The Lightning Round

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Thanks for all of the questions you submitted. Please know that I am always happy to try to help with any questions you may have, whether they are related to one of my posts or not. Now, without further ado, here are my responses to 5 questions submitted by readers just like you...

1. What’s the best way for my friend to handle a credit card with a big balance? She’s thinking about transferring the balance to another credit card with a lower interest rate. Is that a good idea? After she pays it off, should she close it? My friend read somewhere that it doesn’t matter as long as it’s not your oldest credit card. Thoughts?

- Becky                        

                         

The best and only way to eliminate credit card debt is to pay more than the minimum. Pack your lunch instead of going out with your co-workers, temporarily decrease your cable package, wait an extra week between nail appointments, or pass on joining that fantasy football league with the buy-in. You must do whatever it takes to pay more than the minimum payment or else the high interest rates can eat you alive! Other options that are often suggested to handle credit card debt include taking out a Home Equity Line of Credit (HELOC) to pay off the debt, temporarily borrowing from your 401(k) or retirement plan (if the plan allows it) to pay off the debt, or even transferring the debt to a different credit card with a lower interest rate. Given the right financial situation, these techniques could be effective and save you interest, but I would urge caution with all of these options because you are only “robbing Peter to pay Paul.” If your friend is going to transfer the balance to another credit card, she should make sure there is no fee for transferring the balance from another card that could negate any interest saved. Eliminating credit card debt should arguably be everyone’s first financial priority, because once the debt is gone, the money you would have otherwise spent to cover your debt and interest payments can easily be saved to build up your cash and establish a rainy day fund.

I don’t think closing a credit card account is necessarily a good idea unless you think that’s the only way to prevent yourself from going into credit card debt again. Using a few credit cards responsibly can be a good idea, and some cards offer worthwhile incentives and rewards, but stay away from opening up all the "take an additional 10% off today’s purchase" cards that you're always harassed about at the checkout counter. Having too many credit cards, closing too many credit card accounts, and not having credit card accounts with long histories can affect your credit. If you have a card that you don’t want or no longer need, I’d cut it up and put the pieces in several different trash cans to minimize identity theft, but I normally wouldn’t recommend closing the account. 

2. What exactly is income streaming, when should we look at turning it on, and should we worry about it “running out” before we want it to?

- Jill                              

When you say “income streaming,” I imagine you are talking about an annuity. An annuity is a financial product that, for an initial investment or series of investments, entitles an investor to a stream of payments or a lump sum in the future for anywhere from a set period of time up to life. The future payments can be fixed or variable depending on what type of product you have. The benefits of an annuity are that it is a way to defer income taxes and guarantee a stable stream of income in retirement. The drawbacks are that annuities frequently come with high fees, limited investment options, and surrender charges if you pull out money in the first several years.

As far as when you should turn it on, it really depends on your specific situation and what type of annuity you have. Regardless, don’t turn on an annuity before age 59 ½ as you could face a 10% early-withdrawal penalty like you do with other tax-deferred retirement plans. If you have a lifetime product, don’t be as concerned about outliving your income stream, but if you don't have a lifetime product, wait (if possible) until you feel like you actually need the additional income. Please note that annuitizing, or turning on the annuity, is often an irrevocable decision, so consider it carefully before you decide. You may also want to consider the potential benefits of cashing in the entire annuity and exploring other investment options that may have lower fees and offer more flexibility.

3. I enjoy reading your blog, but could you tell me a little more about what you actually do?
      

 - Brett                            

Thanks for the question, and I am happy to talk about what I do for a living. I am a financial planner and a CPA. I work for a wealth management firm in Buckhead. My daily responsibilities include examining and evaluating clients’ investment strategies, reviewing and analyzing clients’ current financial situations in comparison with their life goals, and considering clients’ estate plans (wills, powers of attorney, health care directives, trusts, etc.) to make sure they are maximizing their tax planning opportunities and setting themselves up to leave behind a legacy they would be proud of. I help people figure out how to send their kids to college, when they can retire with a lifestyle they will be happy with, and how they can give to charity in the most advantageous ways. I am a jack of many trades, but my goal, and the goal of my firm, is to relieve our clients of the burden of worrying about their finances by getting them on a financial plan or path where they can achieve all their goals and live in a sustainable manner. I chose to work for the firm I did because we know there is a lot more to financial planning than investment management and insurance, and because we don’t work for commissions. This allows me to look my clients in the eye and give them advice with them absolutely knowing that I am advising them with their best interests in mind, not my end-of-year bonus. If I can ever be of assistance to you or anyone else you know, please let me know.

4. I have read a lot recently about the Black-Scholes Model. Can you explain it? Do you use it?

 - Anonymous                  

I know the basics and am capable-enough to have a conversation with you about Black-Scholes, but I’m not sure I can completely explain it. It was derived by some gentlemen who are a lot smarter than me and no doubt had a lot more time on their hands, but here goes…

The Black-Scholes Option Pricing Model was developed in 1973 by Fischer Black and Myron Scholes and is considered by many to be one of the most important concepts in modern financial theory. The equation derives the implied price of European-style stock options by essentially using five variables: the current stock price, the exercise or strike price of the stock option, the time until the stock option expires or matures, the annual risk-free interest rate (usually considered the interest rate on a U.S. Treasury Bill), and the annualized volatility (fluctuation of the stock price) of the stock. The formula is quite frankly disgusting, and I will show you a simplified version here. I can, and have, worked the equation with Excel, but I don’t stand a chance with pencil and paper. Luckily, there are some online calculators that can help you as well, but you need to make sure you are confident in the variables you enter before you rely on the output!

The reason the Black-Scholes Model was so groundbreaking in the financial world (and the reason it won a Nobel Prize in Economics in 1997) was because it was a method that finally allowed everyone to mathematically estimate what the value of a stock option is. If, after running the Black-Scholes Model, the current stock price exceeds the implied stock value, it might be time for the stock option holder to strongly consider exercising the stock option. I know many people who sell their stock options as soon as they receive them, and I know many people who hold them dangerously close to the expiration date, but I don’t know many people who exercise them sometime in the middle. Black-Scholes is great, and I run it for clients from time to time to give them perspective, but let me offer two, much more simple theories of mine relative to stock options:

• Little pigs get fat and hogs get slaughtered- If your stock options are in the money (the current stock price is greater than your exercise price) by a fair amount, what are you waiting for? You can exercise the options and reinvest in a diversified portfolio that has much less risk and still has the opportunity to increase in value. Remember, if the stock price dips below your exercise price, your stock options are worthless.
• The time until your stock options expire is like a runway- If I’m trying to land a big jet, I want the longest runway possible for maximum flexibility and the opportunity to succeed, and I feel the same way about stock options. If you are a couple of years out from the options expiring, you have more control over your landing as you can consider tax implications and your current cash flow needs. Also, if your stock options are in the money, you can eliminate the worry and go ahead and receive some additional money you weren’t guaranteed to receive in the first place! Whereas, if you hold the options until they are a couple of weeks from expiring, you have given yourself a really small runway, and all I can say is that I hope the stock price is up for your sake. You shouldn’t rush pulling the trigger on stock options, but too many people go down with the ship by holding on until the bitter end.

5. I've got two for you... 1. Is it possible to roll a traditional 401(k) into a Roth 401(k)? If not, should I open another account but make it a Roth? I like the idea of paying my taxes now instead of watching them go up over time. 2. Can the second stage in your upcoming series include a couple of tips for just before you say "I do"? Good stuff!

 - Chad                            

I’m glad you’re thinking the way you are. Everyone is trying to figure out what taxes will be like going forward, but I’m beginning to believe more and more that the best-case scenario with the lowest tax rates is what we have now, regardless of what party is in power. If you share that belief, it means that you want to pay taxes now, not later; you want a Roth 401(k), not a Traditional 401(k). It is possible to roll a Traditional 401(k) into a Roth 401(k), but your ability to do that and exactly what avenues you will have to take to do that depend largely on your employer. At best, go ahead and try to combine your 401(k)s into a Roth 401(k), but realize you will have to pay income taxes now on the traditional portion you are rolling over. If your employer won’t let you do the Roth rollover, go ahead and try to combine your 401(k)s together for convenience sake, but know that your plan will have to keep up with the pre-tax (Traditional 401(k)) contributions and after-tax (Roth 401(k)) contributions separately. It is crucial that you make sure this consolidation is handled correctly in the beginning because you don’t want to have to go back and try to figure out how much tax you owe 20 or 30 years from now. For what it’s worth, I had a traditional 401(k) at my first job and rolled it into my new job’s 401(k). I did not convert the old 401(k) to a Roth, I just went with Roth 401(k) contributions going forward.

I love the idea for a post on some engagement or pre-marriage tips! I have actually thought about doing a post on ways to save money when planning a wedding, but I feared the nuclear fallout I might start between some of my bride-to-be readers and their fiancés. That being said, I will go ahead and offer a comment on one thing today that repeatedly bugs me: this mainstream idea that a guy is supposed to spend 3 months’ salary on an engagement ring. All I’ve got to say is that you should spend what you can and what you want to make the girl of your dreams say “Wow.” You don’t want her to ask you what bank you robbed. I know plenty of happy marriages with smaller rocks on the ring, and I know plenty of unhappy marriages or broken marriages with massive rocks on the ring. Getting engaged and married is not about ice sculptures, waterfall pictures, or exotic Venus Flytraps; getting married is about celebrating two people who have decided they want to be together for the rest of their lives.


Thanks again for all the questions. We’ll have another Lightning Round sometime soon!

-Tom

2 Much Cents Update

First of all, let me thank you if you are reading this. 2 Much Cents has gotten much bigger than I could have ever hoped or dreamed, and a large part of that has to do with the suggestions, opinions, and ideas I have received from readers like you. But we’re not done – we’re just getting started!

The reason for today’s post is to let you know about two exciting developments coming up on this blog: “The Lightning Round” and “Now What? Series.”

• The Lightning Round
• Between now and Friday night, August 31, 2012 at 11:59 p.m., I would appreciate it if you would send me any financial question you may have. Don’t worry, there is nothing too simple, and if you ask something out of my league, I’ll tell you that, too. I promise to eventually answer every question I receive, but I will post at least 5 of the questions with 5 answers next week. Whether you decide to submit a question or not, you will want to check it out because I can almost promise that someone out there has the same question, curiosity, or need that you do. Also, if you don’t want your question posted or if you would like to remain completely anonymous, please let me know when you ask your question (otherwise, your first name will appear in next week's post). Feel free to contact me by posting on this site, emailing me, calling me, Facebook messaging me, sending me a telegraph, or any other means of communication you can think of. This was a suggestion from one of my readers, and I think it could be a really good opportunity for me to learn what financial topics you would like to know more about. If it goes well, perhaps we’ll have a “Lightning Round” a couple of times a year.

• Now What? Series
• If you’re like me, you probably cringe when you hear a speaker, teacher, or preacher say they are going to start a series. Well, cringe away, but please hear me out. Also at the suggestion from one of my readers, I am going to offer general, how-to road maps for 5 different stages of life that I hope will help you achieve your financial and life goals. Over the next several weeks we will cover:
1. “You Graduated from College, Now What?”
2. “You Just Got Married, Now What?”
3. “You Just Had a Kid, Now What?”
4. “You’re an Empty-Nester, Now What?”
5. “You’re Retired, Now What?”
• Sure, I’m only a veteran of stages 1 and 2, but I have plenty of experience with clients, family, and friends in stages 3-5 that I’d like to share. If you find these how-to road maps helpful, I hope you’ll consider them in your life and pass them on to other people you know who might benefit from them.

Sorry if you were looking for financial advice today, but I wanted to give everyone a heads up for what is coming down the pipeline with 2 Much Cents. Tell you what, I’ll guarantee that the first person who sends me a question for next week will see their own question on “The Lightning Round” post.

Go ahead. I’m waiting…

Have a great week!

-Tom

Surviving Mayhem

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I like the one where your blind spot is personified. I also like the one where you get to be inside a deer’s head. My favorite one, though, is where they show how to disarm a good guard dog. Yes, I’m talking about the successful series of Allstate commercials, but more importantly, I’m telling you that Allstate is absolutely correct when they warn that “Mayhem is everywhere.” These commercials that you and I enjoy are only funny because the horrible things being shown aren’t happening to us. If they were happening to us and we were uninsured, or even underinsured, we wouldn’t be laughing near as hard.

With Allstate’s ominous warning in mind, let’s take a brief look at car insurance, homeowners insurance, and umbrella policies. This will by no means be an exhaustive or personalized analysis, but it should give you some things to consider to make sure that you and your family can survive whatever "mayhem" life throws your way.

• Car Insurance
• Everyone should have car insurance. Most states even require it. 
• Car insurance is frequently quoted like “50/100/50,” meaning you would be insured for $50,000 per bodily injury, up to $100,000 for total bodily injuries, and $50,000 for property damage. There is no magic set of numbers for me to suggest, but make sure you have a reasonable amount considering your assets. Going with a higher deductible will help keep your premiums reasonable and allow you to increase your coverage amount.
• You will likely want to have collision coverage (what you need when your car collides with another car or object) and comprehensive coverage (think theft, weather, anything but collision). You may also want to consider paying a little extra for uninsured or underinsured motorist coverage (coverage that will look out for you if it’s the other person’s fault, and they don’t have adequate insurance) if it’s not required in your state.
• One other topic to mention here is rental car insurance. Renters frequently go back and forth on whether they should agree to all those additional charges at the rent-a-car desk, but the answer is that you should do your homework before you travel. Many insurance policies and even credit cards already protect you and your rental car. Saying yes to whatever product the rental car agent is offering you could mean throwing away money towards duplicate coverage. Look at your policy or call your insurance/credit card company before your trip so you know what to say at the desk!
• Homeowners Insurance
• Everyone should have homeowners insurance. Your mortgage holder probably requires it, even though state law actually does not.
• You need to think about the value of your home, the value of your personal possessions in your home, and the potential for accidents that could occur in your home when you are considering what size and type of policy you will need. A good insurance agent will be able to help tailor a plan to your specific needs, but insuring your home for 80% or more of its market value or replacement value is not uncommon. In some cases, your insurer will require that you have insurance up to a certain percentage of your home’s value or else they will prorate payments to you in the event that some peril occurs. In English, if the insurance company requires you insure 80% of your home’s value and you only insure 60%, you can roughly expect to be reimbursed for only three-fourths (60% / 80%) worth of your claims!
• If you have a pool, are renting out your home, or have a specific item of particular value like an engagement ring or firearm, you may want to consider additional coverage or higher limits for those items under your policy.
• You want to always make sure your homeowners policy is adequate, but not excessive, so review it at least once a year as property values fluctuate. Just as with car insurance, going with about as high of a deductible as you can afford will help keep your premiums down. You may also want to go ahead and put in that security system you've been considering, as most insurance companies will give you a discount for adding this degree of protection to your home.
• Umbrella Policies
• Umbrella policies (sometimes called PUPs or Personal Umbrella Policies) are up there with sliced bread in my book. Put simply, you need one! These policies have large coverage amounts and are relatively inexpensive. They are usually sold in increments of $1 million.
• I know a $1 million insurance policy may sound crazy to some of you, but you can likely get this type of policy in conjunction with your car and homeowners policies for only a few hundred dollars more a year. The reason you should strongly consider an umbrella policy is because it is very easy for even the most careful person to underinsure a particular peril or inadvertently pass on a certain type of car or home coverage. It’s also possible that if you were sued, the liability could go way beyond your car and home coverage limits or even beyond your current assets if the judgment also applied to your future earnings. I really think it’s worth it if, for a few hundred dollars, you can almost completely erase your insurance risks and put your liability worries at ease!

I know this is a lot to consider, but protecting your and your family’s hard-earned assets is very important. You don’t tug on Superman’s cape. You don’t spit into the wind. You don’t pull the mask off that ol' Lone Ranger, and you don’t mess around with Mayhem!

-Tom

Passing On Your Digital Assets

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Your online billing accounts, PayPal account, Amazon account, Gmail account, Yahoo! account, the pictures on your desktop, your videos on YouTube, your blog, your Facebook, your Twitter, your LinkedIn... When you die, what is going to happen to your “digital assets?”

The current laws governing the treatment of digital assets are frequently unclear, and in most states, nonexistent. Many websites will not provide access to family members after the original user passes away, and those that do often require paperwork and death certificates. When most people pass away, nothing is going to happen to their digital assets, and that is probably not a good thing. Your digital assets need even more protection after you’re gone to protect your identity, to protect your financial assets, to protect your content, and most importantly, to protect your privacy.

By simply taking the time to create a master list of your accounts, usernames, passwords, and wishes, you can make sure that the angry e-mail you drafted but never sent stays your secret. By creating a central database on a memory stick and putting it in your safety deposit box, you can guarantee your Facebook page doesn’t show that picture of you in Vegas as a memorial forever. By telling your spouse the password to your Excel file that lists all your PINs, you can ensure your memoir doesn’t remain permanently inaccessible (like Leonard Bernstein’s is on his old computer). By using the secure services of one of the many “afterlife data companies,” or by following any of the other examples above, you can provide your executor or family members the information they need to fulfill your last digital wishes.

As our culture continues to become more information-driven, digital assets will become more personal and even more valuable. However you prefer to handle passing on your digital assets is up to you, but please develop a plan and keep it updated. If you don’t, it could be a “fatal error.”

- Tom

Good Idea, Bad Idea

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It kills me how complicated people try to make finances and investing. Spend less than you make, save and invest what you don’t spend, and if you want a higher standard of living, work more and have a little good luck. Sometimes, I feel that about covers it. Sure, there are conundrums like credit default swaps (there’s no link because trust me, you don’t want to know!), thoughtful considerations like how you are going to put your children through school, and big decisions like whether to take a lump sum payment or choose an annuity at retirement, but financial planning and investment strategies do not always have to be on the same playing field as nuclear physics!

Today, we are going back to the basics, as I’ll share with you a number of simple, yet not always obvious, financial truths. I’m going to borrow the always-funny, segment-filler “Good Idea Bad Idea” from Steven Spielberg’s animated series, Animaniacs, to talk about some prudent investment principles that everyone should at least consider. Here goes:

GOOD IDEA: Have 6 months to a year’s worth of living expenses in cash.
WHY: Having an adequate rainy day fund can be a lifesaver when something unexpected comes up, and can even give you an added sense of peace when the stock market is being unusually volatile.
POSSIBLY A BAD IDEA: Have 6 years’ worth of living expenses in cash.
WHY: Have you seen interest rates? Your rate of return on your CD or checking account is not going to keep up with inflation over time. If you don’t increase your returns by investing in some stocks and bonds, you will eventually lose spending power compared to others who did invest in stocks and bonds.

GOOD IDEA: Invest in Apple in January 2009 (around $100/share).
WHY: In hindsight, the stock was about to begin a 3-year climb to around $600/share.
POSSIBLY A BAD IDEA: Invest in Apple in August 2012 (around $600/share).
WHY: The stock might go up some more, but it might not. Either way, you’ve already missed most of the ride. Does investing in anything that has increased 6 times in value already really seem like a good idea? Ask some people who bought highly-appreciated real estate in 2006 and 2007 for their thoughts if you don’t believe my warning.

GOOD IDEA: Have a well-diversified portfolio with no individual stock holding greater than around 10%.
WHY: Enron, Worldcom, and Lehman Brothers. They went bust; your diversified portfolio would not have.
POSSIBLY A BAD IDEA: Invest heavily in one or only a few stock holdings, particularly if you have an emotional tie to the stock.
WHY: Enron, Worldcom, and Lehman Brothers. They went bust; your undiversified portfolio could as well, and I don’t care what company you’re talking about! Enron’s own employees couldn’t believe what did happen could have happened either.

GOOD IDEA: Fight the urge to make your investment portfolio more conservative (more bonds, less stocks) after a market downturn or sell-off.
WHY: You rode the elevator down, you might as well ride the elevator back up. After you recoup most of your losses, reevaluate your strategy if you can’t stomach the thought of living through another sell-off.
POSSIBLY A BAD IDEA: Panic at the bottom of a market downturn and exit the market or make your investment portfolio ultra-conservative.
WHY: You just got hammered. Why do you want to get hammered again by making fewer returns than everyone else when the market bounces back and gains positive momentum? Over the long term, it will bounce back.

Look, I could very well be wrong about holding a ton of cash, buying Apple, diversifying your portfolio, and changing strategies after a market downturn being bad ideas in your particular situation. However, to effectively invest over the long run, I really believe you need to focus on the tried and true rules, not the exceptions - even if they’re popular!

I hope you found some of my financial truths meaningful and will remember them in the future. In the epic cartoon-ending words of Porky Pig, “That’s all Folks!”

-Tom