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.

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.

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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.

Four common personal finance tips you should feel comfortable ignoring

By BOB CUNNINGHAM

Have you heard the phrase, “conventional wisdom?”  It’s typically used when information is thought to be so common-sense correct and accepted, that numerous alleged authorities echo the same sentiment, thought, or advice.

When preparing to cross the street, it’s conventional wisdom to look both ways.  Okay, no argument here.

But in the personal finance niche, I have learned over my 30+ years enrolled in TSOHK (The School of Hard Knocks) that conventional wisdom isn’t always the savviest take, nor can it be assumed to be applicable, or even helpful.

Sometimes, it can be downright detrimental.

In this week’s BWE post, I want to talk about some examples of when conventional wisdom simply isn’t the best way to go about your money life. Now, to be fair, not all of these are blatantly false.  It’s just that in some cases they over-simplify a topic, and while I’m usually in favor of keeping things straightforward, I’ll never support the notion of bypassing applicable specifics.

So, without additional adieu, here are some money misconceptions:

1) All debt is bad.  As noted author Robert Kiyosaki of the pioneering finance and investing book, ‘Rich Poor Dad,’ has often said, there is most definitely such a thing as “good debt” as well as bad debt.  Kiyosaki correctly postulates that good debt is used to buy assets, such as stocks and bonds or investment real estate, and bad debt is associated with credit card debt and other methods of purchasing liabilities – things that depreciate over time.

But I’ll take it a step further in noting that a debt doesn’t have to directly purchase an asset in order to be good debt, even if a liability is being bought.  If the debt, in itself, creates the opportunity to profit, I believe it should be considered good debt.  This scenario is most common when discussing home mortgages – low interest rates, the interest being tax deductible.  Mortgages, when utilized correctly, can be truly valuable.  But there are other ways to reap these types of benefits.

For example, say you need a new car – not brand new, necessarily, but an updated vehicle because your current wheels are costing you too much in repair and maintenance.  Because of your stellar credit, you qualify for 1.9% financing through your bank.  You’re looking at spending about $20,000 on a certified pre-owned car.

Should you pass on financing the purchase because you’re acquiring additional debt?  Maybe… if you can’t afford the monthly payment in your current circumstances, none of the forthcoming pointers will truly be applicable. Still, go with the point I’m making here and let’s assume your budget allows for the payment.

Being that this is for buying a car, are we to assume automatically that this is bad debt?  After all, the car will most certainly depreciate in the coming years, right?

Most people would read the above and suggest, “sure the terms are great, but you’re still better off paying cash if you have it available.”  I disagree, because what is being overlooked – and this happens frequently – is the opportunity cost.

Instead of forking over $20K on the car up front, what if I can put that money to work earning, say, 4-5% with tax-free access to this money if I ever need it, and still acquire the car?  Wouldn’t that be a 2-3% positive Rate of Return over what the auto loan is costing me?  Sure is.  And if you’re thinking perhaps that the small profit I’ve illustrated would be devoured by the car’s depreciation, that really isn’t so because the car will go down in value over time regardless of how I buy it.  In other words, if I pay $20,000 cash now, the car will still be worth only $15,000 (or less) in two years.  How I went about buying the car isn’t really relevant.

In short, it actually makes (arguably) more sense to take advantage of the ultra low-cost financing, put the cash to work earning more than that, and still drive my nearly-new ride.

2) Live below your means.  I really hate this expression, which virtually EVERY financial guru insists you must do, because it is so vague.  If the key is to avoid unnecessary spending, just say that.  But even then, more specificity is needed.  If you go out to the movies once a month as your sole entertainment, you’re certainly spending money unnecessarily – you don’t HAVE to go see the flick.  But obviously, if that is your only fun all month long, you’re most certainly living below your means.

I’m also opposed to the concept that you have to set a living standards guideline.  Determine your fixed expenses, and your necessary discretionary expenses, then decide how much of what’s left from your paychecks you’re comfortable with saving and investing, and otherwise live normally.  Make a reasonable, thought-out plan, pay yourself first before you do the rest, and have a life.  Progress doesn’t have to be excruciatingly painful.

3) Tax-deferred is better.  There are some pretty savvy financial minds out there who harp on the idea that if you can defer paying income tax until later, you’re going to be better off because more of your money is working for you. Sounds logical, but I will prove it’s balderdash.

The most obvious example is a Traditional IRA (or an employer-sponsored 401K), which uses before-tax income to be funded, with taxes not due until you take the money out down the line.  This is opposed by the Roth IRA, which uses after-tax money now, and allows you tax-free withdrawals later.

A quick look at the numbers through an example:  Teresa opens a traditional IRA and commits to putting $200 per month into it, for 20 years.  For this exercise, we’ll assume a 25% income tax bracket and a 7.2% rate of return on the invested money.  Richard goes the Roth route, and so his after-tax monthly contribution (based on the same 25% tax rate) is $150 per month, again with the same 7.2% ROR.  Where will each be in 20 years?

  TERESA:  $200 per month for 20 years = $48,000 invested.  At 7.2% ROR, her account balance after 20 years, according to a financial calculator at www.bankrate.com, is $103,844.78.

  RICHARD:  $150 per month for 20 years = $36,000 invested. At 7.2% ROR, his account balance after 20 years is $77,884.34.

Now of course, Richard has already paid his income taxes, so he keeps the whole $77K+ should he choose to take it out.  Teresa, however, still owes the 25% income tax.  Her balance after paying the tax?  $77,884.34.

Well, how ’bout that!  In the end, with both getting the same ROR and owing the same percentage of income tax, they come out exactly the same.  Except for one thing… Teresa paid $25,960.44 in tax, while Richard paid just $12,000.00 ($50 per month times 12 months times 20 years).  Which do you suspect hurts more – $50 each month on the front end, or more than $25K straight to Uncle Sam in exchange for simple account access?

This example demonstrates why the government loves deferred taxes – because it makes more money that way.  Those who insist that tax-deferred is the better method fail to understand that the extra compounding in the account benefits only the government, NOT the account owner.  Why? Because unlike you, the government doesn’t pay taxes (to itself) on the gains.

One last point:  Is it feasible to conclude, based on the current national financial state of affairs (i.e. the national debt nearing $20 trillion!) that tax rates might very well be higher down the road than they are now? I believe so. Sure, they might go down… but who’s willing to bet on that?  Pay now-pay nothing later is a much safer and prudent way to go.  As many before me have pointed out, would you prefer to pay taxes on the seed, or the harvest?

4) Average Rate of Return is important.  Another fallacy I enjoy debunking.  It sounds innocent enough – “the average rate of return for the ABC Fund over the last three years is a sparkling 15%!”  Really?  Okay, well’s let’s consider the following scenario and see if a 15% average annual ROR is truly beneficial.

ABC FUND:  Year 1 ROR = +30%, Year 2 ROR = -55%, Year 3 ROR = +70%. Average ROR annually over the three years = +15% (30 – 55 + 70 = +45 divided by 3 years = +15 per year).  Total opening balance in the account at the beginning of the three-year period:  $10,000.  Total after the three-year period at 15% annual average ROR = . . .  $9,945.

Whaaaaat??  We actually fell by 55 bucks?  What the fudge?

Yep, it’s true.  And this is just the investment itself.  It doesn’t take fees into account.

How can this be?  Run the math, my friends.  After Year 1, with a 30% gain, you would have $13,000.  After Year 2, down 55%, you would have $5,850. After Year 3, even with the monstrous 70% gain, you end up with $9,945.

The above is an example of Wall Street ‘gotcha’ at its finest.  Losses matter much more than gains.   If you have $1,000, and lose half (50%) the first year but gain half in the second, are you now back to even?  Nope… you’re still down 25%.  When you drop 50%, you need a doubling (100%) gain the next year just to get back where you started.  Crazy, but true.

The big banks and investment companies don’t want you to understand this, which is why keeping full control of your assets, through sometimes unconventional strategies like whole life insurance (see last week’s post) is the only way to really know what you have and, better still, what you can expect to have at any point in the future.  Steady gains every year, even small ones, are much better for you in the long run.

Once again, thanks for reading.

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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.

Importance of Emergency Fund over-emphasized by most finance gurus

By BOB CUNNINGHAM

This week’s post is being sent to you via Lake Tahoe, NV, and I gotta tell ya — it’s friggin’ beautiful up here.

But of course, you don’t read this column to hear about my vacation travels, so let me get right to business. I will note, however, that I have intentionally shortened this post in the interest of time (as in, more time for me to play!).

Okay, so did my headline catch your attention?

The idea that having a monetary reserve to cover you in the case of an unexpected significant expense is, on its face, a no-brainer.  We don’t want to have to borrow from friends or family, or go on a Top Ramen diet just because the car radiator is leaking and needs to be replaced.

But the notion that the majority of folks should put emergency funds in a savings account, which yields virtually no interest, while maintaining a credit card balance that charges more than 20% APR, strikes me as non-sense.  Many of the most prominent minds in the world of personal finance insist that you have at least $1,000 – preferably a lot more – set aside and accessible before you pay off debt, invest for retirement, etc.

Phooey on that. There are more productive ways to accomplish the same thing.

The main concept behind emergency money is that it has to be liquid… but that doesn’t mean it has to be as liquid as bank ATM access. Withdrawing from investment accounts, life insurance cash value, and even tapping a credit card can be utilized smartly to accomplish the same goal – and allow the individual to have his or her money working at full income-producing capacity in the meantime.

For example, if you are currently investing in a Roth IRA, you can withdraw the monies you’ve put in (but not the growth) without penalty.  This is, of course, not the ideal scenario for gaining quick funds to pay for an emergency because you want your investment account money to stay put and grow using the magic of compound interest.  But the setback is usually temporary if you do need to tap the funds, and the smart money managers account for the scenario of not having an emergency as well as the what-if something bad happens.

The idea that we probably won’t need those funds set aside for an emergency is the basis of my approach.

If you have a permanent life insurance policy – which I will talk about in detail in a future post coming soon – you can withdraw dividends the policy has earned and/or borrow from the policy’s cash value.

In both the above instances, the average time to have your money in hand is about 3-5 business days.  So you’re probably thinking that in an emergency, you might have to have the money RIGHT NOW.  Then what?

That’s where the credit cards come in.  You see, using a credit card to pay for an emergency is only a dubious idea if you’re not prepared to pay off that charge before the end of the grace period.  But if you use the card to pay the emergency cost as it happens, then use one of the two above scenarios to pay off the credit card, you’re golden.

Now, I realize that not everyone has money invested in a Roth or has insurance cash value to tap, or wants to bother family with the ultimate taboo question.  For some, who truly have no other means to cover a significant unexpected occurrence, it’s a choice between putting some unproductive cash aside or rolling the dice with the knowledge of using a credit card if absolutely necessary and perhaps paying a higher cost in the process.

But people should be aware of all their options, and quite frankly, I’m sick of reading about concepts that are allegedly Finance 101 when, in fact, the logic is potentially faulty.

Understand all the choices and consequences, and then proceed with the best strategy for your particular situation.  Don’t get pigeon-holed into following the masses.

As always, thanks for reading.

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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.

Whoa… let’s back up for a moment

By BOB CUNNINGHAM

In case you didn’t already recognize the signs, this site is new… and is published by a blogging newbie.  I don’t mind admitting that.  I’ve been writing professionally nearly 30 years, for established publications and as a freelancer, but BuildWealthEarly.com represents my first foray into the blogosphere.

And as I was contemplating my next post, and briefly reviewing what I’ve released so far, it occurred to me that I have failed to share this blog’s true message – my actual philosophy on personal finance, and the often contrarian angle from which this subject matter will be provided in the coming weeks, months, and (hopefully) years.

Yes, I established in my introductory post that I am not a financial professional in the sense that I sport a bunch of impressive designations in front of my name – my only official title is as a licensed life insurance agent in California – but instead I am relying on a combination of my “PhD in the School of Hard Knocks” and some diligent research over the last decade-plus.

Still, I hadn’t truly shared my perspective – so here it is:

“Most of what you have learned about money, either from your parents, teachers/professors, or from so-called gurus, is NOT truly in your best interest.”

Say whaaat?

There are many, many valid basic points that I would never try to contradict – spend less, save more, know what you’re investing in, etc.  This is mostly common sense that doesn’t require you to read it in a blog post in order to recognize it as fiscal wisdom.

But the American system of, shall we call it, “public economics,” is mostly baloney. Our system is still the best in the world, in my opinion, but it falls shy of being truly valuable across the board for most citizens.  Far from it, actually.

I will give you one example now – trust me, you will get plenty more in future posts.  The 401K Plan.  We have been told that your company’s 401K plan is far and away the best way for an individual to save for retirement.  Put every dollar in that you can muster, many experts recommend.

As Col. Sherman Potter said on the 20th century TV show, “M*A*S*H*, at least once, “Monkey muffins!”

OK, so how would you react if I offered you the following savings plan? My strategy that I recommend to you is not liquid, meaning that once you put money into this instrument, you cannot retrieve it (for an emergency or any other reason) until the government says you can – beginning at age 59 1/2 and with the account open at least five years – unless you wish to pay a 10% penalty for the privilege.  This strategy frequently charges you among the highest fees in the industry, as much as 2.5% of your holdings annually, and gives you  little if any say in what specific investments your money will go into.  This strategy says to save a small amount on income taxes now, by having your contributions taken from your paycheck pre-tax, but pay a much larger gross amount of taxes in the future, when you are finally allowed to access the dough.  Oh, and if you happen not to need your money when you get past retirement age, well, that is irrelevant because when you turn 70 1/2 the government forces you to withdraw a minimum amount, the failure to do so costing you not only the taxes you would owe but IN ADDITION, a 50% penalty tax for good measure.

What do ya think?  Sound like a good way to go?

I just described the primary characteristics of the typical company-sponsored 401K plan.  Does Uncle Sam rock or what?

Now, to be fair, the 401K does have one desirable trait – the possibility of a company match.  Many companies offer some sort of matching funds to your contribution – a percentage of what you put in based on a percentage of your income.  But here’s the kicker – not every company offers a match.  In fact, according to multiple sources, the percentage of companies which offer matches, among those that sport 401K plans at all, is declining.

Under most typical circumstances, it makes sense for folks to contribute enough to their 401K plan in order to maximize the benefit of any company match.  But not always, and never a penny more than what counts toward the match.  There are simply other strategies available, which virtually anyone can utilize, that are significantly more beneficial than what Washington D.C. has laid out for you.

And very soon, we will be going into those.  Thanks for reading.

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DISCLAIMER:  This post represents the author’s opinion only, sometimes based on and supported by cited numbers and sometimes not. In no way should any part or all of the content of this post be interpreted as official financial advice, nor does it represent an intention to solicit readers into a specific strategy or investment.  Profitability is NEVER guaranteed.  Invest at your own risk.