August 22, 2016
You probably deal with money just about every day, but how well do you really know your financial situation? What you don't know could hurt you.
People have a bad habit of reacting to financial needs rather than planning for them. This tends to be a less rational, and often more expensive, way of making financial decisions. A better approach would be to ask yourself some fundamental questions about your finances before you are facing a deadline or a problem. Think of this as getting to know your finances a little better so you can manage them more effectively.
10 questions to get to know your finances
Here are 10 questions that will help you get to know your finances a little better:
1. Are you regularly surprised by running out of money?
It's one thing for money to be tight, but if you repeatedly are taken by surprise by coming up short on being able to pay your bills or by overdrafting your checking account, it is a sign that you are not in control of your budget. Step one is formulating a budget that lets you live within your means, and step two is putting controls in place to make sure you follow that budget.
2. Do you save up for big purchases or rely mostly on credit?
Borrowing may be necessary for major purchases like a house or a car. But if you find yourself making routine purchases on credit, you are making those items way more expensive than they need to be by adding interest to the cost. The more you can wait and save up in a savings account to buy things, the more you will be able to afford.
3. Have you formulated a retirement savings plan?
People tend to assume that buying a house is the biggest financial decision they will ever make, but chances are you will need even more money to retire on than it costs to buy a house. It takes years of effort to build up enough of a nest egg, and that effort starts with figuring out how you are going to save that money.
4. Is your retirement savings on track?
It may be hard to feel a sense of urgency about something that may be 20 or 30 years in the future, but if you wait until retirement saving becomes urgent, you will have left it too late. Start holding yourself accountable now, so you won't have to try playing catch up in the last few years of your career.
5. Do you have a written investment policy?
This should include a prioritization of goals, asset allocation parameters, and criteria for measuring performance. Otherwise, investing is like trying to do a job without knowing what the job description is.
6. How well have your investments performed?
People tend to focus on the big winners and losers in their portfolios, but what matters more is how everything has performed in aggregate. Performance measurement should focus not just on how well you have done, but whether your investments have behaved appropriately for the prevailing market conditions.
7. What is your credit score?
Banks, insurance companies and even prospective employers are going to know this about you, so you should probably know your credit score yourself.
8. What could you do to improve your credit score?
If your credit score is less than perfect, it could cost you in the form of higher interest rates, or even limit your ability to get credit. Identify what you need to do to address any problems so your score will improve over time.
9. How much demand is there for your job skills?
Sure, you know how much money you make, but your value in the marketplace is really determined by how much demand there is generally for your skills. Periodically checking employment ads for similar jobs will tell you whether you need new skills to improve your job security, and whether or not you are being paid what you are worth.
10. What would happen to your finances if you were out of work for 6 months?
It may seem tough to build up that big a cushion, but the median duration of unemployment peaked at nearly 26 weeks in the aftermath of the Great Recession. Knowing how close to the edge a period of joblessness would put you is a good test of your financial wellness.
Some of these are questions that people just neglect to ask. Others are questions they are afraid to ask, because they might not like the answers. However, you are going to come face to face with financial reality eventually, so better to ask these questions when you have the time and opportunity to deal with them constructively.
Comment: What other questions should you ask about your finances?
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August 17, 2016
Finance has a way of turning useful tools into dangerous weapons. The U.S. saw this a decade ago with mortgages, and now a similar problem is shaping up with student loans.
A mushrooming of student debt
There is now $1.36 trillion of student debt outstanding, and what is most striking is the pace of increase. This debt has doubled in the past eight years, a rate of growth that is comparable to that of mortgage debt leading up to the housing crisis. On its way to reaching its peak level in mid-2008, mortgage debt roughly doubled over the prior seven years - and we all know how that turned out.
Not surprisingly, this mushrooming of student debt its taking its toll. According to Federal Reserve figures, some 11.8 percent of students with loans are officially considered to be in default.
The price of student loan forgiveness
A populist solution is to simply forgive part or all of the student loan debt. A common assumption behind this proposal is that profiteering banks have taken advantage of students by enticing them into loans they didn't understand and can't afford.
Here are four reasons why student loan forgiveness could be costly:
1. Taxpayers foot the bill
One problem with this is the U.S. government has guaranteed the vast majority of the student loan debt outstanding, so if loans are forgiven or students simply default on them, it is the U.S. taxpayer who will foot the bill, not some deep-pocketed bank. This would amount to a national subsidy of tuition, which is an idea worth discussion. But this solution is expensive enough that it should be planned in advance, not backed into after the fact.
2. Students who already paid back tuition wouldn't benefit
Also, deciding retroactively to broadly subsidize tuition would be patently unfair to those students who worked hard to earn tuition money or pay off their loans.
3. Government loan guarantee programs could disappear
Besides this unfairness, a general student loan repayment amnesty would have a couple of other hazards. It would most likely result in government loan guarantee programs being sharply curtailed in the future. Removing or scaling back government support for student loans would cause bank rates on those loans to skyrocket, especially given how high default rates have been.
4. Less accountability among schools
The other hazard is that simply forgiving student loans would not hold academic institutions accountable for making sure the tuition dollars their students are paying are well spent.
Real student loan reform
A big problem is that the aggressive marketing of some academic programs leads to heavy enrollment in schools or courses of study with low graduation rates, shaky career prospects or both.
To fix this, consider restricting government-backed student loans in the following ways:
- By degree program. The government agonizes over how to create a workforce with the right skills. Restricting loans to degree programs with reasonable employment prospects would be one way of discouraging students from pursuing credentials for which there is no demand.
- By school. Schools which consistently graduate a small percentage of their students are essentially conning young people out of their money - or ultimately, the government out of its money. Attendance at those schools should not be eligible for government-backed financing.
Shockingly, the federal government only requires schools to address high loan default rates when 30 percent of their former students are in default. If there is one lesson these schools can teach effectively, it is that the government cannot afford to be so forgiving.
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August 15, 2016
Retirement is likely to represent an inflection point in your finances, as you go from earning and accumulating money to spending down your wealth. Think of that extreme turnaround as a sharp, hairpin turn in the road - taking it smoothly doesn't depend solely on how you react when you are in the turn itself, but also on how you approach it and how you proceed on the other side of it.
In other words, transitioning your finances for retirement should not be something that happens all at once on the day you retire. You need to start planning this transition in the decade leading up to retirement, and then be prepared to continue to adapt to changing conditions as you move through your retirement years.
7 ways to transition finances for retirement
The following are 7 components of transitioning your finances for retirement:
1. Ramp up retirement savings
For many, the years leading up to retirement are their peak earnings years, so that period is a golden opportunity to ramp up your savings. Also, once you reach age 50 you can take advantage of higher contribution limits on 401(k) plans and individual retirement accounts (IRAs), so your savings can also benefit from additional tax deferrals.
2. Identify what lost benefits will cost you
Tracking your expenses is a basic building block for budgeting, but simply projecting your current expenses into the future might not work for retirement planning. If your job has generous medical and dental benefits, you may incur a sizable new expense once you retire and have to replace some of those benefits out of your own pocket. On the flip side, there may be expenses related to your work, such as commuting or wardrobe costs, that will be reduced once you retire. In any case, recognize that the nature of your spending is going to change when you retire, and plan around that.
3. Take the retirement budget challenge
Once you have an idea of how much you will need to spend in retirement, calculate what this represents as a percentage of your retirement savings so far. Financial planners have traditionally used 4 percent as a rule of thumb for a sustainable spending rate, though some have begun to question whether that number still works in an era of minuscule bond yields and even lower bank rates. In any case, if your annual spending needs represent more than 4 percent of your nest egg, it is a sign you need to save some more before you retire.
4. Re-think retirement age
Age 65 has traditionally been thought of as retirement age, though some professions have different targets. However, with people aging more healthily and living longer, it might make sense to challenge traditional retirement age thresholds. Every additional year you work is an opportunity to replace a year of spending with a year of earning. If you are in good health, you might not want to surrender your income so soon.
5. Assess your mortgage situation
The ideal situation is to synchronize your retirement with paying off your mortgage, so that a major expense goes away at about the same time your wages stop coming in. If this is not possible, then before you retire, take a good look at whether you could benefit from refinancing or a home equity loan. You might find it easier to qualify for a mortgage while you are still earning a steady income, so don't put these decisions off till after retirement.
6. Prepare for your liquidity needs
Make sure money is available when you need it by planning for how to efficiently withdraw funds from tax-advantaged plans, and how to create liquidity without forcing untimely security sales.
7. Don't get too financially conservative
Between the need for liquidity and the likelihood that your savings will go from positive to negative cash flow once you retire, your investment approach should become somewhat more conservative. Just don't go too far in the direction of stability and liquidity. You may still have decades ahead of you, and you will need some growth to keep up with inflation over that period.
One fundamental way that financial decisions are different in retirement is there is less room for error. Once you start depending on your nest egg, you no longer have years and years to ride out any investment volatility, nor do you have a weekly paycheck to shore up your savings. Financial decisions in retirement mean the rehearsals are over and the action is now live. The plus side is that in addition to a sizable savings account, you will have had many years by then to accumulate the experience needed to make good financial decisions.
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August 5, 2016
Desperate times call for desperate measures. When investors are desperate for income yield, that desperation can lead to disastrous investment decisions. Keep in mind that investments are sometimes like the fable of the tortoise and the hare: Things with the highest apparent performance often don't have the staying power investors need.
One example is high-yield investments. High-yield investment programs (HYIPs) come in many forms. They might be exotic packages of high-interest foreign bonds. Or might be what are optimistically called high-yield securities these days, but which were once more tellingly known as "junk bonds." Also, high yields are often the come-on for investment scams that ultimately fail not only to provide the promised income, but which also fail to return all of the investor's principal.
5 signs of trouble with high-yield investment programs
When should the caution bells start ringing? You should start asking some hard questions when any or all of the following are true:
1. The yield is out of proportion with generally available alternatives
Markets are reasonably efficient. If an investment is offering a significantly higher yield than other alternatives, it either means the investment carries significantly higher risk, or the promised yield is fictitious.
2. Limited liquidity or trading
If there is not an open and active market for an investment, you should be especially cautious. The absence of a viable market for an investment means there is no general corroboration of the price being represented. The cost of arranging a sale on the back end might cost you more than any extra yield you earned.
3. No independent custody
Beware of investments you can't hold in an ordinary bank or brokerage account. That means there is no independent institution to verify pricing, or even the security's existence.
4. There's an aura of secrecy
People get sucked into frauds by the illusion they are getting an inside deal. Be cynical about any hush-hush arrangements - when investors have a legitimately valuable opportunity, usually the last thing they want to do is keep it a secret.
5. A sense of urgency
Another sign of a scam is when you are pressured to buy in on a tight deadline. Those deadlines are often created as a means of preventing people from thinking things through.
Risks of high-yield investments
Not all high-yield investments are outright scams, but some may simply be bad investments. Here are some of the things that can go wrong:
1. The numbers you are shown might be past returns, not current yields
Be wary of past returns on yield-oriented securities in a low interest rate environment. Falling interest rates create price appreciation in yield-bearing securities, but once rates have fallen those price gains are unlikely to be repeated and the current yield is now much lower.
2. The high yield might be a sign of default risk
Credit risk can undermine an income portfolio. A high interest rate won't help you if the bond issuer defaults on interest or principal payments.
3. A high yield based on foreign securities may be offset by currency changes
Yields can be very high on securities from countries with high inflation rates, but often that inflation will cause the local currency to decline at a rate that will offset any yield advantage.
4. The investment might be fictitious
From Charles Ponzi to Bernie Madoff, pyramid schemes have centered around promised returns that are just too good to be true. Remember, these schemes can suck you into investing more by actually paying some early returns. Don't let some initial success fool you into turning a small mistake into a bigger one. If you watch out for the five warning signs listed earlier, you have a good chance of recognizing the next Ponzi or Madoff.
Low risk investment alternatives to high-yield investment programs
In a sense, many HYIPs are fool's gold. Whatever advantage they offer in yield is offset by the risk of principal losses, and in the case of pyramid schemes and other outright scams, even the yield might be illusory.
When measured against the possibility of losing money in a HYIP, even low bank rates start to look more attractive. To make the most of available bank rates, look for long term CD rates that come with relatively mild early withdrawal penalties. That way you can benefit from the higher yields on longer-term CDs but still have an affordable escape route should bank rates rise. Also, be sure to compare CD rates among banks to be sure of getting a competitive rate.
Then, the next time you hear of an emerging market collapse or an investment scam gone sour, you will appreciate that sometimes slow and steady really does win the race.
Comment: What do you think of high-yield investment programs?
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August 3, 2016
Your spouse probably likes to fancy him or herself as a saver, but you might use a different word. It could be a word like cheap, miserly or killjoy.
A spouse with Ebenezer Scrooge-like tendencies can do more than simply cramp your style. Rigid personal finance habits can affect everything from vacations to housing to decisions regarding children. Spouses who can't compromise could find their marriage in jeopardy.
"Money is one of the big contributors of marital problems," says Joe Heider, president of Cirrus Wealth Management in Cleveland. "If you don't come to terms with it, it can even come to divorce."
Financial experts say there is a right way and a wrong way to address the problem.
Here are five tips for dealing with a penny-pinching spouse:
1. Know the signs of frugal money habits instead of cheap
"There's cheap, and there's frugal," says Keith Klein, a Certified Financial Planner and owner of Turning Pointe Wealth Management in Phoenix. Before you become too outraged by your spouse's money habits, be sure you aren't confusing the two.
Frugal individuals are searching for the best deal, something Klein says shouldn't be discouraged. Spouses who are trying to maximize household dollars don't necessarily deserve the cheap label unless they reach the point of putting off necessary purchases indefinitely.
Ken Moraif, senior advisor with Money Matters in Dallas, adds that a miserly spouse may also be in the right if a major purchase is coming down the pipeline. In those cases, it may be best to rein in spending and ramp up savings.
2. Lead with questions, not demands
However, if your spouse is truly cheap and only concerned with paying as little as possible, you could have a problem on your hands. Buying the cheapest items available, without consideration of quality, could mean you end spending more in the long run since cheap items may wear out and require replacement more quickly.
"If you really think your spouse is being cheap, don't present them with a demand," Klein says. "Ask them why they want to go the cheap route."
Their answer may provide the insight needed to reach a middle ground. Heider says some people hold on to old attitudes about money even when their circumstances have changed. For example, a spouse who grew up in a low-income family may be cheap because he or she is fearful of returning to a point of poverty.
Other times, there may not be any deeper meaning behind an individual's miserly personality and he or she just want to build savings accounts.
"Some people want to save money for the sake of it," Moraif notes.
3. Break out the budget spreadsheet
After having a conversation about spending philosophies, it's time to crunch some numbers. Couples need to work on their finances together, and Heider says a smart budget is one that includes some fun money.
"Don't deprive or the spendthrift might start hiding spending," he says.
Moraif goes one step further and says couples should feel free to spend all their money once they've paid the bills and put at least 10 percent of their gross income into retirement savings.
"To a great degree," Moraif says, "I find my job as a financial advisor is to give [my clients] permission to spend money."
He stresses that retirement savings have to come first. In some cases, couples may want to set aside extra for an upcoming major purchase. Beyond that, Moraif reminds people that money is a tool to be used and not necessarily something to be hoarded.
4. Use your negotiating skills and compromise
Creating a budget both spouses can live with requires some finesse.
"It's a matter of degrees and a matter of negotiating," Heider says.
A spouse who wants more discretionary spending or more money in a particular category may have to compromise by agreeing to cut the cable bill, disconnect the landline or buy a cheaper car.
"Make sacrifices in other places to make the person comfortable," Heider adds.
5. Consider separate bank accounts to keep the peace
While financial experts tend to agree a joint checking account for household expenses is ideal, they also say separate accounts for spending money can have benefits.
"If you agree on a budget, [you can have] separate accounts containing the amount of money you've agreed upon," Moraif says.
This strategy avoids the possibility of appalling a cheap spouse who can't believe his or her partner spent so much on a particular purchase. Separate accounts mean only the buyer needs know whether their new shoes cost $20 or $200. However, by limiting the money in separate accounts to that amount stipulated in the budget, a thrifty spouse can feel confident that their husband or wife isn't dipping into funds earmarked for other expenses.
Having a cheap spouse may not be much fun, but consider that they may not be thrilled to be living with a spendthrift either. With open communication and a bit of compromise, there's no reason financial opposites can't eventually live in harmony.
Comment: How do you deal with a spouse with different financial habits?
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