July 22, 2016
The Securities and Exchange Commission on Oct. 30, 2015 opened the door for ordinary investors to put money into crowdfunding opportunities that were previously open only to the wealthy. Now that this door has been opened, should you walk through it?
Investing in small, private companies provides an alternate form of equity to traditional, publicly-traded stocks, and also gives people access to the explosive growth potential of start-ups. In doing so though, it could introduce a whole new element of risk to your investment line-up.
Why the limitations?
Crowdfunding was previously restricted to what are known as "accredited investors," which include individuals making more than $200,000 a year or who have a net worth in excess of a million dollars, not including their primary residence. The SEC has now made it possible for smaller investors to participate in crowdfunding, but only within certain limits.
Why the caution about allowing this form of investment? For one thing, private companies do not have the same level of requirements for audited financial reporting that public companies do, and so there is the potential for unsophisticated investors to fall for a gaudy sales pitch that is not backed up by a sound business model. Also, investing in start-up companies rather than those with a measurable earnings track record carries a much higher risk of failure.
Updated crowdfunding guidelines
While the SEC loosened the restrictions on crowdfunding, it has not eliminated them altogether. Now, people with incomes of less than $100,000 can invest the greater of $2,000 or 5 percent of either income or net worth, which ever is smaller. Those with income and net worth of more than $100,000 can invest up to 10 percent of the lesser of income or net worth, up to a maximum investment of $100,000.
These restrictions apply to all crowdfunding investments in aggregate over any given 12-month period.
Is crowdfunding for you? 7 things to consider
Crowdfunding is trendy, and you could make the argument that it can add both diversification and a new source of growth opportunities to your portfolio. However, you have to ask yourself if you are prepared both financially and emotionally to make the type of investments that might lose most or all of their value.
You also have to ask yourself whether you are prepared to do some detailed analysis of proposed investments, both when you are looking to buy and then regularly thereafter to monitor your investments.
Here are seven things to consider when investing in a private company via crowdfunding:
The SEC investment limits should help make sure crowdfunding investments don't represent too big a portion of your wealth, but given the specific risk of any one of these investments, you should look to spread your money over multiple opportunities rather than depending too heavily on any one.
Very often, these companies won't have an earnings track record yet, which makes valuation difficult. If there are substantial assets involved, you could look at what the investment price represents as a portion of those per-share assets, but more likely you will have to rely on the company management's projection of earnings as a basis for price comparisons.
3. Track record of key people
Since the venture itself is likely to have a limited history when you invest, what you are really buying into is the talent of the key people running the show. Look at their backgrounds for evidence of past success, and also for warning signs such as legal troubles or frequent business failures in their past.
4. Scope of market
Understanding the extent of the market for the company's products or services will help give you a sense of the growth potential.
Look at both the number and relative strengths of competitors to gauge how difficult it might be for a new firm to succeed.
6. Defensible position
If a company has a promising new product or service, think about whether there are patents or other factors which will make it possible for them to defend their market position, or whether it would be easy for competitors to quickly jump in with similar offerings.
Think beyond just what the company is offering, and look at whether they have a viable way of marketing and delivering their wares.
Crowdfunding is no different from other types of investments in this sense: it is not the method of investment that makes something a good or bad idea, but instead the details of what you are buying and how much you pay for that. Don't get too caught up in the growing popularity of crowdfunding to forget to look at the fundamentals.
Comment: Have you considered crowdfunding investments?
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July 18, 2016
Retirement saving is an abstract concept to people who aren't close to retirement age. It's easy to blow off because in the here and now, failing to save does not seem to have any consequences. People need to make it seem more real to get better motivated to save. One way you could do that is by taking a test drive and spend a month on a retirement budget, and see how you like it.
Majority of Americans at risk for saving too little for retirement
Study after study of American retirement savings have shown that the average worker is falling well short of the savings they would need to support their current lifestyles. As a recent example, the Center for Retirement Research (CRR) at Boston College estimated that roughly half (52 percent) of Americans risk not being able to maintain their standard of living in retirement. This is even when taking into account that less income should be needed in retirement than during one's working years.
Why are so many on track to come up short? Just look at the numbers. The CRR found that the average retirement savings of people in their 50s totaled just $110,000. This is disturbing because that age group has most of its saving years behind it, and is rapidly approaching retirement. Using the common rule of thumb that a 4 percent withdrawal rate allows for sustainable retirement assets, these savings would produce just $4,400 a year in retirement income. Even if you doubled this withdrawal rate, which would probably entail drawing the balance down over time, the result wouldn't augment Social Security benefits enough to provide much of a retirement lifestyle.
How to take the retirement budget challenge
To make this more real to you, try to live on the type of retirement budget your current savings would be likely to support. See the step-by-step process below to take the retirement budget challenge:
1. Project your retirement savings amount
Use a retirement savings calculator to project what your current rate of savings plus investment growth would add up to by the time you retire. This will tell you the total retirement savings you are on track for currently.
2. Figure out what yearly spending your savings can support
Again, 4 percent withdrawals are considered sustainable, but since it is not realistic to expect that everybody will be able to afford to live off their retirement savings without drawing them down. So, you might want to use a higher assumption, perhaps something between 4 percent and 8 percent. Applying this percentage to your projected savings tells you what your annual retirement income your nest egg would produce.
3. Be realistic about Social Security income
You can go to the U.S. Social Security Administration website and get a projection of what your retirement benefits will be. In the end, those benefits are based on the 35 highest-earning years of your career, so if you plan to retire early or if your income drops off later in your career, those benefits may not be as high as you think.
4. Make a budget based on your projected annual allowance
Your income from retirement savings and your Social Security benefit is what you would have to live on. Now create a monthly budget based on that amount.
5. Spend a month living on that budget
As an experiment, try living on that budget for a month. Don't take it so far that you fail to pay bills that you already owe, but limit any discretionary spending to what that budget would allow.
6. Figure out a budget you can live with
If your retirement savings rate is as meager as most Americans' rates, chances are you won't find that budget is very doable. So, figure out how much retirement income you would actually need to have a decent lifestyle.
7. Work backward to see what you need to save
Go back to the retirement calculator and see how much you would have to save to get to a workable retirement income. The experience of trying to live on less might just motivate you to ramp up your savings accordingly.
One way to think about this exercise is that it should encourage you to narrow the gap between your lifestyle now and the one you will be able to afford in retirement. If you get a taste of what it would be like trying to get by on a lot less money, you might decide it's better to spend a little less now, in order to afford a retirement budget that is less of a steep drop-off from how you lived during your working career.
Comment: Have you tried the retirement budget challenge? Tell us your experience below.
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July 15, 2016
Often, people become aware of their credit score only once it has become a problem. For example, a loan or other application gets turned down, and you find out about reports with more detail on your financial history than you remember.
Rather than wait for your credit report to become a problem, learn more about your score and manage it to your advantage.
What financial factors make up a credit score?
Credit scores are a commonly used way to measure credit risk. In order of importance, here are the components that make up a credit score:
1. Payment history
At 35 percent, this is generally the largest portion of a credit score, though scores are weighted differently depending on how relevant each component is to an individual's situation. Your payment history takes into account how well you've kept up with payments on credit cards and loans in the past. It also looks at whether you have any history of bankruptcy or debts referred to a collection agency.
2. Amounts owed
The amount of money you currently owe generally will comprise 30 percent of your credit score. This includes:
- How many different accounts you owe money to
- What percentage of your available credit you are using (AKA credit utilization)
- What portion of any existing loans you have paid down
3. Length of credit history
This will usually represent 15 percent of your credit score. It takes into account your oldest and newest sources of credit, as well as the average age of all your credit accounts. Note that from a credit utilization standpoint and in terms of the age of your accounts, closing old accounts might actually be counter-productive.
4. Credit mix
Around 10 percent of your credit score will be based on the type of credit accounts you have. It is considered beneficial to have a mix of credit card accounts and installment loans (such as a mortgage or student loans), as long as you have a good payment history with them.
5. New credit
Another 10 percent or so of your credit score is based on how many new accounts you have opened recently. Opening several new accounts in a short period of time can be a red flag.
The connection between credit history and creditworthiness
Credit scores are useful because they take a number of factors and boil them down to a single, readily comparable number. There has been a movement in recent years to encourage lenders to consider other factors when a person has had limited access to credit in the past. In any event, credit score is not the only thing a potential creditor is likely to look at.
To a large extent, credit scores represent your history with credit, while overall creditworthiness is a function of both your past performance and your future ability to repay the loan. Income (particularly your income in proportion to your overall financial obligations) is an important factor in creditworthiness, as is the length of time you have held your current job.
4 keys to good credit
Obviously, there are many things that impact creditworthiness, but there are four things that should increase your credit score:
1. Work to establish a good credit history
You might think of having no debt as being a sign of financial rectitude, but to potential creditors it simply means you are an unknown. Establishing a history of modest borrowing and timely payments shows that you have had successful experience with managing credit.
2. Think before you open or close an account
A big part of what creditors are looking for is stability, so be aware that too many changes, like closing older accounts, can upset that stability.
3. Make your payments on time
It's not enough that you eventually pay off your debts - you have to demonstrate that you generally make your scheduled payments on time. Use automatic bill payments if they help you keep on track, and maintain a regular schedule for paying your bills.
4. Focus on paying off balances
Don't take on debt simply because you can make initial or minimum payments. Budget for the future to make sure you can pay down the debt within a reasonable time and make any balloon payments that you'll face in the future.
Maintaining good credit impacts more than your ability to qualify for loans and credit cards. It can also affect your insurance rates, and may be a factor that potential landlords or employers look at as an indication of your reliability. Because your financial history is such a big factor in determining creditworthiness, it is something you have to start managing even before you have a need for credit.
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July 14, 2016
Turning 40 may find you a little bit older and achier, a little more wrinkled and grey. Still while it may be getting harder to stay in the physical shape you used to be in, this is a time when you should be growing stronger financially.
Unfortunately, some people react to life in their 40s by having a midlife crisis. That sort of crisis boils down to a sense of anxiety over time that has passed and goals that haven't been met. Among other things, it can be easy to feel that way about your finances at age 40 because you are getting toward the half-way point of your working life. If you don't start securing your financial future soon, you will find that too much time has slipped away from you.
How to prevent a financial mid-life crisis
To prevent a financial mid-life crisis, here are eight things you should do once you turn 40:
June 23, 2016
People often are not sure how to feel about age 40 as a milestone. It has traditionally been thought of as the official entry point into middle age, but it does have some compensations. Compared to 10 years earlier, you are likely to be wealthier, your career should be further along and your personal life is probably more settled.
All those developments entail some changes to your financial situation. While such developments usually happen incrementally, your 40th birthday is a good reminder to take a look at how much your circumstances have changed, and what adjustments you should make as a result.
Personal finance checklist for age 40
Here are 10 financial issues to address once you turn 40:
1. Gain traction on retirement saving plans
According to the National Institute on Retirement Security, average retirement assets more than double between the 35-to-44 age group and the 45-to-54 group. In other words, your 40s is where retirement savings need to accelerate so you can begin to accumulate a significant balance.
2. Take stock of progress on retirement targets
It might be comforting to witness that retirement plan balance growing, but don't look at that balance in isolation. Always look at retirement plan targets to see how you are doing relative to your goals. Even an impressive retirement plan balance looks a lot thinner once you spread it out over a couple decades of retirement spending.
3. Consider if savings targets fit your lifestyle
Say your savings are on target with your retirement plan. Now consider when you formulated that retirement plan. If it was back in your early 30s, both your income and your lifestyle may have improved since then. If that is the case, it may be time to raise your retirement targets so they would support that improved lifestyle. Early on, it is unrealistic to base retirement planning on the assumption that you will achieve financial success, but once you reach that success, it is wise to adjust your plans and the amounts in your savings accounts accordingly.
4. Assess whether your house meets your needs
If you have owned a house for several years, think about your present family situation and decide whether you are likely to stay in that home or move to something that better meets your needs down the road.
5. Look into buying if you currently rent
If you rent your current residence, age 40 is a good time to evaluate whether homeownership is ever going to be in the cards for you. Your conclusions will determine whether you should focus on making your current living arrangement more cost-effective, or whether you should start saving for a down payment on a new home purchase.
6. Research options to save on mortgage
If you are staying in your current home, see if you can save money on your mortgage. Refinancing is one option, but if you are financially comfortable, other options include shortening your remaining mortgage term or paying the loan off altogether. Both of these moves would reduce your long-term interest expense by eliminating years of interest payments.
7. Set a timeline for eliminating high-cost debt
If your mortgage is not the only debt you have to deal with, formulate a plan for paying off that debt over a specific period of time. Otherwise, chronically carrying debt balances is going to steadily erode your wealth, especially with credit card debt.
8. Get serious about college savings contributions
As you move through your 40s, your kids will probably be rapidly approaching college age. At this stage, saving for college is no longer just a matter of putting the odd hundred dollars aside on the kids' birthdays. Saving money needs to be geared toward a specific plan to meet their needs when the time comes.
9. Update your life insurance
Life insurance is intended to help your loved ones replace your income should you die. If you got that insurance back when your income was much lower, chances are you need more insurance now to replace a higher income.
10. Determine job market competitiveness
Don't let your skills get out of date - consider new training if necessary. If you already have in-demand skills, think about whether you are maximizing the career opportunities for those skills.
Ideally, this financial review will find you are starting to reap some of the benefits from financial moves you began making around the time you turned 30. If not, don't worry - it's not too late to start, but it is time to get going so you have some progress to show by the time you turn 50.
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