Sunday, September 28, 2008

How I turned 20 minutes in $334

My wife received a telemarketing call from a company offering to provide our phone and internet service at a significantly lower rate than we were getting from our current company.  The offer sounded very compelling, but I didn't want to go through the hassle of switching companies.  So I called up my current company, explained to them that I was happy with their service and wanted to continue to work with them.  I also told them about the deal offered to me by the other firm.

The representative on the other line put me on hold for a few minutes while she looked over our billing history and was able to make some changes to our account that brought our monthly bill down.  She then offered me three months of free service and a $100 credit.  All of these savings put together will amount to $334 over the next year.

Not bad for twenty minutes work.  I am often surprised at just how much cable, internet, phone, and credit card companies will do for you if you call them to ask for a better rate or to waive certain charges.  The best part is, making the phone call costs only little bit of time.

Saturday, September 27, 2008

The danger of inappropriate risk - part 2

I explained in the last post why taking on too little investment risk can endanger your retirement.  However, too much risk can also put your financial goals in jeopardy.

Because any stock investment can drop in value by 25% or more in any given year, you need to take on this risk carefully.  If your savings goals are many years from now, it makes sense to harness the power of the stock market's relatively high returns, even with the risk of losing a substantial amount of your investment.  However, as your savings deadline approaches, you should consider shifting into more conservative investments.  Here are a few factors that might help you determine whether you can afford to take on the risk of stock investments:
  1. Is your deadline flexible?  If you can afford to postpone retirement, a new house, or whatever your goal is for a few years in order to recover from market losses, then you can probably afford more risk.  If your goal is set in stone and you can't or don't want to adjust it, then you should probably invest in more stable investments as your deadline approaches.
  2. Is the amount of money you need for your goal flexible?  Perhaps your goal for retirement or buying a new house is not tied to very specific amount of money.  More is always better, buy you might find yourself in a situation where you would be able to weather a drop in the value of your investments and still meet your goal.  If so, you might decide that the possible higher return is worth the increased risk.
  3. How well funded are you?  Often you will find that the more money you have, the more risk you can afford to take.  If your retirement savings are pretty slim and you are living a fair modest lifestyle, you probably can not afford to take any risk that will lower your investment income.  However, if you have more than ample retirement funds and want to take on additional risk, you might very well decide that you are in a position to do just that.
  4. What is your general comfort level with risk?  This is tough to quantify.  However, some people genuinely would rather avoid greater risk even at the expense of almost certainly having less money in the end.  If this is how you feel after understanding what the cost of lower risk is, then it could be a good choice for you.
It is much easier to set up a portfolio for the future that contains the right mix of investments than it is to fix one that clearly had taken on too much risk.  If you have an investment portfolio that has lost money that you really could not afford to lose, figuring your way out of this situation is very difficult.  One the one hand, you have already lost more than you are comfortable with and you don't want to lose any more.  On the other, you don't want to shift into conservative investments until you have recouped your loss.  What do you do?

It is hard to give generic advice in this situation.  Every situation is different and there is not always one correct answer.  However, when I was a professional financial advisor, in most situations like this, I did give the same advice.  It is very difficult to cut your losses and shift to a more conservative portfolio.  If your investments are exposing you to more risk than you can withstand, you need to eliminate that risk - the sooner the better.

Wednesday, September 24, 2008

The danger of inappropriate risk - part 1

The stock market's wild swings up and down are making daily headlines.  The government is putting together a massive 700 billion dollar program to prevent our entire financial system from collapsing.  Large, well-respected companies are going under or being bailed out.  This seems like a good time to talk about risk.

During times like these, many people become scared of the stock markets and hesitant to make investments.  Although you can save for retirement without using stock-based investments, it will be tough and you run a much increased risk that you will not save enough.

In the long run, government bonds - which are very safe investments - return an average of 3.7% per year.  The S&P 500 - a very broad index of 500 companies and a good measurement for the stock market in general - has a long term rate of return of 11.2%.  But, as you well know, if you invest in the stock market, you need to weather volatile times.

Suppose you are 25 years old, plan to retire at age 65, and have nothing saved for retirement.  You believe that you will live to the ripe old age of 95 and want to save enough to provide $50,000, adjusted for inflation, for every year of your retirement.

Let's examine the outcome of three different investment options:
  1. You can be very conservative and invest only in government bonds.
  2. You can choose a moderate portfolio of half stocks and half bonds.
  3. You can be aggressive and invest entirely in stocks until you retire when you will shift half of your money into bonds.
Assuming 2.5% inflation, rounding up to a 4% return on bonds and rounding down to an 11% return on stocks, you would need to save money at these rates in order to fund your retirement:
  1. Conservative: $1864/month
  2. Moderate: $554/month
  3. Aggressive: $232/month
There is certainly risk involved in investing in stocks.  They can drop dramatically in value.  If your investments drop in value just before your retirement, you could be facing big problems.  However, as the example above shows, most people cannot afford to invest enough if they are not investing in stocks.  Therefore, choosing investments that are too conservative dramatically reduces the odds that you will achieve your investment goal.

Tuesday, September 23, 2008

My favorite kind of sale

I'm not much of a shopper.  Perhaps that is one of the reasons that I generally do a pretty good job of managing my money.  Not to say that I don't have my weaknesses, but generally speaking, I don't like to buy things.  However, if I am buying things, I really like to get them on sale.

My absolute favorite thing to buy on sale is investments.

If I go to the grocery store and see that my favorite food (fresh berries of any kind) is on sale, I stock up.  If it's a good sale I will buy much more then I otherwise would have.  This is a natural reaction and a reasonable thing to do.  It makes sense to stock up while the price is low.  While most people have no trouble seeing this logic when it comes to fruit, cans of tuna, or salad dressing, many resist doing so when it comes to far more important purchases - investments.

If you are investing in the stock market, either through individual stocks or better yet through mutual funds, these are great times to be adding to your investments.  Currently, the S&P 500 - a broad index of five hundred major U.S. companies - is at about 1200.  The last time that anyone had an opportunity to buy into this basket of stocks at this price was in mid 2005.

True, the S&P 500 is down almost 25% from its high so your portfolio has likely taken a bit of a tumble.  However, if you are in it for the long term - and you should be if you are investing in stocks - your day-to-day balance shouldn't be a concern.  It can be nerve-wracking to watch the market and your retirement savings lose value day after day.  But you never know just where the bottom will be or when it will be your last chance ever to purchase a stock or a fund at these low prices.  The market might keep going down.  That can be a great thing if it gives you the opportunity to make more investments at relatively low prices.

You will never know exactly when the stock market has bottomed out.  The only thing that you can know for sure is that everyday the market goes down, your investments are on sale and are a better deal than the were the day before.

Sunday, September 21, 2008

What to do if your plan doesn't fit

Creating a financial plan is not always the liberating comforting experience that people hope it will be.  While for some it can be an exercise in reassurance that they are on the right path, for many others it can make their financial goals seem out of reach.  I hope that you are in the first category.  If are not, then please read on.

If the amount that you need to fund your retirement, your kids' education, a new car, and everything else in your plan adds up to more than you think you can possibly save, don't despair.  Just by knowing this, you are already closer to a more secure financial future than you were before.  Ignorance of your problems doesn't make them go away.  In fact, ignorance makes them grow larger - the longer you wait the more difficult it becomes to get your finances on track.  Therefore, by tackling your finances now, you are doing yourself a huge favor.

If you simply don't have enough money to meet your financial goals, you have only three options: earn more, spend less, or adjust your goals.  They all have advantages and disadvantages.

Earning more, if possible, is a great solution.  It should be easy to see how bringing in more money will help make your financial goals more possible.  However, if it were easy to bring in more money, you would probably be doing it already.  For most people, earning more money requires working longer hours or getting another or a different job.  If this is an attractive option for you, then by all means, go for it.

Spending less is a fantastic way to help you meet your financial goals.  The less you spend, the more you have to save.  Almost everyone can benefit from cutting back on their spending.  Once you start to trim your expenses, you might find that it is easier than you expected.  Many people worry that their "quality of life" will drop significantly when spending less.  Sure, you might miss the fun that your spending provided, but you will gain a great deal of satisfaction and security from knowing that your financial future is (or getting closer to being) on track.  Also, after cutting spending, many people come to realize that their "quality of life" depends less on material things and more on life's happy intangibles.  

Living a more frugal life not only increases the amount of money that you have to save, but it can often decrease the total amount that you need to save for retirement.  If you are able to cut your annual spending by a few hundred or few thousand dollars per year, that thriftiness should carry though into your retirement, and you will need less to achieve your retirement.

However, there is only so much money that you can cut out of your spending and it might not be enough to allow you to fully fund your goals.

If you cannot cut back on your spending enough to fund your goals and you are not in a position to increase your income, then you have only one option left: adjust your goals.  If you cannot or don't want to change your income or your spending habits then you will need to modify your goals.  Sometimes, this makes sense.  Perhaps if you delay your planned retirement date by a few years you will be able to live the retirement that you want without changing your current lifestyle.

Beware of making default changes to your goals by failing to plan.  Modifying goals often makes sense.  However, if you fail to save enough for your financial goals, you will not be able to achieve them.  You will, in essence, be forfeiting control of your financial life.  Perhaps your goals need to change.  However, make sure that you actively make that decision - decide what to change and by how much.  Don't let poor money management change your goals for you.

This is very simple in theory, but don't be fooled - it can be very difficult to put into practice.  If you don't have enough money to make your plan a reality, you need to either earn more, spend less, or adjust your plan.  Which ever decision you make, make it on purpose.

Missing money

Do you have any missing money?  You might!  Head over to Missing Money to find out.

As people move from one city to another or close one account and open a new one, they often lose track of exactly where all of their money is.  Missing Money helps reunite you with your misplaced funds.  If you have any money left in old bank accounts, any un-cashed paychecks, any utility deposits that have not been refunded, old insurance policies, or money hiding out in other places, this free web site can help you find it.

I believe that I generally do a good job keeping track of where my money is and has gone.  However, I was pleased to learn that the Virginia Department of Revenue appears to owe me some money.

Thursday, September 18, 2008

Be Your own financial planner part 6 - Be flexible

Congratulations, you are well on your way to being your own financial planner.  You have already made a plan to:
  1. Purchase adequate life insurance for you and your family
  2. Establish an appropriate emergency fund
  3. Track where your money comes from and were it goes
  4. Pay off your debt
  5. Save for retirement, and
  6. Prepare for other major financial events
However, your financial planning is not coming to an end, it is just beginning.  As time goes on, your situation will change.  The market will go up and down, you will move, lose your job, get a raise, have kids, buy a new house, and change your goals.

Therefore, your financial plan will need to be updated over time.  I would recommend that you re-examine your goals and make sure that you are on target at least once every two years.  If you prefer, you can do it once a year.

The final step in creating your financial plan is to remember to be flexible and to regularly reassess your plan.  Your situation and your goals will change over time.  An outdated plan won't do you much good.  So, every year or two, go through steps 1 - 6 again.  You might find that you don't need to make any changes.  But it is always worthwhile to ensure that you are still on target.  Good luck!

Sunday, September 14, 2008

Be Your own financial planner part 5 - Map our your financial goals

Many of the biggest financial events in your life are predictable.  As your own financial planner, it is your job to plan and prepare for them.

Your car will only last so long.  Your kids, if they go to college, will probably do so right after they graduate from high school.  If you are planning on moving to a larger house as your family grows, you probably have a good idea of when you want this to happen.  Events like these happen whether you plan for them or not.  However, they will be easier on your finances if you have planned for them.

Sit down and take a few minutes to think about the major financial expenses you expect to experience over the next five years.  And the next ten years.  And the next twenty years.  When do you think that you will need a new car?  Will your house need significant work at any point in time?  Do you need to save for a vacation?  College tuition?  Will you be moving or purchasing a second home?  Try to think of every specific major financial event in your life for which you can you plan.  Write down what the event is, how much you need to save, and how long you have to save.

The sooner you will need the money for your goal, the more conservative your investments should be.  If you will need the money in five years or less, I would recommend saving your money in a very stable investment such as a savings account, CD, or government bond.  If your goal is more than 15 years away, you almost certainly will want to allocate at least some of your savings for that goal into a stock fund.  For anything in between it's up to you.

More aggressive investments might help you reach your goal faster.  However, they can also tank at just the wrong moment and leave you short of funds.  If your timeframe and goal amount is flexible, you might want to be more aggressive than if your goal amount and time frame are set in stone.  For example, if you are setting aside money to purchase a new car, you might be able to delay your purchase by a few months or purchase a less expensive car than you had previously planned.  If, however, your goal is very specific, there might not be any room for the risk that more aggressive investments entail.

Once you have your goals and timeframes laid out, head over to this savings goal calculator.  Plug in the information about your goals (one at a time), your time period, any money already allocated for this goal, how much you can save every month, and your expected rate of return.  This calculator will then tell you how long it will take you to reach your goal and what amount you would need to save each month to hit your goal at the end of your designated time frame.

There are also a number of great specific college savings calculators.  The CNN Money College Savings Calculator is one of my favorites.

This exercise has helped you complete step six in your financial plan: Prepare for the major financial events in your life other than retirement.

Thursday, September 11, 2008

Be Your own financial planner part 4 - Plan for your retirement

Planning for your retirement will likely be the single biggest financial goal in your life.  Ideally you will be saving for decades and living off the money for decades more.  There are no loans, scholarships, or shortcuts for retirement savings.  Either you save enough to live the lifestyle you want or you don't.

How much should you save for retirement?  That is up to you and depends on when you want to retire, what kind of life you want to live in retirement, and how much you have already saved.  At a bare minimum, I believe that you should be contributing enough to your 401(k) to max out any employer match available.  You should also be contributing to an IRA.

However, you don't want to just follow rules of thumb, you want to make a personal financial plan.

In order to save enough for your retirement you need to estimate what level of income you will need for retirement.  This is one of the reasons why it is important to understand how much income you are living on right now.  Take a few minutes to relax and picture what you want your retirement to be.  Where will you live?  Will you continue to work at all?  Will you want to travel?  What will you do with your time?

Some people believe that 70% of your current income level is a good estimate for what you will need in retirement.  I think that for the sake of estimating your total needs, it is better to start at 100% and work down (or up!).  Personally, I find that when I have more free time, I spend more money - not less.  However, I think that there are a few parts of my budget that I will be able to cut or eliminate once I am retired.

How do you think your financial needs will change in retirement?  For starters, you will no longer need to save for retirement.  If you have been saving 10% of your income, then perhaps you can live on only 90%.  If you are no longer working, will your clothing, dry cleaning, or transportation expenses change?  Will your house be paid off?  Will your house need repairs or remodeling? Will you be taking up new hobbies or devoting more time to your existing hobbies?  How much will that cost?

Once you have your estimate, it's time to plug in your numbers to see what you will need to save to meet your goal.  Yahoo Finance has a great calculator to help you figure this out.  Click on the link, plug in the numbers for your situation and see what you need to save.  If you don't know what to use for any of the variables, (such as inflation or investment returns) its okay to leave them at their set defaults.  Even if you are solidly committed to retiring at a certain age or with a certain level of income, I would encourage you to spend a few minutes trying out different scenarios to see how it effects your savings needs.

When you are done with this you should know how much money you need to be saving every month to prepare for your retirement.  Are you already at your goal?  If so, congratulations!  If not, then do what you can to meet your goal right now.  If you can't hit your savings target right away, don't panic.  However, keep working up towards it.  Until you are on track to fund your retirement, whenever you get a raise at least half of your new money (and preferably all of it) should be put aside for retirement savings or debt reduction.  The longer it takes you to increase your savings rate, the higher your savings rate will need to go.  If you are not saving enough, time is not on your side.

Now you have completed step five in your financial plan: figure out how much to save for retirement and start saving that much.

Saturday, September 6, 2008

Be Your own financial planner part 3 - Debt can ruin your financial well-being

In an ideal world you would never need debt because you would always have enough money.  Our world is far from ideal.

I don't believe that there is such a thing as good debt.  However, there is a huge difference between very bad debt and less bad debt.  Managing your finances well might include taking on less bad debt such mortgages, student loans, and loans to start a business.  These types of debt tend to be less bad because:
  • the purpose of the debt is to leave you with an appreciating asset (house), valuable skills, or an increased income
  • they tend to have relatively lower interest rates
  • they often include tax advantages further lowering their cost
Credit card debt or any other debt that involves spending money that you don't have for things and experiences that you can't afford is very bad debt and will destroy your ability to manage your money well.

Imagine if you walked into a store and picked out a sweater to purchase.  As you picked it up, you notice a sale sticker on the tag - it reads: Today only, pay 70% more than the lowest marked price!  Would you buy the sweater?  Of course not.

However, whenever someone racks up charges on their credit card that they cannot pay off in full, this is the deal that they agree to.  Credit cards typically require a minimum payment of 4% of your balance every month.  This means that if you have a $10,000 balance, your minimum payment will be $400/month.  If your credit card charges you a 20% interest rate and you make only minimum payments, then it will take you almost 16 years to pay off your debt and it will cost you over $17,000 in total payments.  This is very bad debt.

America has a problem with credit cards.  Almost half of all households do not pay off their credit card balances every month.  That means that almost half of all households are spending beyond their means and likely failing to invest for the future.  Of households that do carry credit card debt, the average amount is $2,300.

If you have credit card debt, or other types of very bad debt, you need to pay it off as soon as you can.  If you only have one account, you should pay whatever you can above and beyond the minimum payment until your debt is gone.

If you have more than one account with very bad debt, you should make the minimum payment to all of your accounts.  You should also pay whatever extra amount above the minimum that you can afford to the account with the highest interest rate.

If you have credit card debt you should also seek to minimize the interest rate that you pay.  There are two ways to do this:
  1. Call your credit card company and ask for a lower rate.  It won't always work, but it is worth a shot.
  2. If you still have good credit and are getting credit card offers, see if you can find a way to transfer you debt to a card that offers no interest or low interest.  (If you do this be sure to carefully consider any fees that might be charged for balance transfers.)
Once you have taken care of your life insurance needs and have set aside some cash for emergencies, knocking off any very bad debt that you have is the fourth step in your financial plan.

Friday, September 5, 2008

Be Your own financial planner part 2 - Know where your money comes from and where it goes

Imagine what you could do with two million dollars.

Would you spend it?  Save it?  Give some away?  Would it change your life?

The good news is you almost certainly will have at least two million dollars pass through your hands over the course of your lifetime.  The average American with a college degree will earn 2.1 million dollars over the course of their adult working life.  Don't have a college degree?  You can still expect to rake in 1.2 million.  If you have a masters degree, 2.5 million.  PhDs can expect 3.4 million and those with professional degrees will earn a whopping 4.4 million over their adult working lifetime.

Think about the total amount of money that you have earned already over the course of your life.  How many years have you been working?  Can you estimate your average salary well enough to make an educated guess about how much money you have brought in?  Are you happy with the decisions that you have made?  What do you have to show for all of your income?

If you don't know how much money is coming in and where it is going, you will struggle to accumulate wealth.  Over the course of your lifetime you will earn a significant amount of money.  Some of it, you will need to spend on housing, food, healthcare, taxes, and other things.  What about the rest of it.  Do you know where it goes?

Knowing is as important as doing when it comes to financial planning.  Planning for your retirement is one of everyone's biggest financial challenges.  If you do not know how much money that you are taking in and how much you are spending, there is no way that you can accurately estimate what your needs in retirement will be.

Handling the money that you earn is the very bedrock of your financial plan.  You do not need to have a huge salary to plan your finances well.  However, if you do not know how much money comes in, how much goes out, and where it goes to, you will not be able to effectively plan to use this money to meet your goals.

Step three in creating your financial plan is to know how much money you having coming in, how much goes out, and where it goes.  You don't need to track every penny, but you do need to have a very good feel for what happens to your money.

Wednesday, September 3, 2008

Be your own financial planner part 1 - Be prepared for emergencies

You will have financial emergencies in your life - your car will need work or your furnace will break down.  You will also experience other hardships that have a major financial component - you will experience the loss of a loved one or you might lose your job.

There is nothing that you can do to prevent things like these from happening to you.  However, there is a great deal that you can do to ensure that you are financially prepared for them when they do happen.

There are two main elements to financial preparation for emergencies: life insurance and cash reserves.  These are the first components of your financial life that you should address.  Until you are prepared to deal with financial emergencies that could happen tomorrow, there is no point in saving for financial goals that are still years away.

Imagine that you work out a stellar financial plan that will enable you to fund your retirement and all of your other financial goals but neglect to set aside emergency cash reserves or purchase life insurance.  If your car breaks down the next day and you need to pull money from a retirement account or take on debt to have it repaired, or worse yet, if you or your spouse is run over by a bus, all of your planning won't have helped you.

Therefore, I believe that the first step in any financial plan is to purchase the proper amount of life insurance for you and your spouse.  You should include enough insurance to replace lost income, cover childcare expenses, and take care of any other financial hardships that would be brought about by you or your spouse's death.  Term insurance is generally the cheapest, and often the best type of insurance for these needs.  This earlier post has more information on determining your needs for insurance and this one discusses the different types of insurance available.

Once you have your life insurance squared away, you need to make sure that you have an emergency cash reserve set aside in a savings account.  This money should be set aside only for emergencies and should be in a separate account so that you are not tempted to spend it or use it for anything else.  Many professionals recommend that you keep 3 - 6 months worth of living expenses on hand.  Personally, I keep a bit less than 3 - 6 months of living expenses.  I like to have my money invested and working for me as hard as possible.  Because I work for the government I consider it very unlikely that I will lose my job on short notice.  I also have access to credit and investments should I need to raise a large amount of cash quickly.

The proper amount of cash reserves is something that you and your spouse will need to decide together.  I would advise you to set aside at least $1,000.  However, decide an amount that makes you and your family comfortable.  Frugal Dad has a great post about his thoughts on the proper amount for an emergency fund.

Once you have met your life insurance needs and set aside cash for emergencies, you are less susceptible to the financial ups and downs of life and are ready to tackle the rest of your financial goals.

Step one in your financial plan is to obtain adequate life insurance.

Step two in your financial plan is to set aside an emergency cash reserve.

Tuesday, September 2, 2008

Be your own financial planner

I started this blog because I believe that, armed with desire and a small amount of information, anyone can do a great job as their own personal financial planner.  I want to help you manage your money and plan your financial life better.

When I was a professional financial advisor, I worked with clients that had millions to invest and clients that had only a few hundred dollars.  I devised a unique plan for each client, but the concepts behind each plan were (and still are) universal.  These general concepts are:
  • Be prepared for financial emergencies
  • Know where your money comes from and where it goes
  • Debt can ruin your financial well-being
  • Plan for your retirement
  • Map out your financial goals
  • Be flexible - situations and goals will change over time
Over the next several days I will discuss each of these concepts and how it relates to your own personal financial plan.  It is my goal that at the end of this series, you will have the knowledge needed to create your own basic financial plan that will take into account your needs for emergency cash reserves, life insurance, debt elimination, retirement savings, education savings, and other long term financial goals.