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How to Save $10,000 for Retirement With It Only Costing $7,200 To You
In a post back in March of this year (shown at the link below), I developed a very useable spreadsheet for everyone to use in calculating how much they should save for retirement each year.
My Money Blog – What Percent of Your Salary Should You Save for Retirement?
However, one thing I left out of this post was demonstrating how powerful (and just how much money you can save) by being able to invest money in your 401k or Traditional Roth IRA account pre-tax. Therefore, this will be the subject of today’s post.
In my opinion, the best way to demonstrate the potential savings is with an example.
Let’s say that a 30 year old woman named Shantel makes $75,000 per year in gross income. She has been putting off saving for retirement for a very long time, but finally, she has committed to herself that this year will be the year. And, she wants to save $10,000 towards her retirment goal of $1,000,000. Clearly, she has quite an aggressive goal!
So, we know what Shantel wants to accomplish. Let’s first take a look at what her take-home income would be, assuming that she does not contribute anything towards her retirement goal and she has a tax rate of 28%.
$75,000 x (1-28%) = $54,000 take home pay
Now, let’s take a look at what her take home pay would be if she decides to contribute $10,000 towards her retirement account.
$75,000 – $10,000 401k contribution = $65,000 x (1-28%) = $46,800 take home pay
Difference in take home pay = $7,200 (28% less than $10,000 saved for retirement)
In this example, you can clearly see the POWER of paying yourself first (before the government takes ahold of the money through taxes). In fact, you end up allowing yourself to come out $2,800 ahead!
Now, let’s see what happens when you spread this advantage out over the number of years Shantel has until retirement at age 65.
In one scenario, we will assume that Shantel saves $7,200 per year after tax towards her retirement. In the other scenario, we will assume that Shantel saves $10,000 per year pre-tax (since it doesn’t cost her any more purchasing power to do this). In both cases, we will assume that she invests the funds at a rate of return of 10%.
The results of can be seen in the Google Docs spreadsheet at the link below.
Google Docs – Shantel’s Quest to Become a Millionaire
What we see is that by investing pre-tax, Shantel is able to become a millionaire 3 years quicker than she would if she were to invest her funds after-tax.
Even more impressive is that fact that at age 65, by investing pre-tax, she is able to accumulate close to $800,000 more for retirement. Quite an impressive sum!
So, I hope this article has given you some added perspective, and perhaps incentive, for doing your best to take advantage of your tax-sheltered savings accounts. This pre-tax contribution idea is especially important for those of us shooting for early retirement.
As always, please let me know if you have any questions.
Keep on learning!
Jacob
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Live Life to the Fullest – Create a Dream and Life Values Based Approach to Personal Finance – Part 4 – Place Your Dream and Life Value Savings Plan on Autopilot
In the action plan, we have defined end goals for our dreams and values and identified specific actions that can be taken in the next two days.
However, what we have not addressed is what sort of financial actions are required in order to make your life value goals and dreams become a reality. This (Step 6) will be the focus on today’s posting.
Step 6 – Financial Actions To Take to Automate Your Life Value Goals and Dreams
How to Save for Life Value Goals – Next 12 Months
Since everyone’s goals that they will want to accomplish are different, it is hard to make blanket statements about how you should save for them. However, there are two critical aspects of savings plans that you should consider incorporating in order to achieve your goals.
1) Make it automatic – set up your accounts to automatically transfer money at a designated time each month so that you don’t have to think about it.
As I was filling out the life values and dreams action plans, I found myself asking, “Why have I not gotten it together enough to execute on these actions before, given that they are obviously very important to me.” I suppose the best answer to this is that life just got in the way and distracted me.
I feel like an example will illustrate this very well for everyone. For this analysis, let’s look at my Freedom value based goal of going to the Grand Canyon in 2011. This is something that I have wanted to do since 2007-2008. Even though I have enough money to go on this trip, I just have not gotten myself in line and disciplined enough to specifically save the money and plan for it.
What has happened is that when my income comes in around the 1st of the month, it gets saved through my normal process of moving it to my individual and retirement investing accounts. And, no funds are committed specifically to achieving this life value goal of mine.
I’m sure this type of thing happens to a lot of people!
How the automatic solution helps:
However, what I can do to fix this annoying situation going forward is to 1) calculate the total cost of the trip to the Grand Canyon, 2) calculate exactly how much I must save each month in order to be ready for the trip by the set date, and then 3) set up my high yield online savings accounts to automatically transfer that amount each month.
If you are in the market for an online high yield savings account, I would recommend ING Direct (it is what I use as well). Just click on the link below to visit their page!
2) Keep your savings liquid (since will be used within next 12 months)
Since David Bach’s book instructs us to only set goals for our life values for things we want to achieve within the next 12 months, we will only want to invest our savings in short-term, liquid investment instruments.
Online high-yield savings accounts work very well for this purpose! For more information on these types of accounts, click on the link below.
My Money Blog – High Yield Savings Accounts
How to Save for Life Dreams
David does a superb job in his book discussing the various ways to invest your savings for your life dreams. I especially like the way he breaks up the decision according to the time frame for which you are wishing to realize your dreams.
- How much should you save each month for funding your dreams?
- David suggests setting aside 3% of your take-home (after taxes, retirement deductions, etc) pay in to your dream account.
- I think this is appropriate, and I have set up an automatic transfer accordingly.
- To reiterate, make sure you make the 3% transfer automatic so that you don’t have to think about it.
- How to invest for short-term dreams (2 years or less in the future)
- Because this is in the very near-term, we will only want to invest in highly liquid instruments, such as the high yield online savings accounts described at the link above.
- Since the dreams I am planning for are less than 2 years away, this is the instrument I will use for the time being.
- How to invest for mid-term dreams (2-4 years in the future)
- Short-term bond funds
- If I were investing in a short term bond fund, I would choose the Vanguard Short-Term Bond ETF with the ticker symbol, BSV (shown at the following link) Vanguard Short Term Bond ETF.
- It follows a passively managed, index approach to investing of which I am a fan.
- I would not invest in a mutual fund from Vanguard because it would require that I have the $3000 minimum investment to buy the fund.
- Balanced funds (is one fund that invests in both stocks and bonds)
- If I did have a mid-term dream, I would prefer investing in a short-term bond fund over a balanced fund to minimize risk.
- How to invest for long-term dreams (4-10 years in the future)
- Index mutual funds
- For more information about index mutual funds, visit my previous post at the following link – My Money Blog – Index Funds and Asset Allocation
- How to invest for very long-term dreams (10+ years in the future)
- For this term of dream, David recommends considering a Variable Annuity.
- For more information on annuities, see the recent post at the following link – My Money Blog – Should I Invest In Annuities?
I hope this post has been useful for your to take further action on executing on your life value goals and dreams. Please let me know if you have any questions.
Keep on learning!
Jacob
To receive updates on topics such as this one as soon as they are published, click on the link below to subscribe to My Money Blog:
Live Life to the Fullest – Create a Dream and Life Values Based Approach to Personal Finance – Part 3 – Discover Your Dreams and Take Action on Them
. Click on the link to pick up a cheap used copy of the book from Amazon.com. -
Step 1 involved discovering the importance of money in your life.
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Step 2 involved discovering the purpose of money in your life.
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Step 3 was to list out your top 5 values you want to focus on over the next 12 months.
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Step 4 covered how to create an actionable plan for executing on these life values.
- List our your top 5 dreams on a piece of paper.
- Remember – with this exercise, you want to dream big! Don’t be worried if one or more of your dreams “seems” unrealistic.
- For each of your top 5 dreams, further refine them so that they are specific and measureable.
- 48 hour action plan –
- As discussed in the life values section in Part 2 of this series, list at least some specific action that is possible to take upon your dreams in the next two days.
- Next, for each of your dreams, list who, if anyone, you want to share them with.
- Fifth, you will want to list what specific life value (from Part 2) this dream helps you fullfill.
- Personally, I feel this is one of the most important steps. For me, it is interesting to see how related my dreams are to my life values.
- Finally, for each of your dreams, write down a rough estimate of how much it will cost.
Do you have all of these 6 items recorded for each of your dreams? Good work!
Feels like quite an accomplishment doesn’t it?
My Results for Step 5
Jacob’s Top 5 Dreams
- Backpack on the Inca Trail in Peru
- Hike all of the Appalachian Trail in Virginia
- Own a cabin in the mountains/woods
- Be part of starting/growing a biotechnology company
- Visit Yellowstone National Park
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Dream – Backpacking on the Inca Trail in Peru
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Specific, measurable – Go on a 4 day backpacking trip on the Inca Trail in Peru, finishing at Macchu Picchu in 2012.
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48 hour action plan – Search online for Peruvian tour companies that offer these guided backpacking trips and their prices.
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Who share dream with? Family or friends.
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What value(s) does this help fullfill? Freedom and Health
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Approximate cost – $3,000
My Money Blog – Create a Purpose Focused Financial Plan – Part 4
Jacob
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Live Life to the Fullest – Create a Dream and Life Values Based Approach to Personal Finance – Part 2 – Determine and Take Action on Your Life Values
In Part 1 of this series (shown at the link below), I introduced everyone to the first two steps towards creating a dream and life values based approach to your life, and vis a vis, personal finance. Step 1 was to determine the importance of money in your life, and step 2 was to verbalize its purpose.
My Money Blog – Part 1 – Creating a Purpose Focused Financial Plan
This approach to personal finance is a subject I learned recently in reading David Bach’s very interesting book titled, “Smart Couples Finish Rich.” If you are interested in learning more about topics such as this one, I would encourage everyone to pick up a cheap used copy of his book from Amazon, using the following link – Smart Couples Finish Rich: 9 Steps to Creating a Rich Future for You and Your Partner
In Part 2 of this series, I will walk everyone through steps 3 and 4 of the journey towards creating this type of financial plan. I will also explain how I have applied it to my life as an example.
Note: Below is a link to download the section of David Bach’s book explaining this topic (it is free) in pdf format. I would encourage everyone to read this section. It just may change your life! You never know!
FREE PDF Download to Purpose Focused Financial Plan – Smart Couples Finish Rich
Creating a Purpose Focused Financial Plan (continued)
Step 3 – Create Your Value Circle
To create your Value Circle, you will need to think of and record the top 5 most important values to you (not your friends, family, spouse, etc) that you want to focus on in the next 12 months
In this exercise, it is best to think about what is important to you at the most basic level. Another important distinction to make is that you are listing out your top 5 values. Not activities. Not material desires. VALUES. If you get stuck (like I did), there is a great list of values in page 21 of the pdf above.
Once you have them ordered. print off a copy of the Value Circle below, and list them in the 5 areas.
- Making a difference
- Health
- Freedom
- Family/friends
- Growth
- Top 5 Values
- In this column, write down the top 5 values you identified for yourself in Step 3 above.
- The idea is that you will start your plan with these values in order to take action appropriately so that you address the person you want to “be.”
- Top 5 Financial Goals
- In this column, for each of your top 5 values, write down down specifically what you want do “do” in the next 12 months that relates to your values.
- For this section, it is perfectly OK for some of your top 5 goals to not have anything to do with financial matters.
- Specific, Measurable Translation
- In this column, for each of your top 5 financial goals, list a very detailed endpoint that you can hold yourself clearly accountable to reaching by the end of the year.
- Basically, the purpose of this column is to go from the general to the specific.
- 48 Hour Plan
- In this column, for each of your specific, measurable translations, list some type of action step you can take in the immediate term (next 48 hours).
- Personally, I love this idea because studies have shown that even if you take a very small action step towards a goal immediately, you are far more likely to complete it.
- Help Needed
- In this column, list the names of any people you will need to turn to or lean on for assistance in realizing your goals.
- Define Start and Stop Limits/Timings
- This column is pretty self explanatory. However, you will want to list the dates/timings for when you will start and finish the goals for each of your top 5 values.
Once you have filled out your Plan, be sure to place a reminder on your calendar to reevaluate your values, goals, and actions 6 months from now to see how you are doing and where you can make improvements. Document action steps required so that you don’t lose track of what you have committed to doing.
- Making a difference
- Goal – Contribute 5% of my income to charity this year and a few hundred Dollars in a Microplace.com microloan to Latin America.
- Make specific – Contribute $ XXX to charity in 2010 year (specify exact amount I need to donate). Partcipate in $500 microloan to Latin America using Microplace.com
- 48 hour plan – Total up charitable contributions already made this year. Determine how much remaining to reach 5% of income level.
- Help needed – Need to find and use a good charity search engine. Additionally, when tax time arrives in 2011, I will need the accountants help to realize my tax benefits from making contributions.
- Start and stop timing – start = today, end = December 31, 2010.
- Health
- Goal – Do more trail running half marathons.
- Make specific – Compete in 5 trail running half marathon races in 2010 year.
- 48 hour plan – Search for half marathons to do on www.runningintheusa.com. Find 5 specific races to target. Sign up early to commit to doing them.
- Help needed – Someone to go to the races with me. TBD.
- Start and stop timing – start = today, end = December 31, 2010
- Freedom
- Goal – Travel to places in domestic US that I have always wanted to see.
- Make specific – Go to the Grand Canyon and hike to the bottom during Spring Break, 2011.
- 48 hour plan – Set up travel savings account and determine approximate price of Grand Canyon trip.
- Help needed – Ask around for friends/family that would be interested in going.
- Start and stop timing – start = now, stop = when go on trip Spring Break, 2011
- Family/friends
- Goal – Go visit home in Arkansas more often.
- Make specific – Visit home in Arkansas every 2 months instead of 1X every 3-5 months.
- 48 hour plan – Talk to family about possible trip home to Arkansas in July to see if would be feasible.
- Help needed – See bullet above.
- Start and stop timing – start = now, stop = ongoing.
- Growth
- Goal – Practice Spanish language more often.
- Make specific – Listen to movie in Spanish or with Spanish subtitles 1X per week, and talk to someone in Spanish 1X per month.
- 48 hour plan – Pick a DVD to listen to in Spanish, preferably one that I know the words to already (Harry Potter possibly?).
- Help needed – Need to find someone to chat with in Spanish.
- Start and stop timing – start = now, stop = Summer 2011
I hope you all have found this post/exercise insightful and helpful in improving both your financial situation and quality of life going forward. Please let me know if you have any questions.
The link to Part 3 of this series is shown below. The topic is on determining and taking action upon your life dreams! Click on the link to find out more!
My Money Blog – Create a Purpose Focused Financial Plan – Part 3
Keep on learning,
Jacob
To receive updates on topics such as this one as soon as they are published, click on the link below to subscribe to My Money Blog:
Live Life to the Fullest – Create a Dream and Life Values Based Approach to Personal Finance – Part 1 – Determine the Purpose of Money in Your Life
Take a moment and reflect on that statement. There is a big difference between the two when you stop and think about!
This posting series will chronicle my journey to discover and create this Purpose Focused personal finance strategy and strive to give you all advice from my learnings that you can adapt to your situations.
Step 1 – Determining the Importance of Money in Your Life
The first step to creating this system for yourself is to ask yourself the simple question, “How important is money in my life?”
After really thinking about this for 5-10 minutes, rank the importance of money in your life on a piece of paper, using the scale of 1-10. A score of 1 would indicate that you believe that money is the root of all evil, and a score of ten would mean that you think money is the most important reason for living.
Next, if you have a partner/spouse, rate and record how you think he or she feels about money, using this same scale.
This simple exercise is a great way to get the creative juices flowing to drill down to what you believe is the true purpose of money in your life.
Step 2 – Determine the Purpose of Money in Your Life
Having ranked the importance of money to you, it is now time to search your soul a little and verbalize exactly what you feel is the purpose of money in life.
In Bach’s book, I believe he skips over this exercise too quickly (he goes straight to listing your specific life values. That will be the subject of part 2 of this series). I feel that is very important to have a good grasp in your mind how you feel about money in general.
To get you all thinking, I will ask some rhetorical questions – do you feel money helps you to buy things? does it help provide you security? the freedom to travel? the ability to attract people to you? to give you power? to give you recognition?
Now, record on your piece of paper what you are thinking!
My Results from Steps 1 and 2
After thinking about it for a while, I came up with that money is a “7” on the 10 point scale of how important it is to me in my life. How did I come up with that ranking? It basically all comes down to the purpose of money in my life.
To me, money is very similar in importance to blood. Someone once said that blood is very necessary for life, but it is not the purpose of life. I feel that money is very similar because it is unmistakenly necessary for people to do what they want to experience in life, but it is not the purpose of life.
Give this quick exercise a go, and let me know if you have any questions.
Keep on learning!
Jacob
Part 2 of this series can be found at the link below. It contains Steps 3-4 of creating this dreams/values based approach to personal finance.
My Money Blog – Create a Dream and Life Values Based Approach to Personal Finance – Part 2
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My New Favorite Financial Organization System
- First, the way the pockets were labeled did not fit my specific personal finance needs.
- In other words, since I was not able to customize my filing system to make it logical and Jacob-user friendly, I was very unmotivated to follow it.
- Second, the flap that comes over the pockets to protect them and keep things from falling out was a hindrance to having quick access to my files.
Regardless of my excuses for not having a good financial system, I realized when I was reading David’s book that I needed to start over and follow a new organizational mantra.
Using the guidance in Bach’s book, I was able to create a user-friendly and effective financial organization system of which the setup I will describe below. To follow along with me, click on the link below, print yourself out a copy of the two-page excerpt, and read on!
Note: In this post, I will give a quick summary of each file folder category and/or comment on the contents that I place in them. To read the complete details of how to set up the system, click on the link above.
Creating David Bach’s Effective Financial Organization System
- Go to the office supply store and purchase 25 hanging folders, a cardboard box in which to hang them, and 50 manilla file folders to place inside of the hanging folders.
- Label 13 hanging folders, as described below:
- Tax returns – In this folder, place 7 manilla file folders – one for the tax returns and tax documents for each of the last 7 years. Since charitable contributions are included as a line item on my tax returns, I place my donation reciepts in this file as well.
- Retirement accounts – In this folder, place 1 file folder for each of your retirement accounts (IRAs or 401k).
- Social Security – In this folder, you should place your most recent Social Security Benefits Statement. Refer to the following link for more information – My Money Blog – Discover Your Future Social Security Benefits
- Investment accounts – In this folder, place 1 file folder for each of your non-retirement investment accounts (stocks, bonds, ETFs, mutual funds, etc)
- Savings and checking accounts – In this folder, include a separate file folder for each of your savings or checking accounts
- Household accounts – In this folder, include separate file folders labeled as follows – “house title,” “home improvements,” and “home mortgage.” In addition, I found it useful to include a separate file folder for each of the 2 apartments I have lived in in the past 2 years.
- Credit card DEBT – In this folder, include separate file folders for each of the credit cards you have.
- Other liabilities – This folder would contain subfolders for all other liabilities that are not housing or credit card related. For me, I also created a subfolder for the personal loan I took out in college to help build credit. For more information on that topic, click on the following link – My Money Blog – Build Your Credit Score From Nothing.
- Insurance – This folder should contain separate folders for each of your different insurance accounts.
- Family will or trust – This folder should contain the most recent copy of your will that you create with your lawyer (not by yourself).
- Children’s accounts
- FinishRich inventory planner – This folder should contain each of your semi-annual updated versions of the Financial Inventory Sheet (shown at the link below) to keep track of your net worth. I also keep the historical and most recent copies of the worksheet (at the 2nd link below) that helps you track where your money is going.
- Career/Jobs – This hanging folder is not included in David Bach’s system. In this folder, I created a separate file folder for each of the jobs I have held. In them, I place paystub information and various additional job-related information I want to hang on to.
David Bach’s Financial Inventory Sheet
Well, it’s that simple! You have now created a powerful, custom-built financial organization system that you will be more likely to use than any other (because, hey, you created it). As you get new statements in periodically, simply place them in the appropriate file, and it will make producing historical records a breeze!
This is just one of the very powerful messages in David Bach’s book, “Smart Couples Finish Rich.” I would highly recommend that you purchase a copy for yourself and read it cover to cover several times. More posts to come soon on my numerous learnings from it!
Save Yourself 50% On Your Monthly Bills With a 5 Minute Phone Call
Yesterday, a reminder popped up on my Microsoft Outlook calendar that the 6-month $38/month “promotional” pricing period for my high speed internet service was expiring on June 4th of this year. On June 4th, it was slated to resume the “normal” pricing program of $60 per month.
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Billed @ $38 per month – (after asking for discount)
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Total Cost = $4,560
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Billed @ $60 per month – (no taking 5 minutes to ask for a discount)
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Total Cost = $7,200
5 Essential Financial Products Most People Need
Tonight, I have the honor of introducing an article by My Money Blog’s first guest-poster, Alban. Please visit his website at the following link to read more of his articles! – Home Loan Finder. To become a guest poster on My Money Blog, simply email me at the address in the Contact Me section.
As you go through life, your financial needs will change, but there are five important financial products that most people will need at some point. As a result, it is important that you know why you need each of these products, and that you know how best to use them to make the most of your finances no matter what stage of life you are in right now.
1. Savings
A savings account is something you can have from the time you start school and a good savings plan will make it easier to achieve every important milestone in your life from a new bike to a new house. With the best savings account you can:
• Live within your means by saving for purchases and avoiding credit
Spending less than you make seems like a simple plan to follow, but for most people credit is so readily available that it is just as easy to make purchases which don’t fit within the budget with the intention to repay them later. Unfortunately it is also easy to forget about putting the extra amount from next week’s wage onto your credit card when you can roll over your balance for the next month and the next. However if you get into the habit of saving for your purchases then you won’t have to worry about accumulating bad debt or rising interest and without crippling credit card debt you’ll more easily be able to preserve your credit rating, apply for a home loan, or simply enjoy the freedom of not owing anyone anything.
• Plan for emergencies
Emergencies happen and unexpected bills arrive and whether you need extra funds because one of the kids is sick, the car broke down or that last heatwave shot your power bill through the roof, you need to have an emergency savings fund to cover these emergency expenses. Again, having the funds available in a savings account can mean you don’t have to resort to your credit card and you can rest easy knowing you have a secure financial plan no matter what happens.
• Teach your children good financial habits
You can lead by example, but you can also open a savings account for each of your kids to teach them the importance of saving. Most savings accounts will allow account holders as young as 12 years old, while younger savers can have their account held in trust, or in your name. Teaching your children how to stick to a savings plan is a lesson which will serve them for life.
2. Credit Card
You may have heard a credit card referred to as a necessary evil and while a credit card isn’t always necessary and it doesn’t have to be evil, it does make sense to have a credit card at certain times in your life:
• You can build a responsible credit history
Being able to hold a credit card account and make regular payments to maintain control of your credit limit makes a positive impression on your credit report. If you maintain your responsible credit card use it can be helpful when it comes time to apply for a home loan or personal loan.
• Spend the bank’s money and earn interest on your own
If you choose a credit card with a long interest free period, you can spend on your card during this period, while you leave your wages in a high interest savings account. Before the interest free period ends, you transfer the amount you need to pay off your credit card purchases and you don’t get charged interest, and you continue to earn interest on your savings.
• If you can’t control a credit card, use a debit card
A debit card looks and acts like a credit card in that it allows you to make purchases online, over the phone or in person by choosing the ‘credit’ function. Unlike a credit card, a debit card accesses your own funds each time you use it, so when your money runs out, you can’t spend on the card anymore. This means there are no interest charges and no monthly payment to make, plus it allows you to budget your purchases for what you can afford with the money you have available.
3. Term Deposit
A term deposit account was typically for large, long term investments, but you don’t have to wait until you have the corner office or the company partnership to start investing in a term deposit because just about anyone can enjoy a secure, guaranteed savings account. A term deposit account allows you to:
• Save for long term plans without having to manage your savings
Once you have chosen the term and investment amount you can afford within your budget, you don’t have to monitor or manage your term deposit account. It goes about earning interest and keeping your money save, so it can grow towards your future plans of children, a house or further investments.
• Choose the best term and investment amount so you don’t break the term
If you access your funds before maturity you will be charged early access fees and the interest you are paid will be calculated on a lower rate. However, before your investment is fixed you can invest just the amount you can afford, and you can choose a term between one month and five years to invest.
• Grow a guaranteed investment amount calculated for the future
During a term deposit, your rate of interest is fixed so you will earn the same guaranteed rate every day of your term. This means your returns are also guaranteed, so at maturity you have a principal amount, plus interest returns, which have been calculated to keep up with official rate rises and the costs of inflation.
4. Home Loan
Another necessary evil, since most of us would be saving our whole lives to accumulate enough to buy a house, and just as few are lucky enough to borrow or be given enough to buy our first home. Instead, we need a home loan, however a mortgage is much more than just another monthly bill if you know how to use it:
• Borrowing money for your house and leave your savings free to live
If you were trying to save up all you had to be able to afford to buy a house, there would be no money left to live. However, when you take out a mortgage on your home, you buy a property you can afford, with a loan you can afford and you are then free to use the rest of your savings to live out the other dreams you have.
• As you pay off your loan you build equity
As the value of your loan decreases, the value of your home is likely to be increasing – as property prices do over time. This builds equity because the bank will now be willing to lend you more money, up to the value of what your house is now worth. You can leave this equity in your loan to grow for a time when you want to sell and use it to go towards the price of your new home, or you can apply to have the equity available for a family holiday, a renovation or an investment.
• Choose a feature packed loan
You are going to have a home loan for a substantial portion of your life, so you want to make sure it is working for you. Therefore, consider the features you could benefit from, such as an offset savings account where the funds in your savings account reduce the interest you pay, a payment holiday option where you can pause your payments when you have kids and less spare cash, or a redraw facility where you can pay extra into your home loan each month, but have the option to redraw it if you need it.
5. Retirement Plan
This is the point that all your other financial products have been working towards; a time of your life when you are free from work commitments and so you also want to be free from financial commitments too. You have worked hard to get to your retirement, so make sure it works hard or you:
• The pension is increasing but you want to live the best you can
Since you’ve worked hard for the majority of your life, you want to be able to enjoy your retirement in the comfort and style you’ve always dreamed of. This is why you need a solid retirement plan so that you really can rest and enjoy your golden years.
• Plan your retirement budget
Be clear about the type of retirement you want to have and you will be better able to map out a financial plan, and pinpoint the financial product you need. Whether you want to live six months of the year overseas or you want to buy a bigger house so your family can stay with you when they visit, if you make a budget for the life you want to live, you will be able to work out how much you need to make that dream a reality in the future.
• The future can be an expensive place
This means your retirement plan needs to not only meet the budget for the life you want to live, but also needs to grow at a rate which stays ahead of inflation costs. If you work out your retirement budget now, the amount your plans will cost in 30 years when you retire will be much greater.
Planning your future and the financial products doesn’t have to be difficult, and if you take the time to map your needs, and match them with these five essential financial products, the future may be more expensive – but you’ll be prepared.
Thanks for reading.
Alban is a personal finance writer. He provides budgeting and personal finance tips and helps people to find the best home loan online.
If you are interested in becoming a guest poster on My Money Blog, please email me at irwin.jacob@gmail.com.
Keep on learning!
Jacob
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Should I Get Pre-Qualified or Pre-Approved for a Home Mortgage Loan?
In a posting from last week (see link below), I mentioned that my application for a mortgage loan pre-approval was recently rejected. I also mentioned that it was fairly surprising when the rejection decision came back to me.
My Money Blog – Can Graduate Students Get Approved for a Home Mortgage Loan?
However, what I did not mention was that the reason that I was so surprised was due to the fact that the same lender had pre-qualified me for a loan several weeks prior.
From this experience, I learned that there obviously must be a big difference between getting pre-approved for a loan and getting pre-qualified. But – just what is that difference exactly? The answer to this question and the decision of which to pursue will be the subject of today’s post.
“Mortgages for Dummies” by Eric Tyson does a wonderful job exposing the differences between these two related, but significantly different, processes. If you are interested in learning more about the details of mortgages, I would highly recommend clicking the link below and picking up a cheap, used copy of this useful book on Amazon.com.
Mortgages For Dummies, 3rd Edition – Amazon.com
What does it mean to get pre-qualified for a home mortgage loan?
In Tyson’s book, he describes mortgage pre-qualification as, “potentially a waste of your time and money and may even be grossly misleading.” Well, he definitely seemed to hit the nail right on the head with this description, at least as far as I experienced this process.
Loan pre-qualification is essentially a “casual” agreement with the loan officer about approximately how much money they might be able to lend you, after quickly reviewing your financial situation. It is very fast and cheap. It usually only takes 15 minutes or less.
In the pre-qualification process, since the lender does not verify the facts about your financial situation, he/she/it is not bound by any contracts to loan you any of the money for which you get pre-qualified.
This sounds like a waste of time to me…
And, what’s more – the mortgage broker told me that in this day and age, pre-qualification is just as good as pre-approval. Talk about a trustworthy, knowledgeable professional!
What does it mean to get pre-approved for a home mortgage loan?
On the other hand, mortgage pre-approval is a much more serious process. In my mind, it is ALWAYS going to be the way to go in the future. The process involves the following steps be taken by the mortgage lender:
- Review your credit history/credit report/credit score
- Analyze your past, present, and future income and expenses
- Amount of cash, investments, and debt you have
- Analyze your prospects for future employment.
- This is where the mortgage lender got stuck with my pre-approval application. They were wanting a note from the university I will be attending this fall to guarantee my continued employment for at least 3 years. I think this is a little ridiculous, but it is what they were wanting.
Keep on learning!
Jacob
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Index ETFs vs. Index Mutual Funds – Which Are Better?
In the majority of the posts to date, I have limited the analysis of the different investment instruments that can be used to satisfy the different asset allocation components to index mutual funds. Please see link below for more details.
My Money Blog – Mutual Fund Posts
However, in one post back in January of this year, I introduced the idea of using ETFs (Exchange Traded Funds) to invest if you are just starting out and only have a relatively low amount of money ($100-$3000).
My Money Blog – Use ETFs to Begin Investing with $100
Not included in this article was an explanation of what an ETF exactly is and how they stack up against regular index mutual funds. These topics will be the subjects of today’s post.
Note: Even though there are both ETFs and mutual funds that are actively managed, we are going to only focus on the index version of each of these, since we have learned previously that actively managed funds do not outperform the market.
What exactly is an ETF?
According to Investopedia.com (see link below for more information), an ETF, or Exchange Traded Fund, is an investment instrument that is very similar to a mutual fund, but is traded like an individual stock.
When you purchase a share of an ETF, your money is pooled with other investors’ funds, which are then used to buy shares of numerous individuals stocks, in order to be representative of an index (such as the S&P500) of which the ETF seeks to track. In this way, an ETF is very similar to a mutual fund.
Investopedia.com – ETF Definition
However, the pricing of an ETF is set throughout the day by the market demand/supply (not based on Net Asset Value at the end of the day like a mutual fund price is calculated)
Comparison of Historical Performance
Before delving in to the detailed comparison of the characteristics of mutual funds and ETFs, let’s take a look at how an ETF and mutual fund that track the same index faired during the last year.
For this comparision, we will look at the two Vanguard.com instruments shown below:
- Vanguard Total Stock Market ETF – Symbol VTI
- Expense ratio = 0.07%, minimum to purchase = 1 share = $59
- 1 year return = +41.3%
- 3 year return = – 4.14%
- 5 year return = + 3.64%
- After tax returns still ~0.1% higher than index fund from Vanguard below.
- Vanguard Total Stock Market Mutual Fund – Symbol VTSMX
- Expense ratio = 0.18%, minimum to purchase = $3000
- 1 year return = + 41.2%
- 3 year return = – 4.23%
- 5 year return = + 3.52%
As can be seen from this comparison, the only difference in return between the two instruments appears to be the 0.1% advantage that the ETF carries over the index mutual fund due to having a 0.1% lower expense ratio. Otherwise, the returns appear to be otherwise equal.
Comparison of Characterisitics of ETFs and Mutual Funds (Indexed)
The table below shows a comparison of the different attributes of index ETFs and mutual funds
Note: this table comes to us from page 256 of Jeremy Siegel’s “Stocks for the Long Run” (my investing bible). I would definitely suggest that you click on the link below and pick up a cheap used copy of this very useful book from Amazon.com.
Management
Shares of both ETFs and mutual funds can be bought that are managed in an index fashion. However, ETFs can be bought and sold throughout the trading day, similar to an individual stock.
Fees/Espense Ratios
Generally, ETFs have slightly lower fees than the corresponding index mutual fund. This can be seen in the example above. However, both index mutual funds and ETFs offerred from Vanguard have fees that are much lower than the industry average.
Trading Costs/Commissions
Typically, trading ETFs has involved paying regular brokerage commissions for trading (trading mutual funds of the brand in which you hold your account is free of commissions). However, according to a recent article and the Vanguard fee schedule link below, Vanguard has begun offering commision free ETF trading in-house. Definitely use this to your advantage!
Vanguard.com – ETF Commission Fees
Dividend Reinvestment
In Siegel’s book, he mentioned that ETFs do not offer dividend reinvestment. However, when I just opened a brokerage/ETF account with Vanguard.com this morning, there was an option that stated that they were now offering dividend reinvestment. Excellent! This is generally preffered for long term investing!
Tax Efficiency
Overall, both index mutual funds and ETFs are very tax efficient. However, ETFs are slightly better in the realm of taxes due to the fact that they generate fewer capital gains than mutual funds (mutual funds generate capital gains when the fund must sell holdings when individual fund investors sell/redeem their shares).
Note: this slightly advantage seen in tax efficiency for ETFs only applies to funds held in taxable accounts.
Price/Pricing Fluctuations
Before investigating this topic for this post, I tended to shy away from index ETFs because I expected that the ETF would not track its respective index as effectively as an index mutual fund. This was due to my belief that since an ETF can be traded all day long, it would therefore be subject to emotional overreactions (selling and buyin) of investors.
However, in reading more of Siegel’s book on the subject of ETFs, I discovered that ETFs actually track their respective indices very closely because insitutional/large investors can turn in shares of an index for the corresponding ETFs or exchange ETFs for their respective shares. In other words, arbitragers (investors taking advantage of price differentials) cause any price differential to disappear quickly. Thank goodness that those folks on Wall Street take care of that so I don’t have to worry about it!
Purchase Minimums
As I mentioned in the link about beginning to invest with ETFs, ETFs are much better for beginning investors because you only have to buy 1 share in order to get full diversification to the index that the ETF represents.
On the other hand, index mutual funds usually require a minimum investment of $3,000-$10,000 to buy a particular fund. One good thing though is that you do not have to maintain a balance minimum of $3000 in order to keep the fund.
Bottom Line
The key takeaway for me is that because Vanguard has started offering 1) dividend reinvestment and 2) commission free ETF trading, I am going to now use both Vanguard ETFs and mutual funds (index, of course). ETFs will fit well in my taxable Vanguard account in situations when I cannot afford the $3000 minimum to purchase a new mutual fund, but still want exposure to a certain asset class in order to balance out my asset allocation %’s.
So, bottom line is that you should probably use both ETFs and mutual funds, keeping the caveats shown below in mind.
You should only use mutual funds (stay away from ETFs) if you know you are subject to easy emotional reactions when the market either goes up or down. Since mutual funds do not fluctuate in price throughout the entire day, you will be less likely to over-react and sell/buy at inappropriate times.
You should only use ETFs (stay away from mutual funds) if you like to use leverage/margins, hedge your investments by selling ETFs short, and enjoy moving quickly in and out of your investments (I do not recommend this approach).
Keep on learning!
Jacob
To receive updates on topics such as this one as soon as they are published, click on the link below to subscribe to My Money Blog: