Advances in investment theory have dovetailed nicely with ancient wisdom to present investors with a new and exciting paradigm for investing. These advances, known as Modern Portfolio Theory, were developed by primarily by Nobel prize winning economist Harry M. Markowitz. Modern Portfolio theory emphasizes the importance of disciplined investing that focuses on proper asset allocation rather than on trying to pick winning stocks, or timing the market. Asset allocation is generally defined as the allocation of an investor's portfolio among a number of major asset classes. Markowitz and others in the field of Modern Portfolio Theory have taught us that it is much better to create diversified, efficient, disciplined investment portfolios than to try to beat the market.
The way in which asset allocation dovetails with ancient wisdom is that it turns our focus inward rather than outward. It focuses us on our own investing behavior rather than on an endless chase to try to outsmart the market with hot stock tips, market timing and other such lures. Once we have determined an asset allocation that is appropriate for our risk tolerance, then our work is to stay centered and disciplined, to hang in there with our asset allocation strategy, and not get swept up by the hot tip of the day.
The new paradigm is that our focus is on a sense of centeredness, mindfulness, and discipline with regard to our investing. We don't need to be in a competitive frame of mind to be successful investors. We don't need to outsmart others. Instead, we enter into investing with the positive view that even as markets go up and down as they will, over the long haul, a maintaining a proper asset allocation is a sound strategy. We become less focused on the daily ups and downs of the market, and stay centered and mindful, aware that wise investing is a long-term project.
This centeredness allows us to resist the allure of speculative buying when markets heat up. I remember in the late 1990's talking with an old friend near the dizzying height of the internet stock bubble. He showed me a glossy financial magazine featuring a picture of a deliriously happy couple holding up handfuls of cash. The headline trumpeted "Everybody's Getting Rich"
"It's true" my friend asserted. "There's no limit to how much you can make off the stocks of these internet companies. The old rules don't apply to the new economy." He urged me to invest in a high tech company that was just going public, assuring me that we would both make a killing. He was certain his stock, a provider of online services, could not miss. He was convinced it was "the new AOL". Despite his enthusiasm, I declined to invest. I was committed to maintaining my portfolio's asset allocation. It turns out that my decision was prudent, since the company he was touting is now in bankruptcy, with its stock value at zero. My friend had invested far too much of his portfolio on this gamble. Like so many others, he got caught up in the financial euphoria of the tech bubble only to have the bubble burst in his face.
The new investing paradigm helps us maintain our composure when markets go through their inevitable ups and downs. We avoid the trap of chasing the latest hot tip, and learn that building wealth is a long-term project. We stay committed to a long-term strategy of maintaining an appropriate asset allocation, and do not over-react to market volatility. With a sense of commitment and centeredness, we build true wealth over time.
Friday, May 22, 2009
Deferred Student Loans - There Are Rules, You Know!
Getting to college, saving the money and earning it as you go is only a part of the story. Most students will borrow at least some of the cash they need.
Once the classes have finished and it's time to get out into the real world, it's also time to decide how you are going to handle your deferred student loan into the future.
You don't want a cloud hanging over you forever, nor do you want to miss then fun your new earning power gives you.
So what's the deal then?
Let's just look at what a deferred student loan is all about. Whilst some student loans are deferred, you need to realize that many require payments even while you are still at college, which as you might already realize, is like topping up a water barrel that has the plug already out at the bottom.
Question is, can you put money in at the top fast enough to stop your barrel becoming empty?
So, if you can, it might be a great idea to have a loan, like a Stafford loan that needs no repayment until graduation is over, often with a 6-month grace period as well, to get you started in your job and new home etc.
Whatever the benefits of this are, there are rules upfront. If you leave college, or do too few hours of class, for example, you may well be required to pay back all you have borrowed right away. From this point of view, so long
as you stay enrolled in the college that you have chosen, or a similar qualifying one, you will be OK In this way, the loan is regarded as a deferred student loan.
With a Stafford Loan, there are two ways that it works. Sometimes the deferred student loan is offered by the college itself.
The alternative is where private funding is arranged, by a specialist in student loans and guaranteed by the federal government. Repayment is the same in both situations and the loan remains payable under the terms of the agreement.
An alternative, the Perkins deferred student loan, comes through the college and has government funds to back it and is focused on those who cannot afford a loan from any other sector.
You need to remember that there is a range of schedules for deferred student loans that are not as 'deferred' as you might want. Getting into one of these without the right plan going forward will give you a tough time, so make sure that you realize fully what you are getting into.
You see, as an example, a 'Federal Direct Parent Loan for Undergraduate Students' start their repayment demands within a couple of months of classes starting!
This is not really one of the deferred student loans that you would want to take, if you are in the emptying that water barrel situation. If you do find you have one of these loans, it's vital to get your budgeting and cash flow well organized well before you start to fall behind.
Once the classes have finished and it's time to get out into the real world, it's also time to decide how you are going to handle your deferred student loan into the future.
You don't want a cloud hanging over you forever, nor do you want to miss then fun your new earning power gives you.
So what's the deal then?
Let's just look at what a deferred student loan is all about. Whilst some student loans are deferred, you need to realize that many require payments even while you are still at college, which as you might already realize, is like topping up a water barrel that has the plug already out at the bottom.
Question is, can you put money in at the top fast enough to stop your barrel becoming empty?
So, if you can, it might be a great idea to have a loan, like a Stafford loan that needs no repayment until graduation is over, often with a 6-month grace period as well, to get you started in your job and new home etc.
Whatever the benefits of this are, there are rules upfront. If you leave college, or do too few hours of class, for example, you may well be required to pay back all you have borrowed right away. From this point of view, so long
as you stay enrolled in the college that you have chosen, or a similar qualifying one, you will be OK In this way, the loan is regarded as a deferred student loan.
With a Stafford Loan, there are two ways that it works. Sometimes the deferred student loan is offered by the college itself.
The alternative is where private funding is arranged, by a specialist in student loans and guaranteed by the federal government. Repayment is the same in both situations and the loan remains payable under the terms of the agreement.
An alternative, the Perkins deferred student loan, comes through the college and has government funds to back it and is focused on those who cannot afford a loan from any other sector.
You need to remember that there is a range of schedules for deferred student loans that are not as 'deferred' as you might want. Getting into one of these without the right plan going forward will give you a tough time, so make sure that you realize fully what you are getting into.
You see, as an example, a 'Federal Direct Parent Loan for Undergraduate Students' start their repayment demands within a couple of months of classes starting!
This is not really one of the deferred student loans that you would want to take, if you are in the emptying that water barrel situation. If you do find you have one of these loans, it's vital to get your budgeting and cash flow well organized well before you start to fall behind.
The Canyon of Incumbrance: Young Texas And I Crawl Out of Debt
I'm not going to lie. Sure, I'll admit it. I've been pushed past the point of shame, and have fallen straight into the abyss prominently named, "The Lonely Canyon Of Incumbrance." I'm one of those people.
Yes, in my youth, I made some financial blunders and managed to sink myself into a molehill of debt. I refuse to call it a "mountain" -- I refuse! It would only discourage me. But, between student loans and credit cards that got me through tough times (and a few luxurious ones), my "molehill" has added up to more than I want to mumble out loud. Let's just say that at this point, I skim over the "account summary" section of my bills and go straight to "minimum due."
Looking around my dark and scary abyss, though, I realize I'm in good company. Ninety-seven percent of bankruptcies declared in this country are non-business related, and millions of Americans have had to do it. Unsecured consumer debt has risen to an all-time high of $2 trillion, the highest in the world. Factor in mortgages -- a type of secured debt -- and we're up to $9 trillion. Texas is plagued by debt, too. No wonder so many of us can't afford those high premium health insurance policies. (Texas leads the nation with nearly 25% uninsured across the state - that's 5.4 million.)
I won't say it's not my fault. Of course it is. Credit cards were easy; student loans were even easier. And while I worked all through college, somehow the red column in my non-existent financial ledger still added up to an atrocious figure.
Part of the problem, I truly believe, is that with credit cards so easy to get and use nowadays, our generation is forgetting how to manage money. We want what we want, and we want it now. Damn it. Credit card companies know this. They're marketing to college students like never before, and the millions of students in Austin, Dallas, and Houston can attest to this.
After realizing I couldn't afford health insurance and save my credit at the same time, I decided to start accumulating sound advice on financial planning, instead. After several free consultations with credit counselors, I knew there was hope. All I had to do was budget.
It sounds so terribly easy. "Of course," you say. "I do budget." But you may not be budgeting as well as you think. Three dollars a day on your favorite mocha frappuccino adds up to 90 bucks a month, which accumulates to about $1,000 every year. An extra $100 for that snazzy cell phone, when you could get a free one from the provider, is money you could be using to pay off a high-interest credit card. That doesn't mean you can never have your mocha. It does mean outlining a realistic budget for it.
(1) Decipher what you really need, versus what you really want.
Everyone must have food, shelter, clothing, and, for most working individuals, some kind of transportation allowance.
HousingIn general, shelter should take about one-third of your income. With the recent rise in housing costs, this may not be realistic, but do the best you can. Be willing to take an apartment without a view for a little while. If you save a little extra on rent, you'll be a lot closer to buying your own place in a few years.
FoodReduce costs on food by buying non-perishables in bulk when possible (which can be done by joining a wholesale club, or special ordering products through a grocery store), sign up for membership discounts at those grocery stores (which are almost always free and painless), and use coupons! (Think of those extra three bucks as a cappuccino.) Watch for sales and stock-up on good deals.
Co-op groceries are also a great way to cut food costs. Some offer work exchange opportunities in lieu of paying membership fees, and even if there is a small sign-up charge, the savings and profit-shares you'll get over the years will be worth it.
Plan meals ahead, and be willing to cook. Ready-made meals are generally more expensive, as well as less nutritious. Taking your lunch to work, and while out on day trips, can save thousands of dollars a year. If you have the space, grow your own herbs and produce, too. It's fun, cheap, and quite easy once you know what you're doing.
TransportationPublic transportation is a great invention. It's environmentally friendly, and generally a lot cheaper than owning your own vehicle, particularly in large cities. Many employers even offer incentives, such as discount transportation passes, for taking the bus or subway to work.
If public transportation isn't realistic, research carefully before buying a vehicle. Look not only into in-city fuel efficiency -- which is different from how much gas the vehicle will use on the highway -- but also warranties, maintenance schedules, and loan interest rates.
Look into buying a used car directly from the owner, as well. It'll save you the dealership mark-up, and the seller can set a much better price for him or herself than a trade-in would provide. Just make sure to have a mechanic thoroughly check the vehicle over first.
Pay Down High-Interest DebtHigh-interest debt eats more income than you probably even want to think about it. Credit card companies are happy to accept minimum payments, because it means they're collecting amazing profits on excessive interest rates. Would you buy something if it was, say, 16%, 25%, or 35% higher than the ticket price? Well, that's exactly what you're doing when you charge something you won't be able to pay off within the grace period.
To make it worse, most credit cards pay off lower interest rates first. That means if you transferred a balance onto your card for a great, low interest rate, but still have debt at a higher interest rate on the same card (or continue charging on that card), you won't be able to pay down the higher interest rate until the entire balance of the lower interest rate is cleared.
While you should put something into a savings or money market account for emergencies, you're losing money if you invest in those before paying down high-interest debt. It just doesn't make sense to plunk $1,000 into an account earning 5% interest, when you could use that grand to pay off debt accruing three, four, five, or even six times faster.
Yes, in my youth, I made some financial blunders and managed to sink myself into a molehill of debt. I refuse to call it a "mountain" -- I refuse! It would only discourage me. But, between student loans and credit cards that got me through tough times (and a few luxurious ones), my "molehill" has added up to more than I want to mumble out loud. Let's just say that at this point, I skim over the "account summary" section of my bills and go straight to "minimum due."
Looking around my dark and scary abyss, though, I realize I'm in good company. Ninety-seven percent of bankruptcies declared in this country are non-business related, and millions of Americans have had to do it. Unsecured consumer debt has risen to an all-time high of $2 trillion, the highest in the world. Factor in mortgages -- a type of secured debt -- and we're up to $9 trillion. Texas is plagued by debt, too. No wonder so many of us can't afford those high premium health insurance policies. (Texas leads the nation with nearly 25% uninsured across the state - that's 5.4 million.)
I won't say it's not my fault. Of course it is. Credit cards were easy; student loans were even easier. And while I worked all through college, somehow the red column in my non-existent financial ledger still added up to an atrocious figure.
Part of the problem, I truly believe, is that with credit cards so easy to get and use nowadays, our generation is forgetting how to manage money. We want what we want, and we want it now. Damn it. Credit card companies know this. They're marketing to college students like never before, and the millions of students in Austin, Dallas, and Houston can attest to this.
After realizing I couldn't afford health insurance and save my credit at the same time, I decided to start accumulating sound advice on financial planning, instead. After several free consultations with credit counselors, I knew there was hope. All I had to do was budget.
It sounds so terribly easy. "Of course," you say. "I do budget." But you may not be budgeting as well as you think. Three dollars a day on your favorite mocha frappuccino adds up to 90 bucks a month, which accumulates to about $1,000 every year. An extra $100 for that snazzy cell phone, when you could get a free one from the provider, is money you could be using to pay off a high-interest credit card. That doesn't mean you can never have your mocha. It does mean outlining a realistic budget for it.
(1) Decipher what you really need, versus what you really want.
Everyone must have food, shelter, clothing, and, for most working individuals, some kind of transportation allowance.
HousingIn general, shelter should take about one-third of your income. With the recent rise in housing costs, this may not be realistic, but do the best you can. Be willing to take an apartment without a view for a little while. If you save a little extra on rent, you'll be a lot closer to buying your own place in a few years.
FoodReduce costs on food by buying non-perishables in bulk when possible (which can be done by joining a wholesale club, or special ordering products through a grocery store), sign up for membership discounts at those grocery stores (which are almost always free and painless), and use coupons! (Think of those extra three bucks as a cappuccino.) Watch for sales and stock-up on good deals.
Co-op groceries are also a great way to cut food costs. Some offer work exchange opportunities in lieu of paying membership fees, and even if there is a small sign-up charge, the savings and profit-shares you'll get over the years will be worth it.
Plan meals ahead, and be willing to cook. Ready-made meals are generally more expensive, as well as less nutritious. Taking your lunch to work, and while out on day trips, can save thousands of dollars a year. If you have the space, grow your own herbs and produce, too. It's fun, cheap, and quite easy once you know what you're doing.
TransportationPublic transportation is a great invention. It's environmentally friendly, and generally a lot cheaper than owning your own vehicle, particularly in large cities. Many employers even offer incentives, such as discount transportation passes, for taking the bus or subway to work.
If public transportation isn't realistic, research carefully before buying a vehicle. Look not only into in-city fuel efficiency -- which is different from how much gas the vehicle will use on the highway -- but also warranties, maintenance schedules, and loan interest rates.
Look into buying a used car directly from the owner, as well. It'll save you the dealership mark-up, and the seller can set a much better price for him or herself than a trade-in would provide. Just make sure to have a mechanic thoroughly check the vehicle over first.
Pay Down High-Interest DebtHigh-interest debt eats more income than you probably even want to think about it. Credit card companies are happy to accept minimum payments, because it means they're collecting amazing profits on excessive interest rates. Would you buy something if it was, say, 16%, 25%, or 35% higher than the ticket price? Well, that's exactly what you're doing when you charge something you won't be able to pay off within the grace period.
To make it worse, most credit cards pay off lower interest rates first. That means if you transferred a balance onto your card for a great, low interest rate, but still have debt at a higher interest rate on the same card (or continue charging on that card), you won't be able to pay down the higher interest rate until the entire balance of the lower interest rate is cleared.
While you should put something into a savings or money market account for emergencies, you're losing money if you invest in those before paying down high-interest debt. It just doesn't make sense to plunk $1,000 into an account earning 5% interest, when you could use that grand to pay off debt accruing three, four, five, or even six times faster.
Leverage Land Mines
Financial leverage is like a land mine. You might be unaware of it until it blows up. Buying stocks on margin is an obvious form of leverage (the mortgage on your home is another) and all of us understand how risky it is to buy on margin.
Simply put, leverage magnifies your gain or loss and, since you're borrowing money which must be repaid, you can lose more than your entire investment (the investment and the loan amount). Okay, you say, point made, but I don't leverage my investments. Are you sure?
Did you know that many mutual funds use leverage to enhance their returns? To illustrate, let's take a look at two Nuveen municipal bond funds (Nuveen is one of the top municipal bond mutual fund companies): Nuveen Municipal Market Opportunity and Nuveen Municipal Value. It's kind of hard to tell how they differ from the names, so let's look further. Both funds are mostly invested in triple A municipal bonds, the average maturity is approximately 20 years for the bonds held in each fund and, for you quants (quantitative analyst), the duration is 5.5-6.0 years. The funds are quite similar.
Let's look at the five year returns (as measured by NAV). Municipal Market returned 6.21% annually; Municipal Value 5.90%. 31 basis points annually for five years is a noticeable difference for municipal bond funds. Why did Municipal Market perform better? There could be a number of reasons but an obvious one is its leverage.
Municipal Market is leveraged 36%. In a period of stable or declining interest rates we'd assume it would outperform Municipal Value, as it did. But, what if interest rates rise? Shouldn't its leverage reduce its return. And, if you aren't sure which way interest rates are going, or think they're going up, you want to avoid funds with leverage.
The leverage employed by the Municipal Market fund, and many other funds, is an "auction rate" preferred. Like any preferred stock, the principal does not have to be repaid-that's good. But the "auction rate" means the dividend rate (think interest) is reset regularly, typically every week or month, depending upon the instrument.
If interest rates rise, the cost of the preferred increases. The result of rising interest rates can be a decline in the NAV (due to a decline in price of long term bonds) and an increase in expense (the rising cost of the preferred), which further reduces NAV. A double whammy (not a defined financial term).
Simply put, leverage magnifies your gain or loss and, since you're borrowing money which must be repaid, you can lose more than your entire investment (the investment and the loan amount). Okay, you say, point made, but I don't leverage my investments. Are you sure?
Did you know that many mutual funds use leverage to enhance their returns? To illustrate, let's take a look at two Nuveen municipal bond funds (Nuveen is one of the top municipal bond mutual fund companies): Nuveen Municipal Market Opportunity and Nuveen Municipal Value. It's kind of hard to tell how they differ from the names, so let's look further. Both funds are mostly invested in triple A municipal bonds, the average maturity is approximately 20 years for the bonds held in each fund and, for you quants (quantitative analyst), the duration is 5.5-6.0 years. The funds are quite similar.
Let's look at the five year returns (as measured by NAV). Municipal Market returned 6.21% annually; Municipal Value 5.90%. 31 basis points annually for five years is a noticeable difference for municipal bond funds. Why did Municipal Market perform better? There could be a number of reasons but an obvious one is its leverage.
Municipal Market is leveraged 36%. In a period of stable or declining interest rates we'd assume it would outperform Municipal Value, as it did. But, what if interest rates rise? Shouldn't its leverage reduce its return. And, if you aren't sure which way interest rates are going, or think they're going up, you want to avoid funds with leverage.
The leverage employed by the Municipal Market fund, and many other funds, is an "auction rate" preferred. Like any preferred stock, the principal does not have to be repaid-that's good. But the "auction rate" means the dividend rate (think interest) is reset regularly, typically every week or month, depending upon the instrument.
If interest rates rise, the cost of the preferred increases. The result of rising interest rates can be a decline in the NAV (due to a decline in price of long term bonds) and an increase in expense (the rising cost of the preferred), which further reduces NAV. A double whammy (not a defined financial term).
Texas Invests In Its Future: The Young See Hope For Retirement
No wonder so many of us run from discussions on financial matters, ignore our bills, and spend too much money, as if in rebellion. It's scary out there.
Last year, the Employee Benefits Research Institute released the results of a study concluding that the majority of Americans are unprepared for retirement, are not saving enough for it, and have unrealistic expectations about how much they will need to live comfortably in their golden years. Texas is no exception. With its high poverty rate, and even higher rate of those going without health insurance, it's lucky many can get through day-to-day life.
Being one of the millions in debt myself, I can understand this. The rising cost of housing, food-- even clean drinking water -- can drive anyone with a limited income to distraction. I decided to stop changing the television channel with every new disastrous financial report, and to start researching, when an investment counselor said to me with matter-of-fact conviction, "You know, young adults now just may need a million to retire." After the initial (and expected) incredulous gasp, I decided gulping air wasn't going to do me much good. As usual, knowledge and simple planning gave me hope. Here are a few tips on digging yourself out of the panic.
Checking and Savings Accounts:
The first step in building a sound financial future is practicing money management skills with both checking and savings accounts. Most of us have at least one of them; keeping track of their balances is an entirely different matter.
Free checking accounts are fairly easy to procure. At one point, it was common for financial institutions to charge monthly fees for the privilege of stashing money with them, but the banking industry rakes in so much profit from successfully luring their customers into other investments that it's just not necessary anymore.
The theory is that if one has a free account with a particular financial institution, there's a good chance that person will return to that institution for other investments as his or her income grows -- investments that will make both the customer and the bank happy.
By all means, take advantage of this. Texas abounds with students -- students needing any freebies they can get -- so it shouldn't be difficult to find a bank offering free checking and savings accounts, especially in cities like Dallas, Houston, and Austin. Look for a checking account without a minimum balance requirement, and one that doesn't, of course, charge monthly fees.
Free checking accounts are not usually interest-bearing, so put only enough money in it every month to cover your monthly bills, plus a little padding. Keep track of your balance; the greatest risk with these accounts is the astronomical overdraft fees most of them charge. Once all of your bills are paid at the end of each month, stash extra income in an interest-bearing savings account. The average APY (Annual Percentage Yield) on low-balance savings accounts hovers somewhere just around 0.5%, but at least it's something.
Short to Middle-Term Investments:
Once you feel you've established a healthy pattern of money management -- no overdrafts, a properly balanced ledger, and all bills paid in full -- start looking into other investments. Most of the time, you'll need at least $500.00 to invest in other types of accounts, and, at least initially, look for those with better APYs than your current savings account, but will not inflict penalties for withdrawing funds whenever you need them.
Money Market Accounts:
Money market accounts are great investments at any age, but they're particularly advantageous for beginning investors simply because there are no penalties for withdrawing any amount at any time, no waiting period to continue investing (you can, likewise, deposit money at any time), and the funding is usually only a check away. There are several types of money market accounts, so be sure to investigate the minimum investment required, interest rates, and restrictions on each before making any commitments.
Money markets work by pooling investments from thousands of contributors into an assortment of (usually short-term) funds from municipal bonds, to stocks. The result is a fluctuating interest rate that is almost always at least a few percentage points higher than that of a standard, low-balance savings account. According to USA Today, non-bank money market funds are currently at about 5% APY.
Certificate of Deposit:
Certificates of Deposit, or "CDs" have been around longer than the replacement for the tape cassette. Interest rates are fixed, rather than fluctuating, are usually comparable to money market accounts and can be purchased at a bank or other financial institution, including many sites online, for terms as short as three months. Of course, the longer the term you lock in, the higher the rate you will obtain under most market conditions In other words, whatever interest rate you lock in at the beginning will remain the same throughout the course of the investment. Once you've invested in a CD, however, you cannot continue adding to the same one during the life of that investment, until renewal -- which is one reason you may want to go with a shorter term.
The primary disadvantage of CDs lies in the substantial penalties inflicted if the investor withdraws his or her money before the allotted time. The average APY for a six-month CD is currently 3.59%; for a one-year CD, 3.77%; for a five-year CD, 3.96%, although some banks may offer better deals. CDs are a good idea if their current APYs are higher than contemporary money market accounts, and you don't expect to -- or perhaps don't trust yourself to -- handle the money for a while.
Health Savings Account:
Health Savings Accounts, or HSAs were created by a 2003 Medicare bill, and are, without a doubt, worthy of consideration for many individuals and families. HSAs strive to address the growing problem of underinsured Americans (Texas knows this well, with over 25% of its population going without any insurance) by allowing investors to save for qualified medical expenses and future retirement health expenses, on a tax-free basis.
These accounts are only made available to those with qualifying high-deductible health insurance policies, and are a great choice for many young, middle-class Americans. HSAs provide incentives for saving towards healthcare, and a bit of financial padding in case of disaster. The major disadvantage is that penalties are inflicted if the money is withdrawn for unqualified expenses prior to the age of 65.
Retirement Accounts:
The types of retirement accounts available to Americans are too numerous to mention, and are highly dependent on employers in most cases. Entire sections of libraries and many websites are dedicated to this subject. The first, and most important thing to do, is to check with your employer to see if, or what, retirement plans are offered. Some companies offer employee benefits, including flexible 401(k) plans and matching funds. Look seriously into these options.
However, rather than briefly attempting to delve into the plethora of accounts that may, possibly, be available to you, this article will focus on an account available to all, regardless of employer
-- the Roth IRA account - which has become increasingly popular since becoming law in 1997
Now, IRAs have been around for some time, but traditional IRA accounts require funds going in, and coming out, to be taxed. This means that whatever dividends or proceeds an investor earns over the years will be taxed upon withdrawal. Considering that IRA interest rates are compounded, this could (and is intended to) add up to quite a bit over several decades
Roth IRA accounts, on the other hand, do not tax funds upon withdrawal. Funds invested into the account are considered taxable income going in, but the compounded interest or proceeds can accumulate tax free, until the age of 59 1/2, at which point they can be withdrawn without penalty or taxes. A Traditional IRA, on the other hand, is not taxed going in, but is subject to tax coming out, at whatever rate of income will apply to you at that time -- the assumption being that you will withdraw most of this money during retirement, when you will not have other earned income driving up your tax rate,. This means that whatever your Roth IRA account balance statement is, is the amount you have for retirement, free and clear. No more taxes.
If an investor begins an IRA account in his or her twenties, and contributes a modest amount every month (possibly matched by an employer), principle and compounded interest could conceivably yield a million or more dollars over four decades. The way to think of a Roth IRA, as opposed to a Traditional IRA, is that you are paying taxes on the seeds instead of on the crop.
Now, that's something to think about. Maybe retirement is possible...
See, that wasn't so hard. Respect yourself (and your anxiety levels) enough to seriously investigate financial opportunities. There's a good chance you're missing something you have the funding for -- right now, sitting in a no-, or low-, interest-bearing account. If you have any kind of steady income, financial security should be within your grasp. A comfortable retirement is in your future. Just take a deep breath, open your bills, and start acting like the adult you always dreaded you'd have to be someday.
Taking care of your financial responsibilities can have a positive effect on your anxiety levels, sense of security, and overall health. Being aware of your health, and what you can do to safeguard it, will certainly affect you as you age, and eventually your wallet as well.
Last year, the Employee Benefits Research Institute released the results of a study concluding that the majority of Americans are unprepared for retirement, are not saving enough for it, and have unrealistic expectations about how much they will need to live comfortably in their golden years. Texas is no exception. With its high poverty rate, and even higher rate of those going without health insurance, it's lucky many can get through day-to-day life.
Being one of the millions in debt myself, I can understand this. The rising cost of housing, food-- even clean drinking water -- can drive anyone with a limited income to distraction. I decided to stop changing the television channel with every new disastrous financial report, and to start researching, when an investment counselor said to me with matter-of-fact conviction, "You know, young adults now just may need a million to retire." After the initial (and expected) incredulous gasp, I decided gulping air wasn't going to do me much good. As usual, knowledge and simple planning gave me hope. Here are a few tips on digging yourself out of the panic.
Checking and Savings Accounts:
The first step in building a sound financial future is practicing money management skills with both checking and savings accounts. Most of us have at least one of them; keeping track of their balances is an entirely different matter.
Free checking accounts are fairly easy to procure. At one point, it was common for financial institutions to charge monthly fees for the privilege of stashing money with them, but the banking industry rakes in so much profit from successfully luring their customers into other investments that it's just not necessary anymore.
The theory is that if one has a free account with a particular financial institution, there's a good chance that person will return to that institution for other investments as his or her income grows -- investments that will make both the customer and the bank happy.
By all means, take advantage of this. Texas abounds with students -- students needing any freebies they can get -- so it shouldn't be difficult to find a bank offering free checking and savings accounts, especially in cities like Dallas, Houston, and Austin. Look for a checking account without a minimum balance requirement, and one that doesn't, of course, charge monthly fees.
Free checking accounts are not usually interest-bearing, so put only enough money in it every month to cover your monthly bills, plus a little padding. Keep track of your balance; the greatest risk with these accounts is the astronomical overdraft fees most of them charge. Once all of your bills are paid at the end of each month, stash extra income in an interest-bearing savings account. The average APY (Annual Percentage Yield) on low-balance savings accounts hovers somewhere just around 0.5%, but at least it's something.
Short to Middle-Term Investments:
Once you feel you've established a healthy pattern of money management -- no overdrafts, a properly balanced ledger, and all bills paid in full -- start looking into other investments. Most of the time, you'll need at least $500.00 to invest in other types of accounts, and, at least initially, look for those with better APYs than your current savings account, but will not inflict penalties for withdrawing funds whenever you need them.
Money Market Accounts:
Money market accounts are great investments at any age, but they're particularly advantageous for beginning investors simply because there are no penalties for withdrawing any amount at any time, no waiting period to continue investing (you can, likewise, deposit money at any time), and the funding is usually only a check away. There are several types of money market accounts, so be sure to investigate the minimum investment required, interest rates, and restrictions on each before making any commitments.
Money markets work by pooling investments from thousands of contributors into an assortment of (usually short-term) funds from municipal bonds, to stocks. The result is a fluctuating interest rate that is almost always at least a few percentage points higher than that of a standard, low-balance savings account. According to USA Today, non-bank money market funds are currently at about 5% APY.
Certificate of Deposit:
Certificates of Deposit, or "CDs" have been around longer than the replacement for the tape cassette. Interest rates are fixed, rather than fluctuating, are usually comparable to money market accounts and can be purchased at a bank or other financial institution, including many sites online, for terms as short as three months. Of course, the longer the term you lock in, the higher the rate you will obtain under most market conditions In other words, whatever interest rate you lock in at the beginning will remain the same throughout the course of the investment. Once you've invested in a CD, however, you cannot continue adding to the same one during the life of that investment, until renewal -- which is one reason you may want to go with a shorter term.
The primary disadvantage of CDs lies in the substantial penalties inflicted if the investor withdraws his or her money before the allotted time. The average APY for a six-month CD is currently 3.59%; for a one-year CD, 3.77%; for a five-year CD, 3.96%, although some banks may offer better deals. CDs are a good idea if their current APYs are higher than contemporary money market accounts, and you don't expect to -- or perhaps don't trust yourself to -- handle the money for a while.
Health Savings Account:
Health Savings Accounts, or HSAs were created by a 2003 Medicare bill, and are, without a doubt, worthy of consideration for many individuals and families. HSAs strive to address the growing problem of underinsured Americans (Texas knows this well, with over 25% of its population going without any insurance) by allowing investors to save for qualified medical expenses and future retirement health expenses, on a tax-free basis.
These accounts are only made available to those with qualifying high-deductible health insurance policies, and are a great choice for many young, middle-class Americans. HSAs provide incentives for saving towards healthcare, and a bit of financial padding in case of disaster. The major disadvantage is that penalties are inflicted if the money is withdrawn for unqualified expenses prior to the age of 65.
Retirement Accounts:
The types of retirement accounts available to Americans are too numerous to mention, and are highly dependent on employers in most cases. Entire sections of libraries and many websites are dedicated to this subject. The first, and most important thing to do, is to check with your employer to see if, or what, retirement plans are offered. Some companies offer employee benefits, including flexible 401(k) plans and matching funds. Look seriously into these options.
However, rather than briefly attempting to delve into the plethora of accounts that may, possibly, be available to you, this article will focus on an account available to all, regardless of employer
-- the Roth IRA account - which has become increasingly popular since becoming law in 1997
Now, IRAs have been around for some time, but traditional IRA accounts require funds going in, and coming out, to be taxed. This means that whatever dividends or proceeds an investor earns over the years will be taxed upon withdrawal. Considering that IRA interest rates are compounded, this could (and is intended to) add up to quite a bit over several decades
Roth IRA accounts, on the other hand, do not tax funds upon withdrawal. Funds invested into the account are considered taxable income going in, but the compounded interest or proceeds can accumulate tax free, until the age of 59 1/2, at which point they can be withdrawn without penalty or taxes. A Traditional IRA, on the other hand, is not taxed going in, but is subject to tax coming out, at whatever rate of income will apply to you at that time -- the assumption being that you will withdraw most of this money during retirement, when you will not have other earned income driving up your tax rate,. This means that whatever your Roth IRA account balance statement is, is the amount you have for retirement, free and clear. No more taxes.
If an investor begins an IRA account in his or her twenties, and contributes a modest amount every month (possibly matched by an employer), principle and compounded interest could conceivably yield a million or more dollars over four decades. The way to think of a Roth IRA, as opposed to a Traditional IRA, is that you are paying taxes on the seeds instead of on the crop.
Now, that's something to think about. Maybe retirement is possible...
See, that wasn't so hard. Respect yourself (and your anxiety levels) enough to seriously investigate financial opportunities. There's a good chance you're missing something you have the funding for -- right now, sitting in a no-, or low-, interest-bearing account. If you have any kind of steady income, financial security should be within your grasp. A comfortable retirement is in your future. Just take a deep breath, open your bills, and start acting like the adult you always dreaded you'd have to be someday.
Taking care of your financial responsibilities can have a positive effect on your anxiety levels, sense of security, and overall health. Being aware of your health, and what you can do to safeguard it, will certainly affect you as you age, and eventually your wallet as well.
The Tortoise Has Retired, The Hare Is Still Running
Many people spend their time hoping to get rich quickly, like winning the lottery, or getting an unexpected inheritance from a distant relative. The reality for most is that, like the tortoise in the old story we heard as children, slow and steady wins the race !
The tortoise and the hare both started at the same starting point in life. Both came from middle-class families. They were neither so rich as to be able to afford the many luxuries in life, nor so poor as to not have the basics of a roof over their heads, regular meals and a good education.
Mr Hare was all ready to go from Day One after graduation. He was going to prove that he would get out from his middle-class roots and move into high society. Both he and Mr Tortoise managed to land jobs in the same company. Each began to work his way up.
Mr Tortoise worked steadily. He did what he was told, sometimes he had a little spark of brilliance, but for most part, he was just the reliable steady worker. Mr Hare was determined to get ahead quickly. He put in long hours, made sure the upper management noticed him and very soon, he was moving through the ranks much faster than his old friend, the tortoise.
Mr Hare felt he had to keep up with his rising status, and his high income. He bought a bigger house, and a bigger car. He married a beautiful hare who knew how to dress well and make him look good during the company gatherings. Mr Tortoise plodded along. He bought a modest little home, had a second-hand car, and married sensible , if slightly dowdy Mrs Tortoise.
Both were promoted as the years went by. The tortoises stayed in their modest home and had 4 little tortoises. The hares upgraded their home and car every few years to keep up the image. While they bought country club memberships and overseas holidays, Mrs Tortoise bought little houses with the aim of generating rental income from them.
The junior tortoises went to college on scholarships. The junior hares went to the very best private schools, paid for by Mr Hare. Mrs Hare did not want to be associated with Mrs Tortoise. She could not believe their husbands were collegues. She was glad they did not live in the same neighbourhood.
Soon the junior tortoises and junior hares graduated and started work. Junior tortoises had grown up in a frugal environment and lived within their salaries. Junior hares found they could not get the lifestyle they were accustomed to on their meagre salaries. So Dad and Mom helped out.
One day, on his fifty-fifth birthday, Mr Tortoise sat down and did his sums. He realised that his rental income from his four little houses was more than his salary and perfectly adequate for them to live on comfortably for the rest of their lives. The young tortoises had grown up and started their own races. The senior tortoises did a bit of travelling, spent time with their grandchildren, but otherwise, their lifestyles did not change much. They still lived in the same modest home they had bought when they got married.
On his fifty-fifth birthday, a tired Mr Hare sat down and looked at his finances. He realised they only had enough savings to last them about three months, if he stopped working today. His salary was their only means of income to support their lifestyle. The young hares had started work and now needed their parents' help in putting a downpayment on their new homes. They said things were different now. Life was harder and they just could not afford to have the same lifestyle they used to have on such low salaries. But they did not know how to live any other way. Mr hare realised there was no hope of retiring anytime soon.
When the older tortoises died, they left behind a large sum of money in a trust fund for their grandchildren, and have a substantial amount leftover to give to charity. The junoir hares wondered where all their money had come from.
When the hares died, they left nothing for their children. There was even a small mortgage left on their beautiful large family home, which the younger hares were unable to pay off. The home had to be sold. The junior tortoises could only watch sadly as their friends were forced to downgrade, wondering why their apparently rich friends were really so poor.
Not everyone will follow this route. But for most of us, slow and steady still wins the race in the end.
The tortoise and the hare both started at the same starting point in life. Both came from middle-class families. They were neither so rich as to be able to afford the many luxuries in life, nor so poor as to not have the basics of a roof over their heads, regular meals and a good education.
Mr Hare was all ready to go from Day One after graduation. He was going to prove that he would get out from his middle-class roots and move into high society. Both he and Mr Tortoise managed to land jobs in the same company. Each began to work his way up.
Mr Tortoise worked steadily. He did what he was told, sometimes he had a little spark of brilliance, but for most part, he was just the reliable steady worker. Mr Hare was determined to get ahead quickly. He put in long hours, made sure the upper management noticed him and very soon, he was moving through the ranks much faster than his old friend, the tortoise.
Mr Hare felt he had to keep up with his rising status, and his high income. He bought a bigger house, and a bigger car. He married a beautiful hare who knew how to dress well and make him look good during the company gatherings. Mr Tortoise plodded along. He bought a modest little home, had a second-hand car, and married sensible , if slightly dowdy Mrs Tortoise.
Both were promoted as the years went by. The tortoises stayed in their modest home and had 4 little tortoises. The hares upgraded their home and car every few years to keep up the image. While they bought country club memberships and overseas holidays, Mrs Tortoise bought little houses with the aim of generating rental income from them.
The junior tortoises went to college on scholarships. The junior hares went to the very best private schools, paid for by Mr Hare. Mrs Hare did not want to be associated with Mrs Tortoise. She could not believe their husbands were collegues. She was glad they did not live in the same neighbourhood.
Soon the junior tortoises and junior hares graduated and started work. Junior tortoises had grown up in a frugal environment and lived within their salaries. Junior hares found they could not get the lifestyle they were accustomed to on their meagre salaries. So Dad and Mom helped out.
One day, on his fifty-fifth birthday, Mr Tortoise sat down and did his sums. He realised that his rental income from his four little houses was more than his salary and perfectly adequate for them to live on comfortably for the rest of their lives. The young tortoises had grown up and started their own races. The senior tortoises did a bit of travelling, spent time with their grandchildren, but otherwise, their lifestyles did not change much. They still lived in the same modest home they had bought when they got married.
On his fifty-fifth birthday, a tired Mr Hare sat down and looked at his finances. He realised they only had enough savings to last them about three months, if he stopped working today. His salary was their only means of income to support their lifestyle. The young hares had started work and now needed their parents' help in putting a downpayment on their new homes. They said things were different now. Life was harder and they just could not afford to have the same lifestyle they used to have on such low salaries. But they did not know how to live any other way. Mr hare realised there was no hope of retiring anytime soon.
When the older tortoises died, they left behind a large sum of money in a trust fund for their grandchildren, and have a substantial amount leftover to give to charity. The junoir hares wondered where all their money had come from.
When the hares died, they left nothing for their children. There was even a small mortgage left on their beautiful large family home, which the younger hares were unable to pay off. The home had to be sold. The junior tortoises could only watch sadly as their friends were forced to downgrade, wondering why their apparently rich friends were really so poor.
Not everyone will follow this route. But for most of us, slow and steady still wins the race in the end.
Yielding to Real Estate Investment Trusts (REITs)
Income is hard to come by these days. Treasuries are yielding less than 5%. The bond market is in disarray, credit spreads are widening (meaning the price of existing bonds is declining) and there are serious liquidity issues (which also impact value).
Have you considered Real Estate mutual funds? Many have current yields in the 5-8% range (primarily REIT-Real Estate Investment Trust-funds). Now, let's be clear on this. These are equity funds and equity funds carry greater risk, and have greater volatility, than bond funds. (Of course, investors in subprime mortgage funds have found out that debt funds are not without risk!) However, equity funds also offer the potential for increasing income and capital appreciation.
Real Estate mutual funds cover a lot of territory and you want to make sure you know how your fund invests. I selected two top performing funds: CGM Realty and Cohen & Steers Realty Focus I (Cohen & Steers are the godfathers of real estate funds).
Take a look at their holdings. CGM's biggest holdings include two international mining companies, two real estate brokerage companies and one Real Estate Investment Trust. The Cohen & Steers fund's largest holdings are all US REITs. Both are excellent funds but they have very different investment strategies. CGM is more capital appreciation oriented where as Cohen & Steers is more income oriented.
The moral to this story is that you have to drill down into a funds' portfolio to make sure it's right for you. (In addition to looking at the stocks it owns, be sure to check to see if the fund uses leverage to enhance its return.)
Income oriented investors should focus on REIT funds(although I've avoided REITs that invest in mortgages for the time being). REIT stocks, in general, have declined more in price during the current market correction than has the Dow or S&P 500. Some argue that Real Estate Investment Trust stocks were overvalued. Whether or not that was true, many high quality REITs are now yielding in excess of Treasuries. Historically, this has been a good entry point.
Of course, many high quality Real Estate Investment Trusts are still yielding in the 2-4% range, so the correction in the REIT market may not be over. And, one of the drivers of REIT stock prices-buyouts by private equity firms-may be ending.
On balance, though, this appears to be a good time for income oriented investors to own REIT funds. Pick a good fund and you'll get high current income and an investment whose value and income stream will increase over time.
Have you considered Real Estate mutual funds? Many have current yields in the 5-8% range (primarily REIT-Real Estate Investment Trust-funds). Now, let's be clear on this. These are equity funds and equity funds carry greater risk, and have greater volatility, than bond funds. (Of course, investors in subprime mortgage funds have found out that debt funds are not without risk!) However, equity funds also offer the potential for increasing income and capital appreciation.
Real Estate mutual funds cover a lot of territory and you want to make sure you know how your fund invests. I selected two top performing funds: CGM Realty and Cohen & Steers Realty Focus I (Cohen & Steers are the godfathers of real estate funds).
Take a look at their holdings. CGM's biggest holdings include two international mining companies, two real estate brokerage companies and one Real Estate Investment Trust. The Cohen & Steers fund's largest holdings are all US REITs. Both are excellent funds but they have very different investment strategies. CGM is more capital appreciation oriented where as Cohen & Steers is more income oriented.
The moral to this story is that you have to drill down into a funds' portfolio to make sure it's right for you. (In addition to looking at the stocks it owns, be sure to check to see if the fund uses leverage to enhance its return.)
Income oriented investors should focus on REIT funds(although I've avoided REITs that invest in mortgages for the time being). REIT stocks, in general, have declined more in price during the current market correction than has the Dow or S&P 500. Some argue that Real Estate Investment Trust stocks were overvalued. Whether or not that was true, many high quality REITs are now yielding in excess of Treasuries. Historically, this has been a good entry point.
Of course, many high quality Real Estate Investment Trusts are still yielding in the 2-4% range, so the correction in the REIT market may not be over. And, one of the drivers of REIT stock prices-buyouts by private equity firms-may be ending.
On balance, though, this appears to be a good time for income oriented investors to own REIT funds. Pick a good fund and you'll get high current income and an investment whose value and income stream will increase over time.
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