Welcome to the inaugural installment of our new feature, Coffee With an Expert! Today, we’re having coffee with Tom Watts, CEO and founder of wealth management firm Watts Capital Partners. All questions have been asked by our readers and the Sweatpants & Coffee community.

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Hello Tom, thank you so much for chatting with us! Tell us a little about yourself.

It’s a pleasure to be here on Sweatpants & Coffee. My love is investments and making money for clients. My parents started me buying stocks when I was in fifth grade. They would match 1:1 any money I put in the market. Working with their stockbroker, I put my allowance and lawn mowing money into stocks. My first stock was Standard Oil of California. I went on to major in Economics at Stanford University and earn an MBA at Harvard Business School. I spent the next few decades analyzing investments for mutual funds and hedge funds, and other professional investors. What I enjoyed most, however, was counseling individual investors. To do that full-time, I founded my firm Watts Capital Partners. My team and I now work with about 70 families, helping them create financial plans, and investing their money to achieve their financial goals.

1. What would your best advice be for someone taking the first steps into investing, and how much is reasonable to invest for a “small-wig”? I have a 401K and a matching plan from my employer, but I would like to learn more about investing some of my own savings. I don’t necessarily know that I want to invest thousands, but I’m curious about what a decent first investment might be.

You’re right on track investing in your 401-K, particularly if your employer matches. We generally recommend investing at least up to the maximum level that will be matched. The limitation with 401-Ks is that you generally can’t use the money until you are 59 ½. It’s also good to have a regular brokerage account where you can access the money any time.

To answer your question about investing, a good first investment is something that is broadly diversified, such as an Exchange Traded Fund (ETF) or mutual fund. I would need to know more about your personal situation to recommend a specific fund. A foundation for most of our clients’ portfolios is an ETF called the SPDR (prounounced “Spider”) S&P 500 ETF. Its symbol is SPY. This tracks the stock market as a whole, as measured by the S&P 500 index. The value of SPY will bounce around and may decline, but over time should appreciate. The long-term return of the SPY has been a little over 9% per year.

The minimum amount to start investing is whatever it takes to open an account at the firm you choose. Watch out for account fees, though. Some of the banks like Wells Fargo have dizzying arrays of minimum account fees. One of our favorite places to buy SPY or other securities is Charles Schwab. Account fees are minimal and the minimum investment is usually $1,000. IRAs have a lower minimum of only $100, and College Savings Plans for kids have a $25 minimum.

2. What’s something I need to consider now if I know that my future financial obligations (10+ years from now) will include caring for my elderly parents?

It’s great that you are planning ahead. The longer you have to put your plans in place, the better you will be prepared.

The greatest cost for most elderly people is healthcare. In fact, 30% of national healthcare costs are spent in people’s last year of life. The first step is preparing for this potential cost. Help your parents get their medical insurance in order. This means first helping them manage their Medicare. Second, it means getting a Medicare supplement policy for them.

One important part of the medical costs is long-term care. When people hear the term long-term care, the first image that comes to mind is often senior living facilities. For many though, the preferred long-term care option is in-home care, even if it’s just having someone come in for a few hours per day. Rather than choose a dedicated long-term care insurance policy to fund these costs, our clients often choose to buy a permanent life insurance policy with a long-term care rider. That way, any unused portion of the long-term care benefits goes to the insured’s heirs. These policies also have quite liberal definitions of the costs that can be paid under the policy. You might consider buying the policy for them now and making the payments.

A second part of caring for your elderly parents is managing their finances. This means understanding their income – what Social Security are they likely to receive? What pensions will they have? – understanding their expenses, and understanding their assets. Working through those with them in advance can help both you and they understand where their income gap might be and what it will take to fill it.

Finally, I’m sure you remember the safety message at the beginning of every airline flight: “Secure your own mask before you help others.” This same rule applies to you helping your parents financially. The stronger the financial situation you create for yourself, the better position you will be in to help them. Have a financial plan for yourself. Your plan will provide resources and flexibility to use as you see fit.

3. Right now, our retirement savings are in diversified stocks and funds. We are considering looking into an investment property. Is this a wise decision, and what questions should we be asking?

An investment property can be a good idea. Real estate has two big benefits relative to stocks and bonds:

1) You can put a lot of leverage (debt) on it to increase your returns (although this also increases your risks). In the long run, stocks have produced an 8-9% annual return. Real estate has only produced a 2-3% return un-leveraged. The higher returns from real estate investing come from making only 20% or 30% cash down payments and taking out a mortgage to pay for the rest of the property’s purchase price.

2) The depreciation of the property shelters part of your income from taxes.

If you can buy a property for a reasonable price that pays for itself, this can be an excellent way to build long-term wealth.

Where most people get into trouble investing in real estate is that they pay too much and the carrying costs of the property wipe out their profits. They end up having to pay out-of-pocket to cover a period of vacancy or to fund maintenance expenses. Even if the price seems reasonable compared to comparable properties, if your property is not cash flow positive, after you take into account all costs and a reasonable estimate for vacancy and maintenance, it is probably too high a risk for you to consider. It only takes a few months of vacancy to erase a year’s worth of price appreciation.

An additional downside to having an investment property is the time and headache it takes to manage it. Do you want to spend your time mowing the lawn, fixing the toilet, collecting rent from non-paying tenants, or managing eviction proceedings? The owners I know that do the best with their investment properties do much of the maintenance work themselves, and have flexible jobs so they can visit their properties during the day. If you have to hire a management company to do all these tasks, the chances of making money decrease significantly.

An additional downside to real estate is that it’s illiquid. If you need the money that you have invested in the property, it might take you months to sell. If the real estate market is weak, such as in 2002-2004 or 2008-2010, it could take much longer for you to access your cash, assuming that you can sell the property for more than the mortgage. You want to make sure that you have plenty of other cash resources and can hold on for the long-term.

And finally – don’t put all your eggs in one basket, or in one property. Starting out, don’t put more than 10% of your invest-able assets into real estate. After you have owned a few properties and know you are good at choosing and managing them, you can go higher, but do it gradually.

Keep in mind that owning an investment property is not the only way to invest in real estate. A good financial advisor may be able to find real estate limited partnerships and other professionally managed investments that give you excellent returns without the headaches. Right now, we see real estate investment opportunities with a current 6% yield or more, plus expected appreciation that pushes expected returns to the 10% range.

4. Can you recommend any good (and preferably free) apps or websites for creating and maintaining a budget? What’s the most important consideration when creating a budget for your household?

Our favorite budgeting app is Mint. We recommend it to all our clients. It tracks your spending by category on a real-time basis, tracks your bank balances, and lets you know when bills are coming. You can also go to Mint.com. Others include iReconcile, Expenditure and MoneyBook.

In creating your budget, the first thing to do is break down your costs between fixed costs such as your mortgage payment, car payment, insurance and taxes; and your variable costs, such as food and entertainment. Once you subtract your fixed costs from your after-tax income, you will know how much you have to spend on variable costs. This approach gives you two ways to manage your costs. First, you can take a close look at your fixed costs to see if you can reduce them – should you get a cheaper car? Should you move to cheaper housing? More easily, on a weekly basis, you can manage your variable spending. Set a fixed amount of cash that you take out of your ATM every week. Then make it last all week. Separately, have a maximum amount that you spend on credit cards each month. You can track your credit card spending using Mint or by just going online at your credit card company. If you’re nearing your limit, start postponing expenditures until the new month starts.

5. What’s the quickest way to pay off $40K in student loans, assuming a $35K per year job and a tight budget?

When paying off your student loans, first target the one with the highest interest rate. Pay that off first, while paying the minimum on the others. That will ensure you pay the least amount of interest and apply most of your payment to reducing principal.

Also, try to use any extra cash to pay the loans down a little faster. That could mean applying a bonus from work or a cash gift from Mom toward your loan. Or take your left over cash each week and apply it to the loan. You can transfer this to a separate “loan” account at your bank, then apply the extra amount to your payment each month. Some loans allow you to make multiple payments per month by electronic transfer without additional cost. Set up the loan payment on your bank account as an electronic payment, and send in that extra whenever you have it.

If you want to get creative, you can also raise extra money to help you pay it off. Sell those extra items in your closet, or that power saw that you don’t use. Or, take some part-time work for a few hours per week.

6. I’ve always heard the advice that if you ever want to retire, you must put away a minimum of 10% of your income. Is that advice still relevant/accurate? If so, where should we be putting it to get the best returns on our savings?

For most people, 10% of your pre-tax income is a good number if you are young and plan working until you’re 65. Many people try to move that to 15-20% to give them flexibility to retire early or have a more luxurious retirement. You can get a much more precise number by projecting your future expenses and the amount of savings you will need to fund it. A financial planner can do this in detail for you. For a simpler approach, there is an excellent retirement calculator on Bankrate.com.

After you have an emergency fund set aside that can pay your expenses for a few months, you’re in a position to invest your savings for higher returns. For long-term investing, simple ETFs or mutual funds that track the stock market should be a core part of your investment. The SPDR (pronounced “Spider”) S&P 500 ETF, which has the ticker symbol SPY, should be a part of your long-term portfolio. You can do what’s called “dollar cost averaging” and buy a little bit every month or quarter. That way, you’ll buy it at both high and low prices. You can balance this investment with an investment in bonds or other fixed return investments. As you get older, the portion allocated to bonds can grow.

7. We are two years away from the first of two kids in college and have been saving in college savings accounts. What is your best advice, especially before applying for additional financial aid? Are there any reliable calculators out there that take allowable expenses into account when estimating financial aid eligibility?

Federal aid is generally based on your annual completion of the Free Application for Federal Student Aid (FAFSA), which provides a snapshot of your financial picture in your “base year,” that is, the last complete year before your student draws on the aid. For example, if your first child is starting her freshman year in September 2017, the FAFSA will be based on calendar year 2016. You will have to continue completing the FAFSA each year for each year of school. The place to start is fafsa.ed.gov, where you can see how the government and how many colleges and universities will look at your and your kids’ financial situation.

There are several actions you can take to maximize your children’s eligibility for financial aid. The first approach is to minimize the base year income for you and your children. This can include deferring income, postponing taking capital gains, accelerating losses, and maximizing deductions. The income calculation also allows for a number of deductions such as taxes and insurance. Make sure to deduct the actual taxes paid on your tax return, not your withholding. Also, gifts to your children are considered income. If their grandparents want to contribute to their education, have them wait until the child graduates and make the contribution to pay off the student loans.

The second approach is to minimize assets in your children’s names and take full advantage of the assets that are excluded in the calculation of assets available to fund expenses. Your assets and your childrens’ 529 accounts are both reported on the FAFSA as a parental asset. For these assets, a maximum of 5.64% is assessed as a student’s Expected Family Contribution (EFC). Other assets in your children’s names are assessed at a much higher 20% rate. This suggests you might want to move non-529 assets out of your children’s names into yours at least a year prior to applying to financial aid. Your assets that are excluded include retirement accounts, life insurance, annuities, and assets employed in a small business. Now may be the time to move some of your liquid assets to your retirement account. Personal property such as cars are also excluded, so if you’re considering buying a new car, do it before the base year. Real estate is normally treated as an investment asset. If you have an investment property, maybe it’s time to sell it and put the proceeds in an investment account, or if possible, move the ownership of the property to your retirement account. For a more detailed understanding of ways to maximize your children’s eligibility, a good source is finaid.org.

Regarding the spending rules, those are pretty straightforward. Allowable expenses include tuition, fees, books, supplies, room and board. Costs that you can’t pay for are travel, extracurricular activities, or spending money. You can find additional information on these rules at savingforcollege.com.

Do you think that investing in marijuana is appropriate? We are seriously considering it because it’s being legalized in so many places, and we feel like getting in now investing in the medicinal shops, growers, etc. would have a huge payoff later. Are there risks in investing in something that isn’t legal everywhere, including in my home state?

There is no questions that marijuana is set to become a big industry. Four states and the District of Columbia have already allowed recreational marijuana use. Combined recreational and medical sales of marijuana grew 74% in 2014 to $2.7 billion, and are projected to reach $10.8 billion by 2019, according to ArcView.

Whether investing in marijuana is appropriate is a broad question, depending on your values. A growing segment of the investing world is investing in ways that contribute to society as well as to the bottom line. This approach goes by the name Socially Responsible Investing, or Environmental, Social and Governance (ESG) investing. Investors taking this approach often avoid investing in industries such as alcohol that have negative health consequences or avoid investing in companies that have negative social practices, such as not providing benefits to workers.

Aside from values, the major complication of investing in marijuana is legal. Selling or possessing marijuana is still illegal at the federal level. Many banks cannot accept deposits from business selling marijuana. Paying income taxes on your earnings from marijuana sales is also complicated, since it’s illegal. Not paying taxes will land you in jail. Remember, in the end Al Capone was brought down by tax evasion, not his other criminal activities. The patchwork of state laws also presents a potential trap. You mention that marijuana isn’t legal in your state. Make sure you know the laws in your state, including the tax laws. It’s not worth breaking the law for short-term profits.

Setting aside moral and legal issues, many experts believe the best cannabis investing opportunities are in the tangential businesses. Products that save time and money in the supply chain, such as hydroponic growing systems and plant processors have created good opportunities. Hospitality also offers potential investments. Colorado has seen an explosion of tour and “party bus” services. One company, the MaryJane Group has launched pot-friendly Bud & Breakfast lodges and plans cannabis-friendly movie theaters and lounges. For more ideas, you might follow the Twitter feeds of @weedbusiness or @weedBizDaily. The National Cannabis Industry Association, as well as your state associations, are also good sources of where to start.

9. I’m a mom-and-pop business owner in a small town with very few employees. I’ve been following the raising of the minimum wage in Seattle (my home state of Washington) with great interest – it seems like a great idea for the workers and a terrible idea for the business owners. If the minimum wage were raised mandatorily, I wouldn’t be able to afford my staff, and if I raised the prices to accomodate it, I’d likely go out of business. I keep hearing that raising the minimum wage across the board is a good idea, but I just don’t buy how that could true for someone like me. Are there ways that small business owners can comply with these regulations without going under? Am I worrying over nothing? (Meaning, minimum wage will likely never be universally raised, employers under a certain size won’t have to comply, etc.)

As a personal financial planner, this important business issue is beyond the scope of my expertise. A higher minimum wage has broad implications for employers, employees and the national economy. One option to you may be to contract for more of your workers rather than have them as employees. This is a tricky issue that you should consult your accountant on. More importantly, this is an issue that must affect people across your industry, as well as many small businesses. Check with your industry association. They will have begun to think through the implications of higher minimum wages for your industry. Also check with your local office of the federal Small Business Administration. They have a number of offices in Washington State which can be found at sba.gov.

10. I’d love to hire a personal financial advisor. What’s the most important question I should ask one that I’m considering?

A starting point for evaluating financial advisors is understanding how they are compensated, how that compensation may affect their incentives, and whether their interests are aligned with yours as the investor. Fee-based financial planners charge either an hourly fee or a fee based on the assets you have under management with them. For example, my firm charges 1% per of assets managed for the first $2 million. Our incentive is to have the assets we manage increase in value. Brokers charge commissions based on each investment. Commissions may be as much as 7% of the amount invested or more. While a commission-based model can also work for investors, one of the risks is that the advisor has an incentive to sell you new products as often as possible. Insurance agents also work mostly on commission, and are generally compensated by the company whose policy they sell. One of my favorite sayings is, “To a hammer, every problem looks like a nail.” While insurance plays an important role in every individual’s financial plan, there is a risk of relying too much on insurance-based products for investing and savings.

Aside from compensation, you should consider a wide range of issues such as the advisor’s investment track approach, their clients’ experience, and whether they have run afoul of any regulatory rules. This article from Forbes magazine provides a good list of 10 questions to ask when choosing a financial advisor.

Do you have any final thoughts? As a financial advisor, what’s something you wish that everyone knew? Any universal pieces of advice?

A few years ago, I began a meditation practice. A saying that came out of that practice is, “Don’t just do something, sit there.” In investing, the best approach is to establish a long-term plan and stick to it. I see lots of individuals who think they are going to make money by trading stocks, or by moving in and out of different types of mutual funds. Every time I ask them if they track their portfolio’s monthly returns relative to the stock market overall, they say, “No, but I made 25% investing in Apple, or I made 30% investing in Facebook.” Unless the return on your entire portfolio consistently beats the returns of a stock index like the S&P 500, you are better just buying a simple ETF, like SPY. In 2012, SPY had a total return of 16%. In 2013, the return was 32% in 2014 it was 14%. If you had held this one ETF in your portfolio for three years, your portfolio would be up 74%. Every study shows that very few investors beat the S&P 500 consistently. Every study also shows that active traders, particularly individual investors, vastly under-perform the markets. Again, I have never met an active investor who can tell me what the after-tax returns on their portfolio have been.

Active traders face another hurdle to outperforming the markets – TAXES. Gains on the sale of every investment held less than a year is taxed at your federal income tax rate for ordinary income, which can be as high as 39.6%, plus your state income tax rate. If they hold their investment for a year, the federal rate on realized gains falls to between 15% and 23.8%. If they hold the stock long-term, they can defer paying this tax for decades. Again, establish a long-term plan. Then stick with it.

I am often surprised by how many people walk in our door and say, “Oh, I would by happy with a 12% return.” Or, “I want an investment that will earn 25%.” Very few managers beat the market consistently. If somebody tells you they can, they are probably lying. Ask to speak to their auditors. The stock market returns 8 to 9% long-term. More diversified portfolios which are appropriate for most investors are more likely to earn in the 6% range annually. The key to having large savings accounts is to let that 6% return compound over many years. Start investing early. Make regular contributions. Don’t borrow money or tap into your savings to buy things that go down in value like cars. If you follow these simple rules, you’ll end up with the money you need.

Tom Watts is the CEO and Chief Investment Officer of Watts Capital Partners, LLC, based in New York. Tom comes originally from the Pacific Northwest, and has spent most of his career in California and New York. The firm has clients across the country as well as internationally. Tom can be reached at twatts@wattscapital.com. More information on the firm can be found at Watts Capital Partners, LLC.





Emily Parker is a musician, writer, and avid reader who started Bucket List Book Reviews, the ‘1,001 Books to Read Before You Die’ project. For Sweatpants & Coffee, Emily hopes to inspire the reading of the classics by a whole new audience by only reviewing the really good stuff.

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