The most difficult financial challenge for young adults: Buying their first home

By BOB CUNNINGHAM

We can save and invest, eliminate all our debt – especially those nasty and unproductive credit card payments – and engage in activities to increase our income.

But when and how do we go about buying a house?

That’s pretty much what many young adults and families are asking these days. As personal finance education continues to be more and more commonplace, the one major component that is often missing is information about how – and when – to secure that elusive first abode.

Signing a rental agreement is easy.  Loan and escrow documents? Not so much.

I’d love to be able to write in this space that the process for buying a home doesn’t have to be challenging or complicated.  But in fact, it usually is because there are so many variables, from qualifying for a mortgage to saving for a down payment, to covering closing costs, and more.

It can be intimidating.

Still, millions buy their first homes every year, so it is certainly doable.  Here, then, is a summary of steps that can allow you to get from your apartment or parents’ basement to a residence you can legitimately call your own:

1) Commit to the process. You can’t buy a home “half-way,” or realistically just give it a try.  You have to want it, and even more importantly, understand what has to be done and sacrificed to get it.

While there are numerous first-time buyer programs that really do open barriers which otherwise might be nearly impossible to overcome (try being in your 20’s and having to save up 10% or even 20% for a down payment on a $150,000 home), it’s never going to be free to get into a home purchase.  The most common avenue, via the Federal Housing Administration (FHA) first-time buyer program, generally requires a 3% down payment and escrow closing costs.  On the aforementioned $150K house, you’re still looking at about $8,000 out of pocket before you pack a single box.

Hey, Mom and Dad… got a question for ya.  Oh, and have I said ‘I love you’ yet today?  I sure do!

Realistically, even if your parents are willing to help, you’re going to have come up with some scratch.  Let’s say you need $5K on your own.  At $300-400 a month saved, a lot for most people in this category, it will be well more than a year from when you first decide to go for it that you will be able to come up with enough.  Are you TRULY willing to be disciplined and save on that level in order to make this happen?  If not, keep on writin’ those rent checks.

2) Learn and understand what’s involved in owning versus renting, benefits and pitfalls. Sure, when you own you’re buying something that is yours, that typically appreciates in value, and that you can eventually sell.  You can also write off the mortgage interest on your income taxes (unless proposed tax code changes eliminate that – a step that is unlikely except perhaps for the largest jumbo mortgages). Rent money is, by most accounts, squandered money.

On the other hand… and there’s always an other hand… renting doesn’t require you to buy homeowners insurance or pay property taxes, the two of which often cost an additional 15-20% on top of the principal and interest on your mortgage.  And while it’s true that you can do almost anything to a home you’re buying in terms of improvements, if something breaks it’s up to you pay for the repairs.  When you rent, you can generally just call the landlord and the problem will (should) get resolved without any cost to you.

3) Avoid setting your sights too high on your first home.  Oh, but how it would be cool to have an extra bedroom for my man-cave, a pool and hot tub in back, and wrought iron fencing all around with gated entry.  Our palace!

Truth is, you’re probably looking initially at a cookie-cutter, tract 3-bedroom with few luxuries.  You have to crawl before you walk, and walk before you run, etc. I’m fascinated by the advice I read in nationally-recognized publications and websites that suggests finding a suitable home first, then locating the financing to make it happen.  That’s exactly backwards.

As a first-time buyer, you need to determine the maximum monthly payment that you can afford on your current budget, including principal and interest, taxes and insurance (PITI in real estate lingo), AND THEN SUBTRACT AT LEAST 10% FROM THAT FIGURE.  Give yourself some wiggle room.  If you feel like your budget allows for a $1,600 payment (on a traditional 30-year mortgage), limit yourself to a max of $1,440.  There are numerous unforeseen issues that can quickly drain your housing budget.

And make sure you’re realistic as you establish that initial budget.  If your current rent is $1,000 a month, for instance, and you’re unable to save more than $100 or so monthly, where the heck are you going to get that extra $340 every month when you buy?

(By the way, be sure you don’t attempt to qualify for a 15-year mortgage on this first home purchase, even if you can afford the big payment.  Yes, the interest rate for such a loan would be slightly lower, but you’d be backing yourself into the corner of a much larger minimum payment.  Get the 30-year loan, and if you wish and can swing it, pad your payments (check with the lender for the proper way to assure your extra money goes toward the principal balance and that there no pre-payment penalties) or make a half-payment every other week as a strategy to accelerate payoff.  This latter method results in the equivalent of 13 monthly payments in a year, not 12, and cut a 30-year term to less than 23 years.)

After… and only AFTER you determine what you can truly afford to pay monthly, do you set out to find a home.  Determine with your real estate agent (always use one to help you buy – the seller generally will cover his or her commission at the close of the sale) how much you can finance to wind up at the payment you seek.  Work backwards, remembering to factor in your initial up-front costs.  Ultimately, if done correctly, you’ll conclude that the most you can offer is, for example, $165,000.  STICK TO THIS MAX. DO NOT EXCEED.

4) Interview real estate agents and select one to represent you. Don’t just go with the first person you talk to.  Some buying agents really hustle and seek out the best home for your particular situation, while others will focus only on their own listings or those from another agent in the same office, trying to maximize their commission.

In fact, instruct your agent that you do not want to consider any homes which are listings from that agent or that office. If they agree without hesitation, you may very well have a keeper.  Otherwise, move on.  You can always relax that requirement a week or two later if you’re convinced the agent is truly working to represent your best interests.

If you can, try to avoid a buyer representatative agreement.  If you sign one, the agent will be eligible to receive a full share of the commission even if you end up finding the desired home on your own.  Understand, though, that if you find the home but utilize the agent to help you navigate the buying process, have the agent put in your offer, etc., that the agent is entitled to be paid if you, indeed, buy the home and close escrow.

When working with the agent, be specific (and realistic) about what you’re looking for, and stick to your guns.  Be open-minded, but direct.  If you inform your agent that the home must have three bedrooms, and he or she tries to steer you to a 2-bedroom because “it’s a steal,” inform the agent that you have set your parameters and you expect them to be met.

5) If you feel confident about the situation, go for it.  Otherwise, don’t.  Buying a home is, obviously, a major commitment.  If you have reservations about the home you’ve picked, or your agent, or any other variable in the process, take a step back and re-evaluate.  There’s no pressure here.  You’re in charge.

Once you’ve satisfied every facet, and you find yourself excited about the prospect of buying and moving into the home you’ve chosen, have your agent make the offer – ideally, 5-10% below the asking price or your pre-determined maximum price, whichever is lower – and, to repeat, stick to your game-plan.  NEVER let emotions affect your strategy, or be visible to sellers.

Follow these fundamental steps, and the result will be a truly satisfying process.  And if you have to soak in a blow-up kiddie pool in your new backyard until you can reasonably afford to move up in house enough to have a legit party pad with spa tub, accept that… and set your new goals for the upgraded digs, when the timing makes sense.

Once again, I thank you for reading.

***

DISCLAIMER:  This post represents the author’s opinions only.  In no way should any part of the content of this post be interpreted as official financial advice, nor does it represent an intention to solicit readers into a specific company or investment.  Results are never guaranteed.  Utilize the information as you see fit, make all money decisions at your own risk.

In money management, there’s a difference between automation and auto-pilot

By BOB CUNNINGHAM

My son is the worst about it of anyone I know.  You’d think that, being his old man writes about smart money management on a regular basis, he would be averse to such bad habits.  Nope.  Instead, he swipes or inserts his debit card to pay for things… and whatever balance his bank shows in his account at any given time – if and when he bothers to check – must be correct.

This folks, is referred to as money management on auto-pilot.  It’s not recommended.

In a neo-technical society, automation can be a great thing.  Banking apps are all the rage – just snap a photo of the check you want to deposit, complete a couple of clicks, and just like that you have made a deposit.  No need to venture out and walk up to an ATM, deal with a drive-thru, or (perish the very thought of it!) stand in line inside a branch.

But often, people confuse utilizing modern-day tools to assist noble efforts with a hands-off approach that, quite honestly, is just begging for problems.

You need to be on top of your money, gang.

So here is a quick breakdown of how you can utilize automation to your benefit, and what you should be willing to take the extra time required to do just to make sure you really are engaging in intelligent money management.

Use on-line banking…

Why wouldn’t you?  Like the trash-talking big guy proclaimed in the film, White Men Can’t Jump, to explain his sudden departure from the basketball court in the middle of a 2-on-2 tournament game he and his partner were dominating, “This is too easy!”

On-line banking allows you to quickly check your balance, see transactions, and the Bill-Paying feature lets you set up recurring payments on bills which are the same amount every month, such as your mortgage and car payments. You can also sign up directly with the vendor to get regular alerts for how much your bill is and when it’s due (ideal for utilities, for instance), go to your bill-pay page, and authorize payment in less than 30 seconds.

… But monitor it regularly

I go to my bank’s on-line site at least 3-4 times per week.  No, it isn’t because I’m obsessed with seeing a large balance.  Trust me, that isn’t applicable… not because my wife and I are poor – we’re doing fine – but because my regular bank account is used for paying bills and everyday expenses.  The bulk of our assets are located elsewhere, where they can earn a respectable rate of return.

I go there because I want to safeguard against two things – errors and oversights.  Errors are when someone charges you erroneously, or there is an error on the bank’s end (very rare, I have found).  Oversights are when it’s my fault – a charge I didn’t remember to account for, or perhaps a subscription auto-renew that I forgot about or didn’t want.

Simply put, I want to make sure the amount of money shown in our account is what should be shown.  Typically, the quicker mistakes are discovered, the easier they are to remedy.

Have your paychecks direct-deposited…

Many banks offer small incentives for agreeing to have your paychecks directly deposited regularly.  The perks can be fee-free basic accounts, discounts on loan rates, small cash-back considerations, even tangible gifts.  Nothing cozier than watching TV draped in a blanket with “Bank of Cucamonga” emblazoned.

Yeah, I’m kidding about the blanket.  Still, it is more convenient not to have to worry about physically possessing your check, getting to the bank to deposit it or cash it, etc.

…But know what’s being withheld from your net pay and why.

Don’t trust your employer with getting it right.  Be sure you concur with what is being withheld, how many hours you were credited with working, even the pay rate itself.  My other son recently took a new job, only to find out that he was being paid 75 cents an hour less than he thought he was promised.  And of course, he didn’t notice this until about a month in, making a correction (and retroactive reimbursement) more difficult to request and obtain.

Pay Yourself First:  Have money from your check sent directly to an investment account…

One of the oldest adages in personal finance, discussed numerous times on this site. “Pay yourself first” means that you set aside funds for savings before you pay any bills or cover any other expenses.  It assures you save, regardless of circumstances, which is especially critical when you are first starting out and have the maximum time to take advantage of the amazing principle of compound interest.

…And monitor your  balance to assure full credit and growth

Again, don’t trust that the powers that be will get everything right.  I once had a life insurance policy, for which I sent in a contribution toward what is referred to as a “payed-up additions rider,” which allows for growing your cash value more quickly provided you stay within certain parameters.  The insurance company mistakenly credited the payment toward a small policy loan balance I had, that I had just taken and wasn’t yet willing to pay on.

The error wasn’t a big deal, and was easily corrected by the company, but had I not caught it, it would have ultimately cost me money in the form of lost compounding on the funds which never would have reached my desired destination.

By all means, utilize the great modern technology available to us whenever you can, and it makes sense to you.  But whether you go old-school or new-tool, be “accountable” every step of the way.  Pun intended.

Thanks, as always, for reading.

***

DISCLAIMER:  This post represents the author’s opinions only.  In no way should any part of the content of this post be interpreted as official financial advice, nor does it represent an intention to solicit readers into a specific company or investment.  Results are never guaranteed.  Utilize the information as you see fit, make all money decisions at your own risk.

Ultimately, it’s all about retirement

By BOB CUNNINGHAM

On this website, and hundreds of others like it that I read and monitor, we talk about practically anything that has to do with money/personal finance.  And we should… there’s a helluva lot to cover about the subject.

But what it all boils down to, whether you’re in your 50s or half of that, is preparing for the “Big R.”  What proactive steps are you taking, now and in the near future, to properly prepare for retirement?

So let me ask you, is that what we should really focus on ad nauseum?

While planning for the long-term future is certainly important, I contend that excelling in the short-term, including the ‘now,’ is at least equally vital.  In fact, one often facilitates the other.

Maximizing your efficiency in saving and investing now, logically, will result in you having more money to work with later.

Let’s take a quick look at why planning for retirement has become such big business, cliff notes version.  You ready?  It’s because virtually all private companies have deserted the traditional pension system in favor of a 401K/IRA-led way of saving for one’s own career conclusion.  And, many public and government agencies appear headed in the same direction.

Sure… just save some money with your company in its 401K, or do it on your own with an Individual Retirement Account, combine those with the scraps that are our social security payouts – assuming those rates stay where they are now – and you’ll be set.  Who needs a big, fat monthly pension check when the S&P 500 historically averages a 10% annual return?

I’m tellin’ ya, it’s bananas.  And yet our society has fully accepted this monumental shift in monetary focus.  But what people fail to properly gauge is that, while $500,000 in a retirement account may sound like a butt-load of money, it is in fact barely enough to keep a retired couple above the poverty line.

Undoubtedly, you’ve heard that experts traditionally recommend drawing down your nest-egg at about 4% per year, so that you can live while retaining the full balance of your primary account.  In other words, if you start with $500,000, and want to leave a legacy, you should take annual withdrawals from that account of no more than 4%.

Really?  Hmmm… let’s see how that might play out.

Let’s say you’re an average wage-earner in the U.S., about to retire.  Your household income, says Betterment.com, is about $68,000 a year gross.  That’s roughly $50,000 net spendable money after taxes.

If you expect to maintain the same standard of living you’ve become accustomed to, you would have to have about $1.25 million saved.  And that’s not even considering the erosion caused by inflation.  At a 3 percent inflation rate, $50,000 of net spending power becomes just $25,000 in about 24 years, which is roughly the average length of retirement nowadays.

Of course, you can always sacrifice your kids’ inheritance and spend down your money – in fact, I think you should because it’s your money.  But try making $500,000 last 24 years when you’re taking $68,000 withdrawals on a taxable account.  According to calculators on the BankRate.com website, do that and you will be out of money in less than 15 years.

Your retirement account is a Roth IRA?  Cool.  No taxation on the withdrawals.  But with $50,000 annual withdrawals and inflation, your investments had better return more than 14% each and every year if you expect to continue paying the bills 24 years later.

Also, we didn’t enter increased medical expenses or anything else into the equation.  Scared yet?  Ya should be at least nervous.

So what do we do?  If we’re smart, we utilize specific strategies that take the guesswork out of money, and we start doing them now… to benefit us now, a little later, AND into retirement.  We do things that allow us to live a better, smarter life RIGHT NOW and over the ensuing years, and not just obsess about what we’re going to do when we actually get old.

And I have a strategy that makes all of this relatively simple and definitively painless.  Beginning in 2018, this website will be dedicated to detailing this approach and its various advantages on a regular basis.  Yep… I’m going to make you wait for it.

But, if you’ve been reading this blog for any length of time, you already know what I’m talking about.  DPWLI… to know what this acronym stands for, refer to earlier posts, and let me know your reaction to the suspense.

Yes, admittedly, I’m messing with my audience a little here.  But teasers are good, and it won’t be long now before the info will be at your fingertips.

In the meantime…  thanks, as always, for reading.

***

DISCLAIMER:  This post represents the author’s opinions only.  In no way should any part of the content of this post be interpreted as official financial advice, nor does it represent an intention to solicit readers into a specific company or investment.  Results are never guaranteed.  Utilize the information as you see fit, make all money decisions at your own risk.

Some clarification is warranted on the importance of giving, and how to give

By BOB CUNNINGHAM

Wishing you a wondrous and fruitful Thanksgiving holiday from surprisingly scenic Palm Springs, Calif.  My wife and I are here on a brief get-away, and please accept my apologies for being tardy with this post.

As we enter the holidays, I thought it would be prudent to briefly discuss the ‘giving thanks’ aspect of the season.  I believe it’s an important subject to touch on, because many so-called personal finance ‘gurus’ talk about the importance of charitable giving as part of a savvy overall money management strategy.

I support the notion of giving to those in need 100 percent, but I am skeptical of the implications by some that you can tangibly benefit from donating to causes, worthy and otherwise.

The great thing about giving is the intangible positives you derive not only from doing so, but from being in a position when doing so generously makes sense.

Here’s the deal from my standpoint:  You should always give if you want to give.  You should give to whomever you wish, for whatever cause you deem just and appropriate.  But it’s naive to believe that all giving is the same, and for me, getting the most out of each donation – and having the right people benefit from it – is the name of the game.

I know a great many well-meaning folks who give something to everyone, just for the asking.  And I mean everybody.   From the charitable trust that saves two turkeys from slaughter each Thanksgiving, instead of one, to handing a buck or two to that guy named Chuck who frequents the corner gas station in his dented-up ’93 Honda Accord, always in need of “enough gas to get home” without having even once bought so much as a dram of unleaded with what he’s given.

These people who give are generous souls, and of course it is absolutely their right to give any time they damn well please.  But is it the best use of their charitable dollars and cents?  Not really.

I’m not saying some charities are more worthwhile than others… well, OK, I confess I am sort of implying exactly that.  You may very well disagree, and I respect that.  My point is that $10 or $20 sent to, say, St. Jude Children’s Hospital (my favorite charity) or the Wounded Warrior Project (second favorite) is likely to benefit more genuinely deserving people than giving a dollar each to ten folks who are “down on their luck” and working freeway off-ramps.

For one thing, the donations to official charities are much more likely to be used toward the cause they represent.  Secondly, those donations are tax deductible if you make enough of them.  Helping Willie get a burger… and a beer or, worse, a fix in many cases unfortunately… simply isn’t as wise a choice.

Now, obviously, there are exceptions.  There’s a gentleman not far from where I live who is a double-amputee.  I see him a lot at the same intersection, and if the light is red when I arrive there, I often give him something.  Yes, this contradicts what I just wrote in the preceding paragraph, but the guy has no legs from just above the knees.  I figure he needs a break, and the government assistance he is getting is probably far shy of what he realistically needs to live a basic quality of life.

And, truth be told, I made sure his wheelchair doesn’t have curtains to hide underneath the seat.  There are con-artists in all forms out there.

Generally, it is savvier and more helpful overall to focus on legitimate organizations.  In addition to the two I named above, I like the American Red Cross, American Cancer Society, and the Salvation Army, as well as numerous others.

Before I wrap this up, I have one more point to make:  If you’re young and just getting a foothold financially… the type of reader this website is geared towards… I would like to offer the following suggestion:

Don’t give to any charities – not yet, anyway.

Huh?

What I mean is, in the long run you will be able to do a lot more good and assist a great many more worthy causes if you first take care of your own situation the best you can.  It’s like the oxygen mask that falls from overhead during emergencies on commercial flights.  Regardless of the airline or the type of plane, the instructions for its use are always the same for folks who have children with them:

Please secure your own mask first, then assist your child with theirs.

Why?  Because the effort to help the child first could result in suffocation for both, if the adult passes out and the child panics.

With charitable giving, put on your own financial mask first.  Make sure it is snug and secure… that way, you might be in the position to not only help the child (or other worthy benefactor) in the seat next to you, but any needy individuals on the entire airplane…

… So to speak, of course.  Thank you for reading.

***

DISCLAIMER:  This post represents the author’s opinions only.  In no way should any part of the content of this post be interpreted as official financial advice, nor does it represent an intention to solicit readers into a specific company or investment.  Results are never guaranteed.  Utilize the information as you see fit, make all money decisions at your own risk.

Do you have to take risks to make a return on your money? Emphatically… No!

By BOB CUNNINGHAM

Greetings, all.  I’m tapping out this post from the Rio Hotel & Suites in Las Vegas.  I’m here to attend a convention – so it seems appropriate to discuss what some call the “Wall Street Casino.”

Essentially, what we’re talking about is the subject of risk.  More specifically, we want to ascertain why it has become common “knowledge,” that in order to get good returns, you have to be willing to take some risk.

There is some truth to that notion when you look at it from the risk perspective.  There are investments out there that are highly speculative. No one knows what’s going to happen, and folks don’t even have a decent idea of what’s going to happen even if they pretend they do.

And I’m not talking about investments that have a reputation as being risky, such as options trading, day trading, commodities, or even collectibles.  No, sir, I’m referring to that mainstream investment called the S&P 500 Index.

You may have heard of it.

Obnoxiousness aside, financial experts of all kinds will have you believe that investing in the stock market is the only legitimate way to earn good returns, and that if you do it right by conducting proper due diligence, diversify your portfolio, consult a professional, etc., you will most certainly be fine in the long run.

These know-it-alls love to cite that the S&P, which stands for Standard & Poor, has returned an average of about 10% annually since The Great Depression.  I’ve read multiple articles on-line and in print magazines, of late, suggesting you shouldn’t be wary of the potential for a sharp decline in the market such as what we experienced in 2008 and 2009 – even though we’re nearing a record-duration bull market as I write this – because even if it does drop sharply at some point, the market inevitably comes back and then some…

Pish posh.

Folks who saw their investment account balances drop 40% or more nearly a decade ago are just now catching up.  A few are showing a slight gain from pre-2008 levels, but projected as an annual return most would have been better off keeping their money under their Serta Perfect Sleeper.

And with retired people who are counting on taking an income from their investment assets, a volatile market can literally make them queasy because they’re not sure if they’re going to have enough money to do the things they want to do in their golden years.

By the way, that aforementioned 10 percent annual S&P growth is before taxes and fees, and your actual return isn’t 10% because you can only earn that if the market were to return exactly that percentage every year.  We’ve demonstrated multiple times on this site how average returns are a far cry from actual returns.  Here’s another quick example:

(Start with $1,000 account balance.  Earn 60% the first year, lose 50% the second. Your average annual return would be 5% (60 – 50 = 10, divided by 2 years), but your actual return is a 10% annual LOSS ($600 gain first year = $1,600 in account, 50% loss the second year = $800 loss – net result is $1,000 + $600 – $800 = $800 balance in account after the second year.  $1,000 – $800 = $200 loss is 20%, divided by 2 years = 10% loss per year).

Wouldn’t it be nice if there was a financial instrument in which you could store money safely, and still earn a respectable annual rate of return with virtually zero risk?  How sweet to fund it and forget it, knowing that you have a better chance of being struck by lightning – twice – than of losing with that account!

Dividend-paying whole life insurance.  Yes, we have introduced this product on this site, and I’ve written on it numerous times.  And in the coming weeks and months, this blog will adjust its focus from a general personal finance educational approach to a site dedicated to teach as many folks as will take the time to learn, the numerous benefits of utilizing life insurance “living benefits.”

It has to be the right kind of insurance, set up by properly trained agents representing carriers who have been established for more than a century.  But when you use this tool to hold your nest-egg, you will get the following:  Safety of principal and gains, a guaranteed rate of return that can be even higher depending on annual dividends, a structure that legally allows you to access your funds tax-free whenever you want, and a system available by some companies (but not all) that allows you to borrow funds from your cash value – without qualifying – and yet your full cash value continues to earn returns and grow as if you never took a loan at all.

It’s all about educating people.  Our public school system falls far short of any legitimate teaching about money or investments or retirement savings, so it’s up to citizens like myself who are passionate about people of all ages succeeding financially, for the short- and long-term.

Keep reading this space every week, friends.  We will continue to shed light on what is not only a desirable alternative to the gambling that investing in Wall Street and the money markets is, but also a critical undertaking we need to be aware of… NOW.

Thanks for reading.

***

DISCLAIMER:  This post represents the author’s opinions only.  In no way should any part of the content of this post be interpreted as official financial advice, nor does it represent an intention to solicit readers into a specific company or investment.  Results are never guaranteed.  Utilize the information as you see fit, make all money decisions at your own risk.

It may seem as if buying with cash is best, but don’t forget about opportunity cost

By BOB CUNNINGHAM

It is a common misconception that you should always pay cash on purchases.  Old-school thought on this is simple and straight-forward:  If you don’t have enough money on hand to pay the price, you can’t afford it and should save until you do.

Well, I’m here to tell ya that cash isn’t always king.  In fact, many times it is detrimental to your personal finances to pay cash for purchases.  And few people are as old-school as I am… or at least, as I like to think I am.

When you pay cash, there is this frequently overlooked factor called “opportunity cost.”  On small purchases, like a combo meal at Wendy’s, the opportunity cost is pretty doggone small.  But there is still an opportunity cost.

How does that work? Well, what if you use a cash-back credit card to buy your burger and fries? If the card pays 1% cash back, doling out a five and two ones instead of using the card just cost you about seven cents.

That’s $.07.  Not much, of course.  But if you buy lunch using the cash-back card five days a week, in a month you would have earned yourself $1.40, assuming you pay the credit card balance in full before the grace period of roughly three weeks expires.  That adds up over a year to nearly $17 – enough for two free lunches, super-sized.

It should be obvious by now that I’m not calling your attention to this for such small fried potatoes.  Instead, I’d like you to consider your next car purchase.  Let’s say the ride you want costs $25,000.  And for the sake of this discussion, let’s suppose you happen to have $25,000 saved and available.  It’s invested in a stock market index fund inside at an online brokerage account and has earned about 7% since you’ve had it.

Very smart of you to put that money to work, by the way.

Meanwhile, the car dealership is offering 2.9% financing on that sweet-looking sedan.  You have enough money to just pay cash for the car.   Your parents have always told you to pay cash.

Listen to your folks?  Or go into debt?

In my opinion, it’s a no-brainer… with all due respect to Mom and Dad.

If you opt to pay cash, you will have no car payments.  And that is, of course, a good thing.  It merits consideration, to be sure.  But that $25,000 is now tied up, and thus can’t be used for anything else unless you immediately turn around and sell the car (which if you did, you’d be lucky to get $20,000 because new cars depreciate as much as 30% the minute you drive them off the lot according to KBB.com).  So you’ve not only tied up the cash, but done so in a depreciating asset.

On the other hand, if you qualify for and accept the financing, and keep the $25K in the investment account, it would earn about $1,750 if it maintains a 7% rare of return (ROR) annually.  The spread of a 7% return over a 2.9% interest debt is a net positive 4.1%.  Mathematically, when the new car is paid off in five years, you will have netted a positive 20.5% (4.1% multiplied by 5 years).

Plus, you will still have the $25,000-plus if you need it for something else. It won’t be tied up in the formerly new wheels.

But hold on, you say.  What if we need to make the $449 per month car payment from that same $25,000 account?  OK… $449 times 12 = $5,388 in payments each year, with $388 of that being interest (we arrive at that by knowing the $25,000 cost of the car divided by five years equals $5,000 to principal per year, with the remainder being interest).  So in the first year, and the subsequent four years, you pay $388 in interest every 12 months.

But how much did the index fund money earn you?  The answer,  considering the dwindling balance as we make those monthly car payments, ends up at about $1,400.  That’s better than $1,000 more (the first year) to keep the cash and use it to make the payments as we go.  We aren’t considering income taxes in our figures, because you’d have to pay taxes on the gains of the $25K at withdrawal, whether all at once or a little at a time.

The major key to the comparison is the 4.1% separation between the interest rate being paid on the car loan and the ROR on the investment account.  Whether it’s the first year or the fifth, or anywhere in between, that spread is going to average out the same.*

*I’m not saying you can count on your cash to make a 7% return precisely, each and every year.  Of course that isn’t the case.  It might lose one year, but it also might make 30 percent gains the next.  Determining which strategy is the best requires us to use constants (averages) where they don’t typically exist.  If the investments in the account lose money in every one of the five years, then paying cash would have been better because we’ve lost that aforementioned spread.  But five straight losing years is extremely unlikely. Historically, four of the five will be gains with two of those being at least 10 percent. (source – Morningstar.com)

Finishing with our example utilizing a 7% annual return on the investment account, in five years using the auto financing to pay off the car in full, we would still have about $1,900 remaining in the account (according to BankRate.com calculators) to go with a paid-off car that is now worth roughly 10-12 grand.  Paying cash, you would still have a $10,000-$12,000 car… but the investment account would be fully depleted – immediately.

Look, nineteen hundred bucks versus zilch is a huge difference.   So remember – opportunity cost is a big factor to look at when considering whether or not to pay cash for a purchase.  For fast-food lunches, go ahead and use cash or your debit card.  But on the larger purchases, be sure to take advantage of credit IF the rate of return on your saved money exceeds what the creditor charges to loan you the funds.

As always, thanks for reading.

***

DISCLAIMER:  This post represents the author’s opinions only.  In no way should any part of the content of this post be interpreted as official financial advice, nor does it represent an intention to solicit readers into a specific company or investment.  Results are never guaranteed.  Utilize the information as you see fit, make all money decisions at your own risk.

Small savings here and there can add up to surprisingly significant amounts

By BOB CUNNINGHAM

My family and friends often give me a hard time about being frugal.  When I first revealed to them that I had a personal finance blog, they asked if I had written a post yet on cheap eats or the wonderful world of coupon clipping.

It’s not that I don’t enjoy spending money, or that I’m not willing to splurge on occasion.  I am, and my wife and I do.  What I don’t like is feeling as if I have wasted money.  Spending $500 or more on the latest cellphone, for instance, just seems like a bad investment when I can go out and obtain a perfectly functional phone – for talking, texting, and taking basic photos – for less than $100.

My adult kids, ages 27 and 24, want the fancy phones.  Like the old fart in those Consumer Cellular ads, I’m happy with my basic phone.

Either way, there are numerous ways to save small amounts of money on a consistent basis… and when you do these consistently, I believe you will be genuinely surprised by how the little discounts, rebates, and cash back add up.

I do clip coupons, but I’m not obsessed.  Mainly, I look for discounts on grocery brands I buy, and restaurants we frequent.  I also constantly am asking for discounts.  When I recently had the oil changed in my car, I requested “the best deal you can give me. Been a customer here a long time,” and got a discount for a coupon I didn’t have and was afforded an additional  10% senior discount despite being ‘only’ age 53.  If I hadn’t asked, I’d have never received either courtesy,

Also, I’m a big believer in taking advantage of cash-back credit cards.  The process is really quite simple – apply for and (hopefully) get approved for a credit card that offers either a flat cash-back rate for all purchases, or quarterly “specials” with as high as 5% back on certain categories, or both.  The categories, usually featured for three months at a time, include restaurants, grocery stores, gas stations, or department stores among others.

The idea is to use the card each and every time you shop – for virtually all of your weekly purchases.  Concentrate solely on what you would spend anyway.  Don’t spend more just to utilize the card.  Defeats the purpose.

Then at the end of the month, you use your checking account funds to pay off the card.  You never want to carry a balance on the credit card, because you will then be wickedly guilty of stepping over dollars for dimes.  After all, how much sense does it make to get 5% back on groceries, but pay 20% or more interest monthly to carry a balance for those very same trips to the store.

None, of course.

Do this right, by using credit cards as the point-of-sale tool and your bank account to pay the credit card balance in full each and every month, and those 5% purchases here, and 1.5% there (and elsewhere) start to add up nicely.

Although it certainly isn’t recommended for younger adults who are trying to establish themselves as financially healthy long-term, my wife and I like to eat out.  We rarely do fancy dining, but we like Applebee’s, El Torito, Panera Bread, and the like several times a month.  Currently, our Chase credit card pays 3% cash back on all our restaurant purchases (including fast food, although we don’t do much of that).  Generally, in two months we have accrued enough cash that we get a dinner on Chase courtesy of a gift card to most any chain eatery we choose.

Over time, you can acquire a few cards, each of which might be dedicated to a different part of your overall budget – one for dining, one for groceries, one for gas, and one for miscellaneous.  The common denominator among all of them remains paying the balances in full each month, thereby NEVER paying interest on these purchases.

It’s like earning a rate of return on your expenditures, rather than just your investments.  Best of both worlds.

Thanks for reading.

***

DISCLAIMER:  This post represents the author’s opinions only.  In no way should any part of the content of this post be interpreted as official financial advice, nor does it represent an intention to solicit readers into a specific company or investment.  Results are never guaranteed.  Utilize the information as you see fit, make all money decisions at your own risk.

Diversification: An often misunderstood term, and misused investment strategy

By BOB CUNNINGHAM

There are numerous commonly referenced words and expressions in the personal finance world, and truth be told, only a handful of them are utilized correctly.

One of the many you will hear frequently is ‘diversification.’  Most often, diversification refers to the cliche of “not putting all your eggs in one basket.” By diversifying in the investment world, you’re hedging some of your money against the possibility of poor returns in other parts of your portfolio.  You don’t invest all of your money in stocks, for example, but instead should diversify by putting part of your cash in bonds (because bonds tend to run opposite of stocks, although try telling that to those hurt the worst during the recession of nearly a decade ago, when the bottom fell out of both for a time).

Or, don’t just invest in equities.  Take part of it and go into real estate, or gold, or collectibles.  Or all of the above.  Each have their benefits and detriments, and together the idea is avoid too much exposure to one asset class in the event that the primary investment in question happens to tank.

Sounds reasonable enough, except for one thing.  Why do we really need to diversify?  Can’t we just invest conservatively in something that can’t go down, and sit back and enjoy steady, predictable growth?

We sure can, by using dividend-paying whole life insurance to hold and grow our nest-egg.  But this post isn’t specifically dedicated to insurance.  What I want to accomplish here is to illustrate why traditional, conventional saving and investing for retirement and other uses is actually counter-productive, and I’m going to use one of Wall Street’s favorite buzzwords to make my point.

Let’s say you’re convinced that the Standard & Poor’s 500 Index is about to hit the skids.  We have been blessed (?) with the long-running bull market of the modern era, but even the most optimistic of investment experts acknowledge that the run can’t last forever.  So how do you think they would react if you informed them that you believe the market is about to take a downturn, and that you’re going to exit your entire index fund and stay on the sidelines for a while, to see how it all shakes out?

“Well, uh, Mr. and Mrs. Investor, you can do that if you want to, of course, but the smart strategy would be to keep part of your money in the fund, so that you can remain diversified,” might be the reply.  “It’s impossible to know with any certainty what the market is going to do, and you don’t want to miss out on any additional growth.”

So you and your significant other counter by informing the broker that if you’re in cash temporarily, you can’t lose money except for the spending power decline due to inflation, and you don’t expect to stay away long enough for that hit to be anything that should truly matter.

“Well, if you’re uncomfortable staying with your current fund, perhaps you’d like to invest instead in our XYZ corporate bond fund?  But again, I advise you leave some of your investment dollars in the S&P,” retorts the broker.

“So you’re telling me to ignore my instinct and leave at least some money in there, so that my loss that I feel strongly is coming isn’t as significant and that I just might gain more?”

“Precisely.”

“In essence, then, it’s a coin toss… at best.”

“Well, as I said earlier, it’s impossible to know for sure what will happen.”

“Then it sounds to me like I’d be better off invested in something where I do know what will happen, even if the returns might be lower.”

“Well, uh.. um…”

PRECISELY. 🙂

You see, the basic concept of diversification is fine.  An index fund, by definition, IS diversifying because instead of investing in one or just a small group of stocks, you own a piece of every stock in the index, usually at least 50 or more.  In this fictional example, it’s the entire S&P and its 500 companies.

But investing strictly in the S&P doesn’t make much sense, because it’s still 100% in stocks and nothing else.

So what can you do to avoid this conundrum?  The aforementioned life insurance approach is the ticket.  Because you can’t lose money with this product (this assumes you purchase your coverage from one of the long-established, professional mutual carriers and not take a “discount policy” from “Larry’s Life and Health”), the need for diversification is essentially absolved.

Going this route, you invest in an instrument that will pay you a steady 4-6% net (after tax, because done correctly there is no tax) annually plus you will have a host of other advantages – living benefits – that include potentially tax-free access to at least 90% of your cash value at any time, non-qualifying loans that don’t have to be repaid AND allow your money to grow at the same rate as if you hadn’t borrowed, an asset that isn’t reported as one for income tax or estate purposes, and a strategy that is generally immune from lawsuits (seek licensed and appropriate legal counsel to assure this is correct where you live).

All of this, and a death benefit for your designated beneficiaries as well.  Now that’s what I call diversified advantages.

Thanks for reading.

***

DISCLAIMER:  This post represents the author’s opinions only.  In no way should any part of the content of this post be interpreted as official financial advice, nor does it represent an intention to solicit readers into a specific company or investment.  Results are never guaranteed.  Utilize the information as you see fit, make all money decisions at your own risk.

It’s time to review several things we’ve covered in past BWE posts – Part II

By BOB CUNNINGHAM

Continuing with the post from last week, in which we are examining some basic financial principles from a “fantasy and reality” perspective:

“Invest in your company’s 401K Plan.”  The most common workplace retirement savings vehicle is a 401K Plan, which is a qualified (i.e. government-sponsored) account in which the company holds your money and pays a brokerage to invest it for you into various securities.

FANTASY:   Max out your 401K Plan (the government places limits on how much you are allowed to contribute annually) as soon as you can.  The government is truly generous in allowing us an account that can grow tax-deferred.

REALITY:   Doing so means you’re trusting others to manage your money, in markets that are risky and volatile, and forfeiting access to your money until you’re age 59 1/2 (unless you want to pay a 10% penalty on top of standard taxation) and the account has been in existence at least five years.  It’s true that many companies offer a match up to a certain percentage of your income.  As a secondary retirement savings instrument, I’m fine with maximizing the company match (example – company matches 25% of the first 5% you have deducted from your paycheck to be put into your 401K).  Otherwise, there are better places to put your savings where you have safety and complete control. And once and for all:  Tax-deferred doesn’t mean tax-free, and it doesn’t result in more compiled money once you’ve paid income tax at the back-end.

“The most important aspect of investing is Rate of Return.” How much compound interest your money makes as it is invested in stocks, bonds, precious metals, real estate, or any other from among a host of investment choices IS something you’re going to want to track.  But there are other factors.

FANTASY:  You should be investing your money where you can earn the highest returns.  The stock market has risk, but it has gone up steadily over the long-term so if you leave your money in the markets, you’ll most certainly come out ahead.

REALITY:  I can’t quite recall where I first read the following, but the adage is oh-so accurate:  The most important part of savings and investing isn’t the return on your money.  It’s the return of your money.  I’ve never fully understood why otherwise sensible people have allowed themselves to become convinced that they should put their hard-earned life savings at significant risk.  In 2008-09, I personally knew folks who saw their nest-eggs drop by 40 percent.  They are just now fully recouping those losses, and that’s amidst the longest-lasting bull market in any of our lifetimes.  Remember, in a previous post we demonstrated how a 5% return every year can out-perform and average of 10 percent over the same period, in the same way that a 50% gain followed by a 50% loss results in a 25% net loss (Don’t believe me? Try it starting with $100 to make the math simple).  Slow and steady wins the race.  Just ask either the tortoise or the hare.  Better yet, ask them both.  Wouldn’t steady gains with no market risk – that’s zero risk, ladies and gentlemen – seem to be more intelligent when it comes to something as important as retirement savings? As opposed to hoping your funds return double-digits and avoid big declines along the way?  The answer is yes, because it is,

“Buy term and invest the difference.” This expression, of course, is referring to life insurance.  There two primary types – term and permanent.  Term insurance is solely a death benefit in exchange for a monthly (or annual) premium.  Permanent insurance includes products like whole life insurance, and can be set up to function in several capacities in addition to providing a death benefit.

FANTASY:  Because term is cheaper, it is advisable to buy term and then take the amount of money you’re saving on premiums versus permanent insurance and invest it in the stock market or other vehicle for long-term returns.

REALITY:  It sounds logical enough on its face, but two big problems here.  First, the vast majority of folks who intend to follow this strategy won’t “invest” the difference.  They will spend it… on stuff that depreciates.  And I simply don’t believe in unrealistic advice, even if the logic is sound (which it really isn’t here).  Secondly, there’s an obvious reason that permanent insurance tends to be more expensive than term.  IT DOES A LOT MORE FOR YOU!  Dividend-paying whole life, the product choice for permanent insurance suggested by this blog, offers a host of “living benefits” in addition to the fundamental death benefit.  The premiums are higher because the product is superior, on numerous levels. To recommend term strictly because it’s cheaper demonstrates a lack of reasonable research and comparison.

I hope you enjoyed this review and reaped some additional wisdom, or at least some reinforcement, from it.  Once again, thank you for taking time from your busy schedule to join us weekly on this site.

***

DISCLAIMER:  This post represents the author’s opinions only.  In no way should any part of the content of this post be interpreted as official financial advice, nor does it represent an intention to solicit readers into a specific company or investment.  Results are never guaranteed.  Utilize the information as you see fit, make all money decisions at your own risk.

 

It’s time to review several things we’ve covered in past BWE posts – Part I

By BOB CUNNINGHAM

(Note to my readers:  My apologies for being a day late with this post.  This marks a permanent change to Tuesday morning release of my new post each week.  The change is due primarily to professional convenience.  Thanks for your understanding.)

This website is, first and foremost, dedicated to coaching people how to best go about the various tasks related to savvy personal finance.  Achieving success can be accomplished through a mixture of some sound fundamental principles, combined with the reality that many strategies which are considered advisable by the masses are, instead, more beneficial to others.

What does that all mean?  Translated into one expression,

    “Unconventional wisdom, in many cases, is better than conventional.”

As you read, listen, watch, and research the world of personal finance, you will encounter some common themes preached by everyone from the most famous gurus to the tiniest out-of-the-mainstream blogs (I’d like to believe I’m somewhere in between, but closer to the latter than the former.)

This blog has been dedicated to assisting you in deciphering what to believe and trust, and what not to.  We’ve taken individual topics and broken them down into pieces small enough to digest in a way that allows us to effectively learn just how such habits can affect us, short- and long-term.

What I haven’t really done, until the paragraphs to follow today and next week, is put together a summary of the major points made through this blog’s seven months of existence.  So let’s get to it.  I’m calling this, “Personal Finance:  Fantasy and Reality.”  Part I is below, with Part II to run Oct 17.

“Pay Yourself First.”   This is arguably the most common adage in the world of money.  It simply means that you should set aside money for savings and/or investing before you earmark funds to pay your bills and for everyday expenses.  The theory, of course, is that if you get in the habit of doing this, you’re guaranteed to save more and anything is better than nothing.

FANTASY:  Saving even the smallest amount on a regular basis will eventually lead to significant holdings, from which you can build on additionally.

REALITY:  While it’s true that something is always better than nothing, there has to be a definitive goal for increasing savings regularly, and it should only be undertaken after expensive personal debt, such as credit cards that can have APRs well more than 20 percent, is eradicated.  One of the most common mistakes is to save slowly in an account earning less than 1% while simultaneously carrying a balance on a credit card charging 23.9% interest compounded.  Spend every extra dime paying off the card, stop charging stuff unless you pay it off entirely by the due date, and THEN ratchet up the savings to blow away what you would have accumulated – and wasted – otherwise.

“You need to save at least 3 to 6 months of living expenses in an emergency account.”  The idea is that if you have this kind of a reserve, loss of your job for an extended period won’t put you in the poorhouse – or worse, your parents’ basement.

FANTASY:  This is one of my favorite finance fables.  Some pretty well-known gurus claim it’s better to have a year’s worth saved.  Sure, and it would be better if my retirement savings had one or two additional zeroes, too.  In truth, for 95% of the population on this planet it is a complete fantasy to have a liquid cash reserve of $10,000 or more and be willing to leave it alone for a rainy day.  There’s a better HD television available.  It’s an emergency!!

REALITY:  A much savvier plan is a basic reserve fund of $1,000-$2,000 for things such as auto repairs.  But actually, I propose to use your credit cards as your emergency fund.  As long as you’re disciplined – and let’s face it, discipline is required when utilizing any type of advisable strategy – you can use a credit card to charge a true emergency and then formulate a plan to pay off the card with minimal damage.  Saving more than the aforementioned $1K-$2K means you’re not utilizing legitimate funds properly.  You should be investing those funds in debt elimination, or a dividend-paying whole life insurance policy, or if you must, low-cost index funds, or even in your work’s 401K plan (more on that next week).  All are preferable to letting inflation eat away at the buying power of a tidy sum dedicated to nothing… and earning next to nothing in a regular savings account.

“Avoid credit cards.”  Because they are debt instruments, many gurus advise to ignore them entirely, except perhaps for one card that can be used only in a “true emergency.”

FANTASY:  Just pay cash for everything, and you won’t need cards.  Credit cards only benefit the companies who issue them.  They victimize their customers unfairly.

REALITY:  Credit cards are great, but ONLY when used wisely and properly.  Running up a balance on an account charging such high interest rates is fiscal mutilation.  But if you are able to obtain 3-4 cards, each with cash-back allowances (preferably in rotating categories offering as high as 5%), and you use them for everyday regular expenses while ALWAYS paying off the entire balance prior to the next minimum payment being due, you not only avoid unnecessary costs, but also accrue small refunds, and at the same time build a favorable credit history.  Plus, your purchase of tangible goods are often insured by the card company, a service not provided by cash or a debit card.

“When strategically paying off credit card debt, pay off the smallest balance first.” As opposed to eliminating the account with the highest APR, many financial advisers propose the “snowball” strategy versus the “avalanche” approach.

As the AFLAC duck often exclaims, “Huh??”

FANTASY:  Paying off your smallest balances first, before working on the larger ones, yields quicker results and gives you a sense of accomplishment. This increases your chances of sticking with the program.

REALITY:  I won’t argue with psychology because I’m not educated in that area beyond my Psych I college course explaining the difference between Sigmund Freud’s id, ego, and superego.  But our goal is to save money on interest, so why would I pay off an account charging 16% before one jacking me for 24%?  The latter is going to require a larger minimum payment, so I want that one outta-here ASAP.  Look, if you have two accounts of very similar rates (like, within 1% of each other) and you choose the smaller one in order to get rid of it quicker, knock yourself out.  But don’t leap over dollars for psychological nickels.  Just dedicate yourself to the task with the knowledge that it is what is best for your long-term financial health, and save every dollar you can.

That’s it for Part I.  See ya next week for the conclusion of our review.

As always, thank you for reading.

***

DISCLAIMER:  This post represents the author’s opinions only.  In no way should any part of the content of this post be interpreted as official financial advice, nor does it represent an intention to solicit readers into a specific company or investment.  Results are never guaranteed.  Utilize the information as you see fit, make all money decisions at your own risk.