You may be at risk of making a catastrophic investing mistake: not protecting
your assets properly due to a lack of various insurance coverages. Manny,
a successful entrepreneur, made this exact error. Starting from scratch, he
built up a successful million-dollar business. He invested a lot of his own personal money and sweat into building the business over 15 years.
One day, catastrophe struck: An explosion ripped through his building, and
the ensuing fire destroyed virtually all the firm’s equipment and inventory,
none of which was insured. The explosion also seriously injured several
workers, including Manny, who didn’t carry disability insurance. Ultimately,
Manny had to file for bankruptcy.
Decisions regarding what amount of insurance you need to carry are, to some
extent, a matter of your desire and ability to accept financial risk. But some
risks aren’t worth taking. Don’t overestimate your ability to predict what accidents and other bad luck may befall you.
Here’s what you need to protect yourself and your assets:
✓ Major medical health insurance: I’m not talking about one of those policies that pays $100 a day if you need to go into the hospital, or cancer
insurance, or that $5,000 medical expense rider on your auto insurance
policy. I know it’s unpleasant to consider, but you need a policy that
pays for all types of major illnesses and major medical expenditures.
Consider taking a health plan with a high deductible, which can minimize your premiums. Also consider channeling extra money into a
Health Savings Account (HSA), which provides tremendous tax breaks.
As with a retirement account, contributions provide an upfront tax
break, and money can grow over the years in an HSA without taxation.
You can also tap HSA funds without penalty or taxation for a wide range
of current health expenses.
✓ Adequate liability insurance on your home and car to guard your
assets against lawsuits: You should have at least enough liability insurance to protect your net worth (assets minus your liabilities/debts) or,
ideally, twice your net worth. If you run your own business, get insurance for your business assets if they’re substantial, such as in Manny’s
case. Also consider professional liability insurance to protect against
a lawsuit. You may also want to consider incorporating your business.
✓ Long-term disability insurance: What would you (and your family) do
to replace your income if a major disability prevents you from working?
Even if you don’t have dependents, odds are that you are dependent on
you. Most larger employers offer group plans that have good benefits
and are much less expensive than coverage you’d buy on your own.
Also, check with your professional association for a competitive
group plan.
✓ Life insurance, if others are dependent on your income: If you’re single
or your loved ones can live without your income, skip life insurance. If
you need coverage, buy term insurance that, like your auto and home
insurance, is pure insurance protection. The amount of term insurance
you need to buy largely depends on how much of your income you want
to replace.
✓ Estate planning: At a minimum, most people need a simple will to delineate to whom they would like to leave all their worldly possessions. If
you hold significant assets outside retirement accounts, you may also
benefit from establishing a living trust, which keeps your money from
filtering through the hands of probate lawyers. Living wills and medical powers of attorney are useful to have in case you’re ever in a medically incapacitated situation. If you have substantial assets, doing more
involved estate planning is wise to minimize estate taxes and ensure the
orderly passing of your assets to your heirs.
In my experience as a financial counselor, I’ve seen that although many
people lack particular types of insurance, others possess unnecessary policies. Many people also keep very low deductibles. Remember to insure
against potential losses that would be financially catastrophic for you —
don’t waste your money to protect against smaller losses. (See the latest
edition of my book Personal Finance For Dummies, published by John Wiley
& Sons, Inc., to discover the right and wrong ways to buy insurance, what to
look for in policies, and where to get good policies.)
Wednesday, April 23, 2014
Tuesday, April 22, 2014
Allocating college investments
If you keep up to 80 percent of your investment money in stocks (diversified
worldwide) with the remainder in bonds when your child is young, you can
maximize the money’s growth potential without taking extraordinary risk. As
your child makes his way through the later years of elementary school, you
need to begin to make the mix more conservative — scale back the stock percentage to 50 or 60 percent. Finally, in the years just before entering college,
whittle the stock portion down to no more than 20 percent or so.
worldwide) with the remainder in bonds when your child is young, you can
maximize the money’s growth potential without taking extraordinary risk. As
your child makes his way through the later years of elementary school, you
need to begin to make the mix more conservative — scale back the stock percentage to 50 or 60 percent. Finally, in the years just before entering college,
whittle the stock portion down to no more than 20 percent or so.
Monday, April 21, 2014
How to pay for college
If you keep stashing away money in retirement
accounts, it’s reasonable for you to wonder
how you’ll actually pay for education expenses
when the momentous occasion arises. Even
if you have some liquid assets that can be
directed to your child’s college bill, you will, in
all likelihood, need to borrow some money. Only
the affluent can truly afford to pay for college
with cash.
One good source of money is your home’s
equity. You can borrow against your home at
a relatively low interest rate, and the interest is
generally tax-deductible. Some company retirement plans — 401(k)s, for example — allow
borrowing as well.
A plethora of financial aid programs allow
you to borrow at reasonable interest rates.
The Unsubsidized Stafford Loans and Parent
Loans for Undergraduate Students (PLUS), for
example, are available, even when your family
isn’t deemed financially needy. In addition to
loans, a number of grant programs are available
through schools and the government as well as
through independent sources.
Complete the Free Application for Federal
Student Aid (FAFSA) to apply for the federal
government programs. Grants available through
state government programs may require a separate application. Specific colleges and other
private organizations, including employers,
banks, credit unions, and community groups,
also offer grants and scholarships.
Many scholarships and grants don’t require
any work on your part — simply apply for such
financial aid through your college. However,
you may need to seek out other programs as
well — check directories and databases at
your local library, your kid’s school counseling
department, and college financial aid offices.
Also try local organizations, churches, employers, and so on, because you have a better
chance of getting scholarship money through
these avenues than through countrywide scholarship and grant databases.
Your child also can work and save money
during high school and college for school. In
fact, if your child qualifies for financial aid,
she’s generally expected to contribute a certain amount to education costs from employment (both during the school year and summer
breaks) and from savings. Besides giving your
gangly teen a stake in her own future, this training encourages sound personal financial management down the road.
accounts, it’s reasonable for you to wonder
how you’ll actually pay for education expenses
when the momentous occasion arises. Even
if you have some liquid assets that can be
directed to your child’s college bill, you will, in
all likelihood, need to borrow some money. Only
the affluent can truly afford to pay for college
with cash.
One good source of money is your home’s
equity. You can borrow against your home at
a relatively low interest rate, and the interest is
generally tax-deductible. Some company retirement plans — 401(k)s, for example — allow
borrowing as well.
A plethora of financial aid programs allow
you to borrow at reasonable interest rates.
The Unsubsidized Stafford Loans and Parent
Loans for Undergraduate Students (PLUS), for
example, are available, even when your family
isn’t deemed financially needy. In addition to
loans, a number of grant programs are available
through schools and the government as well as
through independent sources.
Complete the Free Application for Federal
Student Aid (FAFSA) to apply for the federal
government programs. Grants available through
state government programs may require a separate application. Specific colleges and other
private organizations, including employers,
banks, credit unions, and community groups,
also offer grants and scholarships.
Many scholarships and grants don’t require
any work on your part — simply apply for such
financial aid through your college. However,
you may need to seek out other programs as
well — check directories and databases at
your local library, your kid’s school counseling
department, and college financial aid offices.
Also try local organizations, churches, employers, and so on, because you have a better
chance of getting scholarship money through
these avenues than through countrywide scholarship and grant databases.
Your child also can work and save money
during high school and college for school. In
fact, if your child qualifies for financial aid,
she’s generally expected to contribute a certain amount to education costs from employment (both during the school year and summer
breaks) and from savings. Besides giving your
gangly teen a stake in her own future, this training encourages sound personal financial management down the road.
Wednesday, April 16, 2014
Section 529 plans
Also known as qualified state tuition plans, Section 529 plans offer a taxadvantaged way to save and invest more than $100,000 per child toward
college costs (some states allow upward of $300,000 per student). After you
contribute to one of these state-based accounts, the invested funds grow
without taxation. Withdrawals are also tax free so long as the funds are used
to pay for qualifying higher educational costs (which include college, graduate school, and certain additional expenses of special-needs students). The
schools need not be in the same state as the state administering the Section
529 plan.
As I discuss in the previous section dealing with Education Savings Accounts,
Section 529 plan balances can harm your child’s financial aid chances. Thus,
such accounts make the most sense for affluent families who are sure that
they won’t qualify for any type of financial aid. If you do opt for an ESA and
intend to apply for financial aid, you should be the owner of the accounts (not
your child) to maximize qualifying for financial aid.
college costs (some states allow upward of $300,000 per student). After you
contribute to one of these state-based accounts, the invested funds grow
without taxation. Withdrawals are also tax free so long as the funds are used
to pay for qualifying higher educational costs (which include college, graduate school, and certain additional expenses of special-needs students). The
schools need not be in the same state as the state administering the Section
529 plan.
As I discuss in the previous section dealing with Education Savings Accounts,
Section 529 plan balances can harm your child’s financial aid chances. Thus,
such accounts make the most sense for affluent families who are sure that
they won’t qualify for any type of financial aid. If you do opt for an ESA and
intend to apply for financial aid, you should be the owner of the accounts (not
your child) to maximize qualifying for financial aid.
Tuesday, April 15, 2014
Education Savings Accounts
Be careful about funding an Education Savings Account (ESA), a relatively new
savings vehicle. In theory, an ESA sounds like a great place to park some college savings. You can make nondeductible contributions of up to $2,000 per
child per year, and investment earnings and account withdrawals are free of
tax as long as you use the funds to pay for elementary and secondary school
or college costs. However, funding an ESA can undermine your child’s ability
to qualify for financial aid. It’s best to keep the parents as the owners of such
an account for financial aid purposes, but be forewarned that some schools
may treat money in an ESA as a student’s asset.
savings vehicle. In theory, an ESA sounds like a great place to park some college savings. You can make nondeductible contributions of up to $2,000 per
child per year, and investment earnings and account withdrawals are free of
tax as long as you use the funds to pay for elementary and secondary school
or college costs. However, funding an ESA can undermine your child’s ability
to qualify for financial aid. It’s best to keep the parents as the owners of such
an account for financial aid purposes, but be forewarned that some schools
may treat money in an ESA as a student’s asset.
Monday, April 14, 2014
Treading Carefully When Investing for College
Many well-intentioned parents want to save for their children’s future educational expenses. The mistake they often make, however, is putting money in
accounts in their child’s name (in so-called custodial accounts) or saving outside of retirement accounts in general.
The more money you accumulate outside tax-sheltered retirement accounts,
the less assistance you’re likely to qualify for from federal and state financial
aid sources. Don’t make the additional error of assuming that financial aid
is only for the poor. Many middle-income and even some modestly affluent
families qualify for some aid, which can include grants and loans available,
even if you’re not deemed financially needy.
Under the current financial needs analysis that most colleges use in awarding financial aid, the value of your retirement plan is not considered an asset.
Money that you save outside of retirement accounts, including money in the
child’s name, is counted as an asset and reduces eligibility for financial aid.
Also, be aware that your family’s assets, for purposes of financial aid determination, also generally include equity in real estate and businesses that you
own. Although the federal financial aid analysis no longer counts equity in
your primary residence as an asset, many private (independent) schools continue to ask parents for this information when they make their own financial
aid determinations. Thus, paying down your home mortgage more quickly
instead of funding retirement accounts can harm you financially. You may
end up with less financial aid and pay more in taxes.
Don’t forgo contributing to your own retirement savings plan(s) in order to
save money in a non-retirement account for your children’s college expenses.
When you do, you pay higher taxes both on your current income and on the
interest and growth of this money. In addition to paying higher taxes, you’re
expected to contribute more to your child’s educational expenses (because
you’ll receive less financial aid).
If you plan to apply for financial aid, it’s a good idea to save non-retirement
account money in your name rather than in your child’s name (as a custodial
account). Colleges expect a greater percentage of money in your child’s name
(35 percent) to be used for college costs than money in your name (6 percent). Remember, though, that from the standpoint of getting financial aid,
you’re better off saving inside retirement accounts.
However, if you’re affluent enough that you expect to pay for your cherub’s
full educational costs without applying for financial aid, you can save a bit
on taxes if you invest through custodial accounts. Prior to your child reaching age 19, the first $1,900 of interest and dividend income is taxed at your
child’s income tax rate rather than yours. After age 19 (for full-time students,
it’s those under the age of 24), all income that the investments in your child’s
name generate is taxed at your child’s rate.
accounts in their child’s name (in so-called custodial accounts) or saving outside of retirement accounts in general.
The more money you accumulate outside tax-sheltered retirement accounts,
the less assistance you’re likely to qualify for from federal and state financial
aid sources. Don’t make the additional error of assuming that financial aid
is only for the poor. Many middle-income and even some modestly affluent
families qualify for some aid, which can include grants and loans available,
even if you’re not deemed financially needy.
Under the current financial needs analysis that most colleges use in awarding financial aid, the value of your retirement plan is not considered an asset.
Money that you save outside of retirement accounts, including money in the
child’s name, is counted as an asset and reduces eligibility for financial aid.
Also, be aware that your family’s assets, for purposes of financial aid determination, also generally include equity in real estate and businesses that you
own. Although the federal financial aid analysis no longer counts equity in
your primary residence as an asset, many private (independent) schools continue to ask parents for this information when they make their own financial
aid determinations. Thus, paying down your home mortgage more quickly
instead of funding retirement accounts can harm you financially. You may
end up with less financial aid and pay more in taxes.
Don’t forgo contributing to your own retirement savings plan(s) in order to
save money in a non-retirement account for your children’s college expenses.
When you do, you pay higher taxes both on your current income and on the
interest and growth of this money. In addition to paying higher taxes, you’re
expected to contribute more to your child’s educational expenses (because
you’ll receive less financial aid).
If you plan to apply for financial aid, it’s a good idea to save non-retirement
account money in your name rather than in your child’s name (as a custodial
account). Colleges expect a greater percentage of money in your child’s name
(35 percent) to be used for college costs than money in your name (6 percent). Remember, though, that from the standpoint of getting financial aid,
you’re better off saving inside retirement accounts.
However, if you’re affluent enough that you expect to pay for your cherub’s
full educational costs without applying for financial aid, you can save a bit
on taxes if you invest through custodial accounts. Prior to your child reaching age 19, the first $1,900 of interest and dividend income is taxed at your
child’s income tax rate rather than yours. After age 19 (for full-time students,
it’s those under the age of 24), all income that the investments in your child’s
name generate is taxed at your child’s rate.
Friday, April 11, 2014
Easing into risk: Dollar cost averaging
Dollar cost averaging (DCA) is the practice of investing a regular amount
of money at set time intervals, such as monthly or quarterly, into volatile
investments, such as stocks and stock mutual funds. If you’ve ever deducted
money from a paycheck and pumped it into a retirement savings plan investment account that holds stocks and bonds, you’ve done DCA.
Most people invest a portion of their employment compensation as they earn
it, but if you have extra cash sitting around, you can choose to invest that
money in one fell swoop or to invest it gradually via DCA. The biggest appeal
of gradually feeding money into the market via DCA is that you don’t dump all
your money into a potentially overheated investment just before a major drop.
Thus, DCA helps shy investors psychologically ease into riskier investments.
DCA is made to order for skittish investors with large lump sums of money sitting in safe investments like CDs or savings accounts. For example, using DCA,
an investor with $100,000 to invest in stock funds can feed her money into
investments gradually — say, at the rate of $12,500 or so quarterly over two
years — instead of investing her entire $100,000 in stocks at once and possibly
buying all of her shares at a market peak. Most large investment companies,
especially mutual funds, allow investors to establish automatic investment
plans so the DCA occurs without an investor’s ongoing involvement.
Of course, like any risk-reducing investment strategy, DCA has drawbacks.
If growth investments appreciate (as they’re supposed to), a DCA investor
misses out on earning higher returns on his money awaiting investment.
Finance professors Richard E. Williams and Peter W. Bacon found that
approximately two-thirds of the time, a lump-sum stock market investor
earned higher first-year returns than an investor who fed the money in
monthly over the first year. (They studied data from the U.S. market over the
past seven decades.)
However, knowing that you’ll probably be ahead most of the time if you
dump a lump sum into the stock market is little solace if you happen to invest
just before a major plunge in prices. In the fall of 1987, the U.S. stock market,
as measured by the Dow Jones Industrial Average, plummeted 36 percent,
and from late 2007 to early 2009, the market shed 55 percent of its value.
So investors who fear that stocks are due for such a major correction should
practice DCA, right? Well, not so fast. Apprehensive investors who shun
lump-sum investments and use DCA are more likely to stop the DCA investment process if prices plunge, thereby defeating the benefit of doing DCA
during a declining market.
So what’s an investor with a lump sum of money to do?
✓ First, weigh the significance of the lump sum to you. Although $100,000
is a big chunk of most people’s net worth, it’s only 10 percent if your
net worth is $1,000,000. It’s not worth a millionaire’s time to use DCA
for $100,000. If the cash that you have to invest is less than a quarter of
your net worth, you may not want to bother with DCA.
✓ Second, consider how aggressively you invest (or invested) your
money. For example, if you aggressively invested your money through
an employer’s retirement plan that you roll over, don’t waste your time
on DCA.
DCA makes sense for investors with a large chunk of their net worth in cash
who want to minimize the risk of transferring that cash to riskier investments, such as stocks. If you fancy yourself a market prognosticator, you can
also assess the current valuation of stocks. Thinking that stocks are pricey
(and thus riper for a fall) increases the appeal of DCA.
If you use DCA too quickly, you may not give the market sufficient time for a
correction to unfold, during and after which some of the DCA purchases may
take place. If you practice DCA over too long of a period of time, you may miss
a major upswing in stock prices. I suggest using DCA over one to two years to
strike a balance.
As for the times of the year that you should use DCA, mutual fund investors
should use DCA early in each calendar quarter because mutual funds that
make taxable distributions tend to do so late in the quarter.
Your money that awaits investment in DCA should have a suitable parking
place. Select a high-yielding money market fund that’s appropriate for your
tax situation.
One last critical point: When you use DCA, establish an automatic investment
plan so you’re less likely to chicken out. And for the more courageous, you may
want to try an alternative strategy to DCA — value averaging, which allows you
to invest more if prices are falling and invest less if prices are rising.
Suppose, for example, that you want to value average $500 per quarter into
an aggressive stock mutual fund. After your first quarterly $500 investment,
the fund drops 10 percent, reducing your account balance to $450. Value
averaging suggests that you invest $500 the next quarter plus another $50 to
make up the shortfall. (Conversely, if the fund value had increased to $550
after your first investment, you would invest only $450 in the second round.)
Increasing the amount that you invest requires confidence when prices fall,
but doing so magnifies your returns when prices ultimately turn around.
of money at set time intervals, such as monthly or quarterly, into volatile
investments, such as stocks and stock mutual funds. If you’ve ever deducted
money from a paycheck and pumped it into a retirement savings plan investment account that holds stocks and bonds, you’ve done DCA.
Most people invest a portion of their employment compensation as they earn
it, but if you have extra cash sitting around, you can choose to invest that
money in one fell swoop or to invest it gradually via DCA. The biggest appeal
of gradually feeding money into the market via DCA is that you don’t dump all
your money into a potentially overheated investment just before a major drop.
Thus, DCA helps shy investors psychologically ease into riskier investments.
DCA is made to order for skittish investors with large lump sums of money sitting in safe investments like CDs or savings accounts. For example, using DCA,
an investor with $100,000 to invest in stock funds can feed her money into
investments gradually — say, at the rate of $12,500 or so quarterly over two
years — instead of investing her entire $100,000 in stocks at once and possibly
buying all of her shares at a market peak. Most large investment companies,
especially mutual funds, allow investors to establish automatic investment
plans so the DCA occurs without an investor’s ongoing involvement.
Of course, like any risk-reducing investment strategy, DCA has drawbacks.
If growth investments appreciate (as they’re supposed to), a DCA investor
misses out on earning higher returns on his money awaiting investment.
Finance professors Richard E. Williams and Peter W. Bacon found that
approximately two-thirds of the time, a lump-sum stock market investor
earned higher first-year returns than an investor who fed the money in
monthly over the first year. (They studied data from the U.S. market over the
past seven decades.)
However, knowing that you’ll probably be ahead most of the time if you
dump a lump sum into the stock market is little solace if you happen to invest
just before a major plunge in prices. In the fall of 1987, the U.S. stock market,
as measured by the Dow Jones Industrial Average, plummeted 36 percent,
and from late 2007 to early 2009, the market shed 55 percent of its value.
So investors who fear that stocks are due for such a major correction should
practice DCA, right? Well, not so fast. Apprehensive investors who shun
lump-sum investments and use DCA are more likely to stop the DCA investment process if prices plunge, thereby defeating the benefit of doing DCA
during a declining market.
So what’s an investor with a lump sum of money to do?
✓ First, weigh the significance of the lump sum to you. Although $100,000
is a big chunk of most people’s net worth, it’s only 10 percent if your
net worth is $1,000,000. It’s not worth a millionaire’s time to use DCA
for $100,000. If the cash that you have to invest is less than a quarter of
your net worth, you may not want to bother with DCA.
✓ Second, consider how aggressively you invest (or invested) your
money. For example, if you aggressively invested your money through
an employer’s retirement plan that you roll over, don’t waste your time
on DCA.
DCA makes sense for investors with a large chunk of their net worth in cash
who want to minimize the risk of transferring that cash to riskier investments, such as stocks. If you fancy yourself a market prognosticator, you can
also assess the current valuation of stocks. Thinking that stocks are pricey
(and thus riper for a fall) increases the appeal of DCA.
If you use DCA too quickly, you may not give the market sufficient time for a
correction to unfold, during and after which some of the DCA purchases may
take place. If you practice DCA over too long of a period of time, you may miss
a major upswing in stock prices. I suggest using DCA over one to two years to
strike a balance.
As for the times of the year that you should use DCA, mutual fund investors
should use DCA early in each calendar quarter because mutual funds that
make taxable distributions tend to do so late in the quarter.
Your money that awaits investment in DCA should have a suitable parking
place. Select a high-yielding money market fund that’s appropriate for your
tax situation.
One last critical point: When you use DCA, establish an automatic investment
plan so you’re less likely to chicken out. And for the more courageous, you may
want to try an alternative strategy to DCA — value averaging, which allows you
to invest more if prices are falling and invest less if prices are rising.
Suppose, for example, that you want to value average $500 per quarter into
an aggressive stock mutual fund. After your first quarterly $500 investment,
the fund drops 10 percent, reducing your account balance to $450. Value
averaging suggests that you invest $500 the next quarter plus another $50 to
make up the shortfall. (Conversely, if the fund value had increased to $550
after your first investment, you would invest only $450 in the second round.)
Increasing the amount that you invest requires confidence when prices fall,
but doing so magnifies your returns when prices ultimately turn around.
Thursday, April 10, 2014
Making the most of your investment options
No hard-and-fast rules dictate how to allocate the percentage that you’ve
earmarked for growth among specific investments like stocks and real estate.
Part of how you decide to allocate your investments depends on the types of
investments that you want to focus on. As I discuss, diversifying
in stocks worldwide can be prudent as well as profitable.
Here are some general guidelines to keep in mind:
✓ Take advantage of your retirement accounts. Unless you need accessible money for shorter-term non-retirement goals, why pass up the free
extra returns from the tax benefits of retirement accounts?
✓ Don’t pile your money into investments that gain lots of attention.
Many investors make this mistake, especially those who lack a thoughtout plan to buy stocks. I provide numerous illustrations of
the perils of buying attention-grabbing stocks.
✓ Have the courage to be a contrarian. No one likes to feel that he is
jumping on board a sinking ship or supporting a losing cause. However,
just like shopping for something at retail stores, the best time to buy
something of quality is when its price is reduced.
✓ Diversify.the values of different investments
don’t move in tandem. So when you invest in growth investments, such
as stocks or real estate, your portfolio’s value will have a smoother ride
if you diversify properly.
✓ Invest more in what you know. Over the years, I’ve met successful
investors who have built substantial wealth without spending gobs of
their free time researching, selecting, and monitoring investments. Some
investors, for example, concentrate more on real estate because that’s
what they best understand and feel comfortable with. Others put more
money in stocks for the same reason. No one-size-fits-all code exists for
successful investors. Just be careful that you don’t put all your investing eggs in the same basket (for example, don’t load up on stocks in the
same industry that you believe you know a lot about).
earmarked for growth among specific investments like stocks and real estate.
Part of how you decide to allocate your investments depends on the types of
investments that you want to focus on. As I discuss, diversifying
in stocks worldwide can be prudent as well as profitable.
Here are some general guidelines to keep in mind:
✓ Take advantage of your retirement accounts. Unless you need accessible money for shorter-term non-retirement goals, why pass up the free
extra returns from the tax benefits of retirement accounts?
✓ Don’t pile your money into investments that gain lots of attention.
Many investors make this mistake, especially those who lack a thoughtout plan to buy stocks. I provide numerous illustrations of
the perils of buying attention-grabbing stocks.
✓ Have the courage to be a contrarian. No one likes to feel that he is
jumping on board a sinking ship or supporting a losing cause. However,
just like shopping for something at retail stores, the best time to buy
something of quality is when its price is reduced.
✓ Diversify.the values of different investments
don’t move in tandem. So when you invest in growth investments, such
as stocks or real estate, your portfolio’s value will have a smoother ride
if you diversify properly.
✓ Invest more in what you know. Over the years, I’ve met successful
investors who have built substantial wealth without spending gobs of
their free time researching, selecting, and monitoring investments. Some
investors, for example, concentrate more on real estate because that’s
what they best understand and feel comfortable with. Others put more
money in stocks for the same reason. No one-size-fits-all code exists for
successful investors. Just be careful that you don’t put all your investing eggs in the same basket (for example, don’t load up on stocks in the
same industry that you believe you know a lot about).
Wednesday, April 9, 2014
Considering your age
When you’re younger and have more years until you plan to use your money,
you should keep larger amounts of your long-term investment money in
growth (ownership) vehicles, such as stocks, real estate, and small business.
As I discuss in Chapter 2, the attraction of these types of investments is the
potential to really grow your money. The risk: The value of your portfolio can
fall from time to time.
The younger you are, the more time your investments have to recover from
a bad fall. In this respect, investments are a bit like people. If a 30-year-old
and an 80-year-old both fall on a concrete sidewalk, odds are higher that the
younger person will fully recover and the older person may not. Such falls
sometimes disable older people.
A long-held guiding principle says to subtract your age from 110 and invest the
resulting number as a percentage of money to place in growth (ownership)
investments. So if you’re 35 years old:
110 – 35 = 75 percent of your investment money can be in growth
investments.
If you want to be more aggressive, subtract your age from 120:
120 – 35 = 85 percent of your investment money can be in growth
investments.
Note that even retired people should still have a healthy chunk of their
investment dollars in growth vehicles like stocks. A 70-year-old person may
want to totally avoid risk, but doing so is generally a mistake. Such a person
can live another two or three decades. If you live longer than anticipated, you
can run out of money if it doesn’t continue to grow.
you should keep larger amounts of your long-term investment money in
growth (ownership) vehicles, such as stocks, real estate, and small business.
As I discuss in Chapter 2, the attraction of these types of investments is the
potential to really grow your money. The risk: The value of your portfolio can
fall from time to time.
The younger you are, the more time your investments have to recover from
a bad fall. In this respect, investments are a bit like people. If a 30-year-old
and an 80-year-old both fall on a concrete sidewalk, odds are higher that the
younger person will fully recover and the older person may not. Such falls
sometimes disable older people.
A long-held guiding principle says to subtract your age from 110 and invest the
resulting number as a percentage of money to place in growth (ownership)
investments. So if you’re 35 years old:
110 – 35 = 75 percent of your investment money can be in growth
investments.
If you want to be more aggressive, subtract your age from 120:
120 – 35 = 85 percent of your investment money can be in growth
investments.
Note that even retired people should still have a healthy chunk of their
investment dollars in growth vehicles like stocks. A 70-year-old person may
want to totally avoid risk, but doing so is generally a mistake. Such a person
can live another two or three decades. If you live longer than anticipated, you
can run out of money if it doesn’t continue to grow.
These tips are only general guidelines and apply to money that you invest for
the long term (ideally for ten years or more). For money that you need to use
in the shorter term, such as within the next several years, more-aggressive
growth investments aren’t appropriate. See Chapters 7 and 8 for short-term
investment ideas.
Tuesday, April 8, 2014
Knowing what’s taxed and when to worry
Interest you receive from bank accounts and corporate bonds is generally
taxable. U.S. Treasury bonds pay interest that’s state-tax-free. Municipal
bonds, which state and local governments issue, pay interest that’s federaltax-free and also state-tax-free to residents in the state where the bond is
issued.
Taxation on your capital gains, which is the profit (sales minus purchase
price) on an investment, works under a unique system. Investments held
less than one year generate short-term capital gains, which are taxed at your
normal marginal rate. Profits from investments that you hold longer than 12
months are long-term capital gains. These long-term gains cap at 15 percent,
except for those in the two lowest tax brackets of 10 and 15 percent. For
these folks, the long-term capital gains tax rate is just 5 percent.
Use these strategies to reduce the taxes you pay on investments that are
exposed to taxation:
✓ Opt for tax-free money markets and bonds. If you’re in a high enough
tax bracket, you may find that you come out ahead with tax-free investments. Tax-free investments yield less than comparable investments
that produce taxable earnings, but because of the tax differences, the
earnings from tax-free investments can end up being greater than what
taxable investments leave you with. In order to compare properly, subtract what you’ll pay in federal as well as state taxes from the taxable
investment to see which investment nets you more.
✓ Invest in tax-friendly stock funds. Mutual funds that tend to trade less
tend to produce lower capital gains distributions. For mutual funds
held outside tax-sheltered retirement accounts, this reduced trading
effectively increases an investor’s total rate of return. Index funds are
mutual funds that invest in a relatively static portfolio of securities, such
as stocks and bonds (this is also true of some exchange-traded funds).
They don’t attempt to beat the market. Rather, they invest in the securities to mirror or match the performance of an underlying index, such as
the Standard & Poor’s 500 (which I discuss in Chapter 5). Although
index funds can’t beat the market, the typical actively managed fund
doesn’t either, and index funds have several advantages over actively
managed funds. See Chapter 8 to find out more about tax-friendly stock
mutual funds, which includes some non-index funds, and exchangetraded funds.
✓ Invest in small business and real estate. The growth in value of business and real estate assets isn’t taxed until you sell the asset. Even then,
with investment real estate, you often can roll over the gain into another
property as long as you comply with tax laws. However, the current
income that small business and real estate assets produce is taxed as
ordinary income.
Short-term capital gains (investments held one year or less) are taxed at your
ordinary income tax rate. This fact is another reason that you shouldn’t trade
your investments quickly (within 12 months).
taxable. U.S. Treasury bonds pay interest that’s state-tax-free. Municipal
bonds, which state and local governments issue, pay interest that’s federaltax-free and also state-tax-free to residents in the state where the bond is
issued.
Taxation on your capital gains, which is the profit (sales minus purchase
price) on an investment, works under a unique system. Investments held
less than one year generate short-term capital gains, which are taxed at your
normal marginal rate. Profits from investments that you hold longer than 12
months are long-term capital gains. These long-term gains cap at 15 percent,
except for those in the two lowest tax brackets of 10 and 15 percent. For
these folks, the long-term capital gains tax rate is just 5 percent.
Use these strategies to reduce the taxes you pay on investments that are
exposed to taxation:
✓ Opt for tax-free money markets and bonds. If you’re in a high enough
tax bracket, you may find that you come out ahead with tax-free investments. Tax-free investments yield less than comparable investments
that produce taxable earnings, but because of the tax differences, the
earnings from tax-free investments can end up being greater than what
taxable investments leave you with. In order to compare properly, subtract what you’ll pay in federal as well as state taxes from the taxable
investment to see which investment nets you more.
✓ Invest in tax-friendly stock funds. Mutual funds that tend to trade less
tend to produce lower capital gains distributions. For mutual funds
held outside tax-sheltered retirement accounts, this reduced trading
effectively increases an investor’s total rate of return. Index funds are
mutual funds that invest in a relatively static portfolio of securities, such
as stocks and bonds (this is also true of some exchange-traded funds).
They don’t attempt to beat the market. Rather, they invest in the securities to mirror or match the performance of an underlying index, such as
the Standard & Poor’s 500 (which I discuss in Chapter 5). Although
index funds can’t beat the market, the typical actively managed fund
doesn’t either, and index funds have several advantages over actively
managed funds. See Chapter 8 to find out more about tax-friendly stock
mutual funds, which includes some non-index funds, and exchangetraded funds.
✓ Invest in small business and real estate. The growth in value of business and real estate assets isn’t taxed until you sell the asset. Even then,
with investment real estate, you often can roll over the gain into another
property as long as you comply with tax laws. However, the current
income that small business and real estate assets produce is taxed as
ordinary income.
Short-term capital gains (investments held one year or less) are taxed at your
ordinary income tax rate. This fact is another reason that you shouldn’t trade
your investments quickly (within 12 months).
Monday, April 7, 2014
Figuring your tax bracket
You may not know it, but the government charges you different tax rates for
different parts of your annual income. You pay less tax on the first dollars of
your earnings and more tax on the last dollars of your earnings. For example,
if you’re single and your taxable income totaled $50,000 during 2011, you
paid federal tax at the rate of 10 percent on the first $8,500, 15 percent on the
taxable income above $8,500 up to $34,500, and 25 percent on income above
$34,500 up to $50,000.
Your marginal tax rate is the rate of tax that you pay on your last, or so-called
highest, dollars of income. In the example of a single person with taxable
income of $50,000, that person’s federal marginal tax rate is 25 percent. In
other words, he effectively pays a 25 percent federal tax on his last dollars of
income — those dollars earned between $34,500 and $50,000. (Don’t forget to
factor in the state income taxes that most states assess.)
Knowing your marginal tax rate allows you to quickly calculate the following:
✓ Any additional taxes that you would pay on additional income
✓ The amount of taxes that you save if you contribute more money into
retirement accounts or reduce your taxable income (for example, if you
choose investments that produce tax-free income)
different parts of your annual income. You pay less tax on the first dollars of
your earnings and more tax on the last dollars of your earnings. For example,
if you’re single and your taxable income totaled $50,000 during 2011, you
paid federal tax at the rate of 10 percent on the first $8,500, 15 percent on the
taxable income above $8,500 up to $34,500, and 25 percent on income above
$34,500 up to $50,000.
Your marginal tax rate is the rate of tax that you pay on your last, or so-called
highest, dollars of income. In the example of a single person with taxable
income of $50,000, that person’s federal marginal tax rate is 25 percent. In
other words, he effectively pays a 25 percent federal tax on his last dollars of
income — those dollars earned between $34,500 and $50,000. (Don’t forget to
factor in the state income taxes that most states assess.)
Knowing your marginal tax rate allows you to quickly calculate the following:
✓ Any additional taxes that you would pay on additional income
✓ The amount of taxes that you save if you contribute more money into
retirement accounts or reduce your taxable income (for example, if you
choose investments that produce tax-free income)
Friday, April 4, 2014
Choosing retirement account investments
When you establish a retirement account, you may not realize that the retirement account is simply a shell or shield that keeps the federal, state, and
local governments from taxing your investment earnings each year. You
still must choose what investments you want to hold inside your retirement
account shell.
You may invest your IRA or self-employed plan retirement account (SEP-IRAs,
Keoghs) money into stocks, bonds, mutual funds, and even bank accounts.
Mutual funds (offered in most employer-based plans), are an ideal choice because they offer diversification and professional management. After you decide which financial institution you want
to invest through, simply obtain and complete the appropriate paperwork for
establishing the specific type of account you want. (Flip to the later section
“Choosing the Right Investment Mix” for more information.)
Taming Your Taxes in NonRetirement Accounts
When you invest outside of tax-sheltered retirement accounts, the profits and
distributions on your money are subject to taxation. So the non-retirement
account investments that make sense for you depend (at least partly) on
your tax situation.
If you have money to invest, or if you’re considering selling current investments that you hold, taxes should factor into your decision. But tax considerations alone shouldn’t dictate how and where you invest your money. You
should also weigh investment choices, your desire and the necessity to take risk, personal likes and dislikes, and the number of years you plan to hold the
investment (see the “Choosing the Right Investment Mix” section, later in the
chapter, for more information on these other factors).
local governments from taxing your investment earnings each year. You
still must choose what investments you want to hold inside your retirement
account shell.
You may invest your IRA or self-employed plan retirement account (SEP-IRAs,
Keoghs) money into stocks, bonds, mutual funds, and even bank accounts.
Mutual funds (offered in most employer-based plans), are an ideal choice because they offer diversification and professional management. After you decide which financial institution you want
to invest through, simply obtain and complete the appropriate paperwork for
establishing the specific type of account you want. (Flip to the later section
“Choosing the Right Investment Mix” for more information.)
Taming Your Taxes in NonRetirement Accounts
When you invest outside of tax-sheltered retirement accounts, the profits and
distributions on your money are subject to taxation. So the non-retirement
account investments that make sense for you depend (at least partly) on
your tax situation.
If you have money to invest, or if you’re considering selling current investments that you hold, taxes should factor into your decision. But tax considerations alone shouldn’t dictate how and where you invest your money. You
should also weigh investment choices, your desire and the necessity to take risk, personal likes and dislikes, and the number of years you plan to hold the
investment (see the “Choosing the Right Investment Mix” section, later in the
chapter, for more information on these other factors).
Thursday, April 3, 2014
Annuities
If you’ve contributed all you’re legally allowed to contribute to your IRA
accounts and still want to put away more money for retirement, consider annuities. Annuities are contracts that insurance companies back. If you, the annuity
holder (investor), should die during the so-called accumulation phase (that is,
prior to receiving payments from the annuity), your designated beneficiary is
guaranteed reimbursement of the amount of your original investment.
Annuities, like IRAs, allow your capital to grow and compound tax deferred.
You defer taxes until you withdraw the money. However, unlike an IRA that
has an annual contribution limit of a few thousand dollars, you can deposit
as much as you want in any year to an annuity — even millions of dollars, if
you’ve got it! However, as with a Roth IRA, you get no upfront tax deduction
for your contributions.
Because annuity contributions aren’t tax-deductible, and because annuities
carry higher annual operating fees to pay for the small amount of insurance
that comes with them, don’t consider contributing to one until you’ve fully
exhausted your other retirement account investing options. Because of their
higher annual expenses, annuities generally make sense only if you have 15 or
more years to wait until you need the money.
accounts and still want to put away more money for retirement, consider annuities. Annuities are contracts that insurance companies back. If you, the annuity
holder (investor), should die during the so-called accumulation phase (that is,
prior to receiving payments from the annuity), your designated beneficiary is
guaranteed reimbursement of the amount of your original investment.
Annuities, like IRAs, allow your capital to grow and compound tax deferred.
You defer taxes until you withdraw the money. However, unlike an IRA that
has an annual contribution limit of a few thousand dollars, you can deposit
as much as you want in any year to an annuity — even millions of dollars, if
you’ve got it! However, as with a Roth IRA, you get no upfront tax deduction
for your contributions.
Because annuity contributions aren’t tax-deductible, and because annuities
carry higher annual operating fees to pay for the small amount of insurance
that comes with them, don’t consider contributing to one until you’ve fully
exhausted your other retirement account investing options. Because of their
higher annual expenses, annuities generally make sense only if you have 15 or
more years to wait until you need the money.
Wednesday, April 2, 2014
IRAs
If you work for a company that doesn’t offer a retirement savings plan, or
if you’ve exhausted contributing to your company’s plan, consider an individual retirement account (IRA). Anyone with employment income (or who
receives alimony) may contribute up to $5,000 each year to an IRA (or the
amount of your employment or alimony income if it’s less than $5,000 in a
year). If you’re a nonworking spouse, you’re eligible to put up to $5,000 per
year into a spousal IRA. Those age 50 and older can put away up to $6,000 per
year (effective in 2011).
Your contributions to an IRA may or may not be tax-deductible. For tax year
2011, if you’re single and your adjusted gross income is $56,000 or less for the
year, you can deduct your full IRA contribution. If you’re married and you file
your taxes jointly, you’re entitled to a full IRA deduction if your AGI is $90,000
per year or less.
If you can’t deduct your contribution to a standard IRA account, consider
making a contribution to a nondeductible IRA account called the Roth IRA.
Single taxpayers with an AGI less than $107,000 and joint filers with an AGI less
than $169,000 can contribute up to $5,000 per year to a Roth IRA. Those age 50
and older can contribute $6,000. Although the contribution isn’t deductible,
earnings inside the account are shielded from taxes, and, unlike a standard
IRA, qualified withdrawals from the account are free from income tax.
if you’ve exhausted contributing to your company’s plan, consider an individual retirement account (IRA). Anyone with employment income (or who
receives alimony) may contribute up to $5,000 each year to an IRA (or the
amount of your employment or alimony income if it’s less than $5,000 in a
year). If you’re a nonworking spouse, you’re eligible to put up to $5,000 per
year into a spousal IRA. Those age 50 and older can put away up to $6,000 per
year (effective in 2011).
Your contributions to an IRA may or may not be tax-deductible. For tax year
2011, if you’re single and your adjusted gross income is $56,000 or less for the
year, you can deduct your full IRA contribution. If you’re married and you file
your taxes jointly, you’re entitled to a full IRA deduction if your AGI is $90,000
per year or less.
If you can’t deduct your contribution to a standard IRA account, consider
making a contribution to a nondeductible IRA account called the Roth IRA.
Single taxpayers with an AGI less than $107,000 and joint filers with an AGI less
than $169,000 can contribute up to $5,000 per year to a Roth IRA. Those age 50
and older can contribute $6,000. Although the contribution isn’t deductible,
earnings inside the account are shielded from taxes, and, unlike a standard
IRA, qualified withdrawals from the account are free from income tax.
Tuesday, April 1, 2014
Company-based plans
If you work for a for-profit company, you may have access to a 401(k) plan,
which typically allows you to save up to $16,500 per year (for tax year 2011).
Many nonprofit organizations offer 403(b) plans to their employees. As with
a 401(k), your contributions to 403(b) plans are deductible on both your federal and state taxes in the year that you make them. Nonprofit employees can
generally contribute up to 20 percent or $16,500 of their salaries, whichever
is less. In addition to the upfront and ongoing tax benefits of these retirement
savings plans, some employers match your contributions.
Older employees (defined as being at least age 50) can contribute even more
into these company-based plans — up to $22,000 in 2011. Of course, the challenge for many people is to reduce their spending enough to be able to sock
away these kinds of contributions.
If you’re self-employed, you can establish your own retirement savings
plans for yourself and any employees that you have. In fact, with all types
of self-employment retirement plans, business owners need to cover their
employees as well. Simplified employee pension individual retirement accounts
(SEP-IRA) and Keogh plans allow you to sock away about 20 percent of your
self-employment income (business revenue minus expenses), up to an annual
maximum of $49,000 (for tax year 2011). Each year, you decide the amount
you want to contribute — no minimums exist (unless you do a Money
Purchase Pension Plan type of Keogh).
Keogh plans require a bit more paperwork to set up and administer than
SEP-IRAs. Unlike SEP-IRAs, Keogh plans allow vesting schedules that require
employees to remain with the company a number of years before they earn
the right to their retirement account balances. (If you’re an employee in a
small business, you can’t establish your own SEP-IRA or Keogh — that’s up to
your employer.) Many plans also allow business owners to exclude employees
from receiving contributions until they complete a year or two of service.
If an employee leaves prior to being fully vested, his unvested balance
reverts to the remaining Keogh plan participants. Keogh plans also allow for
Social Security integration, which effectively allows those in the company who
earn high incomes (usually the owners) to receive larger-percentage contributions for their accounts than the less highly compensated employees.
The logic behind this idea is that Social Security taxes and benefits top out
after you earn $106,800 (for tax year 2011). Social Security integration allows
higher-income earners to make up for this ceiling.
Owners of small businesses shouldn’t deter themselves from doing a retirement plan because employees may receive contributions, too. If business
owners take the time to educate employees about the value and importance
of these plans in saving for the future and reducing taxes, they’ll see it as a
rightful part of their total compensation package.
which typically allows you to save up to $16,500 per year (for tax year 2011).
Many nonprofit organizations offer 403(b) plans to their employees. As with
a 401(k), your contributions to 403(b) plans are deductible on both your federal and state taxes in the year that you make them. Nonprofit employees can
generally contribute up to 20 percent or $16,500 of their salaries, whichever
is less. In addition to the upfront and ongoing tax benefits of these retirement
savings plans, some employers match your contributions.
Older employees (defined as being at least age 50) can contribute even more
into these company-based plans — up to $22,000 in 2011. Of course, the challenge for many people is to reduce their spending enough to be able to sock
away these kinds of contributions.
If you’re self-employed, you can establish your own retirement savings
plans for yourself and any employees that you have. In fact, with all types
of self-employment retirement plans, business owners need to cover their
employees as well. Simplified employee pension individual retirement accounts
(SEP-IRA) and Keogh plans allow you to sock away about 20 percent of your
self-employment income (business revenue minus expenses), up to an annual
maximum of $49,000 (for tax year 2011). Each year, you decide the amount
you want to contribute — no minimums exist (unless you do a Money
Purchase Pension Plan type of Keogh).
Keogh plans require a bit more paperwork to set up and administer than
SEP-IRAs. Unlike SEP-IRAs, Keogh plans allow vesting schedules that require
employees to remain with the company a number of years before they earn
the right to their retirement account balances. (If you’re an employee in a
small business, you can’t establish your own SEP-IRA or Keogh — that’s up to
your employer.) Many plans also allow business owners to exclude employees
from receiving contributions until they complete a year or two of service.
If an employee leaves prior to being fully vested, his unvested balance
reverts to the remaining Keogh plan participants. Keogh plans also allow for
Social Security integration, which effectively allows those in the company who
earn high incomes (usually the owners) to receive larger-percentage contributions for their accounts than the less highly compensated employees.
The logic behind this idea is that Social Security taxes and benefits top out
after you earn $106,800 (for tax year 2011). Social Security integration allows
higher-income earners to make up for this ceiling.
Owners of small businesses shouldn’t deter themselves from doing a retirement plan because employees may receive contributions, too. If business
owners take the time to educate employees about the value and importance
of these plans in saving for the future and reducing taxes, they’ll see it as a
rightful part of their total compensation package.
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