Posted: January 9th, 2008 | Author: Joe | Filed under: Insurance, Retirement, Saving | No Comments »
“It behooves a man to make preparation for a suitable income in the days to come when he is no longer young and to make preparations for his family should he be no longer with them to comfort and support them.”
-Arkad, the Richest Man in Babylon.
Translation: Save for your retirement (don’t burden your loved ones or the rest of society) and get life insurance.
If you follow the 1st cure for a lean purse, and put that 10% of your savings into a high yield savings account (making use of the magic of compound interest), then you’re off to a good start, a solid financial foundation indeed. But high a yield savings account alone is not enough to build the wealth needed for your future income. To avoid the pitfall of inflation eating away your hard earned nest egg, you need to invest for growth while time is on your side.
The key principals here are:
- The time to plan for your retirement is now. Figure out how much you’ll need for retirement, by using a retirement savings calculator and set a plan to reach that figure. Make as much of it automatic as you can. This means using Direct Deposit of your paycheck as well as automatic contributions to 401k/IRA and savings accounts.
- Diversify. Diversify. Diversify. Stocks and Bonds. If you’re worried about picking the wrong stocks, think Index Funds and ETFs. With these flavors of tools and the many online brokers available today, it’s easier than you think!
Be sure to check out these resources about Asset Allocation:
Investing for Beginners: Asset Allocation
Beginners’ Guide to Asset Allocation, Diversification, and Rebalancing
“Provide against a lean purse in their mature years, for a lean purse to a man no longer able to earn or to a family without its head is a sore tragedy.”
This brings us to life insurance and disability insurance. There are a number of online search tools for getting agents to compete for your business, but I’m not going to link any in this post. The truth of the matter is, I haven’t used any of them so I don’t feel right recommending any. I do need to revisit my own policies however. I have one through my employer and one on my own so there’s probably some doubling up going on there.
Just some quick notes on life insurance in general:
- As the quote above suggests, the main purpose of life insurance is to replace your income should something unspeakable happen to you and you are no longer around to financially provide for your loved ones.
- Life insurance for children makes little (if any) sense, since they do not provide an income that would need to be replaced.
- Stay at home moms may not provide an income to be replaced, but they provide a very real and necessary service: caring for your children. If she’s no longer there to care for them, you’ll have to find someone who can or some way you can and either option means $$. So, keep that in mind too.
- Go with a term policy and not whole life or permanent. Term policies are for a set period of time (20 or 30 years) and only pay out in the event of the insured’s death; replacing their income. Whole life (or permanent) policies have an investing component to them, but many people feel that the fees and commissions only serve to build the agent’s wealth at the expense of your own. The thinking here is this: If life insurance is meant to replace your income, then don’t mix life insurance with investing for the future- invest that money on your own in low cost mutual funds (index or ETFs) and keep more of your money working for you, instead of an agent. Also, many times the investing portion of the policy is locked up in an annuity that carries surrender fees and penalties for early withdrawal, so investing on your own (or through a separate investment broker) gives you more control over where you put your money… and it is your money after all. The two big questions most people have about Life Insurance are: What kind should I buy, and How Much Coverage Do I Need? You can follow the links to read my thoughts on those questions.
As for disability insurance… it’s the one most people forget about. We tend to think about the BIG one, as it were, “What will happen to my loved ones if I die?” and we never think of the more mundane, and likely scenario of becoming injured or contracting a disease and being unable to work for a living. I’m fortunate enough to have a good plan through my employer, so I don’t have any experience with shopping around for this one.
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Posted: January 8th, 2008 | Author: Joe | Filed under: Real Estate | No Comments »
“I recommend that every man own the roof that sheltereth him and his.”
-Arkad, the Richest Man in Babylon.
Translation: Own your home and pay towards building equity for yourself instead of your landlord.
This is the 5th of the 7 cures for a lean purse as detailed in George S. Clason’s The Richest Man in Babylon.
Many times home ownership is touted as the only real choice when deciding rent or own your living quarters. But sometimes, it does make sense to rent instead of own. Usually for those who aren’t yet settled in any particular neighborhood, or who are job hoppers. But it also makes sense for retirees who’ve decided they either can’t keep up with the yard and house work, or who just plain don’t want to.
Still, for most people (especially families) who can afford the payments (mortgage, taxes, and interest) on their house with a 30 year fixed rate mortgage (or even better – a 15 year fixed rate mortgage) and who are planning to stay put for 5 years or more, the benefits far outweigh the downside.
So what are the pros and cons to home ownership?
Most people have heard of the financial benefits of home ownership. Things like: the mortgage interest and property taxes are deductible on your taxes, and that gains of up to 250k for individuals (500k for married couples) is tax-free (It used to be that it’d be tax-free only if you rolled the gains over to a new housing purchase within 2 years, but that restriction was lifted with the Taxpayer Relief Act of 1997 (certain restrictions still apply, such as having to be a primary residence for 2 of the last 5 years..)). This last one alone is HUGE for retirees who own their home outright.
Much has also been made of home equity loans, which is the ability to take out a loan on the appreciation of your home’s value, usually at a much lower rate than other loans. Home equity loans are also known as a 2nd mortgage, or home equity lines of credit.
But there are other intangible benefits to owning your own home as well as the financial. A 2006 USNews article highlights some of these benefits of home ownership. One of the items I found interesting was:
“The children of owners are more likely to graduate from high school than the children of renters. Owners’ daughters are also less likely to become teen mothers. Researchers are not sure why this is so, but Joseph Harkness, an associate research scientist at the Institute for Policy Studies at John Hopkins University, says one plausible reason is stability.”
This is not really surprising, but I never stopped to think about it. My wife and I did all of our relocating before our kids were born. Since then, we’ve stayed put. But I think it’s also more than just physical stability. I think there’s a large part of home ownership that’s representative of other facets of a person’s life. I think people who are home owners tend to have, on average, a better financial footing than renters. Partly because they had to get their finances in line to afford a home in the first place and partly because being a home owner typically forces you to pay more attention to things like utility bills, taxes, et cetera.
I know, some of you are jumping up and down with excited cries of, “But what about the sub-prime lender mess?! You can’t say that those homeowners had their finances in order!” That’s true, but it’s important to keep things in perspective. As of June, 2007, foreclosures in the United States were 1.28%. You read right. Less than 1 and a half percent of all outstanding residential mortgages. And mortgage delinquencies were less than %5. And many people who have adjustable rate mortgages have pursued mortgage refinancing. You can read about it here.
Another facet I found interesting was:
“It’s healthier. There is some evidence that homeowners report higher self-esteem and happiness than renters and even better physical health.”
This too makes sense. Home owners aren’t worried about the next rent hike, or if their landlord is ever going to get around to fixing the plumbing, or de-icing the walkway. Of course, home owners have other things to worry about such as: tax hikes and fixing their own plumbing.
But while they can be hassles, they can also be an empowering source of self-esteem and a gratifying sense of self-control and autonomy. In fact, in The Richest Man in Babylon, Arkad speaks of just such things as these intangibles like autonomy and self-esteem.
In summary:
Interest rates are still at historic lows but the recent run up in real estate makes it a lot harder to break into home ownership for those not already home owners. But I think that in the long run, if your life style is suited to being rooted in a specific neighborhood for more than 5 or 7 years and you can afford your monthly payments on a 30 year fixed rate mortgage, then you’ll be far better off than if you rented.
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Posted: January 6th, 2008 | Author: Joe | Filed under: Investing | 1 Comment »
“Misfortune loves a shining mark…. Every owner of gold is tempted by opportunities whereby it would seem that he could make large sums by its investment in most plausible projects.”
-Arkad, the Richest Man in Babylon.
Translation: Don’t take unnecessary financial risk or make foolish choices with your money.
This is the 4th of the 7 cures for a lean purse as detailed in George S. Clason’s The Richest Man in Babylon.
So what is “unnecessary risk”? What does “safety” really mean in regards to money? This section of the book stresses one of the “Sound principals of investment”. Namely: Security for thy principal – don’t put your principal at risk. This strikes me as too conservative in a general sense, so I would say:
“Don’t put your principal at risk for the possibility of astronomical (unreal) gains.”
I make this point because anyone who invests in the stock market, bonds, real estate or even a money market account is putting their principal at risk to some varying degree. A stock can become worthless. Bonds and real estate can lose value and you can be left owing more than you put in, and money markets can fold. I think a money market has only lost value 1 or 2 times in the past, so it’s a small risk to be sure, but a risk nonetheless.
That being said, I think it’s bang on regarding your emergency savings. That principal should not be put at risk. Stow it in a high yield savings account or bank CDs, both of which are FDIC insured.
“Study carefully before parting with thy treasure.”
Don’t invest your money in the latest fad, just because your friends or relatives tried to sell you on it at the weekend picnic. Do your research and due diligence and know what you’re investing in. What are the risks? Are there certain economic conditions that will favor the investment? Is there a business cycle to consider? Seek professional help or knowledge if needed. Or learn about index investing and diversify into the entire stock market.
“Be not mislead by thy own romantic desires to make wealth rapidly. Be not too confident of thine own wisdom. Consult the wisdom of those experienced in handling money for profit.”
If at first you have success, don’t get cocky! Arrogance will lead to financial ruin in a heartbeat if left unchecked. Bulls make money. Bears make money. Pigs get slaughtered.
In short, it’s OK to “play the market”, just don’t do it with your savings – use discretionary income.
In conclusion, proper risk management requires a financial risk assessment to find out how much risk you can handle. You either need to educate yourself about managing financial risk, find an expert whom you trust to do it for you, or put your portfolio on autopilot and become a passive investor using total stock market index funds.
Resources:
How much should you save?
General information on CDs (rates, how to ladder CDs, calculators, etc…)
Introduction to Index Investing
Title image © by Daniel Fahre
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Posted: January 4th, 2008 | Author: Joe | Filed under: Saving | No Comments »
“Put thy treasure to labor. Gold in a purse is gratifying to own and satisfieth a miserly soul but earns nothing.”
-Arkad, the Richest Man in Babylon.
Translation: Put your money to work for you in an interest bearing savings account or relatively safe investments. This is the 3rd of the 7 cures for a lean purse as detailed in George S. Clason’s The Richest Man in Babylon.
“The gold we retain from our earnings is but the start. The earnings it will make shall build our fortunes.”
Your savings alone will not make you wealthy. To build wealth, you need to put your money (savings) to work for you and earn more money. This is also known as the “miracle of compound interest.”
“A man’s fortune is not the coins in his purse, but the income he creates.”
True wealth is not money in the bank. It is a passive income stream that builds steadily. This can be achieved by a number of means.
Emergency savings should be put to work using the afore mentioned miracle of compounding interest, either through a high interest savings account like the ones offered by ING direct or HSBC, or by Certificates of Deposit (CDs).
After you’ve put your emergency savings to work, you should look to longer term horizons; retirement and long term wealth building. This is usually done through riskier vehicles such as stocks, bonds and real-estate. They are riskier, but generally offer higher returns, or yield, than “safer” vehicles. This is why you should never put your emergency money here, only money for long term goals goes here, because you’ll have time to recover from a dip in value.
The photo at the top ©Hector Landaeta.
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