Controlling Your Situation
Robert J. Brown
Certified Financial PlannerTM
Stone House Investment Management, LLC
Last month I wrote about the “good” problems that royalty owners are facing in Northeastern PA these days. Given the response I’ve had, it only seems to make sense to dig into a few of these a little deeper to help those landowners find solutions.
Many of us have had lump sums added back into our cash flows over the years; maybe a fairly sizable amount from an inheritance or much more commonly, a tax refund in the springtime. Remember how excited you were to find out this money would be handed to you and how it would change things for you as it allowed you to take a deep breath and pay down a debt or buy something you’ve always wanted? Fast forward one year later… you’ve already added more debt back to your balance sheet… or that thing you bought is nice, but there is something new out there now that’s catching your eye again. It’s at that point that we ask ourselves, “Where did that money go?”
Royalties put a nice new spin on this scenario because they are recurring lump sums. However, as I mentioned last month, they often fluctuate by large amounts and they are not guaranteed to last forever.
Here are some of the main issues we address with our natural gas clients:
Prioritize – Pay down debts, refinance debts, taxes, special uses or projects, retirement, reserves, gifting… What makes the most sense on paper may not be the way you prefer to do it. Do it your way, but understand why you’re choosing to go that route and how you’re going to make it work.
Break Your Checks Up – Consider setting up multiple accounts for different purposes like the ones mentioned above. Each month, when your check is deposited, transfer a specific percentage to each of your other accounts every month. For example, 35% for taxes, 25% for debt, 10% reserves, 10% retirement, 15% home improvements and 5% gifting. This is a generalization but you get the idea. This compartmentalizes money into categories which helps most of us better visualize how to manage it.
Taxes – Work closely with your accountant on this but he/she should be able to provide you with an estimated percentage to sweep into this account. Please remember that you will very likely need to pay Quarterly Estimated Taxes as this money comes in so this account will likely be filled up and depleted each quarter but separating it from your other money from the beginning will help to prevent accidental overspending or falling short when it comes time to pay Uncle Sam.
Pay Off BAD Debt – In general, credit cards and any high interest loans are the primary target here. With today’s current interest rates at or near historic lows, paying double-digit or even
high single-digit interest to lenders is not something that one should be in the habit of doing. Paying off this type of ‘bad’ debt is typically high on the priority list.
Evaluate GOOD Debt – It’s hard to believe there is such a thing as ‘good’ debt, but most accountants and financial planners would agree that sometimes it makes sense to carry some debt if it is a cheap cost to borrow and/or it is considered tax-deductible interest. With all of the changes to the tax codes, it pays to have a professional who can stay on top of things and determine which, if any, of these debts you may wish to keep and which you should pay off.
Emergency Reserves – Something will come up that you never expected. It always does. Let me say that again… it ALWAYS does. Sweep a little off of each check into a reserve account that is very liquid and very stable. At least when you tap into it, although you will be reluctant to have done so, you will be happy that it’s all there.
Specific Uses – Maybe a better term for this account would be the “fun stuff”. Whether it’s a new truck, equipment, an addition to your home, remodeling, a pool, travel, etc… all of these come with a price tag. Working it into your budget will help to keep it in perspective and hopefully reduce buyer’s regret should future checks shrink substantially.
Retirement – Most of the world has to build their long term savings plans by tens or hundreds of dollars at a time, but royalty owners often have the luxury of doing it by the thousands. That’s an enormous advantage; one that should not be overlooked or taken lightly. By using basic, conservative estimates, you can determine an amount or a range that should be targeted and work month by month to fund that goal. With Social Security under tremendous pressure in the long run, this should be a priority for most people.
Gifting – Often, the best way to gift to your children, grandchildren and even to charities is over the course of time and within your means. In the back of your mind is always the concern that you might be giving away too much and hurting yourself in the long term. In some cases, this causes people to not gift at all. By itemizing things as listed previously, you will have a much better understanding of what you can afford to pass to others and when you can afford to do this.
Retire Early – When that first check or two arrives, you may give serious consideration to an early retirement from your job. Take great caution in this, as many landowners who have been through it are glad they stayed employed as their checks have varied in amounts and not provided quite the cushion they expected. It can work the other way too so be sure your financial house is in order before you separate from that steady income stream provided through your employer.
Fear Of The Unknown – As you build out your wealth by using these various accounts, you will inevitably look to expand your investments into areas that you are not familiar with or have no experience with; such as stocks, bonds, CDs, real estate, annuities, etc… All investments have risk; even cash is susceptible to inflation risk. Rather than fearing any of these and eliminating them from your list of options, it is better to understand them. Research all that is available, how you would invest in these and the pros and cons that exist. At that point, you can best determine which of them would be a good fit for you and which would not.
All of the items mentioned here are meant to provide insight as to how professionals are helping their clients make decisions. If you are learning how to manage your wealth, talking with professionals who have experience in doing just that makes sense. Regardless of whether you use their services going forward, you will gain perspective and education.
Robert J. Brown, CFP®