Investing Archives - Page 2 of 6 - The Broke Professional

Dancing is Not a Good Investment Strategy

If your investment strategy was a dancer

Investing is a patient man’s game.  This applies to almost any type of investing including real estate and stocks.  In general, if you’re investing for the long term (more than 10 years), the best strategy is to have a great plan and stick to it.

Unfortunately, many impatient men (and women) are investors.  This means many plans never make it past the first big market drop.  That’s usually when panic sets in and investors do something short sighted.

A 2015 study proves exactly this.  The study shows that we are our own worst enemy when it comes to investing.  And no other reason even comes close.

Let me set the stage by showing you the study results and what we can learn from them.

People are Not Good at Investing

I recently wrote why many investors are their own worst enemy when it comes to their investment performance.  While the subject of this post is similar, after reading the results of the aforementioned study I felt a separate post was needed.

The study was conducted in 2015, and at the time the S&P 500 Index had a 30-year annualized gain of 10.53%.  That means that every year for the last 30 years, the S&P gained an average of 10.53% per year.  Some years were way more and some years were way less (think 2008).  But on average, a nice 10% return every year.

What this means is that an investor who simply held an S&P 500 index fund for the last 30 years should have returned 10.53% minus fees.  Let us say this investor had some crazy fees which brought the return down to 8%.  Paying high fees is annoying, but 8% is still not a bad overall return.

According to the study, the average investor didn’t do this well.  In fact, they did a lot worse.  The study found that the average investor returned 1.65%!

1.65%!!!???  They might as well have put all that money into an online savings account and saved themselves the stress of investing.

This means that the average investor is probably not using index funds.  And if they are, they are using the wrong ones or are just going in and out of investments way too much.  I think the latter is the culprit for most investors.

Dancing In and Out of Investments

“Since the basic game is so favorable, Charlie and I believe it’s a terrible mistake to try to dance in and out of it based upon the turn of tarot cards, the predictions of “experts,” or the ebb and flow of business activity. The risks of being out of the game are huge compared to the risks of being in it.” -Warren Buffet in his 2012 letter to Berkshire Hathaway shareholders

(The basic game is investing and Charlie refers to Charlie Munger, Buffet’s partner at BH.)

As Mr Buffett explains in this quote, “dancing” in and out of investments is very risky.  I firmly believe this is why the average investor does not even come close to the returns of the S&P 500.

But why does going in and out of investments produce such poor returns?  Shouldn’t we always be looking to get out of our investments when things get bad and find some better places to put our money?

The answer is yes, we should be looking for better places to invest.  But the best place to invest is usually in an index fund that follows the overall market.  And it’s almost impossible to find another group of investments that does better than the overall market on a consistent basis.

And by dancing in and out of investments, most people are actually buying high and selling low.  We should always try to buy low and sell high!  People usually panic and sell investments when things get bad (sell low), and then they try to buy into investments that everybody is saying is “safe” (buy high).

A great example is the recent Brexit vote that will lead to the UK withdrawing from the European Union.  It was expected that the stock market would fall after the vote was yes, and it did just that.  The day after the vote was final, the S&P 500 dropped 66 points, which was about a 3% loss.  Not a huge drop, but pretty decent.

But if you turned on any form of financial news, you would think the Four Horsemen were arriving.  Predictions that the international markets will be in turmoil for years was the theme of the day.  The S&P actually did fall about 1% more the next day, which lead to more doom and gloom.

But about 10 days after the Brexit vote, the S&P 500 was right back to where it was before.  And as of now, 2 months after the vote, the S&P 500 is about 3% higher than it was pre-Brexit!

The Big Takeaway

What this all means is that if you were one of those investors who panicked and sold some stocks after Brexit and then bought more stocks when the market rebounded, you were dancing in and out of the market which means you were selling high and buying low.

And this is why the average investor averages returns a little over 1%.  As the study showed, just owning an S&P 500 index fund for the last 30 years and not doing anything with it would get you a 10% return.

The best course of action for investors who don’t want to make stock picking their full time job is to formulate an index fund strategy that is appropriate to your investing timeline.  Pick the funds.  Rebalance the funds every year so they don’t get too out of wack.  And then leave it alone.

You will be a better investor than the majority of America.

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Why Retirement Calculators are Dumb

I don't think Walter White needs 85% of his pre-retirement income.

I don’t think Walter White needs 85% of his pre-retirement income.

When I graduated from optometry school waaaaaaayyy back in 2009, I started to finally make some real honest to goodness money.  I figured I should learn more about this finance thing and proceeded to read almost every personal finance book at the library.

I started to follow awesome blogs like Ramit Sethi’s and Mr Money Mustache.  Being a personal finance novice, I eagerly soaked up whatever information I could.  This led me to be on both sides of the argument on many different issues.

Debt is evil!  But some debt is okay.  Increasing your income is the way to wealth!  But so is being frugal.  While some of my stances on different issues are pretty solid at this point, I’m always learning new things that affect one opinion or another.

But one thing I’ve never liked throughout my financial journey are retirement calculators.  You know, those websites where you input 5 different pieces of information and you’ll find out how much you’ll have during retirement.

I’m not sure why I’ve never liked them initially.  Maybe because retirement was so far away.  Or the fact that I thought I was done with calculators once I got out of school.  But after reading more and more on personal finance, I’ve realized that retirement calculators are downright dangerous.  That’s because they assume you will participate in lifestyle inflation!

Mo’ Money= Mo’ Problems?

I’ve talked about the dangers of lifestyle inflation a number of times on here.  Pretty much it’s when you start spending more once you start making more.  It is the killer of dreams and it’s what keeps most Americans in debt regardless what income class they are in.  Almost everyone would agree it is a bad thing.

But not retirement calculators.  I was fiddling around with my company’s 401k retirement calculator, and at my current contribution rate (maxing it out!) it said I’m on track to have a great retirement by age 60.  Great news.

Then I started playing around with some numbers.  What if I changed my contribution rate?  What if my salary changed?  I found that if I doubled my salary and kept the same contribution rate, my retirement was in danger.  What in the hell?  If I make double the money I will be worse off during retirement?

In what universe does that make sense?  In the sick universe of retirement calculators, that’s where!

The problem lies in a ridiculous “rule of thumb” that keeps popping up:

“You will need 70-85% of your pre-retirement income during retirement.”

This is not an official rule (hence rule of thumb), but it is adopted by most calculators.  The retirement calculator on CNN.com says this:  “We then assume you can live comfortably off of 85% of your pre-retirement income. So if you earn $100,000 the year you retire, we estimate you will need $85,000 during the first year of retirement.”

According to the same calculator if you work hard and end up making $200,000 per year, saving $85,000 for retirement will magically not cut it anymore.  That’s because they assume the extra money you make will be going towards new expenses and not towards things that can actually produce more wealth.

This assumption shows a lot about the mentality in this country as well as the retirement industry.  While it’s good to be conservative and assume you will need more money during retirement, assuming that your expenses during retirement will increase in step with your pre-retirement income makes no sense.

Conclusion

Maybe this is not a big deal.  Maybe I just got offended because a calculator told me my retirement was in danger since I’m making more money than I was before.  It does make sense to be conservative when it comes to retirement.

But what doesn’t make sense is that this rule of thumb is like gospel throughout the retirement industry.  What financial advisors and retirement specialists should be saying is that when you make more income, don’t increase your expenses!

There are so many financially positive ways you can apply your extra income.  You can pay off debt, increase your emergency fund, invest it into equities or real estate or use it to help out a family member or charity.

The idea that you will need more money during retirement just because you are making more before retirement is preposterous.  Studies show most retirees become naturally conservative compared to their working years.  And it’s also important to remember that during retirement you won’t be saving for retirement anymore!  So a huge expense is already gone.

Lifestyle inflation is what keeps most middle and upper class people in the paycheck to paycheck cycle.  It’s a type of hedonistic adaptation that is dangerous because it can keep you from fulfilling your dreams and spending time with the people that matter.  Don’t let a retirement calculator tell you otherwise!

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I Would Love to do Peer to Peer Lending but…

check-cashing

Our state is too good for P2P lending, but not too good for establishments like this.

Update:  As of February 2016, Lending Club is now open to Maryland residents!  Click here for the details.    I will be doing some heavy research into this before I take the plunge, so look for an update on my journey into P2P lending.  Edit:  Still no Prosper though 🙁  

I’ve been hearing a lot about Peer to Peer Lending (also known as P2P lending).  It’s one of those topics I just kind of glossed over since I had more “pressing” things to learn about like student loans, investing and trying to freelance.  Before last week I had a rough idea of how it worked.  Many people were reportedly getting great returns, but it seemed like a lot more work than I would have liked.  It seemed complex and then some bloggers reported that they were still getting good returns, but not as high as before.  I didn’t think it was worth my time.

But last week I heard an interview on the Stacking Benjamins podcast (which is a great podcast by the way).  The interview was with Simon Cunningham, who runs a website called Lendingmemo.  His interview pretty put P2P lending in a much clearer light for me and I was itching to learn more.  I went over to LendingMemo and got some great information.  Here are what I believe to be the pros of P2P lending:

  • You’re loaning capital to actual people, and not a big corporation.  The vast majority of borrowers on P2P sites are looking for help paying off credit card debt.  I could definitely get behind that.
  • It’s relatively low risk.  The two big P2P sites are Lending Club and Prosper, and they each have their own algorithms they use to determine the risk that a borrower will default on their loan.  According to LendingMemo, the default rate for Lending Club is around 5%, which was a lot lower than I expected.  Higher risk borrowers give investors the potential for higher returns, while low risk borrowers give less a return but a good chance that you will get a return at all.  It’s like a balancing act between risk and reward, which is what investing generally is.
  • Returns are solid.  According to Lending Club, historical returns of their lowest risk loans range from 4.91%-8.38%.  That’s a very good return for what seems like a low risk investment.  And it certainly beats the pants off of an online savings account or CD.  While past returns don’t reflect future performance, it’s good to keep them in mind.
  • It seems like fun.  My preferred method of long term investing, making regular contributions to index funds, is pretty boring.  The only thing I may have to do is rebalance, which takes just a few minutes.  Otherwise, it’s set it and forget it.  With P2P lending there are a few more decisions you have to make, and while they do have an automatic contribution system to make things super easy, you still have to check on your loans from time to time.  This seems like it would be be a fun mental exercise.

I say it SEEMS like fun, because I will not be able to see if it is really fun.  Here’s the notice I received when I tried to sign up for an account at Lending Club:

lending club deniedYes, because I live in the state of Maryland, I can’t participate in direct P2P lending as a borrower or as an investor.  As a medical professional, I’m used to the zany differences from one state to another, but this was just a little annoying.  Some states allow you to use Lending Club only.  Some states allow Prosper only.  There are only 3 states that don’t allow any type of P2P activity (Kansas, Ohio and Maryland), and I happen to live in one of them.  This would firmly fall into the category of a first world problem, but it’s still a problem.  (Here is an interactive map that diagrams all the craziness between states).

So what is an aspiring P2P’er from Maryland to do?  My plan is to do some more research on P2P lending until I know it front to back.  In the meantime I’m still working on getting rid of a 6% student loan, so paying that off would be a pretty good use of my money.  And then I’ll just wait until the curmudgeons in charge of Maryland join the P2P bandwagon.

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Don’t Be Your Own Worst Enemy

Stop getting in your own way!

Stop getting in your own way!

Investing can be a tricky business.  You have to determine why you’re investing and what you’ll be investing in.  Then you have to make investing a habit and do it regularly.  But you also have to watch yourself and make sure you don’t abandon your well thought out plan and change your investments around once the going gets rough.

It has been normal as of late to experience a 2% gain one day followed by a 2.5% loss the next day, and vice versa. Listening to most financial news outlets, you would believe that these are the darkest days the market has seen in a long time.

While it is true that the S&P has seen some dramatic ups and downs as of late, it has not reached the “correction” stage as many financial television stars have been breathlessly predicting the past few months.  Even after the infamous Brexit vote, the stock market actually GAINED ground for the week after a big single day loss after the vote.

For those heavily invested in the stock market, watching these wild swings can be dizzying. But the market goes up, and the markets go down. That’s what it has always done and that’s what it will always do. The important thing for investors to remember is to stay with the plan through thick and thin.

Stick to the Plan

If you and your financial advisor have already formulated a long term investing plan, you can be sure that volatility, or the ups and down of investing, has been taken into account. While timing the market is usually an exercise in futility, the market has historically been pretty predictable as a whole.

Taking a long term view, let’s say 30 years or more, the market has always gone up in any such period. After bear markets and periods of volatility, the market has rebounded to new heights. This was most likely taken into account when forming your financial plan, so there is no need to abandon the plan if a little volatility rears its head.

In fact, doing so would be foolish and harmful to your wealth. To make money with any investment, you need to buy low and sell high. By abandoning stocks in your 401k when there is a downturn, you are essentially buying high and selling low, exactly the opposite of what you should be doing.

Manage your Behavior

Staying the course sounds great in theory, but it can get old after a while and start to wear you down. Listening to the doom and gloom of the mainstream media and talking to people who are making big market moves can make it tempting to pull the trigger.

Pushing that panic button could torpedo your entire financial plan. Sitting on the sidelines during dramatic market swings can actually wear an investor out, and the idea of keeping your money “safe and sound” in a money market account sounds really enticing.

But, again, it’s important to remind yourself that markets go up and down. That is simply the nature of the beast. Find a way to tune out the noise to avoid any volatility fatigue. This could mean not watching any financial media for a few days, getting a pep talk from your advisor or reading a common sense investing book. You can be your own worst enemy when it comes to making investment decisions.

Conclusion

Sometimes, the best course of action in times of turmoil is to do nothing. Let others head for the hills and abandon their stocks, which will invariably happen as we see a rush of investors dumping equities and heading to bonds.

Sticking to your plan will allow you to pick up stocks at a bargain and be poised to gain tremendously when the next market upswing occurs. So while others will be scrambling to get in on the gains, you will already be locked in. Think about that when the idea of staying the course starts to wear on you.

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If You Don’t Want to Work Forever, You HAVE to Start Investing

Investing_money

Investing for retirement is usually not a topic of discussion among new graduates.  Most Millennials would rather talk about Pokemon Go or Game of Thrones,  Two things I have thankfully not gotten sucked into yet.

A discussion about student loans may follow.  And then maybe how crappy the economy is and how hard it is to find a good job or start a business.

But talking about retirement or when to stop working full time is not usually a riveting discussion.  Some just don’t understand how retirement accounts investments work, and they don’t care to learn.  Others dismiss the idea of retirement altogether, claiming that they will just work for the rest of their lives.

Sounds like committing yourself to a life sentence.

If you’re self employed or work for a large company, you need to talk about retirement.  If you have the most fulfilling and rewarding job ever, you still need to talk about retirement.  That amazing job may not seem to fulfilling 20 years from now.

In the business world, you need an exit strategy.  You have to plan for how you’re going to leave your work and set things up so you have enough money to live on.  This is what retirement planning is in a nutshell and the earlier you get a plan set up, the better off you will be.

And the ONLY way to give yourself a shot at a great life post work is to invest.

Why is Investing Necessary?

Being able to save money is an essential step to having good retirement income.  And finding a way to make that money grow is just as essential.  But why?  Can’t you just put money into a savings account or under your mattress and not bother taking investment risk?

No, you can’t.  If someone makes $100,000 per year and is able to save 10% of their income into a regular old savings account every year from age 30 until when they retire at age 60, they will have $300,000 saved up.  Not a bad sum right?

Wrong.  This person was living on $90,000 per year during their working years.  Having $300,000 in the bank mean they can live the same type of life for a little over 3 years.  Even if they cut their cost of living in half to $45,000, that’s still just over 6 years worth of money.  Average life expectancy is around 78, so this person still has a decade or so to live with no money in the bank.

So this person was able to save a decent amount of money for decades and will only be able to survive on their own for 3 years?  How can anyone live a long and fulfilling retirement?  By investing their money, that’s how.

Run Your Numbers

It’s all a numbers game at this point.  This person could decide to either work a lot longer, save a lot more or live on a lot less.  Saving 10% per year for 30 years is actually a pretty good savings rate in this day and age, so I’m not sure how many people would be willing or able to do more.

Obviously, we should always be trying to save more and live on less.  That is the cornerstone of personal finance.  But even better would be to combine those ideals with investing, which allows your money to grow and compound over time.

What would change if this person decided to invest that $10,000 a year into a retirement account instead of a savings account?  After running through some retirement calculators I found that at a conservative rate of return of 6%, this person would have a little over $637,000 to spend in retirement after taxes are accounted for.

You read that right, just by putting their money into a retirement account instead of a savings account, you are able to more than DOUBLE your money.  Now being able to invest like this does require some education and up front work, but not really too much.  And I would say it’s well worth it if you can double your money.

This is the power of investing and this is why everyone, even new grads saddled with student loan debt, needs to start investing early and give their accounts lots of time to grow.

Where to Start?

Stocks, bonds and mutual funds.  Investment properties, house flipping and wholesaling.  Commodities, start ups, local businesses, your own business Bitcoin, and peer to peer lending are just SOME of the ways you can invest.  Where is a new investor supposed to start?

It can be overwhelming when you look at all of the options out there.  And each type of investment has its own world of information to learn.  But the best place to start would be a 401k.  If you work for a company they probably have one and if you’re self employed you can open one for your business.

The reason I recommend starting with a 401k (or a Traditional IRA if your workplace doesn’t have one) is because the contributions you make are tax deferred and so is any growth in the account.  This is very advantageous especially if you start contributing early in your career and give the account time to grow.  Once you choose what type of investments you want, start contributing regularly and watch your net worth skyrocket over time.

My next piece of advice would be to do research!  No one can walk you through investing step by step because there is just so much information available.  Do some research on different ways to invest, such as real estate or dividend investing.  If something strikes your fancy, look into it some more and see if it’s worth putting your money in.

Investing is one of those things that are east to get into but difficult to master.  But you don’t have to be a master to have a stable retirement.  You just have to start early and let your money grow.

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4 Books New Grads Should Have Read BEFORE Finishing School

Students in undergraduate and professional school usually have one thing on their minds: sleep!  The next thing is usually studying to do your best (or to just stay afloat) in your respective program.  Many times this requires a laser like focus where nothing else matters except the next test or practical.

But on the other side of that diploma or degree, real life is going to be waiting.  Which means you are going to have to make a lot of financial decisions which could potentially affect the rest of your life.  I would advise students to take a few minutes a week (that’s really all it takes) to read some good books and form some type of financial plan.

I’ve recommended four books for students to read while they’re in school.  Like I said, it just takes a few minutes a week and I know every student can find a few minutes between ping pong tournaments (and studying of course!)

These are light reads that are packed with great information to get you started on the right financial footing.

Good grades are important, but you’re only in school for a small part of your life.  Taking some time to plan the rest of your life is essential.

Here are the recommended books:

I Will Teach You to Be Rich by Ramit Sethi

This is the first book i read after graduating optometry school.  And I’m glad I did.  It touches on some theory when it comes to investing, but it is ultimately a very practical book and this is what I appreciated about it.  Ramit talks about what specific bank accounts he recommends, how to invest and even how to negotiate when buying a car.  The overarching theme from this book is to DO SOMETHING rather than not acting.  Getting 80% of the way there is a whole lot better than getting 0%.

The Millionaire Next Door by Thomas Stanley and William Danko

If there ever was a book out there that tells you what REAL wealth looks like, this is it.  MND is a light read that talks about the characteristics of real life millionaires.  Despite what society and the media tells us, millionaires don’t usually drive around in luxury cars and have gigantic houses.  More often than not they are hard working people who spend their money very wisely for a long time.  This book is especially important for those new grads looking to get a new car and/or house right away.  If you want to be a millionaire, this book will show you that’s just not the way to go.

Richest Man in Babylon by George Clason

I was fortunate to read this book while I was in optometry school, and I’m really glad I did.  It is a light and short read that can help establish a solid financial foundation.  The book consists of Biblical sounding parables that contain financial wisdom.  The main theme I got from this book is the biggest financial lesson of all: you will never get ahead unless you spend less than you earn.  Constantly spending 100% of your earnings is no life at all.

The White Coat Investor by James Dahle MD

This is a great book geared mainly to MD’s and other health professionals, but has some great advice for everyone.  The White Coat Investor is a fantastic blog that teaches professionals about student loans, investing and keeping more of your money.  Honestly, it is one of the blogs that inspired me to start blogging and trying to help my fellow broke professionals.  Great book for investors and a must have for anyone graduating from professional school.

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How to Get an Amazing Return on your Savings Account

Savings accounts will save your life.

The financial services industry is enormous.  There are countless magazines, commercials, shows and blogs that talk about financial products and services (I do that also, but only with products I use and trust.  Like Digit.)

Companies like Fidelity , Vanguard and Charles Schwab will talk about their mutual fund options all day long.  Life insurance companies will be happy to show you their complex whole life insurance and annuity plans.  If you turn on any business news channel, you’ll start believing that the world is going to end and you need to entrust your financial life to a specific company.

All of this marketing is designed to separate you from your money, and will ultimately enrich the companies in the form of fees and commissions, regardless of your own personal performance.  Marketing is a powerful tool and the odds are stacked against the average consumer.

But what if I told you there is a financial product available that is virtually risk free and will give you great returns throughout your entire life?  This product is not heavily advertised in the financial world and will only get a cursory mention by financial advisers.

That product is the humble emergency savings account.

Savings account?  Really?

Yes really.  And it has nothing to do with the interest rate.

Most people have savings accounts and don’t even know it.  Many banks sign you up for one when you get their checking account, although most people don’t give it a second thought. But they can be a powerful wealth building tool.  How can that be when the interest rates are so low?

A savings account with Bank of America will get you a maximum interest rate of .03%  That’s right, 3 hundreths of a percent.  Almost nothing.

An online savings account with Ally, which I currently use, gives a 1% interest rate.  A LOT higher compared to a Bank of America account, but still not too high in the grand scheme of things.

(By the way, sign up for an online savings account if you don’t have one.  You’re just leaving money on the table if you don’t)

The beauty of a savings account doesn’t lie in the interest rate.  Savings accounts are awesome because they can enhance your financial life by providing positive returns in so many ways.  Here are some examples:

Higher deductibles:  Insurance is a game of risk.  This is true for any type of insurance, including health, auto and homeowners.  If you take on more risk, you pay less in premiums to the insurance company.  If you take on less risk, you pay more in premiums.

Assuming coverage remains the same, the best way to take on more risk, and thus decrease your premiums, is by increasing your deductible.  This will be how much you pay out of pocket before the insurance company starts paying.  The higher deductible you pay, the lower premiums you pay.

What a large savings account does is that it allows you to set a higher deductible because you will be able to cover that deductible payment if need be.  I believe the role of insurance is to help you out in catastrophic cases, such as a car accident or major illness.  In the case of a car accident, having a low $100 deductible is not really a big benefit since the cost of replacing a car can run well into the tens of thousands.

For example, I have car insurance with Geico.  If I choose a $1,000 deductible on one of my cars, which is an amount any decent savings account should have, my 6 month premium is $285.  Not bad at all.  If I leave the coverage the same and change the deductible amount to $100, the 6 month premium jumps to $395.

An extra $110 for 6 months is not bad, but if you have a large savings account, there is no need to spend that extra money.  Apply this principle to all your cars and all of your various insurances (especially your health plan), and you can easily save hundreds of dollars per month just for having money in a savings account to cover those deductible payments.

Bulk Purchases:  This is an easy one.  Buying in bulk is almost always cheaper than not, especially with groceries.  And having money in the bank allows you to do this anytime you want.

If you see something you regularly purchase on sale at the grocery store for half off, you can save a lot of money by buying enough of that item to last you for the month instead of coming back every week and paying the regular price again.

Your savings account just helped you slash your grocery bill.

Pay in cash:  With things like cars, home repairs, remodeling and appliances, most people just assume you have to take out a loan.  That’s just how things are done.  But not if you have cash in your savings account.

We recently got an estimate for a painting job from a number of contractors.  All the estimates were for about $1,000.  Since I will be paying in cash, this will be an easy transaction.  Just transfer from my savings account and pay the contractor.

Most people go would go the loan route.  A good rate for a personal loan would be 6%.  If I could get a 6% loan with a 5 year term, the monthly payment would be $19.33.  What a steal!

Actually, not a steal at all.  The extra interest you would pay over the 5 years would be $159.97.  So having a savings account that could cover that amount right off the bat will save me $160 compared to having to take out a loan.

Leave investments alone:  This is where having a savings account can potentially help you keep a whole lot of your money.  Everyone needs to invest whatever they can as early as they can.  Compounding interest early in life produces great returns later.  This has been proven extensively.

But what if you have been investing so much that you totally neglect your savings account and now you owe someone $5,000?  You’re going to have to tap your investments which is going to cost you in 2 ways:  Transaction costs and diminished investment returns.

If you have to withdraw from a retirement account, add a penalty payment and extra income tax on top of that.  And all the while you are missing out on returns your $5,000 could have been getting if it remained invested.  Not a good situation.

So even if you’re the most gung-ho investor and you’re super excited to get in the game, make sure to set aside some cash just in case.  It will actually help you keep more of your money.

With all the savings to be had from higher deductibles, bulk purchases, not having to get a personal loan or withdraw from your investments, I hope you’re convinced that having cash set aside in a savings account is a good idea.

I hear many people rail against savings accounts because of the low interest rates and how the “opportunity cost” is too high since you could be getting a higher rate of return elsewhere.  But no other account allows you to withdraw money as needed and gives you the peace of mind found in all the previous examples.

So help keep your financial house in order and open an online savings account.  Make sure to keep replenishing it because it is not a matter of if you’ll need it, but when you’ll need it.

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Wealth Savings Account

Another Health Savings Account post?  Yes.  Another one.

HSA post. Another one.

HSA post. Another one.  Another one.

I’ve written about HSA’s previously here and here.  But it seems some people still don’t get it.Since HSA’s are a fairly new concept, I thought I would give one more post at explaining its benefits.

Many people I’ve spoken with who are hesitant about HSA’s are not really hesitant about HSA’s.  There is no reason to be scared of HSA’s because they provide tax free money for healthcare services AND you can keep the money forever.  People love signing up for Flexible Spending Accounts, and you can only use those funds within a year, so those are a little more scary.

No, people don’t have problems with HSA’s themselves, but have second thoughts about signing up for High Deductible Health Plans (HDHP’s), which you have to be enrolled in to be eligible for an HSA.

And they should have second thoughts.  HDHP’s are a big difference from the traditional health plans we’re used to.  You’ll have to pay out of pocket and in full for a lot of things you never had to pay directly for.

A visit to the local urgent care place?  Full price.  Have to pick up some medications?  No coverage yet.  A $1,000 visit to the ER?  Pay the full $1,000.  It’s almost like not having health insurance at all!  (It really isn’t though just keep reading.)

For a family plan in 2016, the minimum deductible needed to be considered an HDHP is $2,600.  That means that insurance will not cover anything until you have spent $2,600 on healthcare expenses for the year.  That sounds preposterous for some people, but it just requires you to plan a little better.

Are HDHP’s for you?

There are two questions you have to ask yourself to see if a HDHP is right for you.

First, are you pretty healthy?  That is, do you or any family member need to go to the doctor often or take a lot of medications.  If the answer is yes, then a HDHP is probably not for you.

But it still may be.  You just have to run the numbers.  It’s almost impossible to predict what your healthcare costs will be in the upcoming year, but looking at how much you spent in previous years can give you a good idea.

HDHP’s have lower monthly premiums than traditional health plans.  That’s one of their big selling points.  If you think you will end up spending enough on healthcare that it will negate those lower premiums, then you should probably go with a traditional plan.

The second question to ask yourself is do you plan to have a surgery or major procedure anytime soon?  If you do and you can do it early in the year, then an HDHP will DEFINITELY be the right choice as you will meet the deductible requirement early in the year and will have almost everything covered for the remainder of the year.

Not all companies accept will let certain elective procedures, like LASIK, be applied to the deductible so make sure to verify what will apply and what won’t.  If it can apply towards the deductible, an HDHP is a no-brainer.

Based on these two questions, I think most people will benefit from going with an HDHP.  So you get much lower premiums, great coverage once you meet the deductible and the biggest benefit of them all…the HSA!

Healthy, Wealthy and Wise

The minimum deductible for an HDHP family plan is $2,600.  The maximum amount you can contribute to an HSA  for 2016 is $6,750.  That means if you max out your HSA contributions for the year (which you should most definitely try to do) and get the pre tax contributions out of your paycheck, you will be able to fully cover the deductible in a little less than 5 months.  Doesn’t get much easier than that.

Remember HSA’s have a triple tax advantage: they are taken out pre tax, they grow tax deferred, and they can be withdrawn tax free for healthcare expenses.  After age 65, you can withdraw funds for any reason and you’ll owe income tax but no penalty.  Since HDHP’s cost much less for employers, many will sweeten the deal by contributing a certain amount into your HSA.

There is just too much good stuff going on here.

And let’s not forget arguably the biggest benefit: the ability for the account to grow tax free.  The default setting for most accounts is to have your HSA money in some type of money market account that earns 1% or less of interest.

That’s cute, but it’s not for me.  Nearly all HSA plans have investment options, and some of them have very good ones.  HSA’s stay with you for life, so if you can invest your funds appropriately you can stand to make a lot of money down the road.

Many would say that’s risky since the money is for healthcare expenses and not necessarily for retirement.  Fine.  What you can do (and this is what I do), is to find out what the out of pocket maximum of your health plan is.  This is the max amount you would have to pay for the year until all of your healthcare expenses are completely covered.

For most HDHP’s, this  number is around $6,500 or $7,000.  Whatever the exact amount is, put that much in the interest bearing portion of your HSA.  Put the rest into investments.  That way, even if everything goes to hell, you will have enough to cover your health care expenses for the year while still having some great tax advantaged growth in the background.

Bottom line, if you’re healthy and single, you have absolutely no reason NOT to be in a HDHP.  If you have a family there is more to consider, but an HDHP will most likely work.  If you have a family and multiple members see doctors and take medications regularly, it may not be right for you.

I don’t know what more I can say about the topic, but I’m sure I’ll revisit it again soon.  In the meantime, max out that HSA contribution!

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Find Your New Financial Normal

Make a few adjustments, and create a new financial normal.

Make a few adjustments, and create a new financial normal.

One thing I’ve noticed over time is that humans are very adaptable creatures.  We conform to our surroundings and can make almost any environment feel routine to us after a while.  Animals do this, as cold weather creatures develop features that can increase survival in even the most harsh of environments.

Call it evolution, adaptation or just the way God made us.  The fact is that we can adapt to most situations and environments given enough time and motivation.  Knowing this, we should theoretically be able to improve our financial situation by changing our environment.

We can get by on less

I was accepted into optometry school fairly late into the process, so I had to scramble to find an apartment near the school.  I asked a couple of people I knew if they needed roommates.  No one did.  I started looking for one bedroom apartments in the area but they were way out of my student salary (aka no money).  I was at a loss.

But then I had an idea.  I called back one of my classmates and asked if I could stay in their living room.  He wasn’t planning on bringing any furniture in the living room and neither was his roommate, so he said that would work.  I just got an air mattress and set up shop.  So I had a place to eat and sleep and paid very little rent since we split it 3 ways (I got to pay even less since I didn’t have my own room).

It was tough the first few days.  One bathroom for three guys.  Not much privacy being in the wide open living room.  Not an ideal living situation.

But I made some adjustments to make things easier.  I spent most of my time studying in the library.  Since studying is what I did almost all the time anyway, I just brought some food from home and ate during study breaks.  It became very doable and I made a couple of good friends in the process.  All for hundreds of dollars less per month than if I got my own apartment.

What this experience showed me is that you can get by on less, even if you don’t think you can.  Sometimes we are forced to get by on less because of a job loss or illness.  Those aren’t fun times.  The time to experiment is while you’re healthy and making money.

Cut your cable and see how things go.  Look at some smaller fuel efficient cars when it’s time for a new one.  Try to eat out a little less every week.  Doing things like this will create a new baseline of spending and you may not even notice the difference after a while.

And if you do start feeling the pinch, then you know that particular thing is something you value and can’t live without.  Simply go back to it and try to cut something else.  Not much to lose there.  This process will save you some money for sure but will also simplify your life just a little more.

Create a New Normal

Cutting expenses is all well and good, but how can we use our adaptability to actually save money and supercharge our finances?

The most recent numbers put the US personal savings rate at 5.2%.  The savings rate for the Millennial generation is actually negative!  These are abysmal numbers and unless the average American is making millions of dollars a year, a 5% savings rate is just not going to cut it!  Your working career could end prematurely because of health issues or job loss, so making sure you have enough savings (and insurance) is key.

So what’s the answer?  Move to a cheaper area?  Cut your cable?  Stop drinking lattes?  All of these are viable solutions to keep more of your money, but probably are not the answer for most people.  The answer?

Create a new normal.

If you’ve only been saving 3% of your salary into your 401(k), log into your account and increase it to 6% and try to live on your new slightly less monthly earnings.  You will make less money than before obviously, but through our awesome ability of adaptation, you will most likely get used to it after a few weeks.

You just doubled your savings rate.

After a while, consider increasing your 401(k) deferral again, especially if you get a raise.  You might find increasing it too much is making things a little tight.

That’s okay.  You can back it down a little bit and increase it later when you’re ready.  More than likely you will end up at a much higher savings rate than you started with.

You can apply this to any almost any financial goal.  Want to pay off your student loans quicker?  Increase your payment to principal by $200 every month and see if you can handle it.  Want a larger emergency fund?  Try to set an automatic contribution to take $100 out of your checking account.

After getting used to your new financial reality, you can try to see if you can save some more.  Make it into a game.  And just like a game, you can push reset if things don’t seem to be going so well.

Most of us underestimate our ability to adapt to new and possibly harsh situations.  Try to create a new financial normal for yourself by cutting a service you don’t need or increasing your savings rate.  You’ll be surprised at how easily you can adapt.

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Keeping Up to Date Can Cost You

Don't end up shaped like the number 7

Don’t end up shaped like the number 7

Most of us will not admit it, but we know what FOMO means (Fear Of Missing Out).  Not only do most of us know what it means, we probably fall prey to it from time to time, especially in our current era of social media hyper consumption.

There was actually a time when we had to call someone to find out when a plane would leave.  That just sounds barbaric.  Now we can get up to the minute (second? millisecond?) flight information, sports scores and weather reports.  There is nothing the world can hide from us!

This constant state of connection also translates into the financial world.  We can get up to the second stocks reports on any company, and trades are performed almost continuously.  While this can seem exciting and adrenaline pumping, it can also lead you to unwittingly destroy your finances.

Get Off Your Phone Dad

Smartphones come preloaded with a “stocks” app that gives you up to the second numbers on the major indices and any individual stocks you choose. The problem is that humans are emotional beings, and seeing that line go lower than it was earlier in the day can produce feelings of anxiety that make us want to reach for the panic button and sell.

If we’re investing for things that are decades away, daily fluctuations in the market shouldn’t faze us in the least bit.  But they do.  So removing ourselves from constantly having to look at prices is the only way to go.

It’s also important to remember that stocks appreciate an average of 8% per year, but if you focus on daily fluctuations and react to news of the latest downturn, you will miss those great returns.

This is not to say we should be totally oblivious to our investment performance.  I personally like to take a look every 3 months to readjust my allocation back to where it should be and just check up on the numbers.

Notice I said every 3 months and not every 3 minutes. That’s because daily fluctuations tell you next to nothing, and are only giving you one piece of a thousand piece puzzle. Figuring out where all these pieces of the puzzle go and formulating your long term investment plan is something you need to do.

The other important thing to remember is that the markets will go up and they will go down. That’s just what they do.  So a sudden downturn should not surprise you.  In some cases a downturn could be just what the doctor ordered because you can buy shares for less than you could before.  That will get you on the rocket ship to big returns once the next upswing occurs.

Not only are equities cheaper during a downturn, but dividends can get a little better in some cases as well.  That should help lessen the impact of any negative returns.  Just remember to re-invest those dividends right away for maximum compounding.

While having all the information the markets have to offer available at your fingertips seems like a technological breakthrough, just looking at it for the sake of consuming information can be very detrimental to your returns.

Keep a cool head and do whatever it takes to stop you from pulling the trigger.  If that means turning off the computer for a bit or chatting with your financial advisor, then that’s what you’ll have to do.  Taking advantage of the ups as well as the downs is an essential characteristic for any successful investor.

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