Dear Paul...

Financial basics for our clients' adult children.

Most of our clients are empty nesters whose children launched their independent lives during the past ten to 15 years. These clients frequently tell us that they are worried and anxious about not having prepared the next generation of their families to cope with adult financial realities.

We usually make ourselves available to visit with clients' grown children to review their practical concerns and offer some basic wisdom on budgeting, consumer debt, saving and investing, home buying, insurance, career decisions and the like. We refer affectionately to this generation of future clients as ACOFACs, our acronym for Adult Children of Financial Advisory Clients. Some of the nicest notes we've received have been from ACOFACs and their grateful parents.

Last week I received a call from the 30-year-old son of a recently widowed client. He asked for some advice about investing $25,000 he and his wife had accumulated in a savings account. As I began to ask Paul the basic questions about their income, savings habits, goals and liquidity needs, it occurred to me that we had literally dozens of ACOFACs in the same financial boat: hard working young family people facing the rising expenses of raising a family and a dauntingly complex world of financial services. Some of these young people had bought their first home, some had not. Some had a little experience with stocks or mutual funds in the last bull market, while others had yet to accumulate any savings at all. Most were untutored in financial matters, and almost none of them were comfortable divulging their personal financial information to Mom or Dad, so they tended to wing it without any guidance.

It occurred to me that it might be helpful if we could prepare some general advice and a list of resources to offer routinely to our clients' adult children on request. Paul lives several hundred miles from our office, making a personal visit inconvenient. So I suggested that what I would like to do for him is to write a three- or four-page letter touching on some of the financial basics related to his investment question-a letter he could refer to as a sort of general guide and resource for financial decision-making for his young family. And, of course, I assured him that he could call us any time.

I told Paul that this was not an entirely unselfish offer, as I had many other ACOFACs with whom I could share these basics. It also occurred to me that readers of Financial Advisor magazine might want to consider preparing a similar letter and list of their favorite resources for their own clients' grown children.

Dear Paul:

It speaks well of your maturity that you are willing to seek out professional guidance for your financial decisions. I am honored that you have asked me to share some ideas out of my own experience. But whatever value my suggestions may have, ultimately it is you and Beth who must make the financial decisions that will influence your family's future. I hope these suggestions will give you a bit of a head start.

Cash Flow: If you haven't done so yet, my first recommendation is that you take some time together to create what your mom and dad used to call a "Budget." Today we usually call it a "Spending Plan," because the idea is to take control of your income in a way that allows you to get the most satisfaction from it rather than wake up in ten years and wonder where it all went. It is a plan for how you want to use your income to achieve what's important to you and your family.

You can find a good budget worksheet along with practical general advice for creating a spending plan at www.personal-budget-saving-money.com.

Personal Goals: Integral to the spending plan process is defining your personal financial goals and trying to quantify them in dollar terms. By listing your near-term financial goals, say those you want to achieve in the next three or four years, you will get an idea just how much money you will need to save each month to have a realistic possibility of achieving them. And you can work the rest of your Spending Plan decisions around these goals.

Protection: As you list your essential living expenses, I hope you will pay special attention to the insurance category. Bad things do happen to good people, and we never know when the ax is going to fall. For serious risks, like the possibility that your house could burn down or a child could need expensive surgery or that the main breadwinner could die prematurely, your savings are not going to be adequate ... you'll need higher-powered protection. Protecting your family against these sorts of possible financial disasters is the legitimate province of the insurance industry.

Some young families are tempted to cut expenses by skimping on life, health, disability, auto and homeowners or renters insurance. Professional financial advisors, even ones who don't sell insurance, unanimously recommend that you budget for disaster protection. A good insurance professional is invaluable; ask relatives and friends to help you find one who will sell you only the protection you need you need.

To get a good idea of the cost of different kinds of term life insurance, try www.SelectQuote.com.

Emergency Money: Because you work in the construction industry, you are already aware that even a very good job can be suddenly disrupted. A good first financial goal for young families dependent on a paycheck to cover their living expenses is to accumulate three to six months of "emergency savings" to help them through a period of unemployment. In your case, three months of expenses is going to be about $15,000. So, of the $25,000 that you have accumulated, it would be a good idea to earmark $15,000 as emergency savings.

Emergency money needs to be easily accessible, and shouldn't be invested in anything that can fluctuate much in value in case you need it suddenly. Today, money markets and bank savings accounts pay very little interest, but at least they keep your emergency money safe and accessible. To earn a little more income on your savings, you may want to put as much as half of it in a short-term bond fund that will earn perhaps 4% a year. But keep in mind that even this pretty safe investment will fluctuate in value. One fund we like to use for this purpose is Vanguard Short-Term Corporate Bond Fund. You can obtain account applications at www.vanguard.com.

Other short-term goals may include paying off credit cards, accumulating a down payment on your first home, or completing your professional education. These savings goals will usually take precedence over investing for longer-term goals like children's college expenses, starting a business, buying a vacation home and funding your retirement. For these goals that are further in the future and/or are more flexible as to when they need to be achieved, it is probably appropriate to invest your money in securities that are likely to be more volatile in value in the short term but that may experience higher returns over the years.

Investing: Finally we get to your original question. Investing is a vast and complex topic. Opportunities abound, but the risk of serious loss is ever-present. So, my sincere encouragement to you is to begin to increase your own investment IQ by doing some reading, and to ask people you trust to recommend investment professionals they have found to be knowledgeable, trustworthy and helpful. These steps will help insulate you against the self-serving advice of charlatans who have been around, as they say in law school, since the memory of man runneth not to the contrary.

As a starting point, I want to recommend to you a brand new book written by two savvy and experienced financial advisors. Resource Planning: The Internet, Money & You by Dee and Gene Balliett is very readable, covers a wide range of personal financial issues and is arranged in two-page snippets that make it really easy for a lay person to get the basic understanding you'll need to avoid big mistakes and to build your family's financial security over the years. The book is a treasure trove of Internet resources; it costs $29.95 at www.Amazon.com. By the way, the Ballietts also have an extraordinary Web site (www.balliettfs.com) with some great coaching advice; I highly recommend investing a half hour to soak up some of their wisdom.

Another book, actually a series of titles that is available in book and audiotape format, is Rich Dad, Poor Dad, by Robert T. Kiyosaki. You can find them on Amazon for under $12. Try Rich Dad, Poor Dad: What The Rich Teach Their Kids About Money-That The Poor and Middle Class Do Not! and Rich Dad's Guide to Investing. These read like novels but are packed with sound advice. One of my own sons, in his mid-thirties, found them really insightful and motivating.

Two no-load mutual fund companies that have extensive educational materials on their Web sites are Vanguard (www.vanguard.com) and T. Rowe Price (www.TrowePrice.com). You might also enjoy The Motley Fool (www.fool.com) for a no-nonsense look at mutual funds, insurance and a host of other personal financial issues. Another respected site for investor education is the American Association of Individual Investors (www.AAII.com); you might even want to take out an annual membership ($49) so you can receive their monthly magazine and have greater access to their on-line educational tools.

Finally, to respond more directly to your investment question, I would like to recommend two sound, all-around diversified mutual funds that you can cut your investment teeth on, once you have covered the bases of goal-setting, budgeting, insurance protection and emergency savings. The first is Vanguard Wellington Fund. This is a mutual fund with a history that reaches back to 1929. It invests in a mix of stocks and bonds designed to provide some growth over the years but with a bearable amount of volatility. The fund was recently invested about two-thirds in stocks and one-third in bonds and cash. In the last 12 months, Wellington (the trading symbol is VWELX) earned a total return for shareholders of slightly over 17%; of course, this was a 12-month period when the stock market was recovering from a three-year bear market. Over the last five years, the fund earned an average of 5.79% a year.

An alternative is the T. Rowe Price Balanced Fund (RPBAX). This is a little more conservatively structured of late, with half its assets in stocks and half in bonds and cash reserves. It's latest one-year return was almost 18%, but for the last five years it lagged the slightly more aggressive Wellington fund with an average annual return of 4.37%. T. Rowe Price and Vanguard are highly respected fund families with below-average expenses, and either of these well-diversified funds will provide good entry-level experiences in investing. As you and Beth put aside investment money each month, you can "dollar-cost-average" into the fund of your choice.

As you gather a little more experience, you may want to make your own mix of stocks and bonds by owning some T. Rowe Price Spectrum Income (a blend of various Price bond funds) and Spectrum Growth (which owns a number of Price stock funds). These are "funds of funds" insofar as the management of the Spectrum funds decides for you the appropriate proportion of short-term and long-term bonds, U.S. and foreign stocks and so forth. If you had invested 60% of your money in Spectrum Growth a year ago and 40% in Spectrum Income, your total return would have been 22.6%! For the last five years that mix would have netted you 5.3% a year.

Keep up the good work, Paul. I hope our general advice about financial priorities will be helpful. Please look into the recommended books, tapes and Web sites, which I am sure will help you and Beth become masters of your financial destiny. And don't hesitate to give us a call if you need a little extra help with questions or problems you encounter on the way.

J. Michael Martin, JD, CFP, is president of Financial Advantage in Columbia, Md.