, which is unconstrained by contribution limitations. These funds provide operational flexibility for a household and serves as another source of funds for all financial goals, not merely the targeted ones mentioned above. An adage that continues to be true is "you have to have money to make money." Personal savings and investment will, over time, continue to enhance the Asset category of your household Balance Sheet.

As critical as getting started is, you must stay on task to ensure that you are meeting your objectives within the Balance Sheet and its accounts. The investment accounts should each be reviewed at regular intervals to determine if they are properly aligned with near-term needs and long-term allocations. This includes both performance measurement as well as review of account holdings to maintain consistency with your objectives. Investment accounts are not the equivalent of "gambling money" and should not be traded as such; but, they cannot be set on "auto pilot" either.

Cornerstone is here to help with each of these steps in the process. Our information bulletins are made widely available so that we can assist individuals with certain aspects of financial decision-making. We are available to assist with both getting started and, just as importantly, staying on track. Please contact us if you would like further information about any of the programs that we provide.

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