25 June 2012

More about Emergency Savings

We've all been through some tough times lately, or know well someone who has. Emergency savings seem to be more of a luxury than ever, but in reality, they are more of a necessity than ever.

We talked about getting your first emergency savings account started last year: Your Karma $1,000

Recap: 1) Saving $1,000 makes you less vulnerable to small attacks on your income. 2) More savings leads to mo' bettah Karma 3) Make saving the money as transparent as possible...if you never see it in your checking account you won't miss it as much.

According to this article published by CNNMoney, 28% of American households have no emergency savings at all. Zilch, bupkis, nada, niente. More Emergency Savings Needed!

Nobody is telling us that saving money is easy. It's not. It can be made less painless, though. The easiest way to do this is to have a portion of your paycheck directly deposited into a savings account. Talk to your HR department and have them set this up for you. It's their job, you are not asking for any favors.

Another helpful exercise is to ask yourself what would happen if you had an emergency expense happen right now. Let's not even get so severe as to talk about a job loss. What would happen if you had to replace a major home appliance right now? Try to find a refrigerator that meets your aesthetic and functional requirements for less than $1,200. If you put that on a credit card with a 24% interest rate and paid it off over a year, that's about $115 extra out of your budget per month.

What would happen if you had to replace a car? Insurance helps, but most reasonably priced policies only cover the replacement value of your car. And after the trauma of an accident, don't you deserve a little shiny and some more safety features?

OK, we do need to address job loss. This is America and we're in a recession. Most planners recommend at least three months worth of living expenses as an emergency savings fund. It may help to keep in mind that "living expenses" and "salary replacement" are two separate things. If you are not earning a salary, you're not paying taxes or making retirement fund deposits, which should make you feel a little better, no? However, if you are not earning a salary, then you are not having things like health insurance paid for, so that needs to be taken into account. When calculating living expenses, keep the following in mind:

  • Rent or house payment
  • Debt obligations such as student loan and car loan payments
  • Credit card minimum payments
  • Utilities and transportation costs
  • Insurance payments - home/renters, auto, health
  • Groceries and eating out. You don't have to totally hibernate while you're unemployed.
How many months' of expenses do you really need? As with all financial planning questions, the answer is "It Depends." Are you planning for just one person or for a multi-income household? Do you have other sources of income that you can tap into during hard times? Is your pay dependent on commissions or other irregular cash flows? Have there been layoffs in your industry or at your company? How long do you think it will take you to find another job? Take all of these factors into account, but don't go overboard. You don't want to neglect saving for retirement so that you can have a year's worth of living expenses in a low-interest rate savings account. Keep a balanced perspective here. 

It's a scary topic for scary times. Although it isn't much fun to anticipate hard times, it is better to talk about building an emergency fund now, before you need it, rather than to wait until the need is imminent. 

19 January 2012

Changing Jobs? Save that 401(k)!!

Okay, we've got a new year, lots of cool topics are starting to crop up, so maybe it's time to start blogging again.


Often when workers change jobs, they find themselves with a decision to make: What do I do with this little old retirement account? It could be a 401(k) or a SIMPLE IRA. Depending on how long you've been working there, the balance probably isn't all that much in terms of retirement planning. It might even look like a tasty morsel chunk of change for managing the change to a new job, or to pay off a smidgen of debt...and get stuck with some taxes.

But wait! You can save your savings and put them back to work for you! As tempting as it may be to cash out of a smallish 401(k), there is a way that you can hang onto it. The first possible alternative is to keep the account in your soon-to-be former employer's plan. This is a perfectly workable solution, but not always attractive if you are otherwise moving on emotionally. Also, the plan manager may charge former employees different fees, which nearly always means more expensive ones.

The other solution is to roll that 401(k) into a Rollover IRA at a brokerage or a mutual fund company. This will allow for emotional separation from your previous employer and potentially give you more control over your account. However, as this article from Smart Money cautions us, this can be an expensive solution. There is absolutely no reason to pay high fees on a small account. The implicit message to you from your service provider is "You are not our core business and we don't really want to be bothered with you, so we'll charge you ridiculous fees until you leave." That's okay, there are plenty of financial service providers who are interested in your business.

What would be my advice for someone with a small account who wants to roll it over? Hie thee to a reputable no-load mutual fund company and roll your account into a low-cost index fund or a balanced fund that meets your long-term investment needs. The accompanying article gives some excellent companies to consider for your account.

And if your account balance is still low enough to be charged fees? Another advantage of moving your account from the previous employer's plan is that you can always add to it. Any of the companies listed in this article will allow you to contribute to your existing account. Of course, you will want to check for income eligibility and contribution limits, but even if your new employer offers a 401(k) you don't have to let your old account lie fallow. It may just take a couple of years of channeling a few bucks a month into the rolled account to get you where you need to be.

Don't let an excellent opportunity for long-term savings pass you by just because you are getting a new job. Roll that 401(k) and keep it growing. In a few years you will be delighted that you did!

12 October 2011

The Search for the Golden Unicorn

Having a good credit score is important, but for some people it just isn’t enough. They want perfection. The goal may be as elusive as a perfect game in baseball or a perfect SAT score, but that doesn’t faze these folks.

Credit scores range from 300 – 850. The score is calculated based on a formula developed by the Fair Isaac, Co., and considers five factors: payment history, amount  of available credit in use, types of credit used, amount of new credit, and length of credit history. Having a high score can save consumers money by giving them access to lower interest mortgages, car loans, and credit cards than people with less than stellar credit scores.

However, the additional benefit to be gleaned from having a perfect credit score as opposed to just an excellent one may not be worth the additional effort. Perfect score junkies invest a fair amount of time and, sometimes, money to continually monitor their credit. According to one expert cited in the article, a score of 780 will grant a consumer access to the best rates. Doing additional credit score gymnastics will not get you better rates.
Monitoring credit is still very important. Prior to the personal credit crisis starting in 2008, the best rates were available to those with scores of 720 and above. Any errors or discrepancies in your credit report should be addressed as soon as they are evident, particularly if you plan on borrowing money, like for a house or a car, in the near future. On the other hand, there has been talk that some credit card issuers are wary of extremely high scores as this indicates that “such people did not generate profit” (Mangla, 2010, para. 18) for those who extended credit to them.

Excellent credit is good enough for most people; for some, searching for the unicorn of an 850 credit score is worth the effort, bless their hearts. 

29 September 2011

9 Secret Ways Stores Seduce Us into Buying

9 Secret Ways Stores Seduce Us into Buying

Check out what the clever folks at LearnVest found for us. Yes, stores are willing to do all sorts of things to separate us from our money. Here are nine ways in which they do it.

Are there any of your favorites in there? I know that I can easily be manipulated by music. It's probably a good thing that my tastes are a little esoteric and not likely to be found in Target or at Publix.

The credit card discount can be a particularly heinous ploy. However, it is most tempting when buying big dollar items, and hopefully you have so thoroughly completed your research that you will not be lured by this siren song. Just plan your work and work your plan and you should be in good shape.

Vani-sizing. Well, guilty as sin here. There are witnesses. I will say no more. 

08 September 2011

How'm I doin'?

Back in the 1980’s the mayor of New York City was an affable fellow by the name of Ed Koch. His best known catchphrase was “How am I doing?”, which in New York-ese came out in a mere three and a half syllables as “How’mIdoin’?” He must have done pretty well because he was re-elected twice.

Sometimes it is hard to know how well we are doing financially. These aren’t things we like to freely discuss with others. ING has provided a way of comparing us to…well, other people who have found their website.  If you would like to know how your finances compare to those of the same age, income, gender, and marital status, hie thee to www.ingcompareme.com and see how you do. 

Before you trot over there, it would be advisable to know how much you have in your retirement accounts, how much other savings you have, and the asset allocation of your investment accounts. What’s that last thing? Your asset allocation is simply the percentage of your assets that are in the following categories: cash, bonds, individual stocks, domestic mutual funds, international mutual funds, target date mutual funds, and other. If you don’t have this information handy, that’s okay. You can guess, or admit that you don’t know, and still be able to see how others like you have allocated their assets. 

Other helpful information to have: your mortgage balance and monthly payment, credit card balances, and your monthly budget in fairly round numbers. After comparing yourself to others like you in savings, spending, investing, debt, and planning, you can print out a nice little report.

A couple of things to remember – the information that ING provides to you in this exercise is based on the input of other people just like you. It is human nature to perhaps round up the amounts one reports or to be optimistic in general. That’s okay, as long as we are all aware of this. Also, this exercise is no substitute for actual financial planning. Just because you compare favorably to your peers does not mean that you have done everything that you can or should do in the area of financial planning. 

So, how are you doin'?

25 July 2011

Don't short change your 401(k)!

401(k) retirement savings plans offer the best chance that many folks have to contribute towards their own retirement. Therefore it is critical that you contribute as much as you possibly can to your 401(k). How much is that? Well, of course, that answer is the same as the answer to most questions about personal finance: It depends.

Here is how most plans work: You, the employee, sign up to have a specified percentage of your pre-tax earnings put into a special account that will be invested and grow so that you can afford to retire someday. This percentage can be anywhere from 1% to 10% in most cases, although Doc has seen some plans that allow for a 20% contribution.

There is a maximum limit for most individuals of $16,500 for 2011 ($22,000 if you are over 50). This means that if you earn more than $165,000, you might have to do some calculating. However, if you are earning that much, you can probably afford the services of a fee-only personal financial planner to help you with this and other things.

The true beauty of the 401(k) plan is that, in most cases, your employer also makes a contribution on your behalf. Typically, an employer will contribute 50 cents for each employee dollar contributed up to 6% of the employee’s salary. Again, your plan may vary. Check with your employer and your HR department. So, if you earn $40,000 per year and have a typical plan, you can contribute $4,000 (10% of salary) to your 401(k) and your employer will contribute $1,200 (50% of 6% of $40,000).

So what happens to that $1,200 if you do not contribute at least the $2,400 per year to claim your stake in it? I don’t know. One thing is for sure, though: you will never see a penny of it. If you do not contribute enough to your own retirement plan to earn the match from your employer, then that money is still your employer’s, not yours. This is part of your overall compensation, money that you are able to earn, but if you do not contribute your share, than your employer will keep those funds for his/hers/its own purposes. Got that? It’s important. It is your compensation and it is up to you to claim it.

If you took a look at the Wall Street Journal linked above, you saw that a lot of people do not contribute as much as they can to their 401(k) accounts, thus missing out on a significant benefit. Do not make this mistake. And don’t be harsh on your employer; they have to look out for their best interests, too. Since 2006, most employers have taken advantage of a law that says they can automatically enroll employees in a 401(k) plan. Typically (a frequently used word when describing 401(k) plans), this number is 3%. So a lot of people come to their first day of work, sign a bunch of papers and save 3% of their pre-tax earnings and call it good. The Employee Benefit Research Institute has found that people are more likely to go with the 3% default contribution than to contribute as much as they need, or even as much as required to claim their full amount of compensation.

But you can do better. First, find out how much your employer contributes. Then, contact your HR department and make sure that you are contributing AT LEAST enough to maximize the employer’s matching contribution and take full advantage of the compensation available to you. It is your money, but you will not have access to it until you take the action necessary to claim it.

For public employees who have 403(b) plans, this is one of the ways in which most of us are not similar to our 401(k) holding counterparts. However, your employer may offer additional ways to save pre-tax earnings, and you should definitely look into those.

Once more, it is your money. Get your hands on it. 

02 July 2011

Quiz answers Part II

OK, here are the rest of the answers to the financial knowledge quiz question. This entry covers interest rates/bond prices, mortgages, and portfolio diversification.

3.      If interest rates rise, what will typically happen to bond prices?
a.       They will rise
b.      They will fall
c.       They will stay the same
d.      There is no relationship between bond prices and interest rates
e.       Do not know

OK, this one is hard, and I’m not sure that everyone needs to know or understand this on a daily basis but there you have it. The short answer is: Bond prices move inversely with interest rates, therefore if interest rates rise, bond prices will fall.

Here’s the longer answer. A bond is a financial instrument that represents a form of borrowing wherein the borrower or bond issuer, and this can be a company, a city, state or even the federal government, issues debt in exchange for capital and agrees to a schedule of interest payments and repayment of the principal at a specified date.

ABC Company wants to borrow money, so they issue you a bond in exchange for $1,000 and agree to pay you 3% interest (or coupon) per year for ten years, at which time you get your $1,000 back.

So what happens in a week or a month or so when XYZ Company wants to borrow money and is willing to pay 4% interest for borrowing $1,000? They will still pay back $1,000 in ten years, so this is exactly the same as the ABC deal except for the interest rate. Obviously this is a more attractive option for investors, as a 4% return is greater than 3%.

How much do you think someone would offer you for the ABC bond now? If they could take $1,000 and realize a 4% return, do you think they would want to pay $1,000 for a 3% return? Probably not. In fact, they would probably only pay about $920 for that bond.

The point here is that when interest rates go up, there are investments in the marketplace that will earn higher rates of return. Investments like bonds that are tied to lower interest rates will not be as attractive to investors as newer issues that will pay more. Therefore the prices of investments that are tied to lower interest rates will fall in price.

You can see how this works in the other direction, too. If you own an investment that pays 3% and new investments are only paying 2%, then yours will be worth more because it generates a higher rate of return.

Again, this question may be kind of complex for a quiz like this, but it is important financial knowledge.

4.      Is this statement true or false: A 15-year mortgage typically requires higher monthly payments than a 30-year mortgage, but the total interest paid over the life of the loan will be less.
a.       True
b.      False
c.       Do not know

Most households will purchase a home at some point in time and need a mortgage to do so. A mortgage is a big, long-term loan backed by a substantial asset (like a house). The mortgage gets paid on a monthly basis over the term of the loan. The conventional length of a mortgage loan is 30 years, meaning 360 monthly payments. Some mortgage loans are written for 15 years. This question is asking which of these is less costly in the long run.

So, all other things being equal or ignored, let’s look at two mortgages. One is for 30 years and the other is for 15 years. Both have the same interest rate, 5%, and both have the same principal loan value, $100,000. We won’t go into detail on the math, but the 30 year mortgage is repaid with monthly payments of $536.82. The 15 year loan is paid back with a $702.92 monthly payment. That’s a pretty big difference when you are evaluating your monthly expenses! However, let’s take another look at the total cost of the loan.

With the 30 year loan, you will be making monthly payments for 30 years, or 360 payments. We know that the payments are $536.82. This means that you will pay 360 * $536.82 or $193,255.20. With the shorter loan, monthly payments are made for 15 years, meaning that you will spend 180 * $790.92 or $143,342.20. That’s a difference of almost $51,000! Since the amount of the principal for both loans is the same at $100,000, the difference is in the amount of interest paid.

Thus, a shorter mortgage does cost more on a monthly basis, but the borrower ends up paying less overall with the difference being entirely interest. So this is a true statement.

5.      Is this statement true or false: Buying a single company’s stock usually provides a safer return than a stock mutual fund.
a.       True
b.      False
c.       Do not know

This question is all about diversification. Have you ever heard the statement “Don’t put all of your eggs in one basket”? That’s all about diversification, too. The idea here is to spread the risk of investing over many assets, and not placing all of your faith on just one company. If you buy a single stock and something bad happens, you have lost your entire investment. If you buy lots of different stocks, then you have spread your risk over many different companies and you chances of losing it all are greatly diminished. However, it can take a lot of money to buy stock in several different companies and a lot of time to do the necessary research to manage your investments. Mutual funds are professionally managed financial entities that buy a wide selection of companies and then repackage them and sell them to investors. That way each investor can share the benefits of ownership of many different companies, diversify risk and generally enjoy a safer return than owning stock in just one company.

There are almost as many mutual funds available as there are individual companies, and they are not all created equal. You still need to be a conscientious investor, but generally speaking, mutual funds offer a reduced risk alternative to owning one individual stock. The statement is false.

I hope that these explanations have been helpful and that you feel more secure in your financial knowledge. While financial knowledge is not the one and only key to financial satisfaction, it is an important component. Remember the motto of Faber College: Knowledge is Good (if you are mystified, it's an Animal House reference).