Category Archives for Invest & Retire
Build Your Credit Score From Nothing – Part 3
Once you have settled on an arrangement that will work for both sides, you can then delve in to figuring out the specifics of the loan (i.e. interest rate you will be charged).
5) After finding out the details of what the $1000 personal loan would entail, tell the loan officer that you want to shop around a little before making your final decision. He/she will completely understand (or should anyway). Then, go to the 1-2 other recommended local banks on your list and do a loan comparison in order to make sure you’re receiving the most favorable terms.
Keep on eye out for Part 4 of this series, coming soon!
My Individual Stocks Gain or Loss Results Reported for 2009 Taxes
So, let’s look at my gains (or losses) for the past two years tax calculations resulting from the individual stocks that I sold vs. the performance of the S&P 500 index:
Year 2008 — $300 loss, S&P500 return = 40% loss
Year 2009 — $592 loss, S&P500 return = 26% gain
So, in 2008, I did all right as compared to the market, but in 2009, the proceeds from the stocks sold in my accounts generated far inferior results.
Just a little background on why I have stock holdings at all:
I have stock holdings remaining still my my first couple years of investing where I dabbled around with different techniques, penny stocks, investing newsletter, etc. Now that I have seen the light and the error in my ways, I no longer actively buy individual stocks, unless it is such a small amount that it is truly just to “play around with.”
What’s the morale of the story here?
For me, it just indicates further the following things:
1) Stick to long-term investing in index mutual funds, preferably in tax-sheltered accounts.
2) I do not trust myself enough with my own money to invest in individual stocks, especially over the long term.
Keep on learning!
Jacob
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Handy Tool to Assist in Performing Phil Town Rule #1 Calculations
If anyone has given Phil Town’s system of investing (from his book, Rule #1, a Simple Investing Strategy in 15 minutes per week) a signficant attempt, you have no doubt found out that running the numbers to calculate the Big 5 Numbers can be a time-consuming, cumbersome task that leaves you thinking, “There has got to be a better way!”
Well, I found out the other day that indeed THERE IS! It’s called the Stock2Own website, and it is free to use (see link below).
Once you enter the site, you can enter the ticker symbol of any stock that you identify for further investigation. From there, the website then automatically generates agressive, conservative, and middle-of-the-road calculations of the Big 5 Numbers. Additionally, the 3 technical indicator charts discussed in Phil’s book (MACD, Stochastic, and Moving Average) are automatically generated for you to view.
Quite a slick system!
Keep on learning!
Jacob
Ways for Parents to Give Their Kids a Financial Head-Start to Life
I want to preface this section by saying that I do not have any kids of my own and have not tried these techniques out. They are merely good advice that I have read in books over the years.
Ways to Give Your Kids a Financial Head Start in Life
In my opinion, the best way to give your kids a financial head start in life is merely to get them exposed to the general idea of finance at an early age, instead of having it be a taboo topic at home. Therefore, any effort is by nature good, but listed below are a few specific methods that I thought would be useful to share.
1. Buy your child 1 share of a stock they would be interested in. The key here is that the stock has to be something they will be interested in following. For example, if your child really enjoys Disney/Pixar movies, buy them a share of Disney stock (DIS ticker symbol). If he or she likes board games, Barbie dolls, Fischer, or Hot Wheels, buy them a share of Mattel (MAT ticker symbol). Use that share of stock to teach them all that you can about the stock market and investing!
2. Give your child (if they are old enough) a task to do to help with doing your taxes – Be sure that the only thing they know about tax time is that YOU DON’T LIKE TO DO THEM AND THAT THE IRS IS TRYING TO TAKE YOUR MONEY. This promotes negative associations for your child around money and something as certain as doing taxes.
3. Keep finance/money an open topic around the house. So many times, the only things that children hear fro you about money is the negative things such as not being able to afford soething, etc. Keep the lines of communication open.
4. Open up college savings fund. Everyone hopes that their child will get a full scholarship to go to college, but the odds are not enough in your favor to take that chance. By opening a college savings fund through an institution like Vanguard, you can tax advantage of tax deferred growth within the account, while still having the luxury to direct the investments the way you want. Remember, you will want to match the maturity of the investment instrument with the time horizon associated with whenever you child will be going to college in order to maximize returns. The link below takes you to the section of the Vanguard site where you can obtain information about 529 education savings accounts. Open one!
https://personal.vanguard.com/us/whatweoffer/college/overview?Link=redlabel
Important Tip To Remember:
When calculating a student’s need for financial aid for higher education, it benefits the student to have as little money to his/her name as possible.
In this case, it means that it is best to place the college savings fund account in you, the parents, name instead of your child’s. This is due to the fact that parent’s are assumed to use 5-6% of their assets to pay for a child’s college education, while the student is expected to use 35% of their assets.
5. Open a Roth IRA for them whenever they first obtain earned income – See my previous posts on reasons to start investing at an early age to see the logic behind this technique. There is no minimum age limit (see article at link below) to when you can open a Tradition IRA, as long as your child has earned income. If you own your own business, even better! You can give your child earnings for jobs he or she performs for your business.
http://www.kiplinger.com/basics/archives/2002/03/story28.html
Useful tip from David Bach’s Smart Couples Finish Rich 
book:
Tell your child that if he or she opens up a Roth IRA and contributes to it, you will match them Dollar for Dollar. This will provide an even greater incentive for them to invest.
6. Show your child the power of compound interest, using the table below. Be sure to point out how little money it takes to accumulate $1MM if you start at an early age.
7. Give your child the gift of want – Encourage your child that if he or she wants to buy something, it is necessary for them to earn the money themselves. This can be done either buy starting your own business venture or getting a job.
This topic is discussed in more detail on a recent post at the following link – My Money Blog – Is it Good to Give Your Child An Allowance?
Keep the ideas coming and good luck!
Jacob
My Current Asset Allocation and Net Worth Growth – February 2010
Twice a month, I update a spreadsheet of all my accounts that calculates 1) my net worth and 2) my current asset allocation. I figured that it might be interesting to post it on my blog once per month
In my previous blog at the link shown below, I explained the details of the mutual funds I invest in and how I figure what my allocation targets are.
http://mypersonalfinancejourney.blogspot.com/2010/01/index-mutual-funds-and-current-assett.html
On February 3rd, 2010, my asset allocation picture was as shown below.
As you can see, I have some serious work to do to get to my allocation targets. Remember, the general rule of thumb is to rebalance your allocation if it exceeds +/- 5% of the target you select.
The areas that I need to drastically improve are highlighted in red below. The reason that I am so over-allocated in domestic large cap equity is that for the past year and a half, I have been contributing 100% of the money in my 401k to buying an S&P500 index fund. I have recently been trying to exchange money out of that and in to bond and international funds (as you can see, the international equity and non-inflation bond funds %’s are more or less on target).
However, my current goal is to get more funds shifted towards investing in Emerging Market funds. Keep on learning!
Mint.com – Budgeting / Personal Finance Tool Website – FREE!!!
This website is a great find that the newsletter that comes from my apartment complex directed me to!
First off, what is the best thing about this website? It is a FREE tool to use. Completely Free. Yes, Free.
Essentially, what you do is go to the website, and it allows you to link your credit cards, savings accounts, checking accounts, car loans, bank loans, house payments, etc all to your Mint.com account. These are secure connections that are read only, so Mint.com does not steal your information.
Once your information is entered, you can then track your spending (see categories that you spend the most in, and what percentage this occurs in), see your investment performance compared to the market averages and what your asset allocation levels are. Overall, a very useful tool! Give it a try.
How about you all? What’s the best personal finance software out there that you’ve found?
I have student loans and credit card debt, which one do I pay off first?
The answer to this question is easy: PAY OFF THE CREDIT CARD, or highest interest loan first. In fact, after paying to ensure you have health insurance to protect yourself, eliminating your credit card debt is the next highest priority on where your money should be going. Not only that, it is the easiest way to get a guaranteed return of close to 20%! No mutual fund in the world can match that guarantee!
Another great thing about student loans is that very often the interest rate is very low or even 0% for several years after college…All the more reason to make sure to pay off your credit card debt first and foremost!
Keep saving and learning!
Account Hierarchy Priority Order
“As new funds come in to my bank account, in what order should I prioritize them to my different monetary needs?”
This is a question I get asked fairly frequently, and indeed, it makes sense to pose the question because it is not totally straight-forward and involves much complexity.
However, the following two priority orders are what I have learned in reading several financial related books and from studying finance in college. In my experience, I’ve found that two orders are needed – one for people that are either debt-free or mostly debt-free and another separate one for people are heavily in debt.
Debt-Free Account Hierarchy
Hierarchy of what order to contribute money to which accounts if you do not have significant amounts of consumer debt (can be paid off within 2-5 years – does not include mortgage debt).
1. Buy or make sure you have adequate health insurance coverage.
This is absolutely the most important and highest ranking thing on the list due to the fact that you will have no income if you get hurt and can’t work. Additionally, medical procedures can cost hundred’s of thousands of Dollars these days. Can you afford that with the cash out of your savings account? I sure can’t.
Most of the time, this coverage will be provided through your employers plan to defray some of the cost. Independent plans are available at a higher monthly premium cost, but is still worth having in the long run.
2. Invest enough cash in a high yield taxable money market savings account to cover 6-9 months of living expenses
The purpose of this account is to have enough a safety cushion to cover your expenses in the event that you lose your job or cannot work due to an injury for an extended period. While it is possible to obtain a personal loan to obtain some extra liquidity, it is best to make sure that you have some reserves of your own.
You can open up a high yield savings account online at Dollarsavingsdirect that I discuss in this previous post with the link below. Whatever account you choose in the end will need to be taxable so you have easy access to it, and can withdraw money at any time without penalty.
Favorite High-Yield Online Savings Accounts
3. Pay off/get rid of your high-interest credit card debt
After you have ensured that you will not be in “financial ruin” if you lose your job or get injured and have to pay for medical expenses, the next highest priority of where to put your money will be to pay off your high interest credit card debt. In essence, this is the best idea to do because you will get a guaranteed 18% return by getting rid of your debt. No one else can promise you that high of a return/money savings!
4. Pay your monthly mortgage payment (only the minimum amount required)
After you have secured health insurance, a sufficient emergency fund, and paid off the majority of high interest credit card debt, you can then think about buying a house/condo/townhouse. If you have not done steps 1-3, I would not recommend buying property.
Since you receive significant tax savings from the interest your pay on your home loan and the property tax paid on your property, you should pay off your required monthly or biweekly mortgage payments. However, you should not pay off any additional principal loan balance at this time, as there are no tax benefits to doing so.
5. Invest in your employer’s 401k only up to the company match level
In general, the investment selections for mutual funds in company 401k programs are not the best. Usually, the management fee levels and management style are not as good as with the indexed mutual funds that Vanguard offers.
For this reason, it is best I believe to invest only enough initially in your 401k to the level which your employer matches. For example, my company matches 75 cents per dollar for what I contribute up to 6% of my annual income. So, I make sure to invest a base level of 6% in my 401k so I can get this free money!
6. Max our your IRA (individual retirement account – either Roth IRA or Traditional IRA)
The next place to contribute your money to is to max out your individual retirement account (I use Vanguard for my Roth IRA). The current contribution amounts for 2009 and 2010 are $5000 per year, and you can still contribute to your 2009 levels until March 31 of 2010. The only thing you have to make sure of is that you can only contribute money in your IRA up to the level of income you make in a year, with $5000 being the maximum. For example, when I was 18 years old and wanted to contribute to my IRA, I could only contribute $2500 because that was the level of income I had that year.
Once the money is parked in your self-directed IRA, you can invest as you want to (see link below for index mutual fund recommendations that I invest in)
My Current Investment Selections and Asset Allocation
7. Finish fully funding your company 401k account
This is the next highest priority account to place your money after maxing out your IRA because you will be able to take advantage of tax-free growth/protection until retirement when you withdraw funds.
With most employers, there is a limit of how much you can contribute to your your 401k. Usually, this level is 25% of your base salary, up to $15-16K per year.
8. Prepay additional amounts to reduce the principal on your home mortage loan
Assuming that you did your homework and obtained a loan that doesn’t involve penalties for pre-paying a home loan (paying off more of the loan than is required by the mortgage amortization schedule), you should now focus committing funds to paying off additional principal of the loan. This will benefit you greatly, as it will reduce the amount of interest you pay going forward.
9. Open up an individual, taxable mutual fund account with Vanguard.com to invest any remaining money
This one is pretty much self-explanatory! Once you have pretty much exhausted all of your tax-sheltered account options and still have money to invest, open up an individual account and invest in tax-efficient mutual funds.
Since this account is not tax-sheltered, be careful about the tax-liability of short-term selling of shares. In the book, Random Walk Down Wall Street by Burton Malkiel, he has a good section summarizing what type of index mutual funds to invest in with taxable accounts.
He suggests using something called Tax-Managed Funds. Essentially, what these funds are are index funds that minimize taxes by deferring capital gains realization. However, the main pitfall I ran in to with these funds is that they require $10,000 of principal to buy into, an amount of money that I do not keep handy. Instead, I do the next best thing which is to invest in large cap domestic index funds in my taxable accounts, since these generally experience less buying/selling than small cap funds.
10. Open up a tax deferred higher education savings account for your children and fund it
As I mentioned in my post at the link below, the government has set up a special type of account that can give you tax deferred growth that you can use to save money for your child’s college education. Take advantage of this with whatever money you have leftover!
However, be sure to place the account in your name (but in support of your child) so that they still qualify for financial aid.
My Money Blog – Give Your Children a Financial Head Start in Life
So, I’ve found that the priority order listed above works great for people with low amounts of debt. However, if you have LARGE amounts of car, student, and credit card debt that you will have to pay off for MANY years to come, this order won’t work.
For complete details about exactly why it won’t work, visit the following post – Account Hierarchy Paradox – Should Paying Off Debt, Saving for Retirement, Having an Emergency Fund, or Securing Health Insurance Be Your Highest Priority?. Because of this, I’ve recently created a second account hierarchy for people with large amounts of debt (see below).
Debt-Payoff-And-Retire Account Hierarchy
Hierarchy of what order to contribute money to which accounts if you DO have significant amounts of consumer debt (that CANNOT be paid off within 2-5 years – does not include mortgage debt).
Note: Before we get started with this list, for the sake of simplicity, I’m going to make the assumption that it is known that prior to embarking on prioritizing funds according to the list below, that you have already met your very basic requirements for survival each month.
These include paying the rent or minimum required mortgage payment, water/electricity/sewer/gas/trash bills (other bills also), and buying food from the grocery store for your family. However, these basic survival needs do not include cable TV, internet, going out to eat every night of the week, or other frivolous spending. With this in mind, let’s get on with the list!
Part A – The Minimum Requirements
1. Pay only the minimum required payment on your credit card and other loans (student, car, etc). DO NOT PAY MORE (yet)!
In the Debt Free Account Hierarchy, you probably noticed that debt payments weren’t addressed until Priority #3. However, if money is very tight and you have large amounts of debt to payoff, the reality of the situation is that you cannot skip out on paying back the minimum required balance on your debts. Well, I suppose you could, but no up-standing citizen wants to have debt collectors calling them up, right?!
Because of this, paying only the minimum required balance on your debt accounts is first on the list. Prioritizing the minimum loan payments ahead of health insurance (see below) was one of the paradoxes I ran in to with this exercise. I wanted to place it first, but ultimately decided against it in the end.
In addition, I would advise you to negotiate a lower APR rate with your credit card company and also discuss your “low-money” situation with your student loan provider (student loans like to see ex-students succeed and may be lenient in pushing back the terms of loan repayment).
2. Buy or make sure you have adequate health insurance coverage.
The next highest priority on the hierarchy is getting adequate health insurance. I cannot stress enough how important health insurance is. If you get in a car wreck or get injured otherwise, medical bills can rack up to be in the $100,000 range or higher, something that could result in financial ruin for the rest of your life. Because of this, you simply cannot afford to go without health insurance.
The trouble? Health insurance is VERY expensive if it is not provided through your employer, especially if you have multiple part time jobs as a lot of people do these days. Typically, if you have to pay for your own health insurance, you should expect to pay between $150-$400 per month. When you are shopping for health insurance, make sure that you find a policy that features a low enough deductible that you can actually pay it with your emergency fund money (see below for details). I personally like to see my deductible be between $500-$750.
Also, remember – with the new health care regulations, you can still be covered under your parents’ health insurance until you are age 26. This may be a viable option for some of the younger people out there.
3. Invest enough cash in a high-yield taxable money market savings account to cover 6-9 months of living expenses (Emergency Fund)
After first paying the minimum payments on your loans so that you don’t have debt collectors knocking down your door and securing health insurance, it is now time to focus as much money you have remaining on accumulating a secure, liquid, readily-available source of cash that you can tap in to in the event of an emergency. Often, this fund is used to pay the deductible on your health insurance (or other forms of insurance) mentioned above. It is very important to state also that the purpose of this account is NOT TO MAKE TONS OF MONEY. It is to provide you with peace of mind and security.
In today’s low-interest landscape, it’s important to be very selective in choosing where to park your emergency fund. I prefer to use a high-yield online savings money market account. These accounts offer much higher interest rates/returns than savings accounts at brick-and-mortar banks and are still FDIC insured! A no-lose situation if you ask me!
So, this all sounds well-and-good. However, you might be asking yourself the following question at this point. – “But Jacob, funds are really tight for me right now. If I’m doing this math correctly, at the current $1000 monthly expenses level at which I am operating, this would sum to $6000-$9000 total. I currently have $0 saved up. This might take me 9 years to accumulate! How do I proceed?”
This is actually a great question! It’s quite tempting to recommend that people only really need a minimum level of an emergency fund (maybe only $500), and after they accumulate this amount, they can move on to higher-earning investments and credit card debt payoff. This is even more tempting given the plethora of options available to people for personal loans in the event of an emergency. For example, you can compare loans online and very quickly narrow down your choices to a loan with suitable terms.
However, at the end of the day (and although there might be some disagreement on this), I believe that the peace of mind and safety that comes from having a sufficient emergency funds outweighs the benefits of being “debt free.” So, my answer to this would be that if it does take you 9 years to accumulate an emergency fund, then so be it. Your debt balances may accumulate significantly, but at least you won’t experience financial ruin if an emergency occurs and you cannot work.
Part B: Beyond the Minimum Requirements
Having fulfilled the absolutely essential requirements listed in Priorities 1-3 above, you can now shift your focus to actually becoming debt free and saving for retirement.
Enter our next paradox: traditional financial wisdom states that if you had to choose between investing in mutual funds for retirement (which at best can earn you 10-11%) and paying off credit card debt balances which carry a 20% or higher interest rate, the clear choice would be to pay off the credit card interest rate first because it represents an AUTOMATIC and GUARANTEED savings.
Indeed, this is the wisdom that applies for myself and many others who are lucky enough to be consumer debt-free. However, if you have large amounts of consumer debt that you cannot possibly pay off in less than 5 years, the choice becomes much harder. On one hand, we need to pay off our credit card debts to capture the automatic savings on the extraordinarily higher interest. However, if you are 24 years old and will be paying off your huge debt balances for 20 years to come, you cannot put off saving for retirement until that time. That would be both very unfulfilling and unwise due to the power of compound interest over long periods of time.
Because of these facts, in the Debt-Payoff-and-Retire Account Hierarchy, I recommend the following hybrid approach:
4. With the money leftover from Priorities 1-3 above, split the balance in to two (2) sub-accounts – one forpaying off debt and one for saving for retirement.
4.1 Use the debt-payoff sub-account to pay off your various debt accounts beyond the minimum balance
In this exercise, funds should be prioritized to pay off your highest interest debt balances (probably credit cards) first and then moving down the chain from there.
4.2 Using the funds in your “saving for retirement” sub-account, invest in your employer’s 401k only up to the company match level
Matching employer contributions represent free money, and we should all take advantage of this! After that, continue working your way through the priorities listed below. This order pretty much remains the same from the original Account Hierarchy.
4.3 Max our your IRA (individual retirement account – either Roth IRA or Traditional IRA).
4.4 Finish fully funding your company 401k account.
4.5 Prepay additional amounts to reduce the principal on your home mortage loan (if you have one).
4.6 Open up an individual, taxable mutual fund account with Vanguard.com to invest any remaining money.
4.7 Open up a tax deferred higher education savings account for your children and fund it.
Which asset allocation calculator on the web is best?
After searching around and trying out the different asset allocation calculators on the internet, I’ve determined that most of them are severely lacking. They either a) do not gather enough information / inputs to result in a well defined choice, or b) produce results that are too broadly defined to know exactly how to invest your money. For example, it will suggest putting 50% of your money, for example, in to equity mutual funds. However, it doesn’t mention how to divide that up between the different subcategories available in that asset class (small cap, large cap, international, emerging markets, etc).
The best calculator that I could find was the one from CNN listed at the link below. I like this one because it does break up the recommendations in to large cap, small cap, foreign stocks, and bonds.
CNN’s Calculator
http://cgi.money.cnn.com/tools/assetallocwizard/assetallocwizard.html
However, the best tips I have found on asset allocation have been from the finance books I have read. These are shared in the post on my blog at the link below.
http://mypersonalfinancejourney.blogspot.com/2010/01/index-mutual-funds-and-current-assett.html
Keep on learning!
Jacob