Should You Pay Off Your Mortgage Or Keep The Tax Deduction?

May 09, 2018

One of the more common questions we receive as people prepare for retirement or just get close to paying off their homes is whether they should pay it all off early or keep paying on it to keep the tax deduction. Here are several reasons why this is a classic case of letting the tax tail wag the dog:

1) The interest decreases as a percentage of your mortgage payment. When you first take out a mortgage, most of your payments are interest so it’s mostly deductible. However, the interest portion steadily declines so that by the time your mortgage is almost paid off, your payments are mostly non-deductible principal. And with the new higher standard deduction amounts, a lot more homeowners may find themselves no longer itemizing their deductions even if they have many years to go on their mortgage (see reason #2).

2) The mortgage interest deduction may not benefit you as much as you think. In fact, it may not benefit you at all. As an itemized deduction, it only helps you to the degree that your itemized deductions exceed your standard deduction ($12,000 per person in 2018) since you only get whichever one is higher. If your standard deduction is higher, you don’t deduct your mortgage interest at all.

Even if you do itemize, your taxable income is only reduced by the difference between the two. If your itemized deductions are $100 more than the standard deduction, that mortgage interest is only reducing your taxable income by $100. You can use this calculator to see exactly how much your mortgage interest is really saving you in taxes.

3) The cost of the interest is always more than the tax savings. Let’s assume that you have $10,000 in mortgage interest (not just payments) and all of that exceeds your standard deduction. Even if you’re in the top 37% tax bracket, you’d still be saving only $3,700 in federal income taxes. Does it really make sense to pay $10,000 to save $3,700?

When it doesn’t make sense to pay your mortgage off early

That all being said, there are some good reasons NOT to pay down your mortgage early. They just (mostly) have nothing to do with taxes. All of the following should be considered higher priorities:

1) You don’t have adequate emergency savings. An emergency fund can help you make those mortgage payments even when you’re in between jobs. Don’t rely on a home equity line of credit for that. Your line of credit might get canceled, especially when the economy is weak or you’re unemployed, which is exactly when you most need it.

2) You’re not contributing enough to get the full match in your employer’s retirement plan. It’s hard to beat a guaranteed 50% or even 100% return on your money.

3) You have higher interest debt. It makes a lot more sense to pay down a 10% credit card than a 4% mortgage. If the rates are close, don’t forget to factor in the tax deduction to reflect the true cost of the mortgage. (Student loan debt is also deductible up to $2,500 per year assuming you don’t exceed the income limits.)

4) You’re eligible for HSA contributions and haven’t maxed it out. Contributing to an HSA is the most tax-advantageous thing you can do since the money goes in pre-tax and then can be used tax-free for health care expenses. If you’re in the 24% tax bracket, you can save 24% on your HSA contributions and earnings that you use for health care expenses. The only catch is that you must have an HSA-eligible health insurance plan to contribute.

5) You can earn more by investing your extra money instead. To be on the safe side, I like to assume you’ll average about a 3% return if you’re very conservative (20-40% in stocks), 4% if you’re moderately conservative (40-60% in stocks), 5% if you’re moderately aggressive (60-80% in stocks), and 6% if you’re very aggressive (80-100% in stocks). If your mortgage interest rate is less than that, you’re probably better off investing your extra savings. If you’re investing in a tax-sheltered account like a 401(K) or IRA, the tax benefits cancel out the mortgage interest deduction.

Depending on your situation, paying off your mortgage early may not be a good idea. But it’s seldom because of the tax deduction.

What To Do If You’re Struggling With Your Mortgage Payments

May 08, 2018

Losing your home to foreclosure and potentially being homeless is one of the biggest financial hardships you can face. However, there may be situations in which walking away from your home actually makes sense. Here are some questions to ask yourself: 

Do you have equity in your home or are you underwater?

Home equity is the difference between the value of your home and what you owe. You get to keep any equity leftover after a foreclosure sale, but that equity is likely to be reduced by late payment and foreclosure fees assessed by the mortgage company. Mortgage companies will typically also accept offers for less than the home’s value in order to sell it quickly and because they won’t benefit from selling it for any more than the mortgage value. On the other hand, if your home value is significantly less than what you owe, a “strategic default” can be your best financial choice even if you can afford the payments.  

How much can you afford to pay?

Start by look at your bank and credit card statements over the last few months and record your expenses on a worksheet like this. Then see if you can find ways to reduce any of those expenses to make the mortgage payments. If you want to keep your home, you may want to prioritize the mortgage payments even over unsecured debt payments like credit cards and personal loans. After all, defaulting on either type of debt will hurt your credit but the latter can be wiped out in a bankruptcy without losing your home. A bankruptcy can hurt your credit score more, but a foreclosure can make it harder to get a mortgage in the future. Plus, we all need a roof over our head.

Are there alternatives to foreclosure?

Once you know how much you can afford to pay towards your mortgage and it’s not enough to get current, contact your mortgage company and see if you can work out a plan with them to avoid foreclosure. This may mean modifying the terms of the loan to make it affordable for you or giving the home up through a short sale or a mortgage release/deed-in-lieu of foreclosure. These options will hurt your credit score but not as much as a foreclosure. 

If you’re having trouble making your mortgage payments, don’t despair. There are options that can keep you in your home or you may even be better off walking away from it. If you’re not sure what to do, see if your employer offers a financial wellness program with free access to an unbiased financial planner who can help you decide which option is best for you. 

How I Earned Two Degrees Without Student Loan Debt

April 27, 2018

Editor’s note: This post is part of our Personal Stories series, where our financial coaches share their own financial journey. We hope you enjoy getting to know us a little better and ultimately learn from our mistakes!

OK, so here’s the situation…

One of the biggest worries many young people have today and many parents have for their kids is the burden of student loans. Given its value in the job market, avoiding higher education doesn’t really seem like the best solution for most people. Fortunately, I was able to finish college and law school without having to take any student loans. Here’s how I did it.

“I got this”

Step 1:

The first step was taking AP (advanced placement) classes in high school, which allowed me to get enough college credits to graduate from college a year early. These classes are harder than the regular curriculum, but admissions officers will often look more favorably on lower grades in an AP class than higher grades in the corresponding non-AP class. Even if your child’s high school doesn’t offer AP classes for certain subjects, they may be able to take the AP exam for those subjects and get college credits anyway if they score well enough. This is what I did for history and government.

Step 2:

The second thing I did was to choose schools (in my case, NYU for college and USD for law school) that gave me significant scholarships. This may force your child to attend a lower ranked school that offers a scholarship rather than a higher ranked one that doesn’t, but a study found that students with comparable abilities making this choice earn about the same income either way.

In other words, it’s more about the student’s aptitude and skills than the name on their degree. (Exceptions are for students from lower-income households and business majors since some businesses only recruit from top schools.) Students who don’t qualify for AP classes or scholarships could follow a similar strategy by attending a much lower cost state school or even a community college and then transferring to a more prestigious school, which is where their 4-year degree would be from.

Step 3:

Finally, I worked while in college. I spent a summer selling cutlery in people’s homes (which helped get me my first job in the investment brokerage business), worked for the school’s admissions office, sold advertising for the school paper, and worked as a teacher and proctor for a test prep company. One study found that students who work part-time in school actually do better academically.

At the end of the day

The end result of all this is that I was able to avoid graduating with burdensome student loan payments. (I did technically have a small student loan from undergrad that I applied for by accident but I quickly paid that off.) This made it much easier to avoid other types of debt and save for the future.

If I could turn back time

The only things I might do differently would have been to apply to more colleges (I only applied to NYU early decision) to see where else I could have gotten scholarships to and perhaps to not go to law school at all. While the JD didn’t cost me any money, there was a significant opportunity cost of not earning much for 3.5 years since I never intended to use the degree. That’s a pretty elementary mistake for a former economics major!

If I could tell you just one thing

The one thing I would tell students and parents is to think of education the same way as a consumer purchase or an investment. Focus on value rather than always the “best” or most prestigious option. They may yield the most short-term emotional benefit but they often cost more, both emotionally and financially, in the long run.

 

7 Common Investing Mistakes

April 11, 2018

Investing can seem complicated and even intimidating to a lot of people, but I’d argue that’s it’s actually the easiest part of financial planning. All you really need to do is make sure you’re reasonably diversified (there is no “perfect” here), keep your costs low, and stick to your plan through thick and thin. No hours of reading the Wall Street Journal or watching CNBC are required.

Here are the most common big mistakes I see people making, along with the 3 steps to avoid all of them: 

1) Chasing past performance

Investments tend to go through cycles so buying whatever happens to be performing best will probably cause you to buy it closer to the top of a cycle then the bottom. If you sell it when it eventually under-performs, you’ll probably sell closer to the bottom. Repeat this enough times and you’re basically buying high and selling low, which is the opposite of what you want to do. 

Even if you’re buying a top mutual fund within a particular category (which eliminates the effects of market cycles), studies have found that these top performers don’t maintain their edge. In fact, they often do worse than average. You would have done better by flipping a coin.   

2) Trying to time the market

Instead of looking at the past through the rear view mirror, what about trying to invest based on what will happen in the future? This makes sense in theory, but in reality, the market is notoriously difficult to predict. You also have to be right not once, but twice. Even if you’re right about when to purchase an investment, how will you know when to get out of it? Professionals fail to consistently do this successfully, so do you really think you’ll be able to? 

3) Not being diversified

Another mistake I often see is people having too much money in a single stock. After all, while the stock market as a whole tends to go up over the long run, a single stock can go to zero and never come back. This is especially dangerous if it’s your employer’s stock since your income is already tied to that company.

A good rule of thumb is to never have more than 10-15% of your portfolio in any one company’s stock. If you have stock incentives or an employee stock purchase plan, consider selling the shares and diversifying as soon as you can to stay within that limit. 

4) “Diversifying” by randomly spreading money between all the funds in a retirement plan

The problem with this “diversification” is that you might not actually be properly diversified. For example, you can end up with 90% of your money in stocks if most of the funds available to you are stock funds. That might be fine if you’re an aggressive investor with a long time horizon but not if you are more conservative or have a shorter time frame to invest. 

5) Being too conservative for a long time horizon

Being too conservative can actually be risky, not in terms of market volatility but the real risk of not achieving your financial goals. That’s because more conservative investments tend to earn as much over long time periods. Even a small difference of return can have a huge impact.

For example, $10k earning 2% over 30 years would grow to $18k, while at an 8% return, it would be over $100k. That’s a “loss” of over $80k that could have gone towards your goals. 

6) Being too risky for a short time horizon

On the other hand, money that you need in the next 5 years should be invested very conservatively. That’s because investing it more aggressively puts you at risk of seeing the value of your investment decline and not recover in time. Don’t think it will decline in the next few years? Go back and visit mistake #2. 

7) Paying too much in fees

One way to avoid these problems is to pay someone else to invest for you, usually through a mutual fund. The problem is that the fees that fund managers charge typically outweigh any value they provide. A Morningstar study found that low fund fees were the most dependable predictor of future fund success.

This is why Warren Buffett has repeatedly recommended that people invest in low cost index funds that simply track the market. In fact, he recently won a $1 million bet by a landslide that a simple low cost index fund would beat any group of hedge funds over a 10 year period. 

3 simple steps to avoid these mistakes

  1. Make sure you’re properly diversified by taking a risk tolerance questionnaire and following the guidelines for your risk level, investing in a fully diversified fund like a target date fund, or using a robo-advisor that can design a portfolio for you. 
  2. Implement your plan using low cost funds like index funds. 
  3. Stick to your plan and rebalance about once a year to stay on track. 

That’s it. The more you fiddle with it, the more mistakes you’re likely to make. Now go enjoy the rest of your money. 

What’s The Difference Between Roth IRA And Roth 401k?

April 04, 2018

We’ve recently received several calls on our Financial Helpline from people who entered their Roth 401(k) contributions as Roth IRA contributions in tax software and were told that they had over-contributed. Since Roth 401(k) plans are relatively new, it’s easy to get these mixed up but the differences are important and not just when filing your taxes.

What’s the same?

Let’s start with the similarities.

  • Both accounts allow you to contribute after-tax dollars that can grow to be tax-free after age 59 ½ as long as you’ve had the account for at least 5 years.

The differences

Now let’s take a look at the subtle, but important differences.

1. Can you contribute?

Roth 401k:

A Roth 401(k) has to be offered by your employer. If your employer offers one and you’re eligible to contribute to the 401k, you’re good to go.

Roth IRA:

A Roth IRA has income limits. (However, there is a way to get around them.)

2. How do you contribute?

Roth 401k:

If your employer offers you a Roth 401(k) option, the contributions are deducted from your paycheck for that tax year.

Roth IRA:

With a Roth IRA, you have to open the account and make the contributions yourself, either by writing a check or having an automatic transfer from your bank account. You also usually have until April 15th (April 17th this year) to make a contribution for the previous year. Not sure where to open a Roth IRA? Here are some low cost options.

3. How much can you contribute?

Roth 401k:

The total limit for employee traditional and Roth 401(k) contributions is $18,500 ($24,500 if you’re over age 50 this year) for 2018.

Roth IRA:

For IRAs, the total limit is a much lower $5,500 ($6,500 if you’re over age 50 this year). The Roth IRA contribution limit can also be reduced if your income is in the phase-out range.

Contributing to one doesn’t affect how much you contribute to the other so you can do both if you’re eligible, which means for 2018 you could feasibly be putting a combined $24,000 into Roth accounts ($31,000 if you’re over age 50).

4. What can you invest the accounts in?

Roth 401k:

With a Roth 401(k), you’re limited to the choices your plan offers but this can often include options not otherwise available like higher-yielding stable value funds and mutual funds with reduced fees.

Roth IRA:

With a Roth IRA, you can invest in almost anything, including stocks, bonds, mutual funds, annuities, and even gold coins, real estate, and your own business if you have a self-directed Roth IRA. The choices (and their fees) will depend on which financial institution you choose to use.

5. How can you get the money?

Roth 401k:

With a Roth 401(k), you’re generally limited to loans and/or hardship withdrawals before age 59 ½ if you’re still employed there and if the plan allows them. Many plans also allow you to take withdrawals at age 59 ½. You can withdraw money after you leave your employer as well.

Roth IRA:

You can take money out of a Roth IRA anytime. (that doesn’t mean there won’t be penalties or tax consequences, so keep reading)

6. Are there penalties on withdrawals?

Roth 401k:

For both types of account, Roth earnings withdrawn before age 59 ½ are subject to taxes and a 10% penalty unless you meet certain exceptions. With a Roth 401(k), withdrawals are considered contributions and earnings in the same proportion as they exist in your account. This means that if you have a balance of $20,000 but $10,000 is the amount you contributed (called the “basis”) and you withdraw $10,000, the IRS will consider 50% of that withdrawal to be earnings and you’ll be taxed and/or penalized accordingly.

Roth IRA:

One of the big differences is that with a Roth IRA, your withdrawals are considered contributions first, which is important if you need access to the any of the money before age 59 1/2. That means you can withdraw the sum of your contributions at any time without tax or penalty. Unlike with a Roth 401(k), Roth IRA earnings can also be withdrawn penalty-free for education expenses and up to $10k (lifetime limit) for a home purchase if you haven’t owned a home in the last 2 years.

7. Can you roll money from one to another?

You can roll money from a Roth 401(k) to a Roth IRA but not the other way around.

What’s the bottom line?

Roth IRAs generally provide more flexibility, both in terms of how the money is invested and withdrawn. However, Roth 401(k) accounts offer greater convenience and allow you to contribute more (and may allow you to contribute at all if you make too much money). They’re both excellent ways to shield your future income from taxes so if you’re eligible, you may want to contribute to both!

 

 

Should You Pay Your Mortgage Off Early Or Keep The Tax Deduction?

March 27, 2018

I recently received a question after one of my workshops from a woman who was wondering if she made a mistake paying her mortgage off early because she no longer has the mortgage interest deduction. I can’t tell you how many times I’ve gotten different versions of that same question (including after a later workshop session that same day). Here are several reasons why this is a classic case of letting the tax tail wag the dog:

1. The interest decreases as a percentage of your mortgage payment. When you first take out a mortgage, most of your payments are interest, so most of what you pay is deductible. However, the interest portion steadily declines so that by the time your mortgage is almost paid off, your payments are mostly non-deductible principal anyway.

2. The mortgage interest deduction may not benefit you as much as you think. In fact, it may not benefit you at all. As an itemized deduction, it only helps you to the degree that your itemized deductions exceed your standard deduction since you only get whichever one is higher. Considering that the standard deduction is now $12,000 per person (or $24,000 for a married couple), AND the income and property tax deduction is limited to $10k per year, many people will fail to qualify for itemized deductions going forward, even if you have many years to go on your mortgage.

Even if you do itemize, your taxable income is only reduced by the difference between the two. If your itemized deductions are $100 more than the standard deduction, that mortgage interest is only reducing your taxable income by $100.

3. The cost of the interest is always more than the tax savings. Let’s assume that you have $15,000 in mortgage interest (not just payments) and all of that exceeds your standard deduction. Even if you’re in the top 37% tax bracket, you’d still be saving only $5,550 in federal income taxes. Does it really make sense to pay $15,000 to save $5,550?

That all being said, there are some good reasons NOT to pay down your mortgage early. They just (mostly) have nothing to do with taxes. All of the following should be considered higher priorities:

Reasons NOT to pay down your mortgage early

1. You don’t have adequate emergency savings. An emergency fund can help you make those mortgage payments even when you’re in between jobs. Don’t rely on a home equity line of credit for that. Your line of credit might get canceled, especially when the economy is weak or you’re unemployed, which is exactly when you most need it.

2. You’re not contributing enough to get the full match in your employer’s retirement plan. It’s hard to beat a guaranteed 50% or even 100% return on your money.

3. You have higher interest debt. It makes a lot more sense to pay down a 10% credit card than a 4% mortgage. If the rates are close, don’t forget to factor in the tax deduction to reflect the true cost of the mortgage. (Student loan interest is also deductible up to $2,500 per year.)

4. You’re eligible for HSA contributions and haven’t maxed it out. Contributing to an HSA is the most tax-advantageous thing you can do since the money goes in pre-tax and then can be used tax-free for health care expenses. If you’re in the 24% tax bracket, you can save 24% on your HSA contributions and earnings that you use for health care expenses. The only catch is that you must have an HSA-eligible health insurance plan to contribute (although you can still spend the funds if you switch to a lower deductible plan in the future).

5. You can earn more by investing your extra money instead. To be on the safe side, I like to assume you’ll average about a 3% return if you’re very conservative (20-40% in stocks), 4% if you’re moderately conservative (40-60% in stocks), 5% if you’re moderately aggressive (60-80% in stocks), and 6% if you’re very aggressive (80-100% in stocks). If your mortgage interest rate is less than that, you’re probably better off investing your extra savings. If you’re investing in a tax-sheltered account like a 401(K) or IRA, the tax benefits cancel out the mortgage interest deduction.

Depending on your situation, paying off your mortgage early may not be a good idea. (At retirement is a different story.) But it’s seldom because of the tax deduction.

Should You Let A Robo-Advisor Pick Your Investments?

March 21, 2018

Technology has revolutionized everything from choosing a restaurant to getting directions or even a ride to that restaurant, but is it time for technology to get you to your investment destination as well? While this may sound like science fiction, the rise of “robo-advisors” over the last few years has made this into a plausible option.

These online automated investment services can provide investment advice or management for typically a lot less than a human advisor. But should you really entrust your nest egg to a computer and if so, which of the many options would make the most sense for you?

Pros of robo-advisors

  • It’s convenient. You don’t have to have a large amount to invest or go to a fancy office and talk to a pushy salesperson. Most robo-advisors have very low minimums and allow you to set up and fund the account from the comfort of your smartphone or at least, your computer.
  • You get a customized asset allocation. “Asset allocation” is a fancy term for dividing your money into various types of investments (called “asset classes”) like stocks, bonds, and cash. Rather than having to make this decision on your own, robo-advisors generally do this for you based on your responses to questions that are designed to determine your time frame and comfort with risk. All you need to do is then fund the account.
  • The costs are relatively low. You could get asset allocation advice from a human advisor, but that typically costs about 1% of your assets. They may also put you into funds with high fees. Robo-advisors generally charge a lot less and use low cost index funds.

Cons of robo-advisors

  • The “advice” is very limited. Robo-advisors generally only help you with your investments. You typically won’t get help with other financial planning issues like how much you should be saving, what type of accounts to invest in, and whether you have adequate insurance coverage and estate planning. The investment advice you do get may also not incorporate taxes or how your money is invested elsewhere.
  • There’s no “hand holding.” One of the most valuable services of an advisor is to talk you out of doing something stupid – whether that’s putting too much in an aggressive tech stock or bailing out when the market takes a downturn. To the extent that robo-advisors do this, they still lack the emotional connection and persuasive/motivational ability of a trusted human advisor.
  • There are generally still advisory fees. Even a small advisory fee can add up over time. You could do a lot of what robo-advisors do without paying their fees by simply investing in an asset allocation fund that matches your risk level or taking a risk tolerance questionnaire and following the asset allocation guidelines.

How to get started if a robo-advisor is what you need

  • Know what you’re looking for. If you’re investing in a taxable account, you might want to look for a robo-advisor that offers tax-efficient investing and/or tax loss harvesting. A few offer access to a human advisor by phone. Make sure you’re also comfortable with the program’s investment strategy.
  • Know your options. Your employer’s retirement plan may offer a robo-advisor program. Some are also offered by particular brokerage firms for their clients. You can find a good comparison of options here.
  • Know what you’re paying. Look at both the fees that the robo-advisor charges and the expenses of the funds it recommends. “Free” robo-advisors typically put you in their own bank accounts and mutual funds, which may be more expensive than another program’s fees.

For investors who are looking for investment management or advice but are unwilling or unable to hire a financial advisor, robo-advisors can offer a simple and relatively low cost solution. (Just be aware of their limitations.) At the very least, they will make human advisors work that much harder to earn the fees they charge.

 

Should You Be A DIY Investor?

March 07, 2018

Should you choose your own investments or have someone else do it for you? It’s a choice that every investor has to make. Let’s take a look at the pros and cons of do-it-yourself investing: 

Pros 

  1. It can be cheaper. You avoid advisory fees and you can choose low cost funds or even avoid fund fees entirely by investing in individual stocks and bonds. This is important as minimizing fees is one of the surest paths to investment success. In fact, a study of various asset allocation strategies found that fees mattered more than which strategy you chose in determining your performance.   
  2. You have more control. Having someone else choose your investments can mean giving up some control. If you are very particular about your investment strategy or want to avoid investing in certain companies or industries for moral reasons, you may be reluctant to give up that control. 
  3. It can be fun. Many people prefer to manage their own investments because they actually enjoy it. This is especially true for more speculative and “hands-on” investments like individual stocks, direct real estate, and more recently, cryptocurrencies. 

Cons 

  1.  It can also be more expensive. Most of the costs of investing are relatively hidden and don’t show up on your statements or trade confirmations. Mutual fund expense ratios are generally buried in the fund prospectus and turnover costs aren’t reported at all but can have a significant impact on your returns. 
  2. You have more control. More control isn’t always a good thing. Some of the most common mistakes investors make include chasing past performance, not being properly diversified, holding on to losing investments too long in the hope that they recover, and paying more in taxes than you need to. At the very least, it can be helpful to have a second opinion. A Vanguard study found that a good financial advisor can save you about 3% a year (net of a 1% advisory fee) in helping you avoid bad decisions. 
  3. It can be time consuming and stressful. Even if you are good at managing your investments, you may not have the time or desire to manage them yourself. Your time may be better spent elsewhere. 

How to get started 

Let’s say you want to be a do-it-yourself investor. Where do you start? Here some tips: 

  1. Have a strategy. You don’t want to just pick whatever happens to be doing well at the time, your brother-in-law’s recommendation, or what “feels right.” Instead, you might want to start by taking a risk tolerance questionnaire like this one and follow the guidelines as to how much to invest in stocks vs bonds vs cash (known as your “asset allocation”). You can also check out these asset allocation models by the American Association of Individual Investors and these “lazy portfolios” put together by various investment experts. Once you’ve decided on a strategy, consider putting it in writing.  
  2. Keep your costs low. Remember that study that found that fees can be more important than your asset allocation strategy? To keep your costs low, consider Warren Buffett’s recommendation of investing in index funds, which tend to have very low fees and turnover costs. By using index funds, you also avoid having to choose an active fund manager, which can be a notoriously difficult choice to make as most underperform the market index (which is what index funds track) and those who outperformed in the past are no more likely to do so in the future. If you don’t have index funds available to you, look for funds with the lowest expense and turnover ratios in their category. 
  3. Consider individual securities. Another way to minimize costs is to avoid fund fees altogether and purchase individual stocks and bonds. (Just be careful of commissions and other trading costs.) To be diversified, make sure you have at least 20-30 different stocks from a variety of sectors and with no more than 10-15% in any one stock. You can use a free stock screener to help you find stocks that meet your criteria. If you don’t know what criteria to use, you probably shouldn’t be picking individual stocks. Don’t worry though. As we saw, most professional investors fail to beat the market so you probably won’t either and would likely be better off with simple index funds.   
  4. Don’t gamble with your retirement or college funds. Your retirement and college funds should be in a boring, diversified, low cost portfolio. If you insist on wanting to “play” the stock market or gamble on Bitcoin, consider doing so only with money you can afford to lose…or just take that money and go to Vegas. You’ll probably have more fun that way.       

Are You Financially Ready To Retire?

March 02, 2018

The day is finally approaching. You’ve been saving and investing most of your adult life for this moment, but now you’re not so sure you’re really ready to retire. It’s a predicament faced by many employees that we work with. While retirement readiness has many non-financial components to it, here’s how you can know if you’re financially ready to retire:

1. How much income will you need? Don’t make the mistake of “guestimating” your expenses. That might be fine when you’re decades away, but you don’t want to discover that you’ve underestimated your income needs several months into retirement. Start by tracking your actual expenses over a few months and then make any adjustments you foresee to your lifestyle (like downsizing or relocating) to create a retirement budget. (You can use this calculator by AARP to estimate your health care expenses.)

2. What will you be receiving from Social Security? You can run a projection on the Social Security web site and enter the exact age you plan to collect. If you’re married, don’t forget that you and your spouse get the higher of your own benefit or a spousal benefit that’s about 1/2 the other spouse’s full Social Security benefit.

3. What other income will you be receiving? If you’re fortunate enough to qualify for a pension, get a pension estimate. Include net rental income from any real estate you own. I’d be hesitant about including income from a part-time job or business since you don’t know how long that income will last.

4. How much can you safely withdraw from your retirement savings? Add up all of your retirement savings, including retirement plans from previous jobs, your current employer’s plan, IRAs, and any other investment accounts intended for retirement. Then multiply that total by 4%, which has been found to be the historical safe inflation-adjusted withdrawal rate from a diversified portfolio over 30 years. (If your portfolio includes small cap stocks, you can increase that withdrawal rate to 4.5%.)

5. How much will you owe in taxes? Your taxes will vary based on your mix of income sources and what state you retire in. You can use this site to estimate your retirement tax liability based on those variables.

If your retirement expenses and taxes are more than your retirement income, you may want to consider reducing your retirement expenses, purchasing an immediate income annuity, taking out a reverse mortgage, or working a bit longer. Otherwise, you probably have the financial resources to retire.  Here are a few steps you can take to help make sure you stay that way:

  1. Make sure your portfolio is diversified and low cost. Keep in mind that the 4% rule was based on a diversified portfolio of market indexes. The simplest way to mimic that is with a target date retirement income fund made up of index funds since they’re designed to be fully-diversified “one stop shops” for people in or approaching retirement. If you prefer a more customized approach, consider using a low cost robo-advisor tool that can design a portfolio for you.
  2. Consider long term care insurance. You can see your entire nest egg wiped out by long term care costs. That’s because Medicare and other health insurance policies don’t cover it. Medicaid does but it’s a poverty program that requires you to spend down virtually all of your assets to qualify and many places don’t accept Medicaid.Long term care insurance can protect your assets and your choice of care. In particular, see if your state offers a long term care partnership program. Purchasing a policy through one of these programs can protect your assets even if you use up all the insurance benefits and have to rely on Medicaid.
  3. Have a withdrawal strategy. It’s not just how much you’re withdrawing but where you’re withdrawing from. If you’re withdrawing from pre-tax as well as tax-free (Roth) and regular investment accounts, you have the opportunity to structure your withdrawals to minimize taxes and even reduce health care costs in retirement. If your situation is complex, this is an area where a tax-aware financial advisor can be helpful.

The idea of retirement can be both exciting and terrifying. Hopefully by following these steps, you can make it more of the former and less of the latter. Are you ready?

This post was originally published on Forbes.

Should You Increase Your 401k Savings Due To Tax Reform?

February 22, 2018

Have you noticed a little boost in your paycheck recently? That’s probably because employers have just started updating their employees’ withholding based on the new tax law, which reduced tax brackets across the board. So what should you do with the extra money?

Should you contribute more?

It may seem like the responsible thing would be to contribute it to your 401(k). After all, if you’re like the average American, you may not be saving enough for retirement and this would be a painless way to get closer to that goal. (You can use this calculator to see how much you should be saving.) Here are a few questions you may want to ask yourself first:

Is the tax bill really saving you money?

While rates have come down, some deductions have also been reduced or eliminated, including the state and local tax deduction. If you pay high state, local or property taxes, you may actually see your taxes go up. You don’t want to find that out at tax time next year and have to borrow from your 401(k) to pay the IRS. You can use a calculator like this to estimate your tax liability under the new law and compare it to what you owed previously.

Do you have adequate emergency savings?

Even if you are saving money, your 401(k) may not be the best place for those savings. Financial planners typically recommend having enough emergency savings to cover at least 3-6 months’ worth of necessary expenses. Otherwise, you may be forced to raid that 401(k) (with possible taxes and penalties) or borrow at high-interest rates in the event of an emergency.

If you can’t bear the thought of neglecting your retirement savings for even a short period of time, consider contributing to a Roth IRA. You can withdraw the sum of your contributions at any time and for any reason without tax or penalty so it can double as your emergency fund. (If you withdraw earnings before age 59 ½, they are subject to possible taxes and penalties but the contributions come out first.)

Just be sure to keep the Roth IRA money someplace safe like a savings account or money market fund until you have enough emergency savings somewhere else. At that point, you can invest the Roth IRA money more aggressively to grow tax-free for retirement.

Do you have high-interest debt?

It probably doesn’t make sense to contribute more to your 401(k) if you have a credit card balance at 19% interest. Those 401(k) contributions would have to earn 19% after-taxes just to break even. That’s something I certainly wouldn’t count on, especially with many financial experts forecasting future returns in the low to middle single digits due to historically low interest rates and high stock valuations. For that reason, my rule of thumb is to pay off any debt with interest rates above 4-6% before investing extra money (unless you haven’t maxed your employer’s match).

Are you planning to buy a home?

If so, consider stashing the extra money in savings. You’ll need cash for the down payment, closing costs, and any furnishings and renovations you want to add. This is on top of your emergency funds, which will be even more important when you can’t call a landlord anymore for home repairs.

If you’re saving money from the tax bill, have adequate emergency savings, no high-interest debt, and aren’t looking to buy a home anytime soon, your 401(k) can get be a great place for those extra savings. Go ahead and adjust your contributions before you start getting used to the bigger paychecks. After all, many said the tax law favors the rich so the quicker you can get there, the better!

 

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Should You Invest More Aggressively To Retire Soon?

January 18, 2018

Are you getting close to retirement but feel like you’re behind on your retirement savings? Have you considered investing more aggressively to catch up? This is a question I’ve gotten a few times on our Financial Helpline (and is probably a sign that the market is getting closer to a peak).

Let’s take a look at the pros and cons

The main advantage is that a more aggressive portfolio is likely to perform better than a more conservative one over time. However, there’s also a risk of a significant market decline, especially when prices are as high as they are now relative to earnings. Earning a slightly higher return for a few years may not make much of a difference in your retirement readiness, but a big loss can mean having to delay retirement, withdraw less income, or face the risk of depleting your retirement savings. That’s why it’s generally recommended to be more conservative as you get closer to retirement.

The exception to the rule

However, there’s almost always an exception to every general rule. The biggest would be if you’re planning to retire early. If your aggressive investments perform well in the next few years, it can make that happen sooner. If they don’t, you can always retire a little later and probably with more assets in the long run. You can also split your investments into more moderate ones for retiring later and more aggressive ones for retiring earlier.

How I do it

For example, I’ve divided my retirement savings into “normal retirement” and “early retirement.” My normal retirement savings are moderately aggressively invested in my 401(k), HSA, and Roth IRA. I just need a modest rate of return in those accounts to reach my “normal” retirement goals.

Two timelines, two strategies

My early retirement investments are much more aggressively invested in my regular taxable accounts. If they do really well, I can retire earlier and don’t have to worry about early withdrawal penalties on that money. If they perform poorly, I can take the losses off of my taxes.

On the other hand, if I was approaching a normal retirement date and was just looking to catch up, I probably wouldn’t take that risk. Instead, I’d try to save more, reduce my retirement expenses, or consider other retirement income sources like an income annuity, a reverse mortgage, or even a part-time job or business. As always, it all depends on your situation.

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Why One Couple Decided To Pay Off Student Loans Before Investing

January 11, 2018

There are three kinds of questions when it comes to personal finance.

  1. The first are those with objective answers like what tax bracket you’re in or whether you would be subject to a penalty for withdrawing from your retirement account.
  2. The second are those with a pretty strong consensus among financial planners. For example, most would say that you should generally build up an emergency fund, contribute at least enough to your employer’s retirement plan to get the match, and pay off high-interest debt like credit cards.
  3. Then there are the questions whose answer depends on you.

When the answer isn’t clear cut

For example, I was recently talking to a young couple who had all their financial basics covered. They had sufficient emergency savings, no high interest debt, and were contributing enough to their retirement plans not only to get their employer matches but also to be on track for retirement. They still had enough savings to either pay off their student loans, contribute more to their retirement plans, or save for a down payment on a rental property. Their best option wasn’t so clear here. Let’s take a look at each option:

Option 1: Paying off the student loans

This is the most conservative choice. Since the interest rate was 4.375%, they were essentially earning a guaranteed 4.375% on any savings they put towards the loans. Try getting that rate at the bank or anywhere else for that matter. Paying off the debt would also provide an emotional benefit of not having the burden of the loan payments and would improve their debt/income ratio, which would help qualify for a better rate on a mortgage for the rental property.

Option 2: Contributing more to their retirement plans

This option would reduce their taxes now and probably overall since they’re likely to be in a lower tax bracket when they retire. They’re also likely to earn more in their retirement accounts than what they would save in interest by paying down the student loans. However, the money would be relatively tied up until retirement (which wouldn’t normally be a problem but they’re already saving enough to be on track to their goal) and there’s no guarantee their investments will earn more than the 4.375% they would save in interest by paying down the loans.

Option 3: Saving for a rental property

A rental property can help them achieve their goal of passive income and the ability to use leverage can provide a higher return on their investment than even investing in stocks. This makes it the most aggressive choice, almost like starting a business. But like a business, real estate is complicated, time consuming, and extremely risky. After all, you can lose more than what you originally put in due to maintenance costs and having to make mortgage, tax, and insurance payments while the property may be vacant.

What they decided to do

Given that they have adequate emergency savings and are currently contributing enough to their retirement plans to hit their goals, I personally probably would have focused on saving for the rental property (which is pretty much what I’ve actually been doing with my savings). However, they decided to knock out the student loans first while contributing extra to their retirement accounts. There isn’t always one right answer. Sometimes the best decision is a personal one.

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What Losing 30 Pounds Taught Me About Achieving Goals

January 04, 2018

Last week, I wrote about setting goals. Let’s face it. That’s the easy part. What about actually achieving them?

Losing 30 pounds last year

Two of the most common topics for New Year’s resolutions are weight loss and finances. At the beginning of last year, I set a goal to go from 222 pounds to 185 pounds and 8-10% body fat. I knew this would be a stretch goal but also doable because that’s what I was about 10 years ago. I haven’t quite hit my goal yet, but I have lost 30 pounds to get to 192 and 11% body fat. Here’s what I learned along the way and how it can apply to achieving financial goals:

1. Track your progress. Measuring my weight every day was probably the most important factor for me in staying motivated. If the number went down, I was encouraged to keep going. If the number went up, I was jolted back on track.

Find similar ways to measure your financial progress. It could be your debt or savings levels, credit score, retirement projections, or overall financial wellness. (Just realize that many of these financial metrics require a longer time interval to see progress than my daily weigh ins.)

I realize that weight isn’t the best metric for measuring fitness. (I also did more comprehensive full body composition tests at my gym every couple of weeks) However, it was the only one I could measure every day, which was important for my motivation. Something is often better than nothing. This bring me to…

2. Don’t make the perfect the enemy of the good. This can happen in several ways. If you’re like me, you may find yourself paralyzed into inaction by analysis paralysis of the “perfect” diet and exercise routine. When you inevitably fall off the horse, you may also feel discouraged to keep going. I had to accept that pursuing “perfection” is an ongoing process with many ups and downs and the key was to focus on doing the best I could at the time.

Your financial progress will likely be the same way. You will have unexpected expenses that will bust your budget. Your investments will decline from time to time. There will be moments when you make financial decisions you regret. Just stay focused on what you can do now to get back on track.

3. Get help. About halfway through the year, I hit a plateau and decided to join a boot camp style gym. I quickly discovered that my previous workouts weren’t as diverse and my form often needed correcting. I also found myself enjoying the workouts more and probably pushed myself harder than I would have on my own. As a result, I started making progress again.

A good financial planner can be like a personal trainer for your money. They can help you set reasonable goals and find the best way to accomplish them. At the very least, they can help hold you accountable for doing what you know you should do anyway.

Like hiring a personal trainer, a financial planner can be expensive. Many also sell overpriced financial products and services like the many dubious supplements and exercise gadgets out there. Fortunately, financial wellness is becoming as common an employee benefit as physical wellness programs. See if your workplace offers access to free financial education and guidance through an unbiased workplace financial wellness program.

4. Do what works for you. I read a lot about diet and exercise and talked to several friends about what they did. But in the end, everyone is different. Through trial and error (see #1 and #2 above), I had to find the right balance between doing the “right things” and what I could actually tolerate/stick with. For example, I try to be super strict with my diet during the day so I can be a bit looser (but still within reason) when I go out on evenings, weekends, holidays, and vacations.

Just like the best exercise or diet is the one you’ll actually do, the same is true for the best money management strategy. Experiment with different ways to manage your money and then make adjustments. (This is why measuring your progress is so important.) Some people keep detailed spreadsheets of their spending, some use apps like Mint, and some give themselves a fixed cash allowance. They’re all different paths to the same place.

Every day is a new day

Whether your resolution for 2018 is to pay off debt, save more or simply be more mindful of spending, I wish you much success. Be kind to yourself and remember that even if you fall away from your intentions, each day is a new day to start again.

Happy New Year!

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2017 By The Numbers

January 01, 2018

Happy New Year!

As we launch into 2018 here at Financial Finesse, we are reflecting on a successful 2017 — a year of tremendous growth in our business as well as in the number of lives we’ve had the privilege and honor to change for the better. We hope that this blog, written by our own financial planner team, has helped you to have a more prosperous year. Here’s a breakdown of what our readers loved this year, by the numbers:

Total pageviews for the year:

157,121

Most popular posts from 2017:

  1. What Are Your Health Insurance Options When Retiring Early? – 1,378 views
  2. How To Have The Money Talk – 1,250 views
  3. How To Avoid Borrowing From Your Retirement – 1,037 views
  4. Do You Need A Cohabitation Agreement? – 805 views

Most popular posts from previous years:

  1. Is Paying Off Your Mortgage Worth Losing The Tax Deduction? – 8,106 views
  2. What An Accident Taught Me About Car Rental Insurance – 5,939 views
  3. How To Be Financially Independent In 5 Years No Matter What Age – 5,275 views

Most shared on Facebook:

  1. Even Jay-Z Has Investing Regrets
  2. The Trouble With More
  3. How My Money Attitude Was Keeping Me Poor
  4. 3 Important Adulting Lessons I Taught My Daughters

Most shared on LinkedIn:

  1. Should You Go Into Debt To Get Pregnant?
  2. The 5 Things You Should Do Right Now To Protect Your Identity
  3. Why You Shouldn’t Worry About Investing At The Top
  4. How Much Will A Hybrid Car Actually Save You?

Readership by city:

New York: 5,638 readers

Chicago: 4,032 readers

Los Angeles: 3,995 readers

Hartford, CT: 2,248 readers

Golden Valley, MN: 1,686 readers

Lives changed:

Countless

Thank you for being a part of our amazing year! Here’s wishing us all a happy, healthy and financially well 2018!

3 Tips For Setting Goals You Can Actually Achieve

December 28, 2017

Note from the editor: As we round out 2017, many people will be setting goals and intentions for the year ahead. To help with that, our blog team will be sharing their take on goals throughout the week — we all have a different opinion! We hope you enjoy hearing how each of us approaches the idea of goal-setting and New Year’s resolutions. From Erik:

It’s that time of year again when many people make New Year’s resolutions only to see them become a source of disappointment and disillusionment. Is there anything you can do to set goals that you’re more likely to achieve? Here are 3 tips that I’ve seen work for financial goals and can be applied to other goals as well:

1. Set the right goals. Make sure the goal you’re setting is actually important to you and not just something that you’re “supposed” to do. Otherwise you won’t feel motivated enough to take action.

  • What are the things that most bother or worry you?
  • What would bring you the greatest amount of happiness?

Focus on the outcome that you want rather than what it will take to get there. For example, one of my top financial goals is to spend less eating out in order to achieve financial independence earlier. The goal is financial independence, not just spending less eating out.

2. Break each goal into achievable action steps. We often start with an ambitious, exciting goal and then feel too overwhelmed to take action. For the goal of financial independence, don’t just calculate how much money it will take. Break that number down into how much you need to save per year and per month. It will look a lot more doable that way.

3. Figure out the price you’re willing to pay. My grandmother used to say that you can have anything you want as long as you’re willing to pay the price. While not literally true, almost every goal does have its price.

Once you’ve broken it down into the action steps, ask yourself what price you’d have to pay and whether you’re willing to pay it. If not, don’t just give up. Instead adjust your goal until the price is right. If the price of financial independence at 50 isn’t worth it, try 60. Otherwise, you may end up waiting until 70 by default.

The 3 important questions

So what goals are most important to you? What steps do you need to take to make them happen? Finally, what price are you willing to pay?

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3 Last Minute Gift Ideas

December 21, 2017

Do you have anyone left on your list that you need last minute gifts for? Without knowing who they are, I would guess that at least one of them would love to have more money. No, I don’t mean that you should give cash. How about a gift that can keep on giving for a lifetime? Here are three good financial books to consider:

For anyone who wants to be a millionaire: The Millionaire Next Door by Thomas Stanley and William Danko. If you haven’t heard of this book by now, it’s full of surprising stories about how most millionaires really live. They don’t drive new sports cars, wear the most expensive designer labels, or eat regularly at the most fancy restaurants. That’s what people do who want to look like millionaires. Real millionaires typically live very modestly, which is exactly how they became and stayed millionaires.

For anyone with a job: What Your Financial Advisor Isn’t Telling You by our CEO Liz Davidson. Despite the title, you don’t need a financial advisor to benefit from this book. It’s also not an expose into the financial advisory profession. Instead, the book covers how to make the most of your paycheck and all the other employee benefits that come with it in order to pay off debt, build wealth and eventually achieve your financial independence day.

For anyone with money to invest: Global Asset Allocation by Meb Faber. It’s been said that 90% of your investment returns is determined by your asset allocation, so which asset allocation strategy should you use? With so many conflicting opinions out there, it’s easy to feel overwhelmed. This book reviews the world’s top asset allocation strategies and reaches a shocking conclusion.

Get moving (or get clicking)

It’s not too late. You still have time to order one or more of these books and have them arrive before Christmas, but don’t wait too long or you may have to pay for overnight shipping. As they say, time is money!

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Are You Financially Ready To Retire? Answer These 3 Questions To Find Out

December 14, 2017

Do you have enough money to retire? How will you turn your retirement savings into income? These are questions we get quite a bit from people approaching a time that can feel both exciting and terrifying. Here are some things to consider:

1. What will your expenses be in retirement? Instead of estimating, take a look at your actual bank and credit card statements and then record your expenses on a worksheet like this. Most people are surprised to see where their money is actually going and that’s probably not a surprise you want once you’re retired.

Then think about how some of those expenses may change in retirement to create a retirement budget. Are you planning to pay off your mortgage, downsize, and/or relocate? Will you spend less on commuting and eating out but more on travel and other hobbies? What will health care cost you?

2. How much income will you be receiving? You can get a projection of your Social Security benefits online. Unlike the statement you get in the mail, the web site allows you to enter your exact retirement date and when you expect to collect benefits. You’ll also want to get an estimate of any other income you’ll be receiving like pension benefits and cash flow from real estate.

3. How much will you need to withdraw from your retirement savings? Take your projected retirement income and subtract that from your retirement expenses. Then divide that number by your total retirement savings to get the withdrawal rate. For example, if your retirement expenses are $50k and your income is $30k, the difference is $20k. Dividing that $20k by $500k in retirement savings gives you a 4% withdrawal rate.

If your withdrawal rate is less than 2%, you can likely safely retire just by living off the interest and dividends from your investments without touching the principal. A withdrawal rate between 2 and 4% is still considered reasonably safe my most financial experts.

If it’s between 4-6%, you face a significant possibility of running out of money so you may want to purchase an immediate annuity (or choose the annuity payout from a pension plan) to reduce the amount you need to withdraw from your retirement savings below 4%. (A reverse mortgage can be a source of that annuity if necessary.) If the withdrawal rate is above 6%, you’ll need to make adjustments like reducing your retirement expenses or even delaying your retirement.

Of course, there are other factors that can complicate this calculation like taxes and retiring before you’re eligible to collect Social Security. You’ll also want to make sure your investments are properly diversified, that you’re not paying too much in taxes or fees, and that you have adequate insurance protection. For these reasons, you may want to consult with a qualified and unbiased financial planner, but these basic steps should give you a good starting point to see if you’re in the ballpark.

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In Search Of The ‘Perfect’ Investment

December 07, 2017

Do you know what the “perfect” investment would look like? According to a chart in this article of returns for a hypothetical “Mystery Fund” with “perfect returns,”  it would have consistent, safe, growth. It turns out that this mystery fund is actually Bernie Madoff’s supposed “returns” to make the point that “if it’s too good to be true, it generally is.”

No such thing

In the real world, there is no investment that offers safe, consistent, high returns like that. Instead, there’s a tradeoff between safety/consistency and long term returns. The “perfect investment” along that spectrum depends largely on your time horizon.

Short term versus long term = different focus, different results

For short term goals, the focus should be on return of principal rather than return on principal. That’s because earning a higher rate of return won’t make a significant difference over just a few years, but a big loss may mean having to delay or underfund your goal. For longer term goals, losses are much more likely to be dwarfed by your gains.

For example, if you earn just 2% in a savings account for 3 years, $10k would only grow to about $10,600. Earning a 10% rate of return (the long term average in the stock market) would give you about $13k – not bad. However, a 40% loss (like in 2008) would leave you with under $8k.

On the other hand, earning 10% over 30 years would mean having over $174k (versus just $18k at a 2% return) and a 40% loss would still leave you with over $100k. While that 40% loss would still sting (and perhaps much more since you’re losing more money), you’d still end up with much more than you would have had with the safe 2% return. The longer your time horizon, the less likely you are to lose your principal.

Of course, this assumes you’re invested in a diversified mix of stocks. An individual stock can go all the way to zero. For that to happen to the stock market as a whole, we’d have to be in something like a nuclear war, an alien invasion, or a zombie apocalypse, in which case your investments are the least of your worries.

Do you really think that’s perfect?

There’s one other thing to keep in mind. I’m not so sure that most investors would actually see the mystery fund in the article as the perfect investment. After all, it trailed the S&P 500 from the mid-1990s to the early 2000s and from around 2006 to 2008. How many investors would have the patience to stick with that long a period of underperformance?

Most of the rest of the time, it simply tracked the market with only a couple of brief periods of outperformance so I’m not sure how many people would have even invested in it in the first place without hearing Madoff’s sales pitch.

Underperformance doesn’t mean unsuccessful

If you define success as consistently beating the market, you’ll never be satisfied. (Even Warren Buffett, arguably the most successful investor in history, has had long periods of underperformance.) You’ll find yourself chasing past performance, buying what’s high and selling when it’s low, which is pretty much the opposite of what you want to try to do.

Instead, you want to pick an investment strategy that matches your time frame and personal comfort with risk. Then stick with it! When it comes to investing, the “perfect” can truly be the enemy of the good.

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5 Financial Rules That You May Need To Break

November 30, 2017

There are certain guidelines that we financial planners tell people to help keep them out of trouble. Most of the time, they’re right on. But there’s almost always an exception to the general rule. Here are some of those rules, why they usually make sense, and when they might not.

RULE: Pay your credit card balances off in full

Why it usually makes sense:

Not paying off your credit cards in full each month means that you’ll have to start paying interest to the credit companies at an average rate of 14%. That’s high, but you could be charged a lot more than that, especially if your credit isn’t too great.

Have you seen those calculations that show how the magic of compound interest can grow your savings over time? Well, when you have credit card debt, that same magic of compound interest is actually working against you. Pretty soon, you could find yourself paying more in interest than you spent on the original purchases. Some will even have to file for bankruptcy…and it all started with carrying that first balance.

Exceptions to the rule: 

There are two opposite situations that I can think of in which carrying a balance can make sense.

  1. If you have a very low rate and would be better off investing the money than paying down the balance. In this rare instance, your credit card debt actually becomes “good debt” like a mortgage or student loan. In fact, I wrote a whole post about how you can make money off zero rate credit card offers. However, that post actually came with a warning from our CEO because you have to be very disciplined to make sure that you save that money and that you keep track of when the low interest rate offer expires so you can pay it off beforehand.
  2. When you’re in such financial difficulty that you’re having trouble paying your mortgage or your car payment. In that case, make sure those bills are paid first because as much as you don’t want to pay interest or fall behind on credit card payments, you don’t want to lose your home or your car even more.

RULE: Aim to have 80% of your income in retirement

Why it usually makes sense: 

First, any target is better than none. In fact, our research shows that most employees aren’t confident they they’re on track to retire comfortably and have never even run a calculator to see how much they need to save. 80% is a good starting place because people tend to need less income when they retire since they won’t be saving for retirement or paying into Social Security and may have their have kids out of the home and their mortgage and other debts paid off.

Exceptions to the rule: 

The key word there was “tend.” Your situation may be different depending on the lifestyle you want to have in retirement and how your various expenses may change. For example, you may want to spend a lot more on travel while someone else may prefer to stay close to home and spend more time with the grand kids. Look at what debts will be paid off but don’t forget to add in the costs of retiree medical insurance and possibly long term care insurance. In short, some people will need a lot less than 80% and some will need a lot more.

RULE: Start contributing to your 401(k) as soon as possible

Why it usually makes sense: 

The earlier you start saving for retirement, the better off you’ll be. The longer you delay, the more you’ll have to save or the later you’ll have to retire. In other words, your future self won’t be very happy that you had other “priorities” with your money. Plus, if your employer offers you a match, you don’t want to leave that free money on the table.

Exceptions to the rule: 

There are three reasons why you might want to delay contributing to your 401(k).

  1. To focus on paying down high-interest debt. This is because high-interest debt can cost you more than you’re likely to earn in your 401(k). Just make sure that you make up those lost contributions once the debt is paid off.
  2. To build up an emergency fund. Your future emergency may not qualify you for a hardship withdrawal and even if you are eligible, you could be subject to a 10% tax penalty, so it’s best to have funds available outside your 401(k) to pay for things that come up. You might be able to borrow from your plan but only up to half of your balance, which may not be enough.
  3. To save for a home purchase. After all, owning a home could be part of your retirement plan too. Once again, just be sure to make up for those lost contributions after you throw that house warming party.

One final note is that you can save for emergencies or a home with a Roth IRA since the contributions can be withdrawn tax and penalty-free at any time for any reason and the earnings can also be withdrawn tax-free for a first-time home purchase as long as the account has been open at least 5 years. The advantage is that anything you don’t use can grow tax-free after age 59 ½ so you’re still saving for retirement too.

RULE: Don’t borrow from your 401(k)

Why it usually makes sense: 

Speaking of 401(k) plans, too often people use them like an ATM. Since the interest you pay just goes back into your account, it can seem like a cost-free loan. However, you’re missing all the earnings that your money would have earned if you hadn’t borrowed it. Meanwhile, the loan payments you’re making could have been additional contributions. If you leave your job for any reason, you may also have to pay the outstanding loan balance back within 60 days or it would be considered a taxable distribution and subject to a 10% penalty if you’re under age 59 ½.

Exceptions to the rule: 

I’ve seen situations where people have used their 401(k) to pay off high-interest debt and get themselves out of severe financial distress. That’s because there’s no credit check and low interest rates mean that the 401(k) loan payments could be a lot lower than the credit card bills.

The key is that this needs to be part of a long-term strategy to get and stay out of debt. The worst thing you can do is find yourself back in debt but with a much lower retirement account balance. Also, don’t raid your retirement account if you’re thinking of declaring bankruptcy since it’s a protected asset.

RULE: Don’t borrow from your home either

Why it usually makes sense: 

In short, you’re putting your home on the line. Lots of people did this during the housing boom, expecting to pay off their loans with rising property values, only to find themselves underwater and struggling to make the payments.

Exception to the rule: 

If you have a comfortable amount of home equity and you’re confident that you can afford the payments, a home equity loan can be a tax-deductible and low-interest alternative to more expensive sources of credit. Just be careful of variable rates and balloon payments that can make that loan not so affordable in the future.

As they say, rules were made to broken. But that doesn’t mean they should be broken lightly. If you’re unsure, talk to a qualified financial professional first. After all, you don’t want to learn the hard way why the rule was created in the first place.

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Should You Do A Balance Transfer?

November 16, 2017

A friend of mine recently asked me about doing a balance transfer, which is a common question I receive. After all, you may get offers in the mail for credit cards with rates that look quite enticing compared to what you’re currently paying. There are definitely some pros and cons, and here are a few other things to consider:

How’s your credit? Depending on your credit score, you may not qualify for the best deals or even any new credit at all. To make matters worse, if your application gets turned down, that will hurt your credit score even more. You can get a free credit score at sites like Credit Karma, Credit Sesame, NerdWallet, and Quizzle to see what balance transfer offers you might actually qualify for before applying. (keep in mind that those sites use their own formula and may not be exactly the same as the credit scoring system the credit card company uses)

What are the fees and how long does the balance transfer rate last? You want the interest savings to outweigh any fees you may have to pay to transfer your balance. Be aware that you may end up with a higher fee once the promotional rate ends. You may be able to find a better long term deal from peer-to-peer lending sites like Lending Club and Prosper.

Can you borrow from your 401(k)? If you can’t qualify for a new credit card or if the balance transfer rate is still higher than 4-6%, you may want to pay off your credit card debt with a 401(k) loan instead. There’s no credit check and you pay the interest back to yourself. But you should also be aware that there are potential downsides to this option as well.

Do you have equity in your home? Another option is using a home equity loan or line of credit to pay off your credit card debt. If you have a good credit, you can qualify for a pretty low rate that’s also tax-deductible. If you’re in the 25% tax bracket, a 4% loan would really be a 3%, which is much less than you can expect to earn by keeping your 401(k) money invested. The big downside is that you can lose your home if you default so this is not a good option if you might have trouble making payments.

Is this part of a strategy to pay down your debt? No matter which of the above options you choose, one of the biggest mistakes people make is to do a balance transfer or otherwise refinance their debt and then run the debt right back up on the old credit card. Make sure any balance transfers you do is part of a wider plan to pay down your balance faster rather than get deeper in debt. That starts with getting control over your spending so you’re living within your means. See some relatively painless ways to save money here and here.

Like with most financial questions, the answer to whether you should do a balance transfer is,“it depends.” Know the pros and cons of your different options. Regardless of your decision, make sure it’s an educated one.

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