The Lightning Round: Round 4

Credit: FreeDigitalPhotos.net

 

Thanks to all of you who submitted a question. Now, without further ado, here are my responses to five of your questions...

1.) I am looking at getting a new car, but I can’t decide how much I should spend. Do you have any tips?                                                                                                       
                                                                                                                                           - Hayley

How much to spend on a car or how much not to spend on a car, that is your question, and it’s a good one! Strictly financially speaking, I’d recommend you take a close look at your monthly income and your monthly expenses, and see how much extra cash flow you usually have on hand at the end of each month. Let’s say you find that number to be around $500. Then I would recommend you make sure you buy a car that allows you to have a monthly loan payment of less than $500. You should talk to the dealership or your local bank to see what kind of car loans and interest rates you could qualify for. That will help you calculate how much car you can probably afford to buy and still make financial progress month to month. If you are one of those people who saves up to buy a car and doesn’t need a loan, I’d recommend that you make sure you will have enough cash in the bank after your purchase to cover somewhere around three to six months’ worth of your living expenses.

 

Outside of the financial nuts and bolts, I would like to share a couple of other thoughts. First, it may not make sense to get a certain brand or a certain model if it costs a lot more than a very similar brand’s equivalent or the next best model. For example, my Jeep is a souped-up less expensive model that has almost everything the more expensive model has on it except the model name. Second, it may not make sense to go with a lesser brand or lesser model than you really want if you can afford it and the savings are only a few thousand dollars. A few thousand dollars is nothing to sneeze at, but if you will be driving your car for the next 10 years (like most people are these days) it might be nice to drive something you are excited about and proud of!

 

Please let me know if you would like to discuss this further or talk about your specific situation.

 

2. Other than a will, what are some other things someone can do to be prepared if they pass away?
                                                                                                                                        - M. Tyler

So often when someone passes away they leave behind a very large and time-consuming mess for their loved ones. This is not intentional, but throw in a few surprise accounts or insurance policies, a few calls to Social Security, and a house full of possessions, and a monumental task is often what heirs, and certainly the executor, inherit first!

Outside of a current and well-drafted will, there are a few things you can do. One, you can make sure you have your primary and contingent beneficiaries in place for any insurance policies, annuities, and retirement accounts you may have. Remember, this is critical, as beneficiary designations trump a will, and if there is no beneficiary designation in place, assets might not be distributed how you want or intend. Second, you can give away special possessions/heirlooms that are below the annual gift exemption ($14,000 for 2015) while you’re still alive to make sure they end up where you want them. You could also potentially direct the distribution of certain special possessions in writing after death as long as your will allows it (consult with your estate attorney to make sure you have the proper language). This can help reduce the chance that two sisters will be fighting over a plate “mother wanted them to have.” Third, having a list of who you want as pallbearers, who you want to officiate your services, what hymns you want sung, and what you would like your obituary to say can also be of great benefit and relief to your grieving survivors. Fourth, having a list of important people to contact in the event of your death with their applicable information can really help your family, too. Finally, selecting and prepaying for your burial/cremation arrangements can also ensure that you get what you want and you don’t create an immediate financial burden on your loved ones at the time of your passing.

I hope this is what you were looking for. Not a happy topic, but certainly one worth considering.

3. What do you think about what’s going on in Greece? Will the European Union last?
                                                                                                                                               - John

I’ll be happy to share some thoughts on this, but this is obviously just my opinion.

I forget exactly what I was reading or where I was, but someone once explained the Eurozone problems to me with a very powerful example that I’d like to now share with you. Essentially think about the United States, a union of states, versus the European Union (EU), a union of nations. If you were to stop and ask a stranger from Georgia and a stranger from North Carolina what they are, what would they tell you? They would probably both say they were Americans; not Georgians or North Carolinians. If you were to stop and ask a stranger from Germany and a stranger from France what they are, what would they tell you? The German would tell you he is a German, and the Frenchman would tell you he is French. See the difference? This is why I think the EU may always have some serious problems.

I think the situation with Greece is too far gone to be worked out unless the rest of the Eurozone just flat out forgives their debts. The Greeks are tired of the austerity measures, and the Germans are tired of loaning money to the Greeks. Greek and German politicians know this. They keep kicking the can down the road and putting band aid after band aid on the problem, but eventually I think there will be a “Grexit,” a humorous and witty term that many have already come up with for Greece’s eventual exit from the EU. I guess we'll have to wait and see what this next round of called Greek elections holds.

As far as the EU, there are a lot of powerful people and countries that really want this to work, so it may continue to exist for quite a while. Personally, as I read about the unemployment and economic contractions going on in other counties such as Spain, Italy, and Portugal, Greece looks a little like the first domino to me. I think Great Britain may have been very wise to have joined the political union, but to have stayed out of the currency union when they joined the EU. There are simply too many little economies and country-specific industries in play. That said, there are still high-quality and thriving companies in Europe, and some countries such as Germany are still doing very well. My best guess, however, is more political, economic, and currency storms are on the horizon. Stay tuned!

4. Are you worried about robo-advisors?               
                                                                                                                                   - Anonymous

A timely question, and one being discussed by many in my industry. For those of you not familiar with the term “robo-advisor,” a robo-advisor is an investment platform that allows an investor to have their portfolio managed online with little to no human intervention. Robo-advisor platforms, such as Betterment or Wealthfront, have made a splash in the brokerage industry by being less expensive, more user-friendly, and more interactive than most of the traditional investment management platforms offered by human advisors.

Am I worried about robo-advisors? Not really. I think their popularity may cause human advisors to step up their game, but as braggadocios as this may sound, I really don’t think a computer can do all that I do. Investment allocation is just a piece of what I help clients with (there’s also tax planning, cash flow planning, estate planning, insurance planning, scenario analysis, and lots of decisions where both finances and emotions both need to be considered), so I really don’t feel that threatened. I’m also very curious to see how robo-advisors do when we get a cyclical market downturn, and investors want to be reassured that the sky is not falling. I want to see what robo-advisors say when a client needs to decide whether to save for their children’s education or retirement. I want to see what robo-advisors say to a son trying to gain control of his late father’s account. If the robo-advisors’ support staffs start taking client calls – and I think they will have to – they will have to raise their prices, and suddenly, they won’t be so robo anymore!

I am also skeptical of robo-advisors because I’ve already seen some of their shortfalls first hand. For example, I had an individual bring me an account that they had elected to rebalance after every deposit. Well, with a little bit from each paycheck going into their account, that meant they rebalanced 24 times in a year, resulting in a lot of tiny, annoying, and tax-inefficient short-term capital gains having to be recognized at ordinary income tax rates. By selecting a friendly looking box to rebalance offered by the robo-advisor, this investor incurred additional trading fees, higher taxes, and a much more complicated tax return than was likely necessary. The investor meant well and knew it was prudent to rebalance his portfolio periodically, but any decent human advisor wouldn’t have allowed a portfolio to be rebalanced twice a month!

I may be in the minority of financial advisors out there who think this, but I’m sort of excited about robo-advisors. I think they can be a helpful tool so people invest sooner rather than later. I think they can make basic analytics more available to more people. I think their gadgets and apps will help modernize some of the ancient and confusing monthly statements being generated by large investment custodians. As a CPA who lived in the world of Turbo Tax and now a CFP in the world of robo-advisors, I welcome the technology and I encourage you to carefully try it, but my caring, easy-to-understand, and customized-to-working-with-you human self will still be ready to take your call when you need me!

5. What about you? What are you most worried about as far as your finances?                
                                                                                                                                    -Kristin

Hey now! I’ll be the one asking questions around here. Just kidding! Thanks for the question!

I’m worried about a lot of things. I’m worried about the new expenses my son just brought into my monthly budget. I’m worried about the mortgage my wife and I took on when we moved. I’m worried if we’re saving enough for retirement considering neither one of us has a job that offers a pension, and I’m less than bullish on the chance of us receiving any meaningful Social Security income by the time we qualify.

How do I sleep with those worries? We spend less than we make. We save as much as we can. By growing our family and buying a house we’ve made a bet on ourselves, and I have faith we can do it.
Sure, there will be hard times and bumps in the road, but I believe we can do it. And I might or might not have a pretty sophisticated financial progress spreadsheet somewhere...

If you build up an adequate rainy day fund, you adequately insure your family should there be an unexpected death, disability, long-term illness, or liability, and you have an adequate estate plan in place to execute your wishes and desires, there’s really not much left to do. Do the best you can, live below (or at least within) your means while still making memories and enjoying experiences, and carry on. Monitor your progress and adjust your strategy as necessary. That’s what I tell clients, and that’s what I do myself.

Still, I do savor diaper coupons, I can’t wait to be debt-free, and I’m not above picking up pennies in the parking lot (heads or tails).

Thanks again for all the questions. Remember, our series on “Normal Investors” starts next week. I hope you’ll check it out because I’d be willing to bet that there is a pretty good chance you aren’t as normal as you might think. Just saying!

-Tom

Compounding – The Good, The Bad, and The Ugly

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• If you were to invest $5,000 per year for 30 years in a portfolio that averaged 5% per year, you’d end up with around $332,000.
• If you were to invest $5,000 per year for 30 years in a portfolio that averaged 6% per year, you’d end up with around $395,000. 
• If you were to invest $6,000 per year for 30 years in a portfolio that averaged 5% per year, you’d end up with around $399,000. 
• If you were to invest $6,000 per year for 30 years in a portfolio that averaged 6% per year, you’d end up with around $474,000. 

That’s the “miracle” of compounding. Sure, investment returns matter a lot, but as you can see from the examples above, how much you save can matter even more! The good part about compounding savings and investment returns is that slow and steady really can win the asset accumulation race in a big way. You might not think you could ever save up $474,000, but do you think you could save $6,000 this year?

 

Recently my wife and I have been looking at houses, and nothing gives me more indigestion than looking at how much a house costs. I’m not talking about the sticker price; I’m talking about how much a house costs over the life of a mortgage. For those of you who have bought a house, this is usually the number that shows up in the top, right-hand corner of one of your loan documents indicating the total amount expected to be paid over the life of the loan. Once interest is baked in on a thirty-year loan, it’s horrifying to see the difference between the initial sales price and what you will actually end up paying. Interest payments alone could be in the hundreds of thousands of dollars! The bad part about compounding interest on a home loan, car loan, student loan, and certainly credit cards is that you keep trying to pay off principal, but you keep getting charged interest. It’s like you have a hole in your bucket. I’ve tried Pepcid, Pepto, and Tums, and the only thing that seems to work is paying off more debt at a faster pace.

 

The ugly part of compounding has to do with the relationship between money and purchasing power. If you have $100,000 in cash and you bury it in the backyard, when you dig it back up, what do you have? That’s right, $100,000. The problem is that while your money was safely hiding underground, there’s a pretty good chance that the cost of goods and services went up (inflation). Think groceries, health care, and education expenses. You might still have the same amount of money, but you are actually poorer than you were because you can no longer buy as many goods and services as you used to since they are now at a higher price. Said another way, your purchasing power has gone down. I don’t see a lot of people burying money in their backyards, but I do see people hold on to exorbitant amounts of cash or an alarming amount of low-interest CDs and bonds. I don’t ever want to take away someone’s “cash blanket,” and I firmly believe that bonds have a place in most people’s investment portfolios to help provide for short-term liquidity needs, reduce overall volatility, and act as an income-producing alternative to stocks. However, just like chocolate cake, too much can be a bad thing. If you have too much invested in cash, CDs, or bonds, your minimal investment returns can lag the rate of inflation, and, compounded over time, you can lose purchasing power even if your assets are slightly growing or staying about the same.

 

That’s the good, the bad, and the ugly truths about compounding.

 

-Tom

 

How to Fix Your Credit

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I know a lot of good people with not-so-good credit. Most people who ask me how to improve their credit are not repeat offenders. They had an emergency, they decided to take a big trip, or they got a little carried away with their first credit cards. Still, some people have serious, recurring credit problems and are headed in the wrong direction. In this post, I'd like to share five tips on how you can right the ship and start improving your credit once and for all.

1. We’ll call this “1(a),” as in order to have credit at all (good or bad), you need to have used credit. If you don’t have a credit card, get one. The sooner you start wisely using a credit card and paying it off every month, the longer your credit history will be. The longer your credit history is good, the higher your credit score, which will help you get the most favorable terms when it comes time to buy that house or car. If you’re solely focused on trying to improve your credit score, you might even consider using your oldest card (the one you’ve had the longest) over your newer ones.
2. Pay off what you owe every month! If you have a mortgage payment or a car loan payment due, at least pay what is due. If you have a credit card bill, don’t just pay the minimum - pay it all off! If you can’t pay it all off, I understand, but you really need to spend less next month so you can pay it off then. Building up credit card debt doesn’t usually end well, trust me.
3. Even if you can comfortably pay off your credit card every month, try to pay it off before it gets near its limit, even if that means making payments several times a month. Some people have low limits (and some people want low limits, which isn’t a bad thing), but believe it or not, letting your credit card bill rise to near its maximum allowable limit can have negative consequences for your credit score.
4. Long-term debt can help. Associated with a long, good credit history is often the steady reduction of student loans, car loans, mortgages, and home equity lines of credit. Steady, recurring payments (with a little extra principal every now and then) are really one of the best things you can do to improve your credit score. Now I’m not suggesting you go take out a huge thirty-year note on a line of credit in the name of boosting your credit score, but I am saying that by steadily paying your long-term debts you are literally showing other lenders that you would likely be a good steward of any funds they lend you in the future.
5. I’ve mentioned this in previous posts (The Best Home Loan You Could Possibly Hope For and TARGETed to cite a few), but you really should check your credit reports from time to time at annualcreditreport.com. You can check your credit once a year with all three credit bureaus for free if you like, but I also like the strategy of people who check their reports with a different bureau each year, and they just rotate to make the task seem less daunting (unless they find an error and then they check with all three bureaus). I would suggest that you check your credit reports at least every several years, but definitely before you buy a car or take on a mortgage. When you get your credit report, you’re looking for errors, to make sure all the types and forms of credit you are using are listed, and to make sure the limits on each type of credit are up-to-date. While we’re not usually talking massive improvements to your credit score, correcting the fact that you made your October 2013 payment on time and that your Visa actually has a $10,000 limit instead of your initial $5,000 limit can only help. If you find an error, here’s a helpful site listing tips and contact information for the three credit bureaus provided by the Consumer Financial Protection Bureau.

Your credit score can range from around 350 to 850, and anything above a 720 or so is usually considered pretty good. Now just like Rome, your credit score cannot be built (or improved) in a day, but unlike Rome, it can be destroyed pretty quickly. Credit reports usually go back about seven years, so unless you find and correct a serious error or two on your credit report, there really aren’t any “silver bullets” (contrary to what some billboards and late-night commercials will try to tell you). If you’ve done a good job handling your debts and you have a great credit score, keep up the good work. If you’ve had some struggles with credit cards and being able to make payments on all of your debts, I’d encourage you to implement these tips and simply do better going forward. As they say, time heals wounds...and credit scores!

 

-Tom

Dealing with Debt

Credit: Stuart Miles

One of the most common questions I receive is about paying down debt. If you only have one debt, be it a student loan, a car loan, or a home loan, it’s pretty easy: make the monthly payments and pay a little extra when you can until you don’t owe any more. Paying off that loan will remove a recurring, fixed expense from your monthly cash flow, eliminate your interest expense, and free up some more cash for you to save or invest. However, if you have multiple debts, things can get a little more interesting…

Let’s say you have a car loan for $15,000 at a 4.5% interest rate and a $200,000 mortgage at 4.75%. What should you do? Any financial advisor with any sense at all would encourage you to make the minimum payments on both of your personal liabilities at the very least, but if you ask some of the great financial minds out there which debt you should focus on beyond your minimum payments should you have a little extra cash lying around, you would probably start hearing conflicting answers. What I mean, is that from a longer-term point of view, you should always attack the debt with the higher (or highest) interest rate to maximize your net worth, but from a shorter-term point of view, you should probably go ahead and pay off the smaller (or smallest) debt to lower your fixed expenses a little bit and take some pressure off your cash flow. Every case is different, but if the interest rates of the two debts you are trying to decide between paying more towards are very close AND the amount owed on one of them is significantly smaller than the other one, I’d usually recommend you go ahead and eliminate the smaller debt. The interest rate savings you are giving up are most likely minimal compared to the satisfaction you will feel and progress you will see by eliminating a debt.

Credit card debt is often another matter entirely. Let’s say you have six credit cards with balances on them that you can’t pay off at the end of the month. What do you do? First, read this blog more often, and unless you find yourself in a really, really bad situation, don’t ever rack up a credit card bill you can’t completely pay off at the end of the month! Just say no! Seriously though, what should you do? I’d get a sheet of notebook paper and write down the name of each credit card, the balance you have worked up, the interest rate you will be charged, the minimum payment due, and the maximum credit limit of each card. Make a nice little chart if you like. Either way, I’d advise you to make minimum payments on all of them and then go after whichever credit card has the highest interest rate regardless of the balance you owe. Credit card interest rates have teeth and fangs, so when we’re talking 15% to 25% interest rates or higher, you should really focus on stopping the “interest rate bleeding” as quickly as you can. One other thing probably worth mentioning is that if you have some credit left on some of the cards with lower interest rates, you could potentially take advantage of that remaining credit and try to pay down (or pay off) some of the cards with higher interest rates if your particular credit card(s) will allow you to do so. It’s a creative approach, and you’d need to be careful, but it could work and save you some interest. If you actually resort to this tactic, don’t just pat yourself on the back: go get a pair of scissors and cut that paid-off credit card down its back!

Everyone with debt is in a different financial position with different cash flows and different assets at their disposal, so my proposed debt reduction strategy is not always the same. Whatever path I advise, or more importantly, whatever path you choose to take, I encourage you to take that “freed-up” cash you have every time you pay off a debt and go ahead and put it towards paying down your next debt. This practice is often referred to as a “snowball,” and if you hold true to this strategy, you can really pick up some momentum towards becoming debt-free. 

Almost everyone has debt or has had debt. Please don’t hesitate to let me know if I can help you come up with a plan tailored to deal with your debt.

-Tom

A New Car! ...or Not?

Credit: M - Pics

You can acquire a car in lots of different ways. Some people buy with cash, some people buy with credit cards, some people buy with the help of an auto loan, some people lease, and some people even steal. Not many of us will ever be fortunate enough to win a game show and just walk away with a car. So, one of my wife’s friends asked what’s the best way to acquire a personal mode of transportation? Well, it depends - on your lifestyle and time frame, on your available assets, and on your “craftiness” at the dealership or car lot. Let’s take a look at how to best get that sweet ride.

Do you have to have the latest and greatest vehicle out there? Do you want to have a new car every 3 or 4 years once that new smell wears off? Are you just looking for a reliable form of transportation for the next decade?  As long as you are financially capable, these lifestyle preferences are neither right nor wrong, but you should at least consider their financial implications.

• Leasing: If changing cars frequently is important to you, then you should consider leasing due to the lower monthly payments and lower probable maintenance costs, but you should also recognize that you will always have a car payment.
• Buying: If you are planning on keeping the car for most of its life or paying towards owning something is important to you, then you should consider buying a car.
• Buying Used: A used car will have a lower price, will depreciate in value at a slower rate, and will have less expensive auto insurance, but it could potentially have more maintenance costs since you would have a limited warranty at best and cannot know what the car has actually been though.
• Buying New: A new car will have a higher price, will start depreciating in value quickly, and will have more expensive auto insurance. A new car will come with a longer term warranty, and like buying a used car, you will eventually own it.

Assuming your car lasts, buying your vehicle eventually means no monthly payments; just gas and maintenance expenses and the ability to sell something you own. Still don’t know whether to lease, buy-used, or buy-new? Let’s consider a car’s true cost and then your available assets.

A car does not cost what the vibrant-colored numerals say on the windshield, and it does not cost what the seller or dealer initially tells you it will. A car will actually cost you the sticker price plus sales tax (probably 5-8%), plus the price of any options or add-ons you may have agreed to, plus the interest you pay over time if you do not buy the car outright. You also will now have to acquire additional auto insurance, pay for gasoline, and be able to afford regular and unplanned maintenance. Now that’s too many variables for me to give you a useful numerical example, but the bottom line is, you need to estimate all the initial and monthly costs of a new car and look at your monthly cash flow and savings. If you see that the new expenses will cause your monthly cash flow to become negative or your current assets to start declining, you need to look at a less expensive new car, consider used cars, or consider leasing. You can save up and get that car you have always wanted next time, without straining or destroying your financial health this time!

Finally, assuming you have decided to buy a car, used or new, here are a few tips on how to get the best deal:

• Do some research and know what kind of car you want before you go shopping.
• Know what options and upgrades are available and what you want before you go shopping. Do not waiver on your decision when you start shopping.
• Do some research and know how much the Manufacturer’s Suggested Retail Price (MSRP) is. This empowers you when the seller is telling you what a good deal you are getting.
• Check your credit score and ensure that the reports are accurate before you go shopping.
• Go to your bank and consider getting pre-approved for a car loan. This gives you an idea of how expensive of a car you can afford, what your monthly payments would be, and what your interest rate would be. This not only helps you decide how best to acquire a vehicle, but it also acts as a safety net and point of reference when negotiating financing with the seller. You hold the cards. See if the seller can beat or match your bank’s offer.
• Plan when you shop. The end of the year when new models are arriving, the end of the month when sales quotas may not have been met, and even rainy days when no one else is buying a car are supposedly the best times to get a deal.

I hope this helps. Happy shopping!

-Tom