Archives For September 2009

       Diversification, index funds, low expenses, tax efficiency…they’re all so boring. Isn’t there a better way? Can’t I use research, insight, intuition, and intelligence to beat the market? Who actually believes this boring stuff anyway?

       The guy in the fancy suit on TV doesn’t seem to believe it. The writers of financial publications are constantly telling us which funds are going to be hot this year, or month, or week. There are millions of investment ideas on the Internet which include all kinds of fancy charts and systems and fantastic results. It doesn’t seem like anyone believes in index fund investing and boring ideas like diversification. Everyone seems to have some secret for how they’re going to beat the market, so why shouldn’t you as well?!

Look Who’s Talking

       Before you begin to think that index fund investing is only for schmucks, let’s take a minute to look at who supports these various investment ideals. First, the side of active management, market timing, and various other strategies to “beat the market”:

  • Stock Brokers and Investment Managers – For a fee or commission (or both!), these guys will help you pick the “right” funds or stocks at the “right” time so you get nice returns every single year. They’ll even send you a gift card or free sports tickets every once in a while just to show you how much they appreciate you!
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  • Some Mutual Fund Companies – Sure they charge higher expenses than Vanguard does, but they’re giving you access to the “best” mutual fund managers in the world. With their team of 5,208 researchers, they’re bound to uncover information that will give them the ability to beat the market. And don’t forget about those mutual fund companies with a long family background of managers. All that experience is sure to come in handy.
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  • Market Timing & Stock Picking Newsletters – In the do-it-yourself mood? Just subscribe to one of the many market timing or stock picking newsletters, and Slick Sam will tell you exactly when you should get in and out of which stocks. He might even set you up with a service where his recommendations can be traded automatically in your brokerage account. You don’t even have to do a thing and you’ll make a 389% return in a matter of months!
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  • The Investment and Financial Media – Dow drops 600 points! Stock futures headed down this morning because the commissioner has a cold! Is your portfolio safe? Ah, the financial media. They constantly keep us up-to-date on the latest market news and even give us advice about the next top mutual funds. All we have to do is keep watching their shows or buying their newspapers and magazines and we can reap the benefits of all their knowledge.

       Do you see what I see? Every single one of these players has a vested interest in selling you something—especially in selling it to you again, and again, and again. My father once told me everyone has something to sell, and he’s right. Even the most objective advisor has to get paid somehow. But we have to look carefully at the seller’s motives before we buy—more so when the product is financial advice.

       Now what about the side of index fund investing, diversification, low expenses, and tax efficiency? Let’s look at the supporters of these really boring investment ideas:

       What do you notice in this group? A few less marketing gurus and a few more academics? So whose advice are you going to trust for the future of your retirement? A fast-talking salesman who rushes through the facts, or a research-driven Nobel Laureate whose life has been dedicated to teaching?

I know who I’m going to listen to.

Do You Need Life Insurance?

Corey —  September 29, 2009 — 3 Comments

       Before you go out and buy life insurance, you need to ask yourself if you really need it. And when you’re buying it, you need to ask yourself how long you’ll need it. Not everyone needs life insurance, and not everyone needs life insurance for their whole life.

If You’re Single with No Dependents…

       If you’re not married and you have no one who depends on your income to provide for their necessities, then you do not need life insurance. If you want to cover your burial expenses, you’re better off just saving up the money yourself. Your savings can cover your burial expenses without putting that burden on anyone else. If you’re young and you haven’t saved enough to cover those expenses yet, then you might consider a 5 or 10 year term life insurance policy. That will give you enough time to save the money yourself, but it won’t cost you very much either. (Especially if you’re only talking about $10,000 or $20,000 of coverage.) And no, you don’t need to cover your debts. Whatever your estate cannot cover will be forgiven at your death. Your parents won’t get stuck with your debts.

If You Can Self-Insure…

       To self-insure means that your assets take the place of insurance. Once you reach a point where your assets can do what your life insurance was meant to do, you don’t need the life insurance any more. This is why most people don’t need life insurance for all their life. If your life insurance is meant to replace your income but you have enough retirement savings to do that, then you don’t need life insurance. This is why a 30 year term life insurance policy will be plenty for most people if they continue to save for retirement. After that length of time, their retirement savings can replace their income if they die.

       Maybe you bought life insurance to cover your mortgage if you or your spouse die but you’re not worried about replacing your income. If your savings could pay off your mortgage of if you’ve paid off your mortgage early, then you don’t need the life insurance policy any more.

Make Sure You Really Need It

       Insurance is meant to cover a risk. With life insurance you’re usually covering the risk that you’ll die but your dependents will still need your income. If your savings can cover that risk for you, then you don’t really need the insurance.

       You should use this same logic when deciding whether you should get term life insurance or permanent life insurance. If you know you’re going to save for retirement and you’ll have a good bit saved after 30 years, then you don’t need life insurance coverage to go beyond that. A 30 year term life insurance policy will cover you until you get to that point, but you don’t need to keep permanent life insurance coverage because you can self-insure.

       Don’t get insurance just because someone tells you it’s a good idea. You need to look at your own situation and ask yourself if you really need it. If you do need it, then ask yourself how much you need and how long you need to be covered. (That is, ask yourself how long until you can self-insure.) Paying for insurance you don’t really need is a complete waste of money.

Uncle Sam says,        If you qualify, making a contribution to a Traditional IRA can help you lower your taxes. You could save anywhere from $500 to $3,000 on your federal income taxes! You could also save on your state or local income taxes depending on how they’re calculated. Here’s what you need to know:

What is a Traditional IRA?

       A Traditional IRA is a tax-deferred account designed to help you save for retirement while providing tax benefits. If you qualify, contributions to a Traditional IRA are tax-deductible up to certain limits. Interest, dividends, and capital gains are not taxable inside a Traditional IRA. You’ll have to pay ordinary income taxes on withdrawals from a Traditional IRA.

Do You Qualify?

       To be eligible to take a tax deduction for your Traditional IRA contributions, you must meet these requirements:

  1. You must have earned income equal to or exceeding your Traditional IRA contributions.
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  3. You must be under age 70 1/2.
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  5. If you (or your spouse) are covered by an employer-sponsored retirement plan, your income must be under a certain limit depending on your situation (single or married).

       Earned income includes anything you receive a W-2 for or any profits from self-employment. Things like interest and dividends are considered unearned income because you didn’t actually do any work to receive them. For IRA purposes, earned income can also include alimony or separate maintenance payments.

How Much Can You Contribute?

       How much you can contribute depends on your adjusted gross income (AGI) and whether you or your spouse are covered by an employer-sponsored retirement plan. You can find out for sure by looking on your W-2. If there’s an “X” in box 13, then you’re covered. Your AGI is all of your income minus any deductions you can take on the first page of Form 1040 down to the IRA deduction. Those deductions are quite limited, so it will probably just be your total income (including interest, dividends, capital gains, etc.).

       If you’re single and you’re not covered by an employer-sponsored retirement plan, the maximum you can contribute (and deduct) to a Traditional IRA for 2009 is $5,000 ($6,000 if you’re 50 or older). If you’re married and neither you nor your spouse are covered by an employer-sponsored retirement plan, you can each contribute (and deduct) $5,000 (make it $6,000 if you are 50 or older). If only one of you is 50 or older, then that person can contribute $6,000 but the other can only contribute $5,000. There are no income limitations when neither you nor your spouse are covered by an employer-sponsored retirement plan.

       If you’re single and you are covered by an employer-sponsored retirement plan, your 2009 AGI must be below $55,000 to be able to contribute the maximum of $5,000 (or $6,000 if you’re 50 or older). The amount you can contribute gets phased out proportionally if your AGI is between $55,000 and $65,000. For example, if your AGI is $60,000, you can only contribute $2,500 (or $3,000 if you’re 50 or older) to a traditional IRA. You can’t contribute (and deduct) anything if your AGI is above $65,000.

       If you’re married, it gets a little more complicated. If both you and your spouse are covered by an employer-sponsored retirement plan, your 2009 AGI must be below $89,000 to get the maximum contribution for both of you. The phaseout begins at $89,000 and goes up to $109,000. Neither you nor your spouse can contribute (and deduct) anything if your AGI is above $109,000. If one of you is covered by an employer-sponsored retirement plan and the other is not, there are two separate limits. To be able to deduct a Traditional IRA contribution for the spouse who is covered, your AGI must be below $89,000 (just as above) with a phaseout going up to $109,000. But to deduct a Traditional IRA contribution for the spouse who is not covered, your AGI only needs to be under $166,000 with a phaseout going up to $176,000. It’s possible that you can only make a deductible Traditional IRA contribution for one of you and not the other (if your AGI is between $109,000 and $176,000).

When to Contribute

       You can make contributions to your Traditional IRA until April 15 of the following tax year (just like Roth IRAs and HSAs). So if you want to make a contribution for 2009, you have until April 15, 2010 to do so.

Don’t Forget to Claim the Deduction!

       You’ll need to make sure you claim your deduction for Traditional IRA contributions on your federal income tax return. You’ll take the deduction on line 32 of Form 1040. (Or you can just tell your tax preparer.) If you don’t claim the deduction, you won’t get any benefit at all!

More Free Tax Saving Tips!

       If you want to learn more ways to (legally) reduce your taxes, sign up for free updates to Provident Planning. It’ll only cost you a minute of your time, but you might just learn how to save yourself hundreds or thousands of dollars!

How to Build Up Your Emergency Fund

Corey —  September 25, 2009 — 1 Comment

       If you’ve decided you need an emergency fund, you know where you’ll keep it, and you know how much you’ll need, all you need to do now is start building it up! There are two main ways you can do this: jump start it or one brick at a time.

Jump Start Your Emergency Fund

       The best way to build up your emergency fund quickly is to jump start it. Use a windfall (like an inheritance or tax refund check) to bulk up your emergency fund by $1,000 or $2,000 all at once. You can also try selling your Stuff to make some quick cash to throw in your emergency fund. You could try getting a part-time or temp job and use all the income to build up your savings. (You can do the same thing to help you pay off debt!) These are all serious steps to quickly building up your emergency fund. However, it’s much more likely that you’ll build it up slowly over time.

One Brick at a Time

       Your other choice is to build up your emergency fund just a little at a time. If you opened an Orange Savings account at ING Direct, you can easily do this by creating an automatic savings plan where you automatically deposit the same amount in your emergency fund every month (or as frequently as you choose). Here’s what to do:

       Make room in your budget. Before you set up an automatic savings plan, you need to know how much you can save each month without breaking your budget. So yes, you’ll need to make a budget. Then, if you don’t have anything left over to save each month (or if it’s not enough), you’ll need to find ways to cut back. Look at your unnecessary expenses (wants) and the areas you care the least about first. These are the things that you can do without and still survive. Either cut back on these items or eliminate them completely. Then use the money you’ve freed up to save for your emergency fund.

       Set up your automatic savings plan at ING Direct. This is very easy to do. Once you log in to ING Direct, just click the Automatic Savings Plan (ASP) icon:

ASP Icon

       Then, you’ll see a screen like this:

ASP Form

       All you need to do is enter the amount, pick the account to transfer from and the account to transfer to, pick the frequency (either weekly, bi-weekly, the fifteenth and end of each month, or monthly), and enter a start date. ING will then automatically make the transfer using the information you’ve provided. You don’t have to do anything else.

       When you’ve reached your goal, just go back to that page to turn off the automatic savings plan. It’s as simple as that.

       You can use this plan with just about any high-yield savings account. I just recommend ING Direct for the reasons I outlined in my article about where you should keep your emergency fund.

Take Action!

       Nearly all the personal finance ideas you need to follow are very simple. Understanding personal finance is not the problem – that’s easy. With a clear, concise explanation I’m sure anyone can understand the basics of personal finance. The hard part is taking the action needed to put the information into use. The actions themselves aren’t hard, but maintaining the motivation and discipline required for success can be daunting. Don’t let fear or complacency keep you from action. Choose success, use the information you have, and take the steps to gain control over your finances today.

       I’m a big proponent of careful and wise giving to make sure resources are used most effectively. There are many charity watchdogs, but after careful analysis I prefer The American Institute of Philanthropy (AIP) over the rest. Here’s why:

AIP Strives for Independence

       AIP does not charge the charities it reviews and accepts absolutely no advertising in its publications or on its website. Heads of nonprofit organizations are excluded from their board of directors to prevent conflicts of interest. Over 95% of their support comes from individual donations (which provide membership and a subscription to AIP’s Charity Rating Guide). This allows AIP the freedom to speak openly and to be critical of unethical practices in the charities they review without fear of losing funding.

AIP Uses Stringent Review Criteria

       AIP’s standards for evaluating charities are considered the most stringent among charity watchdog organizations. They carefully review the financial information of each charity using audited financial statements. This information has been verified and reported by a third-party outside of the charity. This helps AIP see how charitable gifts are really spent. When rating a charity, AIP considers how much actually goes to charitable programs, effectiveness of fundraising efforts, and years of available assets.

AIP Reviews a Wider Range of Charities

       Other charity watchdog organizations will only review charities that are required to file Form 990 as required by the IRS. They will request audited information from religious charities and social welfare groups (like the ACLU, Human Rights Campaign, National Right to Life Committee, and the Sierra Club). These charities and groups are not reviewed by other popular charity watchdogs like Charity Navigator. For example, AIP is the only place I can find a review of one of my favorite charities, Mennonite Central Committee.

AIP Provides Valuable Tips and Reports

       You can find a list AIP’s top-rated charities and their grades for free online. You can see a list of all the charities they review here. A donation of at least $40 is required to become a member, which will provide you with their triannual Charity Rating Guide where you can read reviews of all the charities. Additionally, they provide several free articles about charities and their practices as well as valuable tips. Check out their article on tips for giving wisely to charities or seven tips for reducing unwanted solicitations.

Do Your Homework

       AIP does not screen charities for certain values (religious or otherwise) – they only look at how effective the charities are at using the money they receive. I think their top charities list is a good place to start. But if you want a charity that also follows your values, you’ll need to do further research on your own. I’ll be looking at some of the top-rated Christian charities in future posts. Sign up for free updates to Provident Planning if you want to get future articles in your email or feed reader!

       If you’ve figured out how much you should be saving for retirement, your next step is to actually start investing the money. Vanguard offers the widest range of low cost index funds available to individual investors. This calculator will help you invest in a diversified portfolio of index funds.

*Note: Click the ‘Click to Edit’ button to use the calculator with your own numbers.

       The dollar amount you should invest is in column E, which you won’t see unless you scroll over. You can use the full screen view or download it as an Excel spreadsheet.

       Depending on your age and the amount you have to invest, you might not be able to use this calculator. If you’re still young, there’s no problem using a 100% stock portfolio until you’re within 25 years of retirement. (That’s my plan. The 120 – your age rule is just a guideline.) You can force the calculator to use a 100% stock portfolio by entering an age of 20 or lower.

       Otherwise, follow the directions the calculator provides. If you have less than $1,000, you should continue saving in a high-yield savings account (like ING Direct’s Orange Savings Account). Until you have more than $3,000, you should use Vanguard’s STAR Fund (#0056). If you have more than $3,000 but not enough to use this calculator, you should use Vanguard’s Target Retirement Funds. Vanguard’s website can help you determine which target retirement fund would be best for you.

Questions about the Portfolio Allocation

       I’ve compiled some responses to typical questions about the portfolio allocation used in this calculator.

       Why so little in U.S. stocks/so much in international stocks? Most investment advisers recommend a large portion of your portfolio be allocated to U.S. companies. Why is this? As far as I can tell, it’s because they have more faith in American companies. The truth is that American companies only make up about 40% of the total world stock market. If you put 80% or more of the stock portion of your portfolio in American companies, you’re basically putting all your eggs in one basket. By diversifying into foreign countries, you mitigate the risk that any one country’s dilemmas will adversely affect the value of your portfolio. Even though foreign stocks tend to move like U.S. stocks in hard times (like right now), they will move quite differently in the long run. This reduces your volatility (risk) and increases your return. (Though I can’t guarantee that, obviously.)

       Why add value stocks? Historically speaking, value stocks have outperformed growth stocks. In some ways, this makes sense logically. Because you’re buying companies that are “undervalued”, you’re getting them at a discount. Once these stocks return to their true values and continue to grow, you end up with a higher return than if you had bought the stock at a fair or high price. Not all Value stocks actually recover and many do go bankrupt or out of business. However, the ones that do recover come back very strong and more than make up for the losers. This is why you would buy a value index fund – you’ll own thousands of companies, so no one company will have a huge effect on your portfolio.

       The bonds don’t seem very diversified to me. What about long-term bonds, global or foreign bonds, high-yield bonds, or government bonds? The bond portion of a portfolio should be there to serve as a safety net. It’s designed to offset the risk you’re taking on by investing in stocks. You shouldn’t use the bond portion of your portfolio to seek extremely high returns, so that rules out high-yield bonds. Long-term bonds give you slightly higher returns than intermediate-term or short-term bonds, but they do so at much higher risk. It’s actually so much more risk that it doesn’t make sense to invest in long-term bonds for the safer portion of your portfolio. Global/foreign bonds and government bonds are not listed separately because they are included in the bond funds I’ve recommended. The two funds both invest in a mix of U.S. and international bonds and government and corporate bonds.

Other Questions

       If you have more questions about the recommendations or investing at Vanguard, feel free to leave a comment below. I’ll be happy to answer your questions.

How to Get Out of Debt

Corey —  September 22, 2009 — Leave a comment

       If you realize that debt is slavery and you’re ready to break free, you’re already well on your way to becoming debt free. Half the battle of paying off debt is finding the motivation to bust through the chains and throw off the weight of debt. You can get out of debt, and this article will give you a plan that will lead to success.

Commit

       You must be fully committed to getting out of debt. If you want to get out of debt and stay out of debt, you must focus all your energy on making the changes necessary for success. You can’t keep doing the things you’ve been doing and expect to get out of debt. If so, you wouldn’t be where you are now!

       Before you read the rest of this article, you have to be fully committed to getting out of debt and staying out. You must know why you want out. You must know what your motivation is. You don’t need a grand, complex reason – you just need a reason that you believe in. If you’re really committed to paying off your debt and avoiding it in the future, then you will find success. If not, you might as well quit reading right here.

Establish an Emergency Fund

       Before you try to pay off your debts, you need to have an emergency fund. Any progress you make toward paying off your debts can be completely wiped out once the first emergency hits. Save up at least one month’s worth of your living expenses before focusing on paying off your debts. (But don’t forget to keep making the minimum payment on your debts!) Click here to read about where you should keep your emergency fund.

Set a Goal & Make a Plan

       If you’re ready to do everything necessary to get rid of your debt, great! Now you just need to set a goal. What debts do you want to get rid of? All of them? Everything except your mortgage? Decide right now, and write it down.

       Next, you need a plan. How are you going to pay off your debts? Which debt will you focus on first? What will be your next target? There are multiple ways to approach this. First, you’ll need to know the interest rate, balance, and minimum payment for all of your debts. Then, rank them using one of these three methods:

  1. Highest Interest Rate First – Start your list with the debt that has the highest interest rate. Then put the debt with the second highest interest rate below that. Keep doing this until all your debts are listed. This is the best way to pay off your debts if you’re looking at the numbers only. (You’ll pay the least amount of interest this way.)
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  3. Lowest Balance First – Start your list with the debt that has the lowest balance. Then put the debt with the second lowest balance below that. Keep doing this until all your debts are listed. This method feels good psychologically because you’ll get some small wins fast, but it could cost you quite a bit in the amount of interest you’ll end up paying. (Depending on the interest rates of your debts and their balances, this method could cost you much more in interest because you could be paying higher interest rates for a longer period of time.)
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  5. Highest Stress Level First – Start your list with the debt that worries or stresses you the most. List the next highest stress debt below that. Keep doing this until all your debts are listed. This could be a good way if you worry a lot about your debts, but it could also cost you a lot in interest payments.

       Regardless of how you list your debts, how you’ll pay them off won’t change. You’ll have to pay the minimum payment on all of them regardless of where they’re listed. Then any extra money you can find will go toward paying the first debt on your list. After that one is paid off, you’ll put that first debt’s minimum payment plus any extra money toward paying off the second debt. You’ll keep repeating this process until you’re debt free!

       If you’re behind on your debts and your creditors are starting to tell you they’ll foreclose or send your debt to a collections agency, you’ll need to come up with a plan for how you’ll deal with the situation. Do not go to a debt management service. They cannot do anything that you can’t do by yourself. They’ll want to charge you fees for their service, and that’s the last thing you need while trying to get out of debt. You can negotiate with your creditors by yourself, but you’ll need to remain calm and be ready to compromise. You’ll have to work with your creditors to come to an agreement that’s good for both of you.

Make a Budget & Stick to It

       To attack your debt most effectively, you’ll need to make a budget and stick to it. You must know where your money is going so you’ll know where you can save and how much extra you have to put toward your debts. Once you’ve set your budget, you’ll need to stick to it or you’ll lose all the progress you’ve made in paying off your debts.

       Your budget does not need to be complicated. You simply need to list your income and your expenses in a way that makes sense to you and covers all your bases. Having this list will help you see where you can save the most money and help you determine how much you can put toward paying off your debts.

       Once you’ve got a budget, you need to find a way to stick to it. You can track your spending in a spreadsheet, make your savings, debt, and essential payments automatic, or use the envelope method (where you put each category’s budgeted amount in an envelope every month and only spend from there). Use whatever method you think will work for you. If it doesn’t work, ask yourself why and figure out what you should do instead.

Trim the Fat & Earn More

       To pay off your debt quickly, you need to find ways to save money and earn more. Look at your budget and figure out ways you can save on the biggest categories. Then focus on ways you save in the smaller categories. Do the easiest things first to get the most out of your time. Use the money you save to pay off your debts.

       Look for ways you can earn more money. Can you work overtime? Can you get a raise? Can you start a side-business? Can you sell some of your Stuff? Any extra money you can earn will help you pay off your debts faster.

Celebrate Your Milestones

       Find simple ways to celebrate your milestones. Treat yourself (or you and your spouse, or your family) to something fun when you eliminate a debt or at certain milestones. You could celebrate when you’ve paid off $500 in debt – then $1,000, $2,500, $5,000, $10,000, and so on. Set some milestones that make sense for you, and then celebrate when you reach them!

Share Your Story

       I’m confident you can and will pay off your debt if you follow this guide. If there’s anything I can do to help you, feel free to share your story here or contact me. If you’ve used these methods to get out of debt, share your story here and encourage others!