From the September 1999 issue of Startups

Take It Personal

Every homebased business owner needs a personal finance strategy--it goes with the job. For this, you need at least a basic understanding of personal finances. Thousands of helpful books, videos, software programs and special courses are out there. But again, the problem is the sheer volume. Plus, ever-changing rules and regulations, not to mention the ups and downs of the investment markets, make it difficult to know where to begin, let alone which information to trust.

The following is a primer to help you understand some of the basics of personal finance and also know where to go for additional information.

The Short and Long of It

The first step in any type of financial planning is determining your net worth-listing your assets and liabilities and analyzing your cash flow, then setting financial goals and ranking the importance of these goals.

Short-term goals might include reducing debt or buying a car, creating an "emergency" fund, and buying term and/or disability insurance.

Medium-range goals might include starting targeted savings plans, converting term insurance into an investment-type policy, and creating or expanding an investment portfolio.

Long-term goals might include buying a home, starting or expanding a business, sending your kids to college, or retiring comfortably.

Once your goals are identified, the next step is to develop a blueprint for your financial future by creating a realistic working budget, establishing your risk/debt threshold and estimating future expenses.

At each of these stages, it's important to keep accurate records and to consult with professionals when unsure of your financial options. Remember, the key to successful planning is knowledge, flexibility, fiscal constraint and commitment to your plan. A strategy is fine on paper-but you can't build a secure financial future without following that blueprint.

Numerous resources can help you learn more about financial planning-books, seminars, videos and the like. Also, you should check out local colleges and schools, as well as area business groups and chambers of commerce, that offer basic financial "know-how" courses that are not only helpful, but often free or inexpensive as well.

A word about bankruptcy: The bankruptcy rate in the United States is at a historic high, and yet the fallout from declaring bankruptcy is often far worse in the long run than any current financial crisis. Bear in mind that bankruptcy is a last resort, and declaring bankruptcy will destroy your credit rating for at least seven years, maybe longer.

Further, bankruptcy does not cancel all debt-only commercial debt. Taxes, alimony and child support, court-ordered payment of damages, and most student loans are not absolved through bankruptcy. Consequently, before declaring bankruptcy, you must seek professional guidance and explore all other options, including renegotiating and/or restructuring debt, taking on one or more new jobs and selling off any remaining assets.

Invest Or Perish

Given the track record of the stock market over the past four years, new investors are either wringing their hands over not investing sooner, or grinding their teeth about whether to invest at all in a market many fear is headed for a millennial meltdown.

The truth is, you have no option if you want to keep ahead of inflation. What counts is having a well-balanced portfolio. Many experts say the ideal plan is to have 60 to 75 percent of your investments in stocks or mutual funds, and put the rest in bonds. The secret is taking a long view on stock investments, letting your money work in smaller increments over a longer period rather than moving in and out of various markets looking for that quick score.

You need a basic understanding of how to evaluate stocks, which means understanding a stock's price-to-earnings ratio. In theory, stocks are traded in a somewhat predictable ratio to how much they earn investors--the lower the ratio, the greater their value.

The book value of a stock is all its assets, minus its liabilities, divided by the number of shares outstanding. Got that? By reviewing a company's balance sheet, you can determine the amount of cash each share of stock would be worth if the company were suddenly liquidated. Here's the important part: The closer the book value of a stock to the share price, the greater the value for an investor. It's also important to learn all you can about the management of a company-information that's available in annual reports and, especially, by reviewing investment sources on the Internet. But you need to be careful on the Net, as a lot of information is very suspect and unsubstantiated.

Investing and financial planning is not for amateurs, so it pays to do some educational reading. Read Ernst & Young's Personal Financial Planning Guide (John Wiley & Sons), or visit the publisher's Web site (http://www.wiley.com/ey.html)--it gets my vote for making a seemingly impossibly complicated subject a piece of cake, and all for less than $20.

But understand that using the services of a certified financial planner is pretty much a given if you want to succeed. Read all you want-but you have a business to run. When do you need a professional? In the beginning, middle and end.

For anyone making any initial forays into choosing a financial expert (or seasoned clients and professionals who just want to chat), I recommend the International Association for Financial Planners (IAFP) (http://www.planningpaysoff.com), an interactive site with a lot of e-mail back and forth between planners, clients and potential clients, and general information on the phenomenon known as making money in America. Maureen Landers of the IAFP says it best: "It's about bringing people together-that's what we're all about."

Getting Help

Like most tasks with which we're unfamiliar, it often pays to outsource. Face it--planning life's bottom line is seldom a do-it-yourself project, and there are legions of experts who would gladly help . . . for a fee.

The trick is knowing whom to ask and what to expect for your money. Financial planners can help anyone organize their current holdings and develop a strategy to ensure a more secure financial future. Most people use advisors for estate, retirement and tax planning; however, the IAFP also advises recipients of pension and insurance payouts, lump-sum settlements, and inheritances, as well as those considering bankruptcy, to seek professional help.

If you're simply earning enough to make ends meet, obviously you don't need professional financial advice. However, if you're setting aside at least 10 percent of your annual income or receive any type of economic windfall--or have an especially bad year or two--a financial planner may be the answer. Here, the pros and cons of the two types of financial planners:

  • Commission-based planners help you identify your goals, then sell you financial products to meet them, receiving commissions on these products. The upside: You get a complete package-financial advice and investment vehicles. The downside: Planners receiving commissions may not be objective about your needs and may not recommend products for which they won't receive a commission.
  • Fee-based planners provide guidance for a set advisory fee, rather than receiving commissions. The upside: They're objective because they don't have an agenda. The downside: You have to pay the fee regardless of whether you follow the advice, and you still have to pay commissions on any investment options you select.

Financial Planners At A Glance

Here's a list of resources for finding the one who's right for you:

Matter Of Life . . .

For all the complaints the insurance industry has weathered, it has never been easier to shop around--heck, you can select a policy without getting out of your pajamas. And there are fantastic deals. AccuQuote (800-442-9899, http://www.accuquote.com) is hard to beat for life-insurance quotes. It sells life insurance similar to the way travel agents sell plane tickets: It asks a lot of questions to determine which underwriting class shoppers qualify for, and finds the best coverage based on some 250 insurers in its database.

AccuQuote founder Byron Udell offers the following tips:

1. Match policy length to need. You might choose a 20-year term policy, for instance, to last until your child finishes school. Also buy the best value, not the lowest price.

2. Buy enough coverage. Ten times your annual net income is one suggested guideline. The number and ages of your dependents also factor into the equation. Keep in mind, it's better to have too much insurance than too little.

3. Re-entry does not mean renewal. When a policy expires and you can't qualify for re-entry, you can still renew, but at much higher rates. Before you buy, ask to see the maximum renewal rates.

Basically, you have four types of life insurance to choose from:

  • Term life insurance is purchased for a specific period of time and is renewable, usually at a higher premium. It's especially useful to cover mortgage, education and similar predictable financial outlays that might be a burden on your family should you die prematurely.
  • Cash-value insurance is both a death benefit and an investment/savings account. Insurers invest premiums, and you can borrow against the cash value.
  • Universal life is a form of cash-value insurance in which premiums are invested in fixed-income accounts.
  • Variable life also allows investment of premiums. However, it also offers the investor the freedom to choose how those funds will be invested.

How much and what type of coverage you need depends on your individual case, as does the amount of coverage you require. Many online insurance services explain the various policy options and find the best quote. Here are few of the better services:

The Golden Years

How much will you need to retire? This is definitely a question for your financial planner. There's no easy answer, but every homebased business owner should know about two new options for tax-exempt retirement savings.

The Roth IRA allows tax-free earnings and withdrawals on contributions of up to $2,000 per year, provided gross income does not exceed $95,000 for unmarried tax-paying citizens, $50,000 for the married ones. There's no minimum required distribution at age 70 1/2, and you can continue to contribute and accrue tax-free assets as long as you earn an income.

The Simplified Employment Pension Plan, or SEP IRA, allows annual contributions of up to 13 percent of self-employment earnings up to $24,000. These are much higher allowances than traditional IRAs and are fully tax deductible. Assets compound, tax-deferred, until they're withdrawn.

Self-employed people should take advantage of both SEP and Roth IRAs to maximize tax-free retirement savings. Remember, only funds in an existing IRA can be converted into a Roth, so if you're converting from a company 401(k) plan or similar program, you first have to put the money into a standard IRA and then roll it over.

Also remember the best retirement program is a robust investment program in your peak earning days--and it pays to use a variety of investments. The ideal is to invest 40 to 60 percent in stocks, 20 percent in bonds and the remainder in cash assets.

Getting Real

Real estate remains one of the best investments going, and buying that first home is certainly the first major financial investment most people make. A rule of thumb: Your mortgage should not exceed 28 percent of your post-tax monthly earnings, or 32 percent of pre-tax income. When approaching lenders to qualify for a mortgage, make sure your total monthly debt doesn't exceed 36 percent of your gross monthly income.

A home is like a fixed bond investment, and your mortgage should be actively managed as interest rates rise and fall. Refinancing for even a 1 or 2 percent lower interest rate can yield significant savings over the life of the loan.

Those who want to invest in additional real estate also have a number of options, including:

  • Rental properties. The biggest problem here is finding a property where the rental price covers your investment. To help evaluate potential properties, use a "rent multiplier"-divide the selling price by the gross annual rental price. Property selling for more than seven or eight times the annual rental price is unlikely to cover your costs or provide a return on your investment.
  • Limited partnerships. Participating in limited real estate investment partnerships has both advantages and disadvantages. You deal only with the general partner; investment partnerships require less capital and carry little, if any, management responsibility-plus, your legal liability is more limited than if you owned the property outright. The worth of a limited partnership investment can be gauged using the capitalization, or "cap" rate-that is, by dividing the net operating income by the total investment. If the rate exceeds 8 percent, it's considered a good investment-however, there are commissions, sales and operating expenses in such partnerships above the flat investment rate, so it pays to be extremely careful.
  • Real Estate Investment Trusts (REITs). These are publicly traded entities that invest in "pools" of properties and/or mortgages. You purchase "shares" in them, much like buying shares of stock. Similar to mutual funds, REITs allow you to include a diversity of real estate investments in your portfolio without having to shoulder the risk or financial cost of buying property alone-plus the funds are managed professionally. On the downside, REIT losses don't carry over to investors for tax purposes, unlike limited partnerships, where such losses are often deductible.

Tax Cuts

Since the 1998 tax year, taxpayers have been able to take advantage of the provisions of the Taxpayer Relief Act of 1997, which made sweeping changes to the tax law, notably with respect to IRAs, college tuition and home sales. At a glance, here are a few of the things the act provides:

  • Deductible IRA: Gradually increases deductible IRA limits (in 1998, $50,000 to $60,000 for joint filing; $30,000 to $40,000 for individuals)
  • Education IRAs: Permits annual contributions of up to $500 per dependent for college education
  • Roth IRAs: Allows nondeductible contributions, but tax-free earnings on contributions of up to $2,000 per year
  • Home sales: Taxes gains on most principal home sales at 20 percent. The rollover and age 55 rules are replaced with $500,000 exclusion for joint filings
  • Long-term capital gains: Reduces the highest rate from 28 percent to 20 percent (10 percent for gains that would be in the 15% tax bracket)