What Baseball can Teach you about your Finances

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There is nothing like the start of the baseball season.  Even thought the season seems interminably long, there is something about the anticipation of the Opening Day of baseball games.  It means spring is right around the corner.  Green grass will soon be visible under the dark gray mounds of snow.  And the smell of fresh hot dogs will permeate the ballparks (I’m not sure how “fresh” a hot dog can be, but let’s go with it.)  I’m much more partial to following NFL and NBA games, but with football over and basketball being really boring until the playoffs start, baseball will have to do.

And if there’s one thing I love about sports besides watching them, it’s sports analogies.  I really think any philosophy of life can be explained through sports analogies.  The importance of teamwork in winning games and getting things done successfully in life.  Doing the hard work behind the scenes will usually lead to a good performance on the field and in your career.  The analogies are endless.  There is probably no sport more amenable to analogies than baseball.  After doing some thinking, there are a good number of analogies that can apply to personal finance.  Here are some of the better ones I thought of.

(A fair warning for those who don’t like baseball or don’t get sports analogies.  Just turn back now.  This could get ugly.  Read a Financial Commandment and call it a day.)

Good pitching is essential, but you need to score runs to win

Increasing your personal cash flow is a simple proposition.  Increase the amount of money coming in and decrease the amount of money going out.  Make more money and spend less of it.  In baseball terms, that means score more runs and don’t let the other team score runs.  Having a good set of pitchers and sound defensive play from your fielders will keep the opponents runs to a minimum.  But this alone is not going to win you the championship (That’s why we’re playing the game isn’t it??!!).  You need to be able to put runs up on the board in order to make up for any small inevitable mistakes from the defense.

This means that having a budget and watching where your money goes is not enough in itself.  Sometimes we spend too much on food in a month.  A car repair is needed.  An impromptu vacation is booked.  Things fall through the cracks sometimes so it’s important we put a lot of effort into making more money as well.  It can make up for any small mistakes we make and keep our cash flow going higher and higher.  You can save only so much money.  But the ability to make more money is endless.

Want proof?  The Boston Red Sox scored 853 runs last season, more than any other team in the league.  They also ended up winning the World Series.

As far as allowing the least runs by opponents?  The best 3 teams were Atlanta, Pittsburgh and the LA Dodgers.  All had pretty good regular seasons, but couldn’t quite go all the way.  Shows you that having a good spending plan is necessary and puts you in a great position, but it is consistently increasing your net worth that will get you to the promised land.

You’re eventually going to swing and miss.  You just have to learn from it

Legendary Boston Red Sox player Ted Williams famously said, “Baseball is the only field of endeavor where a man can succeed three times out of ten and be considered a good performer.”  A 30% hit rate is awesome in the baseball world, but is terrible in everything else.  Something useful can be gleaned from these words though.  Which is that failure is inevitable.  You can literally plan for it.  There is no one who has never made a mistake at some point when it comes to their finances.  Be it a poor mutual fund selection, higher than expected credit card bills, or a home improvement project that just won’t stay under budget, mistakes will be made. 

The important thing is to, of course, learn from them.  But it is also important to read blogs just like this one to read about others financial blunders and try our best to avoid them.

Put your pitcher in the best position possible to win the matchup

A common predicament for baseball managers is when their starting pitcher is getting tired and has just let up a couple of hits.  The opponent is threatening and it’s clear your pitcher is gassed.  It’s time to go to the bullpen and choose the best relief pitcher for the situation.  Who to choose can be a tricky choice.  Some pitchers pitch better at home.  Some are better at night.  Some are terrible against certain hitters.  All these variables must be considered before choosing the pitcher that will give you the best chance to win.

Personal finance is no different.  Someone who has a lot of credit card debt and someone who has none should not be doing the same thing with their money.  The person with a lot of debt should try to get by with a smaller emergency fund while paying down their debt, while the person with no debt can save up for a more comfortable emergency fund and invest some money as well.  An professional looking to pay less taxes could opt to put more money in their 401k and HSA accounts.  Everyone has a different situation, and there is no one answer to solve everyone’s issue.  The best action is to analyze where you are and where you want to be, and find the most efficient way to get there.  Simply running the numbers will tell you what you should be doing in many cases.

The season is a marathon, not a sprint

A Major League Baseball team has to play 162 games in the regular season.  That’s a whole lot of games.  Players can get worn down and team morale can take a hit.  The important thing to do is to keep the goal in sight.  If your goal is to win the World Series, brooding over that fluke loss you suffered 2 months ago will not help you get there.  Conversely, reveling in a win against a hated opponent can be your undoing if you lose 3 games in a row right after.

Baseball teams are in it for the long haul, and so are your finances.  For example, if you make an awesome plan to repay your student loan debt, focus on paying off that debt going forward rather than looking at the past few years where you didn’t get around to it.  If you are able to make the extra payments for a whole year, be proud of that but make sure to do it against next year.  Not making your monthly payments a couple of times can derail your plan and your confidence.  As the most overused cliche in the world tells us:  Slow and steady wins the race.

All right well I’m all analogied out for now.  Hopefully those of you who enjoy sports analogies got something from this post.  And those that don’t like them hopefully read this far somehow.  Until next Opening Day.

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4 Smart Ways to Spend your Tax Refund

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Tax season is in the air.  TurboTax and H&R Block commercials can be found everywhere, Liberty tax has costumed employees at every street corner, and people all over the country are swimming in tax refund money like Scrooge McDuck.  But what to do with all that money?  Get iPhones for the whole family?  Season tickets to the Pelicans (yes that’s a real team)?  Or go out to dinner 200 times this year?

The fact is, all those choices are terrible.  But spending your tax refund money on consumer things is usually a bad idea.  I’m not a fan of preachy personal finance articles telling me I’m doing something wrong.  Unfortunately, this is one of those articles.  And if you’re spending your tax refund money on consumer goods that you can live without, it pains me to say that you’re doing it all wrong.  So here are four correct ways to spend your tax refund:

(Disclaimer:  Any monies received from a tax refund were your monies all along!  Contrary to popular belief, it is NOT a bonus from the government for a job well done.  It is your hard earned money so it should be treated that way.)

1.  Get rid of high interest debt.  This definitely includes credit card debt and can also include debts to family members, car loans or student loans.  My threshold for “high interest” debt includes anything above and uncluding 5%.  But others might have a different tolerance.  But get rid of the credit card debt.  That definitely has got to go.

2.  Contribute to an IRA.  The Roth IRA contribution limit for most broke professionals is $5,500.  Many people get enough tax refund money to cover a full contribution or at least most of it.  Take advantage of this and let the money grow tax free.  A much worse option would be to buy a TV for thousands of dollars and see your money depreciate right before your eyes.  Literally.

3.  Invest in yourself.  This can potentially be the best investment you could make.  Take a course relevant to your field to increase your skills.  Take your boss or a co-worker you admire out to lunch and pick thier brain on any topic.  Or even get some exercise equipment and some videos and start getting into shape.  Investing in yourself the right way can produce crazy results if you stick to it.

4.  Fine, go ahead and buy something you want.  But just one thing.  If you have done the previous three suggestions and still have some cash leftover, go take a nice weekend getaway or have a few nice dinners with your family.  If you’re working too hard, this can be detrimental to your health and wealth in the long term, so sometimes a nice break is what’s needed.  Just please don’t get into more debt.

These are 4 great ways to spend your tax refund money, or any money for that matter.  People do weird things when they get a windfall, so if you have some crazy ideas, just put the money into a savings account and sleep on it.  If you consistently get tax refunds every year, using that money wisely can provide a huge boost to your financial well being.

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Filed Under: Investing, Self Building, Student Loans

Drown out the White Noise and Smile

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This is what most financial talk shows should look like.

This is what most financial talk shows should look like.

In my 401K, I currently have a mutual fund that invests in and tracks all of the companies in the S&P 500 (hereafter referred to as just the S&P).  For those of you unaware, the S&P is a stock market index is based on the market movements of the 500 large companies contained in it.  These include behemoths such as Amazon, American Express and Coca Cola.  It’s also fodder for talk radio and TV.  If you listen to the stock updates on the radio or watch it on CNBC, they will always report on the results of the S&P.  And herein lies the problem.

Whether I’m driving home from work or to the supermarket, every so often the news will report on the goings on of the stock market.  “The Dow was up 120 points because of new consumer spending numbers.”  “The S&P was down 20 points because of the latest unemployment numbers.”  Or my favorite, “The market is in complete flux today because the Fed chairman sneezed 3 times in a row.”  For something so essential to the world’s economy, the US stock market is a very sensitive thing.  I always try to keep an ear for the S&P numbers because I’m directly invested in it.  But I shouldn’t.  Because I know that short term fluctuations have no real bearing on a retirement account.  That’s considered “white noise” and it can be hazardous to your finances and to your sanity to continue to listen to it.

Wikipedia defines white noise as “a random signal with a flat (constant) spectral density.”  That sounds too physics-y to me so I will provide an alternate definition.  White noise is that stuff you hear that doesn’t really effect you but you can’t help but listen to.  When you sit in a coffee shop to read a good book but are transfixed by the conversation behind you about someone’s latest medical issues, that’s paying attention to white noise.  Having a conversation with your friend but paying attention to the crazy man on his cell phone, that’s paying attention to the white noise.  And watching shows on CNBC to hear the latest stock trends from the latest talking (screaming?) heads is paying attention to the white noise.  It’s easy to do and seems fun at the moment, but it does nothing for you in the long run.

CNBC and Fox Business have empires to run.  They have people to pay and need lots of money to pay them with.  They need something to fill the airwaves with.  This is why there is an endless stream of talk shows and stock analysts telling you to do something different with your investments.  The best thing you can do is to NOT listen to them.  Investing is like a marathon.  It involves a lot of diligent work over a long period of time.  Trying to speed up the process with a hot new tip will only hurt your long term results and can be harmful to your health.  There is a great post about how much more happier and successful you would be by following a low information diet.  I couldn’t agree more with this premise, because if we humans are given more choices, we agonize over it and sometimes rush to the wrong decision.

There is usually one right choice when it comes to investing for most people.  And that is to set it and forget it.  It requires some diligent work and soul searching up front, but once you decide on how you want to invest, the battle is already won.  Remember to focus on what you can control, your contributions and fees.  You can’t control the market’s ups and downs.  Some think they can predict it, but they’re usually wrong.  Just check back on your investments every year and so and make any adjustments as needed.  Repeat the following year.  That’s all there is to it.

Drowning out the white noise does not mean that you should get complacent.  We should always be looking to expand our knowledge and broaden our horizons.  This can be done by reading well written financial blogs and magazines and classic books that have lasted the test of time.  You can obviously start with this humble blog, but a quick Google search will lead you to many great financial resources out there.  That won’t try to sell you stuff.  And that won’t make you feel like you’re missing out on something big.  So don’t pay attention to all the financial fluff.  Stick to your long term goals and values and keep trying to improve on what you know.

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Filed Under: Investing, Self Building

Big Tax Refunds are Great! Right?

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There are all sorts of unending debates in the world of personal finance, with rabid followers on each side.  Rent versus buy?  Emergency fund or no emergency fund?  Paper or plastic?  Yes, some personal finance writers will go into a strange amount of detail about that last one.  One other burning question:  Tax refund or no tax refund?  Or big tax refund?  Or little tax refund?  There are actually more than one answer and as with many things in personal finance, it can depend on your situation.  But let’s talk about it and find out who the winner is anyway shall we?

The 2014 tax season (for the 2013 financial year of course) is in full swing.  People are waiting for the steady stream of tax papers in the mailbox (luckily you can download a decent amount of them nowadays) and deciding how they want their taxes done.  You can go to a local accountant, a big box one like H&R Block or just do it yourself with tax prep software like TurboTax.  I usually use a local accountant but am heavily leaning towards doing it on my own this time since computers make everything so easy.  There are lots of choices to make during tax season.  And there are two main things Americans want to accomplish after doing their taxes:  make sure the IRS will not be breathing down their neck in the future and to get the highest refund possible.

You can see it in advertising everywhere.  “We will get you your highest possible refund!”  There are promises of getting you your refund the quickest.  There are even some less than reputable establishments that will give you money even before receiving your actual refund, as long as you pay them back with your actual tax refund money.  Along with a big fat interest rate.  The fact is, getting a nice big refund and getting it fast seems to be the ideal situation according to the ads.  The average tax refund for 2013 was around $3,000.  That’s nothing to sneeze at.  I mean, who doesn’t want a big wad of cash delivered to them all at once?  That just sounds awesome.  But it’s not THAT awesome if you look at it objectively.

Getting a tax refund is nice, but it just means the government is giving you back money you rightfully earned in the previous year.  They thank you for the free loan.  Getting an average refund of $3.000 means that you could’ve gotten that money throughout the year.  That averages to $250 a month.  This can be helpful in paying down debt, especially high interest debt such as credit cards or student loans.  This is the main benefit of not getting a large refund.  If you can funnel that $250 every month towards debt or even just an online savings account, you will be ahead, maybe even far ahead, compared to just having that money held by the government until it’s time for your refund.

What about the case for getting a large refund?  Is there even a case?  There might be when psychology comes into play.  Emotions and psychology SHOULDN’T interfere with personal finance decision, but they do.  Some people are savers, and some people are spenders.  If you don’t do anything positive with that extra $250 a month and just let it sit in your checking account and increase your spending, then maybe allowing yourself to get a nice refund will be a kind of “forced” savings (though an automatic contribution to an online savings account would work just as well).  In any case, if you’re the type that might spend $250 a month without thinking about it but will be sure to spend your $3,000 refund on reducing debt or increasing savings or investments, then getting a big refund might be for you.  Ramit Sethi wrote a pretty good post a few years ago about this.  Though he assumes a tax refund of $600, well below the average.

My take?  I would opt for a refund as close to zero as I can get, but that’s because I have student loans to pay and it’s easy to tack on that extra $250 to my highest interest loan.  I would much rather use that increased monthly income to cut down on the amount of lifetime interest I pay on those loans.  But I won’t shout down those people who like big refunds and spend it on positive financial actions such as paying off debt or increasing savings.  I will, however, shout at those people who spend that big refund on a vacation or consumer goods.  If that vacation was something you wanted to do anyway, just stash that money into an online savings account.  You’ll at least earn some interest on it and will be able to use it in case an emergency happens.

As usual, this discussion on a hot personal finance topic ends…inconclusively.  Though I would lean towards having a smaller refund so you can use that money on something positive throughout the year, it’s not a HUGE deal if you go the other way.  People can do stupid things with large amounts of money, so be very careful when you do get that nice refund.

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Filed Under: Investing, Money Savers, Student Loans

Say hello to the HSA

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Healthcare in America is controlled by all sorts of levers and dials.  From insurance premiums, doctor co-pays, hospital visits and costs of medicine, there can be a lot to remember.  There are also different types of accounts which the IRS allows us to fund tax free for our healthcare expenses.  Previously, I wrote about the Flexible Spending Account (FSA), which allows you to set aside a certain amount of money before taxes towards your healthcare expenses.  This is a great benefit for people who usually pay a lot for doctor visits and medications or have a planned procedure in the upcoming year.  These funds are gone at the end of the year, so you definitely have to plan accordingly.

Another type of account is the Health Savings Account (HSA), which is similar to the FSA in that you set aside some money before taxes for healthcare costs, but it is different because that money is yours for life because the account belongs to you, not to your company.  There are some other differences between the two accounts that are worth noting.  My company started offering HSA’s in 2013, but I didn’t sign up for it then because I didn’t fully understand it.  I signed up for it this year (specifically, I signed up for the health plan that ALLOWS me to sign up for an HSA), and am pretty excited about the possible benefits.

HSA’s are accounts you can sign up for in conjunction with so called “High Deductible Health Plans” (HDHP’s).    These insurance plans are being offered more and more lately and will probably become the norm in a few years.  These plans don’t pay for pretty much anything until you meet the deductible amount, which is higher than most other plans.  Hence the name.  For 2014, a plan with a deductible of at least $1,250 for single and $2,500 for family will qualify as an HDHP.  The plans promote and fully cover most annual visits, like your yearly physical and recommended exams for kids.  By promoting yearly “maintenance” exams, the hope is to bring healthcare costs down in the long term.  Time will tell if this works or not.

Once you sign up for one of these plans, which I recently did, you are eligible to sign up for an HSA.  Most companies have a certain bank’s HSA they are associated with and some will even contribute some money into your HSA if you decide to sign up with them.  If your company offers that, definitely sign up with them.  They will take care of setting aside your pre-tax money into the account along with depositing their portion.

For 2014, you can contribute a maximum of $3,330 for an individual and $6,550 for a family.  The portion your company may contribute counts towards this portion, which is different from a 401k company match as only YOUR contributions count towards the maximum.  You can contribute as little as you’d like or up to the maximum.  This money is yours and yours alone to use.  There is no “use it or lose it” rule and some accounts offer investment options or a small amount of interest paid.  This is a huge difference from FSA’s as you actually stand to benefit by leaving your money in the account to grow, rather than scrambling to spend it all in December.

HSA’s are very tax friendly.  They offer a triple whammy when it comes to tax advantages.  First, your money is set aside pre-tax, so you don’t pay any taxes on the money you contribute.  Second, as I mentioned before, some accounts have investment options or pay some interest.  Any gains from this grow tax free inside of your account.  Third, any money you decide to withdraw and use for eligible healthcare expenses is not taxed either.  As a bonus, if you have money in this account when you turn 65, you can use HSA money for ANYTHING, but you will have to pay income tax on it.  But no 20% penalty (ouch!) which you would get if you used the money for non eligible expenses before 65.  In a way, your HSA can serve as a kind of retirement account once you turn 65.

What’s an eligible expense with an HSA?  Doctor visits, surgeries and prescription medications.  You can also use it for glasses, contact lenses and dental work.  You can click on the IRS website for specifics.    You would want to use HSA for those expenses which count against your deductible, like doctor visits and medications.  Once you meet your deductible amount, your insurance plan will start to cover almost everything.

Many young people are hesitant to sign up for High deductible plans and HSA’s because of the perceived high cost of doctor visits.  True, you will probably pay more for a doctor visit on the new plan, but you will probably go to the doctor more when you get in your 50’s or 60’s than you will now.  So it’s a good idea to contribute as much as you can to your HSA while you’re young so you have the money later when you or a family member inevitably need more care.

HSA’s in conjunction with HDHP’s are definitely something to consider, as they are becoming more and more commonplace.  A lot of the plans under the Affordable Care Act are HDHP’s, so you will probably see private companies following suit.  Talk to your human resources department and weigh the benefits of your different plans to see if an HSA would be right for you.

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The most overlooked investment ever

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Very few things in life are a sure thing.  We invest to have more money for the future, but positive returns are not guaranteed.  We study as diligently as we can for that final exam, but we’re not assured to get an A.  We can set up a perfect business plan for the perfect product in the perfect location, but business is not always going to be booming.  We do all the things we do to get ahead, but not of the results are guaranteed.  All we can do is put ourselves in the best position possible to succeed.  And hopefully we will.

Looking at the title of this post, most people would guess that investing in yourself is probably the most overlooked investment.  We would think of things like learning a new language, taking an online course or just getting out of your comfort zone as great investments in yourself.  But an even more overlooked investment, and this should definitely be thought of as in an investment, is your health.  Without good health, literally nothing is possible.  Not being able to get out of bed or always feeling tired or sick can completely destroy any plans of self improvement you have made for yourself.  Your financial health is also tied to your physical health and longevity.  There are direct and indirect costs associated with your health.

Direct costs:  The direct costs are the obvious ones like health insurance premiums and doctor visits.  There is also the cost of medications and any surgeries needed.  These costs can really add up for chronic conditions as well.  In a study released by the American Diabetes Association, people diagnosed with diabetes have average medical expenses of $13,700.  That’s a lot of money to be spending every year.  Add to that the fact that many children are no being diagnosed with diabetes, and people will have to be paying a lot of money for a long time.  The opportunity cost of having to spend all that money on your health, however, can trump the actual cost.  All this money used to spend on diabetes, which for the most part is a preventable condition, could be used to increase savings or investments.  Direct health related costs can definitely be a huge burden on a family’s finances.

Indirect costs:  The indirect costs related to healthcare can sometimes be more alarming than the direct costs.  Indirect costs can include things like time lost from work, decreased productivity at work and loss of production due to dying early.  While these values are almost impossible to measure on an individual basis, the same study conducted by the ADA was able to estimate the effect on the US economy.  People missing work cost the country $5 billion.  Reduced productivity at work cost the country $20.8 billion.  The amount of money lost due to disability was $21.6 billion.  These are staggering numbers to look at based on the effect of only one disease.  The most productive people in the world jump out of bed and attack the day with all they can.  If you aren’t able to jump out of bed easily anymore or are tired and in pain most of the day, it is obvious that your productivity is going to drop.

Looking together at the direct and indirect costs of poor health, it becomes clear that having health issues can be a real financial strain.  As I said in the beginning of this post, nothing is guaranteed.  And that includes your health.  Athletes at the top of their game and in the best shape of their life can suddenly be diagnosed with diabetes.  A drive to the supermarket which we have made hundreds of times before can end up in a deadly accident.  A leisurely bike ride to help out health and stress levels can result in tragedy.  These types of things can happen but we shouldn’t worry about them because we can’t control them.  What we should worry about are doing the little things day after day that will allow us to be as healthy as possible, as long as possible.

Treating our health like an investment account will definitely pay great dividends down the road.  Having good health will allow us to avoid the direct and indirect costs of poor health, which can easily derail any financial plan.  More importantly, being healthy will allow you to be at your most productive and enjoy your life to the fullest.

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401(k)’s: Focus on what you can control

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I remember the day when I accepted my first real job as an optometrist.  There was a lot of excitement because I would finally be making some real money.  Also, I was kind of excited about having the ability to contribute to a 401k account.  I know, not the most traditional thing to get excited about when getting a new job, but a few months before is when I started reading personal finance books which all extolled the wonders of the 401k.  I read that it was the best retirement account around and had great tax advantages as well.  I had to wait 3 months on the job before being able to start contributing, so I used that time to read up on 401k’s and investing in general.

My all time favorite book on investing is The Bogleheads’ Guide to Investing, which expounds upon the investing ideas of John Bogle, the founder of Vanguard.  Vanguard heavily emphasizes the importance of low investment fees and simple asset allocation.  Meaning you shouldn’t pay a lot to invest your money and you shouldn’t have to think about it too often either.  I’m naturally a conservative person, so this mode of thinking is right up my alley.  I thoroughly enjoyed this book and took its values to heart.  After reading other great investment books like A Random Walk Down Wall Street and heeding the words of investment gurus such as Warren Buffett, I was comfortable with the ideas of simple asset allocation, low investment fees and buy and hold investing being the core of my investing strategy.

The 3 months were finally up, and I was able to create my account, look at the investment choices and start contributing!  After reading about something theoretically for a few months, you can’t wait to apply it no matter how mundane it might be.  After logging in I found out that our 401k plan had 33 investment choices.  Not too many but enough for some variety I suppose.  I looked at the 5 year returns of the various mutual funds and didn’t find anything great.  In fact, a lot of them had negative returns.  Why do most of these investments suck?  No matter I thought, as I already know from my research that past performance does not dictate future results.  It was only a couple of years back where we had the financial crisis so that was understandable as well.

Next, I checked what is arguably the most important aspect of keeping more of your own money when investing.  And that is fees!  I specifically checked the expense ratios of all the available funds.  I was surprised (once again) to see that the expense ratios were higher than I would have expected.  The lowest expense ratio was .5%, not bad but not near the Vanguard levels of .1-.3 I was accustomed to seeing.  Many of the funds had expense ratios above 1%, which is much higher than the Vanguard average (though it seems like every fund’s expense ratio is higher than the Vanguard average.)

On top of all that, there wasn’t a very wide variety of funds to choose from.  I learned all about large cap, mid cap, small cap, bonds, income etc.  The vast majority of the mutual funds were invested in domestic large cap funds with only a couple of bond funds.  The rest were target date funds with pretty high expense ratios.  Nothing seemed to be matching up to my idea of the perfect retirement account.

I eventually realized it’s not really worth it to stress about those factors I couldn’t control.  The firm that runs our company’s 401k was not one of my choosing and either were the investment options it contained.  This was all decided by my company’s HR department years ago and unfortunately there was not much I could do to change things.  This is the account my company offered and I had to make the best of it.  I had to focus on what I could control and simply forget about what I could not.  There are two main variables I could control which are also two of the most important variables for retirement success: contribution amount and investment fees.

I believe the best thing you can do with your retirement accounts is actually contribute to them.  I have talked with people who have 401k accounts available to them yet don’t contribute because of lack of knowledge on the subject or because they don’t want to take home a little less money.  The fact is, saving early and saving often is the most important factor contributing to a healthy retirement account.  Sure, investment returns are important, but the theme of this post are things you CAN control, and investment returns aren’t one of them.  Also, deciding to contribute 5% of your income doesn’t mean you take home 5% less money.  That 5% contribution is tax deferred, meaning you won’t pay taxes on it until you withdraw it decades from now.  What that means is if you decide to contribute $100 and you get taxed 30%, you’re actually only reducing your take home pay by $70 not $100, because that’s how much you would have gotten anyway after taxes.  Ideally, but in now way is this guaranteed, you will likely be paying less taxes when you retire so that tax bite shouldn’t be too bad.

Another factor that can guide your contribution amount is whether your company gives a matching contribution.  A “401k match” simply means your company will contribute to your retirement account up to a certain threshold, which is decided by the company.  A typical employee match is a 100% match up to a 3% contribution rate.  This means if a 3% contribution for you equals $1000, your company will contribute $1000 to your account as well.  This sounds like free money.  That’s because it is.  This is a great way to optimize your 401k contribution, as no other retirement accounts will give you extra money just for contributing.  If you can’t decide how much to contribute, contributing up to the match amount is a GREAT start.

The next most important thing you can control is the fees your investments charge.  All mutual funds are now required to clearly reveal their investment fees, so there is no excuse not to pay attention.  Now, while you can’t control what fees the investments charge, you can simply pick the investments with the lowest fees.  Lower fees mean no matter what your investment returns are, a lower percentage will be eaten up by the mutual fund company.  This may not be too big of a deal early on, but if you have a $50,000 account balance with a mutual fund that charges 1% for yearly maintenance, that’s $500 you lose.  A .5% charge means you lose $250.  And it gets more glaring the higher your balances get.  Fees matter, and choosing the investment options with the lowest fees is almost always a great move.

You’re not guaranteed to make money with a 401k.  In fact, you can lose money if you’re not careful.  Contributing an appropriate amount and keeping your fees low will not assure huge gains, but they certainly will help.  My parting advice is that even if your 401k is not the greatest, contributing up to the employer match amount and choosing low cost funds will be the best thing you ever did.  If you have some money left over you still want to invest, that is wonderful.  You can use it to invest with Vanguard and their awesome mutual funds with .1% expense ratios I read all about.  Which is exactly what I did.

 

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Filed Under: Investing

How to make your money work for you

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If you want to hire people to work for you, then you need a business of some sort.  However, even if you don’t yet have a business big enough to hire people, you can have employees work for you.  These employees work 24/7, don’t complain about parking spaces, and don’t leave the office microwave a mess.  They will work hard at any job you tell them to, and will try to get more of them to work for you.  Where do you find such ideal workers without outsourcing to a foreign country?  They are actually currently sitting in your wallet/purse and in your bank account.  These employees are your money that you work so hard to make.

“Make your money work for you” is a phrase that most people have heard but not many people do.  Getting a paycheck and using that money to pay for your expenses and nothing else is just going to keep you on the conveyer belt of consumption.  Putting some money aside in a savings account regularly is a great idea, but even that won’t make you money as the monster known as inflation will make that money less and less valuable over time.  To really make your money, well…make you money, you can put it to work into different types of accounts depending on what your goals are.

If your goal is to increase your retirement savings, there are some accounts that are great for that.  Assuming retirement is a few decades away for you, putting your money to work in a 401k would be a wise move.  If you don’t have one at your workplace or your 401k just isn’t that good, another option is an Individual Retirement Account (IRA).  There are many brokers that offer an IRA (Vanguard is my favorite one because of its low fees and ease of investing), but the important thing is to invest according to when you will need the money.  In general, the farther off retirement is, the more you should be invested in a broad array of stocks because stocks have a good chance of making you money in the long term.  If you need the money soon, then your money would probably be better off invested in “safer” investments such as bonds or money market accounts.  There are of course billions of variations in between, but you’re much better off following these general rules than not doing anything at all for retirement.

If your goal is to have some money for college expenses for your kids, a 529 plan would be a good place to start.  Most states offer their own 529 plans, and some give tax breaks for doing so.  The investments in 529 plans can be geared to the year your kids will be expected to start college.  If you start early on, it is easy to have a nice fund by the time the little guy or girl is going off to school.

Finally, if your goal is just to save up for a vacation or something else which is a year or two down the road, an online savings account is a good place to put your money.  The interest rate can be low for savings accounts, but the money made from interest is just a bonus as the main objective is to have a place to stash money to be used relatively soon.  A Certificate of Deposit (CD) account is also a good choice as they can offer slightly higher interest rates  as long as you don’t withdraw any money for a specified period of time (usually 1,3 or 5 years).

These are just some of the ways to make your money work for you.  If you give your money a job, such as saving for retirement or saving for a vacation, you can usually find a good place to put it to work.  Once you pay money for expenses like car insurance or a cell phone bill, that money is gone and can never work for you ever again.  If you can pry some money away from expenses and re-direct it to work for you, it will do you a world of good.

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Filed Under: Financial know how, Investing

Financial Commandment #2: Pay yourself first…and automate it!

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Paying yourself first is probably the most powerful and under utilized method to building real wealth.  The idea behind it is very simple.  Instead of paying all of your monthly bills and expenses and then putting the rest into savings, paying yourself first means you put some money into savings first and then pay whatever bills you have after.  This method just plain works because of two main reasons.  First, YOU decide how much money you want to save and then you adjust your expenses after that.  It can be empowering to decide your own savings rate and it is in sharp contrast to the first method where your bills and expenses dictate how much money you set aside.

The second reason paying yourself first works is related to Financial Commandment #1.  It literally forces you to live within your means because setting aside money for yourself as your first step ensures that money is not being used on something you may not need.  This is a surefire way to get out of debt and build real savings and wealth.  People can be very fickle creatures so the best way to make a habit out of spending less than you earn is to make it impossible to spend more in the first place.

Paying yourself first is an amazingly effective financial practice, but again humans can tend to revert back to old habits.  If paying yourself first is a relatively new practice, it can be tempting after the initial excitement to cut back a little bit on your savings rate.  The best way to avoid this is to pay yourself automatically.  This is very easy nowadays and here a a few ways to do just that:

Online savings accounts:  Most big banks will offer you a savings account in addition to their checking account.  You should avoid this because the interest rates on savings accounts from big banks are usually atrociously low and more importantly, it still makes your money easy to access.  Using an online savings account separate from your checking account is a much better idea because their interest rates are usually much higher (though not incredibly high as most online accounts pay around 1%), but also it creates an extra barrier against you from withdrawing that money on a whim.  Some great online savings accounts include Capital One 360, Ally, and American Express.

IRA:  Opening an IRA is easier than ever.  You can open one if you’re employed or self-employed.  I have had my Roth IRA with Vanguard for a few years now and it has been great.  They allow you to automatically contribute as much as you want and as often as you want.  They also have a very good selection of mutual funds which have very low fees.  It takes about 5 minutes to sign up and connect your bank account.  They also offer very good guidance as far as which mutual funds would be best for your situation.  Of course nothing is guaranteed with stocks or mutual funds, and there are key differences between traditional and Roth IRA’s which will be a subject of later posts, but for long term growth, it’s tough to beat a monthly IRA contribution.

401k:  A 401k can be a great way to automatically pay yourself.  Most 401k’s allow employers to take a pre-determined, and pre-tax, amount from your paycheck and put it into your account.  This is a great deal because it lowers your taxable income and since that money is automatically deducted from your paycheck, you’re not going to spend it.  There are some things to watch out for in 401k plans such as higher than normal fees and the fact that you have a limited selection of funds to choose from.  However, many companies offer a match on your contributions.  They vary among companies, but if you contribute 5% of your paycheck and your company matches the full 5%, that’s like getting a 100% return for free.  Not a bad deal at all.

These are the more popular ways to automatically pay yourself.  While you can just go and change your contribution amount even if you are doing monthly contributions, this extra step makes it a little tougher to do.  Automatic contributions are the best way to pay yourself first and grow your wealth.

Leave a comment below and share your favorite way to pay yourself first. 

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Filed Under: Financial Commandments, Financial know how, Investing

Should I invest with student loan debt?

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After graduating college or professional school, there are many things on a person’s mind.  When can I start working?  How much will my starting pay be?  My student loan debt is how much???  Investing is usually the furthest thing from a graduates mind.  Yet this could be a mistake as recent graduates have the most powerful investing tool on their side: time.

Time spent investing is one of the biggest contributors to investing successfully.  Compounding interest is your friend here, and the more time you give it to work, the more it will do for you.  This article at get Rich Slowly gives a nice visual aid in this point.  The bottom line is that waiting even 5 years before starting to invest can greatly effect your nest egg.  Even small contributions like $25 a month can be very helpful and provide you with a good point to start adding to as your financial situation improves.

Now that we know how important it is to invest early on, the questions becomes how to prioritize your investments versus your student loans.  The simple answer is to just look at the interest rates and compare them to possible rates of return.

I’m an advocate of making extra payments to any student loans above 6% before increasing your initial investment amount.  The reason I pick 6% is that paying off student loans early is a guaranteed return on investment.  Paying off a loan early means you won’t have to pay that interest rate on that extra money you paid, effectively giving you a future 6% return on investment.  Numbers vary depending on who you ask, but the historic return in any 25 year period of the stock market is around 7%, not counting taxes.  I’d rather take a guaranteed 6% return from paying off a student loan rather than a possible 7% return from investing in the stock market.

Using this 6% rule of thumb, or whatever rule works best for you, can make it a lot easier to determine when to pay off student loans early and when to invest.  The other advantage of paying off student loans early, especially if you’re close to eliminating one, is that it frees up more income for you.  Now depending on your financial situation, and the 6% rule of thumb, you can decide if you want to use that extra money to pay off another student loan or to increase your investing account.

Deciding when to pay off student loans and when to invest can be a pretty personal decision with many factors involved.  Leave a comment below and talk about your investing strategy while having student loan debt.

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Filed Under: Investing, Student Loans
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