- You are here:
- Home »
- Blog
My Current Asset Allocation and Net Worth Growth – March 2010
From February 6th (when the last portfolio update was published – see link below) to March 5th, the S&P500 index went up 6.8%.
My Money Blog – February 2010 Portfolio and Net Worth
During that time period, my net worth increased 8.16%. I am now only 4% off of my short term target net worth for this year. Almost there! Additionally, I have now contributed $4300 of the $5000 allowed for my Roth IRA.
Currently, 26% of my net worth is invested in fixed income instruments, and 74% is invested in equity. This is just off of my targets of 25% and 75%, respectively, for these categories.
While the overall percentages for these categories are looking good, a detailed look (table below) at the allocation breakdown reveals that I still have some room for improvement.
Remember: a red flag goes off if your current % allocation in a category is greater than +/- 5% off of the target allocation.
% Cash (money market target 5%) 12%
% non-inflat Bond Funds (target 15%) 15%
% TIPS Bonds (target 5%) 0%
% International Equity (Target 11%) 12%
% International Emerging Markets (Target 11%) 7%
% Domestic Large Cap (Target 8%) 30%
% Domestic Small Cap (Target 9%) 6%
% Domestic Small Cap Value (Target 13%) 6%
% Domestic Large Cap Value (Target 13%) 7%
% REIT (target 10%) 6%
In the past month, I’ve been working very hard to move money to my emerging market mutual fund account. The progress can been seen because I now have 7% of net worth in that category. This is a good thing!
Also, as mentioned before, I currently have a VERY large percentage of my portfolio in Domestic Large Cap stocks. This is due to the fact that I was contributing 100% of my 401k contributions purchase S&P500 index fund shares for 1.5 years. I am now moving towards allocating that money to international and bond funds.
My next move for the March/April time frame will be to do the following:
- $700 contribution to my Roth IRA for the Vanguard Emerging Markets Index Fund
- Since I can no longer invest in my tax-sheltered IRA, I now shift to contributing to my individual Vanguard mutual fund account and online high yield money market accounts. This is only because I have fulfilled all of the higher priority items on the My Money Blog – Account Hierarchy. I’m never going to let you all forget that hierarchy!
- Purchase an inflation adjusted bond mutual fund (TIPS)
- Begin contributing again to the small-cap value and large-cap value funds.
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:
"Play" Money – What Is It and How Much Should I Have?
In the previous post about penny stocks (see link below), I discussed how penny stocks (stocks trading under $2 per share) are a very risky investment instrument, and as such, intelligent investors should not invest their retirement nest-eggs in these low priced stocks.
However, if you do feel inclined to trade penny stocks for learning or the excitement (both are OK), I recommended only investing what I call “play” money in these stocks. I gave a general explanation about what “play” money is, but I didn’t have a chance to get in to the details of 1) what is it, and 2) how much play money should a person have? These two topics will be the subject of today’s post.
1. What is play money?
So first, what is the concept of play money exactly? In T. Harv Eker’s book, “The Secrets of the Millionaire Mind,” he recommended that your paycheck should be split in the following way, because it is the way millionaires do as well. Please note that this is your paycheck that you receive, after pre-tax deductions have been extracted.
If you haven’t read T. Harv’s book, pick up a cheap used copy of it at Amazon. I’ve pasted the link below if you’re interested! It’s worth the read!
- 50% of your paycheck should be kept in your checking account for monthly living expenses (food, childcare, gas, etc)
- The remaining 50 % should be split as follows: (The %’s below are % of your total take-home income)
- 10 % given to charities (My Money Blog – Donating Money)
- 10% spent for you or your family’s education (My Money Blog – Invest in Your Education)
- 10% placed in to a “financial freedom account” – This is also known as your Traditional or Roth IRA. (My Money Blog – Roth IRA vs. Traditional IRA)
- 10% should be placed in a savings account and marked as long term savings for spending. (My Money Blog – High Yield Savings Accounts)
- 10% should be used as Play money.
2. What is the correct amount of play money?
As the bullet point mentioned above, T. Harv recommends setting aside 10% of your total take-home income for play money.
For example, if your gross salary is $5,000 per month and we assume you pay 28% taxes, and contribute 15% of your income to your 401k pre-tax, this would give you a take-home pay of $3060 ($5000 – $750 to 401k = $4250 – 28% taxes = $3060 take home pay).
You would then keep 1/2 in your checking account ($1530), and allocate the remaining 1/2 according to the bullets above.
This would translate in to $306 play money (10% of your take home pay). Sounds like a good, reasonable amount right? Now, naturally, you can adjust this number down as it best suits your situation. I usually end up spending less than this each month and have money left over. If that happens, no sweat! Just transfer it to one of the other allocation categories.
Hope this post was helpful and 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:
Does It Pay To Know Another Language?
An important decision that many people face in life is whether or not to learn another language. However, is it really worth the effort financially, and which language does it pay the most to learn?
These are both questions we’ll investigate during today’s post.
Does Knowing a 2nd Language Earn You More Money?
As it turns out, the answer to this is a resounding “Yes.”
In the article I found at the link below from the Aol.com job section, it states that 67% of business executives (one the highest earning work group classifications) surveyed knew more than one language. Addtionally, a CareerBuilder.com search yield over 6000 job results requesting bilingual applicants. This sounds like a promising market!
Why It Pays to Be Bilingual – Aol.com
In fact, I learned that on average, bilingual pay ranges between 5 and 20 percent per hour more than the position’s base rate, according to Salary.com. This is quite a signficant find.
There are two additional cases that I wanted to make from my personal experience that prove the benefits of being bilingual.
First, if you work in a multi-national corporation (as I do) with offices in almost every country in the world, you are more likely to have increased job flexbibility to move different places if you already know the language. This can result in several things; either avoiding being laid off by downsizing in a certain country or gaining valuable experience at different locations, thus accelerating the promotion process.
In fact, from what I’ve seen so far, people that get promoted the fastest are individuals that have worked at many different locations, and are therefore, able to provide a lot of depth in their perspectives. This definitely benefits the company.
The second case that I wanted to make for being bilingual is that in my experience, you immediately gain much more respect from people you are dealing with if you are able to at least try to speak their language. This will enhance your professional success and personal happiness.
Note: Learning a foreign language is exponentially easier at an early age because the brain is willing to accept new knoweldge without question. So, do yourself and your children a favor, give them a financial head start on life by exposing them to foreign languages early!
What Language Pays the Most to Know?
The short answer to this is that speaking the language that is used by the majority of the market where your particular business is conducted will make you the most money.
What does this mean exactly?
For example, if you are in the service industry in the USA, the two most common languages are English and Spanish. In fact, Latinos are now the nation’s largest minority group, accounting for half of the nation’s population growth since April 2001, according to the U.S. Census Bureau. In this case, knowing Spanish as a 2nd language would benefit you greatly. It is estimated that the buying power of Hispanics in the USA could reach as much as $1 trillion by the end of this year (2010). That is a big potential market to capture!
On the other hand, if you are in the manufacturing industry, it might be better to speak Japanese or Chinese, since so much business is shifting to that region nowadays.
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:
Are Penny Stocks A Good Investment?
Wait…Really? I can buy 200 shares for $20. Wow! Just imagine what would happen if the stock started going up in price a lot. I’d be rich!
Boy, those penny stocks sure are attractive! But, are they worth their salt as investments? Are they too risky? Do penny stock newsletters work? These are all topics we’ll try to tackle during this post.
What is a penny stock exactly?
According to Wikipedia.org (see link below), a penny stock is any stock that trades for under $5 per share in OTC (Over-the-Counter) fashion. OTC is basically a forum in which lower-volume stocks can trade. It is outside of the normal stock markets, such as NYSE, AMEX, or NASDAQ.
What is the historical performance of penny stocks?
After extensively searching for any evidence of studies conducted on the historical returns of penny stocks without success, I then came across the article below from Fool.com (see link). The article states that penny stocks, in their true form, aren’t subject to the disclosure rules that apply to larger companies. Therefore, you really can’t safely use their disclosure filings. They also aren’t followed by analysts or the financial press.
Wow! This explains a lot as to why I couldn’t find any solid historical return information.
What this means to me is that no one really understands them. Since I am not overly smart, why should I even try to understand penny stocks when I have all of the clear evidence of returns with index mutual funds and asset allocation? That’s right conscience. I should not.
Fool.com – Penny Stocks
Are Penny Stocks Too Risky?
Absolutely. As stated above, they aren’t subject to the same filing requirements as companies traded on the regular stock exchanges. This is enough for me to stay away from these OTC stocks.
But, what about stocks traded on the AMEX, NASDAQ, and NYSE for $5 or less?
Good question! Let’s take a look.
Another search for a comparison of average returns for this type of investment instrument also yielded nothing. Due to this lack of data, I would not buy them for myself as long-term, retirement nest-egg investments.
However, as I have mentioned in other posts, I believe that having “play money” to invest to keep you interested in investing and learning finance is a healthy exercise.
How much would qualify as “play money”? Naturally, this amount will change from person to person. For me, it would be no more than $100-$200, and it would be looked at as more of an entertainment/education expense than a money saving exercise.
In the beginning days of my investing career, I was slightly more naive and eager to experiment with different things. One of the things that I did experiment with were the “penny stocks” listed on the regular exchanges, selling for less than $5.
To guide my efforts, I used some birthday money to purchase a subscription to the Penny Stock newsletter at the link below. It was the best, most-unbiased, legitimate, and least hyped-up newsletter I could find. I then began to invest in the stocks recommended.
Even though I was slightly naive back in those days, I still was aware that this would only be play money. And, as such, I never invested more than a couple hundred Dollars in these stocks.
How was my track record with this newsletter? No so good. I ended up losing about a third of my play money. However, it didn’t hurt anything because those funds were marked as entertainment, and I was ready to lose it to begin with! It was also a valuable learning experience because I learned portfolio management, how to buy stocks, etc. The key was that it kept me interested in learning! See my point?
So, the bottom line here is that OTC penny stocks are not good to buy at all. Penny stocks on the AMEX, NYSE, and NASDAQ exchanges are not good investments, but can be fun to use your “play money” with.
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:
Cost of Living Comparison and Calculator
As you may or may not know, I am currently in a 2 year rotational program with the manufacturing division of the company for which I work. Essentially, the program consists of three 8-month rotations in different functional areas of the company, with the idea of giving you a well-rounded view of how things work. It is truly a great thing! And one that I am a big fan of!
After the 2 years of rotating is over, the members of the program will then find full-time, permanent positions within the division. These permanent positions can be anywhere within the company. However, most of the time, it is at one of the New Jersey, Philadelphia, Durham, North Carolina, or Virginia locations.
Given the options available, I thought it might be interesting to look at how the cost of living compared between the different locations. Additionally, it gives me the opportunity to share a very useful tool with everyone: cost of living financial calculators.
The cost of living calculator that I enjoy using can be accessed using the link below from BankRate.com
BankRate.com Cost of Living Calculator
Plugging in my current income and the possible work locations, I found the following results:
• You would need a 23.52% increase in salary to maintain the same standard of living moving from Virginia to Philadelphia.
• New Jersey and Philadelphia have approximately the same cost of living.
• You would need a 22.21% increase in salary to maintain the same standard of living if you moved from the Durham, NC area to the Philadelphia/New Jersey area.
• You would only need a 1.07% increase in salary if you moved from Virginia to the Durham, NC area.
This is very interesting information, and it is definitely something to keep in mind when you have options of where you can work. Naturally, there may be jobs that are only available in certain locations, so it won’t apply all of the time.
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:
Retirement and Time Value of Money Financial Calculators
In previous posts (see link below), I have talked about several types of financial calculators available on the Internet to calculate asset allocation and emergency fund goals. However, what I realized I had not yet addressed was a tool that I use almost daily with this website: Retirement / Time Value of Money Calculators!
My Money Blog – Financial Calculators
The Time Value of Money
First, what is the concept of The Time Value of Money? Basically, it is the idea that by saving a Dollar today and investing it for the long-term with compound interest, the money will grow exponentially over time.
The basic equation for the Time Value of Money is shown in the graphic below. Essentially, it is computed by multiplying the present value (PV) x (1+ interest rate)^(number of years).
Exponential growth of money sounds very good right? Let’s now see how it can be applied to your retirement calculations.
Essentially, there are two methods to do the calculations regarding your retirement nest-egg (both employ exponential growth): using Excel Spreadsheets and using pre-built retirement calculators.
Personally, I favor using Excel Spreadsheets because they are quick and highly customizable to my particular analytical needs. However, let’s look at each tool one by one.
Pre-Built Retirement Calculators
Pre-made calculators essentially do all of the things that a spreadsheet can do, except that the calculations take place automatically at the click of a button.
My favorite pre-built retirement calculator can be accessed using the link below. The reason I favor this one is because it allows you to enter information about your specific situation both before and after retirement.
Pre-Built MSN Money Calculator
However, one thing that I do not like about these calculators is that many do not take in to consideration the decrease in buying power of money over time (aka inflation).
Calculations Using Excel Spreadsheets
Once you master the art of making Time Value of Money spreadsheets, the sky is basically the limit with how detailed you can make it. However, for the sake of keeping things simple, I wanted to only discuss two basic applications of Excel spreadsheets that I use all of the time: compounding interest and discounted monetary quantities over time due to inflation effects (these are also known as calculating future value and present value for you finance geeks out there).
To demonstrate these two applications, let’s build a spreadsheet to calculate the amount of money you will have at retirement. An example of the finished spreadsheet can be found at the following link:
TVM and Retirement Calculator Spreadsheet – Google Docs
After checking out the example, just follow the steps below to create your own:
1) Open Excel
2) Create 5 columns (Columns A-E). In Row 1 of each column, type in the labels “Age,” “Current Amount,” “Annual Amount Contributed,” “Salary,” and “Percent Salary Contributed Each Year” from left to right for Columns A-E.
3) In the age column (Column A), type in your current age in cell A2. Using the addition function (=A2 Cell + 1), copy the code until you have ages listed from your current age until the retirement age of 65.
4) In the Current Amount column, Column B, type in the Dollar amount that you currently have saved for retirement in cell B2.
5) In the Salary Column (Column D), type in your current salary in cell D2. Next, you will type in the formula to let you grow your salary, assuming an annual raise of 5%. To do this, type “=D2 Cell*1.05” in cell D3. Next, copy this code down the entire column until your retirement age.
6) In Column E, type in the % of your salary you currently and/or plan on contributing to retirement for all of the years until age 65.
7) Complete Column C by copying the following formula down the entire row: “=D2 Cell * E2 Cell.” This will give you the amount that you plan to contribute each year, based on the % specified in Step 6.
8) Now for the most important step!
In cell B3, you will type in the Compound Interest formula. This sounds scary, but it really is very easy. So, in cell B3, type in the following, “=B2 Cell*(1+ rate of return) + C2 Cell.” You can choose the rate of return that best suits your investment portfolio. The average return of the stock market that I use is either 12.4% (aggressive) or 9% (moderate). Next, copy this formula down the entire column until you fill out the table. In words, what this formula is doing is growing your previous year’s balance by the interest rate and then adding the new money you contributed during the year.
9) You can then view what balance you will potentially have at retirement in the last cell in Column B. You have just completed the compounding interest/calculating future value portion of the exercise! Congrats!
10) Now, in order to get a more realistic picture of the buying power we will have at retirement, the amount at age 65 in Column B needs to be discounted by the rate of inflation, which can be assumed to be 3.2%
To do this, type in the following formula below the last calculation in Column B: “Column B Cell @ Age 65 / (1.032)^(65-Your Current Age).” When you do this, the amount should go down signficantly. That will then give you an idea in today’s Dollars how much you will have!
So, congratulations! You have just learned a very powerful financial tool that you can use to calculate anything that involves the Time Value of Money (house values, costs of living, opportunity costs, etc). The opportunities are endless!
I know this topic is a little dense, so please let me know if you have 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:
How Much Does A Kid Cost and Can I Afford One?
This post comes as a result of a recent request from a co-worker of mine, and being the finance nerd I am, I couldn’t resist investigating it!
The question is, “How much does a kid cost to raise and how do you determine if you can afford one?”
Ok, so turns out, it really is two questions. Let’s tackle each one individually:
How Much Does Raising a Child Cost?
After studying several estimations of the cost of a child from different resources, I found that the cost of raising a child from age 0 to age 22 can range anywhere from $250,000 to $500,000.
Since this was such a wide range, I then began looking for a tool that would allow me to calculate the cost of raising a child, given an individual’s specific conditions/goals. The best thing I found was the financial calculator at the link below.
Cost of Raising a Child Calculator
By assuming that a child is born this year (2010) in the northeastern USA to a two parent home with a annual income of >$64,000 and plans to go to a public college, the tool calculates a total cost to raise the child of $348,418.
Out of curiousity, let’s just see what happens when we leave all of the variables the same, except that we’ll change the location from the northeast to the southern USA. The resulting cost then comes out to be $340,552.
Note: the topic of cost of living differences between locations will be the topic of another post. However, to wet everyone’s appetite for now, let’s look in to this specific case a little further.
At first glance, the financial difference between where you decide to raise your child doesn’t appear to be that great. However, in the interest of fun and looking out over the long-term, let’s apply the miracle of the Time Value of Money to the equation. Completing the subtraction, the difference comes out to be $7,866.
Now, let’s assume assume that a couple has a child at age 26 in the South, raises the child for 22 years, at which time they are 48 years old. They then place the $7,866 that they saved by living in the South in to their IRA, and invest it at 12.4% return until retirement at age 65. By applying the equation of compound interest, this one lump sum of approximately 8K grows to $57,382.73 by retirement. Quite a big sum! This is just food for thought for deciding on your relocation options for having a child.
Can I Afford A Child with My/Our Current Income?
According to the MSN article below, it appears that the total yearly cost of raising a child only fluctuates by around $1000 from year to year. So, for the sake of analysis, we are just going to assume that the total cost of $348,418 (using total child cost for the Northeast) is distributed equally to each of the 22 years to raise the child.
Yearly Cost Breakdown of Raising a Child – MsnMoney.com
Performing the division, this results in an annual cost of $15,837, or $1,320 per month, or $329 per week.
Now that this has been broken down in to terms that humans can grasp, the reality begins to sink in. Do you have an extra $1,320 per month?
So, as you begin to think about this possibility given your personal financial situation, I will do the same thinking out loud below.
Currently, the income that my bank account sees each month after my fixed housing expenses are taken out is $1700. Normally, I spend approximately $700-$1000 per month on living expenses (food, entertainment, transportation, etc). This only leaves $700 for a child. Big surprise right? In my situation, I would have to do some serious rearranging of my financials to be able to support a child.
So, I’ll leave you with the question…Can you afford a child?…..
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:
Buying a New Car vs. a Used Car
Two well known car buying tips are that 1) they are indeed not investments, but expenditures and 2) their value depreciates greatly the minute they are driven off of the lot.
But, the question remains, if you can afford either a new or used car, which should you buy?
To help us figure out this questions, let run through a couple quick examples cases – Bob and Larry (both 30 years old).
According to the article below, in the first year of ownership, a new car can lose up to 20 percent of its value, and by the fifth year, your car will depreciated by over 65 percent. On average, the life expectancy of a new car is 7 or 8 years.
Depreciation of a Car, Years 1-5
Bob’s Situation
Bob only buys new cars. So, let’s assume that he buys a $20,000 fully stocked Honda Accord every 7 years, as the website states.
Larry’s Situation
Larry only buys used cars. In fact, he is so particular, that he only buys 1 year old fully stocked Honda Accords. Applying the 20% depreciation rate during this first year and assuming for simplicity that his Honda Accords were originally worth the same $20,000 price that Bob’s are, Larry will buy a $16,000 Accord every 6 years (still assuming the 7 year life of the car).
Let’s now assume that this pattern continues until the guys retire at age 66. At the end of this period, Bob has bought 6 new Accords, and Larry has bought 7 used Accords. Suming up the totals for each person, it can be seen that Bob has spent 120K on new cars, and Larry has spent 112K on used Hondas.
This is a difference of $8,000, or an average of $222 per year that Larry saves. This amount is not overly impressive, especially when you take in to account that Larry will have slightly increased maintenance costs with the car being used.
However, if we look back in our example, we are assuming that Larry actually can afford a new or used car, but just opts to purchase used. So, let’s assume that each year he buys a car, he takes the $4000 that he saves by buying a used car, and invests it in his retirement account at an interest rate of 12.4% until retirement at age 66.
What does the total come out to now? The result is much more impressive. Larry will have $471,588.79 in his account due to the miracle of the Time Value of Money!
What’s the morale of this story? Well, if you can find a good used car, and don’t mind the extra headaches of getting it repaired a little more often, your pocketbook will sure benefit!
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:
Innovative Ways to Obtain Cash for a House Downpayment
“I want to buy a house, but I just don’t have the cash for the downpayment.”
This phrase is a familiar tune that people hear around the world. However, there are some innovative ways to get access to cash you probably didn’t know you had that I wanted to share with you today!
Glossary – The IRS’s definition of a first time home-buyer/purchase is that you, or your spouse, has not owned a principal residence in the past two years. You don’t actually have to be buying your first house. Awesome!
For first time home-purchases, the IRS allows you to tap in to two retirement resources of yours at an early age, without penalty: Your IRA(s) and 401k retirement accounts.
So, let’s look at the all-important details that you will need to know to access these funds to buy your first house.
Cash from your 401k Retirement Fund
As stated previously, the government allows people to withdraw money from their 401k account to buy a first-time residence. This cash will be given in the form of a loan to yourself. Generally, the loan must be paid back over five years, although this can be extended for a home purchase. You are usually allowed to borrow up to 50% of your vested account balance to a maximum of $50,000.
Additionally, loan payments can be deducted from payroll checks (another added benefit). While interest rates vary by plan, the rate most often used is what is termed the “prime rate” plus one percent. The current prime rate is 3.25%, meaning that an estimate for the current interest rate you would pay on the 401k loan is 4.25%. Again, you have to remember that this is a loan to yourself, and therefore, the interest you pay is to yourself as well!
Another great thing is that money obtained from 401k loans are not subject to income tax or the 10% early withdrawal penalty, unless you stop your employment with your 401k employer.
See the link below for a great list of pros and cons to mull through before taking out a 401k loan.
Get a Loan from Your 401k
Cash from Your IRA (Individual Retirement Account)
According to Bankrate.com (Using IRA’s for Home Buying), both Roth IRAs and Traditional IRAs can be used for homepurchase expenses. However, they are treated a little differently. So, let’s address the stipulations for each individually.
Roth IRA-
With Roth IRAs, the IRS rules dictate that you can withdraw up to $10,000 from your account for first time home-purchases, provided that you have had the Roth IRA account open for a minimum of 5 years.
Hint – this is another benefit that can be created by getting your children to invest early!
If you meet these qualifications, the $10,000 will be tax and penalty free.
Traditional IRA
For Traditional IRA’s, each individual can withdraw up to $10,000 towards the purchase of that “first-home” tax and penalty free. However, the IRS’s rules are even more lenient for Traditional IRAs. The IRS says the “first-time homebuyer” using your IRA funds for a down payment can be you, your spouse, one of your children, a grandchild, or a parent.
Just be careful about the timing of withdrawing the funds. If the funds are not used for an eligible home expense within 120 days, taxes and penalties will apply.
What are eligible expenses?
Turns out, you can use the funds from your IRA for more than the downpayment; you can also use them for closing costs, financing costs, settlement costs, and construction costs.
So, all in all, it turns out that Uncle Sam does want us to own our own houses after all!
Keep on learning!
Jacob
To receive updates on topics such as this one immediately as they are published, subscribe to my blog by clicking the link below:
Online Money Market Savings Account Applications
In a previous post (see link below), I detailed the reasons why I use online money market savings accounts for my cash saving needs. However, what I didn’t discuss in that post was applications the online money market savings account should be used for.
My Money Blog – Choosing a Bank – Part 2 – Savings Options
I use an online money market savings account for the following three purposes:
1) Accumulating cash for the 5% cash portion of my target asset allocation (this was described in a previous post – My Money Blog – Index Funds and Current Asset Allocation)
2) Saving for long term spending
3) An emergency cash fund – “saving for a rainy day” (most important)
Note: In my opinion, even though all three of these accounts are with the same bank (Dollarsavingsdirect.com in my case); I believe it works best to have three separate accounts, one for each use above. It is a lot easier to keep an eye on what is going on this way!
Since No. 1 above was already explained in the Asset Allocation post on My Money Blog, let’s investigate the other two uses.
Saving for Long Term Spending
This is the account that is designated as cash needed for future large purchases. Examples could possibly include house down-payments, cars, boats, a wedding ring, vacation, etc.
The key here is to make sure that the money you dedicate to certain future purchases remains dedicated to those items. For example, you wouldn’t want to save for a house down payment for 10 years, and then spend it all on an expensive trip to Paris one summer. See what I mean?
Emergency Cash Fund
This is, hands down, without a doubt, the single most important use of the online money market account. It is also one of the reasons why I wanted my account to be FDIC insured. As my previous post mentions (My Money Blog – Account Hierarchy Order), having an emergency cash fund is the 2nd highest priority on your financial hierarchy list.
Why do you need an emergency fund?
The purpose of this account is to have enough a safety cushion to cover your monthly living expenses in the event that you lose your job or cannot work due to an injury for an extended period.
How much do you need to put in it?
The most widely excepted answer for how much you need in the account is 6-9 months of living expenses. However, there are possible exceptions to this rule. For example, if you are in graduate school and still receiving monetary support from your parents, you could probably get away with less than the 6 month minimum.
However, no one should under any circumstance have an emergency fund with less than 3 months of expenses in it.
Calculating how much you need for the emergency fund is a fairly simple exercise, provided that you are comfortable tabulating your monthly expenses. They are some really handy dandy calculators out there on the internet for this very purpose. One of my favorite ones can be found at the link below:
Calculate Your Emergency Fund Quantity
Once you have calculated how much money you will need, you can use the calculator at the link below to figure out how long it will take you to save/reach your emergency fund total goal:
Bloomberd Calculator – How Long to Reach Emergency Fund Savings Goal
There you go! You are on your way to wisely saving cash! That wasn’t so painful was it? Let me know if you all have any questions.
Keep on learning!
Jacob
To receive updates on topics such as this one immediately as they are published, please click the link below to subscribe to My Money Blog.