Poorer Than You posed the question: Where to Stash Your Rainy Day Fund?
Pros: Interest rate usually meets or beats inflation, transfers to checking account, separation from checking decreases temptation to spend, no minimum balance requirement
Cons: Slow transfers may hinder urgent emergencies, limited by federal law to 6 transfers out of the account per month
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Personally, I’m using a credit card/online savings account combination right now. After I graduate from college and grow my emergency fund, I’ll move most of the fund to a money market savings account, and perhaps keep a couple hundred dollars in cash as well.
Here are my thoughts:
A money market fund is where I used to hold emergency funds, but things have changed. Money market funds are paying less than inflation (especially true inflation - which exceeds reported inflation). Right now high yield savings is where I have my emergency funds. You need to not only pick a good choice but pay attention to see if the marketplace shifts and certain options are not as appealing as before.
I would use a credit card for immediate spending needs and then paying the balance in full with funds from high yield savings. But right now high yield savings accounts pay more than money market funds, so just stay with high yield savings. If money market funds pay more in the future then I would put the emergency funds there.
Related: Personal Finance Basics: Health Insurance - personal finance tips
Foreclosure Filings Continue to Rise
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last week the Mortgage Bankers Association reported that about 2.47 percent of home mortgages were in foreclosure during the first quarter of the year, almost double the 1.28 percent rate of a year earlier, and the highest point since the group began compiling such figures in 1979. A Credit Suisse report this spring predicted that 6.5 million loans will fall into foreclosure over the next five years, reaching more than 8 percent of all U.S. homes.
There numbers really are astounding. How lame were the decisions of banks and mortgagees that nearly 1 in 40 mortgages are in default (and that number likely increasing in the next year to much more?
Related: Homes Entering Foreclosure at Record (Sep 2007) - Homes Entering Foreclosure at Record - Ignorance of Many Mortgage Holders
Graduates should put off living large after college
The key, experts say, is a simple one: Live like a poor college student for a couple more years. While you’re doing that, you can pay off your debt, start a savings plan and embrace healthy habits that will serve you well for life.
This is exactly what I did. Outside of paying for college, extra living expenses in college were small. Just retaining the spending habit of college gets your personal finances off on a good start.
Patty Procrastinator lives a little better when she first gets out of college and doesn’t start saving in the 401(k) until she’s 32. From that point, she also saves $500 a month, her employer adds $250 a month, and she earns a 9% return — just like Sallie. But at age 65, Patty will have only $1.7 million. That decade of delay will cost Patty $2.4 million.
Incidentally, Sallie contributes from her own money just $60,000 more than Patty does. The rest of the difference comes from employer contributions and investment returns.
By immediately starting to save for retirement and other needs you create a great foundation for your finances. Start saving for a house, a new car, create an emergency fund… Then you can create a situation where the only loans you need to take are for a house and maybe a new car - avoiding credit card debt or other personal loans.
Related: Personal Finance Basics: Health Insurance - Initial Retirement Account Allocations - Why Americans Are Going Broke
Half of Gen X Doesn’t Expect to Retire
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“They are earning money and paying into Social Security and yet they fear they may never see the payback,” said Moloney. “They feel they deserve it, but it looks like a financial black hole to them right now.”
The government certainly is failing to pay for future obligations today instead choosing to raise taxes on the future. But Social Security itself is actually in better shape than most think. We really do need to move out the benefit payment date (when it began projected life expectancy was almost the same as the date payments would start - which would mean moving the retirement date more than 15 years later, I believe). Going that far is not needed but it should be moved back. But really social security is in good shape for 30 years or more. First, it isn’t going to go from good shape to failed in a day. And second, they will make adjustments as they have in the past to make it work (the adjustment they made in the last 15 years helped a great deal so now they can just add some additional delays in when it starts paying out… and extend the good condition of Social Security without too much trouble).
Medicare is the huge problem. The country either needs to stop paying an extra 50-80% for health care than other countries do (and thus reduce the cost of Medicare liabilities) or massively cut benefits or massively increase taxes. Likely a combination of all 3.
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Lazy Portfolios update by Paul Farrell provides some examples of how to use index funds to manage your investments:
I think the article is a bit misleading in showing the out-performance of the S&P 500 index (during periods where the S&P 500 index does very well these portfolios will under-perform it). The out-performance shown in the article is largely due to the great performance of international markets recently. Still the strategy is well worth reading about. The strategy is based on using index funds from Vanguard (very well run mutual funds with very low fees). But don’t get tied into Vanguard, if they start to focus on lining their pockets by increasing your fees look for alternatives.
Overall, I give this concept high marks. Dollar cost average appropriate levels of money into such a strategy and you will give yourself a good chance at positive results.
My preference would be to include significant levels of international and developing stocks. For aggressive long term investing I like something like:
40% USA total stock market
15% Real Estate
25% international developed stock market index
20% developing stock market index
When aiming for more security and preserving capital (over growth) I favor something like:
30% USA total stock market
10% Real Estate
25% international developed stock market index
10% developing stock market index
10% short term bond index
15% money market
Of course all sorts of personal financial factors need to be considered for any specific person’s allocations.
Related: Allocating Retirement Account Assets - Why Investing is Safer Overseas - Saving for Retirement - 12 stocks for 10 years - what is a mutual fund?
What Should You Do With a Check Out of the Blue?
The USA government is sending out checks to taxpayers in an effort to encourage spending which in turn will provide stimulus to the economy in the very short term. First, this is bad policy in my opinion. Second, if you support this policy the precondition is you run surpluses in order to pay for it when you want to carry out such a policy. They have not, instead they have run huge deficits. What they have chosen to do is spend huge amounts and have the taxes paid by the children and grandchildren of those the politicians are spending the money on today. I would support Keynesian government spending in a serious recession or depression - just not for a country already with enormous debts and in a very mild recession.
But ok, so the government chooses to spend your children’s taxes foolishly, what should you do now? This is very easy. Whatever is the wisest move for your personal financial situation for any windfall you receive, regardless of the source of that windfall. If all your savings needs are met there is nothing wrong with buying some toy. But most people need to pay off debt, build an emergency fund, save for retirement or something similar not get another toy. Of course would be nothing wrong with donating it Kiva, Trickle Up, the Concord Coalition or your favorite charity.
The politicians are acting like a 5 year old that wants a new toy. I can too get the new toy now :-O, Mommy you can use your credit card. So what if you already bought me so many toys you couldn’t afford by using your other credit cards and they won’t lend you any more money. Just get another one. Similar to how congress recently yet again increased the allowable federal debt limit to over $9,000,000,000,000.
The stimulus effect of spending is that if you actually purchase a new toy (say a TV), then the store needs to replace that TV so the factory makes another TV… The store, shipper, factory, supplier to the factory all pay staff to carry this out, those staff can buy new books, dishwasher… and the business may buy a new forklift or computer to keep up…
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So lets say you have a 401(k) and are adding to it regularly, you own your house, you have no credit card debts, you are paying off your car loan and overall your financial house is in fairly good order. Still you keep hearing the news about credit crisis, mortgage meltdown, dollar depreciation… It is enough to make you nervous but what should you do?
Frankly very little in the macro economy has much impact on what is a smart long term strategy. Should you move your retirement money into a money market fund, because of the risks of stocks now? No. If you are good enough to time the market you are already amazingly rich (or will be soon). But either no one is able to do this or next to no one is. Occasionally you might get lucky and time things right but being able to consistently do so over 40 years is just not something that happens.
So what you should do now is what you should always do. Have cash savings. Pay off your mortgage (don’t over-leverage yourself - don’t take out equity just because you have some). Save for retirement. Have health insurance. Don’t take on credit card debt (or most other debt). Keep up your employment skills (learn new skills…). Diversify your investments (stocks, international stocks, real estate, cash…).
People often get careless when the overall economy is good. And so maybe you failed to do what you should have been doing then. But the right thing to do today is essentially the right thing to do always. For example, Americans are drowning in debt. They were also drowning in debt 3 years ago. That problem is the same. If you have too much debt you should fix that. Not because of all the fear today, but because to much debt is always bad. You should not take out too much debt in the first place and if you have to much you should fix it whether the economy is strong or weak.
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Some people think all financial info is boring. I actually find a good deal of it interesting but this tip is pretty boring. Building a cash safety net is an important part of your personal finances. We have explained previously the very simple idea that you don’t buy what you can’t pay for. If you can’t pay for it this month, don’t buy it.
But that leaves out one thing. Even if you do have the cash you should be building up a cash reserve before buying luxuries. The typical advice is to build up 6 months of expenses in cash (rent or mortgage, food bills, utilities, health care, etc.). Now actually building up to that level can take awhile and forgoing all non-mandatory expenses until you have that saved is not usually reasonable. But as part of your personal finances building up an cash reserve is important (even if it is boring).
A significant portion of downward spirals in personal finances are started when people have emergency expenses and have to borrow that money (since they don’t have cash reserves). If you are over say 26 and don’t have a cash reserve yet saving for it should be part of your monthly budget. How quickly you build that up is a personal decision but I would say a 1% of the target amount (so if you are aiming for a cash reserve of $20,000 then $200/month).
If your finances don’t allow that, then do what you can. But realize that is one of the weaknesses in your personal finances and try to fix that as soon as possible.
Very important personal financial allocations for you to put first include: current needs (food, car payment, rent/mortgage, utilities…), insurance, creating a cash reserve, retirement savings, saving for future purchases. Then there are luxuries and treats, such as: eating out, vacations, cable TV… Many people put current needs, luxuries and treats fist and then say they don’t have the ability to do what is responsible. That is not often true for those that actually have an internet connection to read this blog.
Related: Buy less stuff - Saving for Retirement - How to Use Your Credit Card Responsibly - Trying to Keep up with the Jones
Great advice from Warren Buffett. He spoke to students at UTexas at Austin business school and one of the students, Dang Le, posted notes of the discussion online. The internet is great.
On diversification:
Great advice. Warren Buffett uses great concentration (little diversification) but you are not Warren Buffett.
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Getting turned down by HBS [Harvard Business School] was one of the best things that could have happened to me, bad luck can turn out to be good.
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We did an informal office survey by looking at the total tax footprint versus the total income. I earned 46 million and paid a tax rate of 17.5%. My rate was the lowest, the average was 33%, and my cleaning lady paid 40%. The system is tilted towards the rich. The Forbes 400 total net worth has gone from 220 billion to 1.54 trillion, an increase of 7-to-1. You see in legislature that there is lobbying carried on by the powerful over issues such as the estate tax and carried interest for private equity investments. We need to flatten income and payroll taxes, and those making under $30,000 shouldn’t be bothered.
It is hard to beat reading Warren Buffet’s ideas on investing and economics.
Related: Buffett on Taxes - The Berkshire Hathaway Meeting 2007 - Buffett’s 2006 Letter to Shareholders - Warren Buffett’s 2004 Annual Report - books on investing
The title of a recent article asks: Are you a sucker to invest in a 401(k)? The answer is an emphatic: No.
But what if instead you had bought that tax-efficient stock fund outside your plan? Wouldn’t your tax bill be lower? Yes, but that’s the wrong way to look at it. If you skip your 401(k) in favor of a taxable account, you must first shell out taxes on that $10,000, which leaves you with just $7,200 to invest (assuming the same 28% bracket).
Plus, over the next 20 years, you’ll have taxes on any dividends and gains the fund pays out. Even though you will get a lower 15% rate on your gains when you sell, you end up with $28,950, or about $4,600 less than with the 401(k). A tinier final tax bill can’t make up for having to pay taxes all along.
This is a very good short simple personal finance article. It explains an issue that might be tricky for some to understand. Those that read it can learn more about personal finance. And it has several points - some of which, I can imagine, might be hard for some to understand. But it does a good job of explaining things simply. And a few points, made well in the article, are often overlooked or under-appreciated:
tax rates will go up - we are passing higher taxes onto the future by not paying our bills now
the tax deferral is a huge benefit - often minimized when people discuss the benefits of IRAs
401(k) employer matches are another huge benefit
As I have said before, learning about personal finance is a long term effort. If you don’t understand everything in an article that is fine, over the years you want to learn more and more. Hopefully this is a useful step on that journey.
Related:
Roth IRAs a Smart bet for Younger Set - Saving for Retirement