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Financial Rules of Thumb Series – Is Saving 10% Enough?

[This post is part of the Financial Rules of Thumb series.  Check out the rest here!]

Saving 10% of your income is often tossed out as a solid rule of thumb.  Is it a good rule of thumb?

The Upperline: Generally solid advice, but you should run the numbers to see if you need to save more, or if you can afford to save less.

If you’ve started saving at a young age and are spending within your means, 10% may be enough.  Use one of the tools online or contact a fee-only financial planner to help you get some clarity on what it will take to retire the way you want to retire.  Liz Weston suggests what I think may be a better rule of thumb, which is “Save 10% for basics, 15% for comfort, 20% to escape.

Now, some common misconceptions about saving:

I’m saving 10% in my 401(k), so I’m on track.

Saving in your 401(k) or other retirement plan at work is a great step in securing your financial future.  My main concern here is that while having tax-deferred savings is great, you’ll want to have some savings that you can get your hands on before retirement, in an emergency fund or some other investments.  Things happen, and you’ll need to replace your air conditioner, or pay some medical bills at some point, and you can’t (strikethrough) probably don’t want to raid your retirement to pay for that.  Stay on track with your retirement savings, and start setting some money aside in your savings account for a rainy day.

I can’t save that much, so why bother?  I’ll just have to work forever anyway.

It’s natural for us as humans to see a goal that looks far too far away for us to reach, and we get discouraged.  Frustrated by what we feel is a lack of progress, we do nothing.  Even if you can only save 1% of your pay, that’s magnitudes better than 0%.  Then, take a few more steps towards your goal by:- Paying yourself when you pay off other debts.  Have a car loan that you’re close to paying off?  Set up an automatic transfer from your checking to savings once it is paid off, in the amount of the car loan.  You’re used to making that payment, now pay yourself and set that money aside for the future.  When you get raises, set up an automatic deposit into savings  for part of that raise.  Take some to spend and automatically save the balance for your future goals.

Remember – additional debt payments count as savings

If you’re paying off debts on an accelerated schedule, remember to count that money in your savings total.  It’s money that you were going to have to repay anyway, but you’re paying it off sooner than you needed to.  Pat yourself on the back and be sure to credit those extra payments towards your “savings” target.  Just be sure you only count the extra portion not the part you’d have to pay regularly.

(Big thanks to my friend @RussThornton of Wealthcare Capital for giving me a 2nd opinion on this piece)

Can the Eiffel Tower Help You Make Better Financial Decisions?

Our brains are really facinating.  We often feel like we’re in control, yet we can see ourselves making decisions that we know we will regret tomorrow.  Yet thinking about that regret, and knowing that it’s a bad decision still does almost nothing to change our behavior.

Eiffel Tower at Night

Eiffel Tower at Night - Karen Boudreaux - All Rights Reserved

Why is that?  Perhaps the problem is what we are focusing on.

A recent study by Deborah MacInnis ,the vice dean for research and strategy at USC gives us some insights on how what we focus on can help us act differently.  In the study, they placed subjects alone in a room, with a large piece of chocolate cake, utensils, and water.  (Why they didn’t use milk, I don’t know.  Maybe it would have made the cake even more irresistible.)    They told them to eat as much or as little as they wanted, but first they were told to focus on the pride they’d feel when they resisted the cake.  Another group was told to focus on the shame they would feel if they ate it, and the third group was given no instructions at all.

The results: those that focused on pride ate far less than those that focused on shame.  They also ate less than the control group.  Why might that be?

In the early stages of my relationships with clients, I often tell them “You can’t say no until you have a bigger yes.”  In this study, focusing on yourself and thinking about how good you’ll feel when you make the right decision led to better results.  In your financial life, you’ve got to say no to lots of small things every week in order to meet your goals.  Focusing on the thing you’re resisting just makes it harder.  If not going out to eat is what allows you to have money for that big vacation you’ve been dreaming about, it gets easier to do the right thing.

 Get detailed to make your vision even more compelling.  Traveling to Italy is a good goal, but traveling to Venice, Florence and Rome is better.  It’s easier for your brain to be motivated by specifics than generalities.  I encourage clients to clip photos from magazines, or browse and save some from sites like Picasa, Flickr, or other online photo services.  Looking at pictures of the Eiffel Tower can be a great motivator if Paris is your dream.  You’re not saying no to dinner, you’re saying yes to the adventure that you truly want to have.

Like the study suggests, don’t focus on resisting a great dinner out, focus on having an incredible experience, walking along the Seine, viewing the Eiffel Tower in the distance.  Small steps every week, focused on that long-term goal, will get you there.

What other tips could you recommend to those struggling to make better financial decisions?

6 Tips for Refinancing Your Home – Financial Rules of Thumb Series

[This post is part of the Financial Rules of Thumb series.  Check out the rest here!]

Rules of Thumb for refinancing your mortgage are hard to come by.  The one I’ve heard most often is “Refinance your home when interest rates have dropped by more than 1%”    Interest rates are still hanging around historic lows.  So should you refinance?

The Upperline:  A 1% drop is a good indication that it’s worth considering, but you’ve got to run the numbers, and make some assumptions.

To run the numbers, use any of the great calculators available on the internet (I like Bankrate.com’s Mortgage Refinancing Calculator) and input your information.  Don’t assume you’ll get the lowest rate possible, run the numbers assuming a higher rate.  If you get a lower rate, wonderful, but don’t count on it.

6 things to consider when looking at refinancing:

  1. Don’t fall for false comparisons.  If you’ve been in your home for 5 years, don’t compare your current mortgage to a new 30 year mortgage.  You’d be swapping the remaining 25 years of payments into a new 30 year payment plan.   Of course those payments would look smaller.  Don’t extend the time if you can at all help it.
  2. Can you qualify? Your situation may have changed since you got your original mortgage.  Some questions to consider:  Is your credit better or worse than you bought your home?  Has your income situation changed?   What about other debts?  All of these factors (and more) will determine if you can even qualify to refinance.
  3. Do you have more than 20% equity in your home?  Considering price drops around the country, how much equity do you really have?   It’s going to be hard to refinance at the best rates if you’re below that 20% number.  Do a bit of research before you pay for an appraisal on the refinance.  Tools like Zillow.com and Trulia.com can give you an estimate of the value of your home, or a trusted real estate agent can give you a ballpark figure.
  4. How much longer will you be in this home?  If it’s less than 5 years, you’d have to save a lot on the refinance to make the closing costs worthwhile.  (Zillow has a great Closing Cost Calculator to give you an estimate, including amounts from local service providers.)
  5. Don’t extend your mortgage to save money.  Although banks advertise rates on 30 and 15 year mortgages, chances are they’ll issue you an odd-year mortgage (for example, a 27 year mortgage, if you’ve been in your current mortgage for 3 years).  It’s worth asking.  Do whatever you can to not extend the number of years you’ll be paying.  If your bank won’t do this and you’d still like to refinance, take the lower payment and:
  6. Continue paying your current mortgage payment after refinancing.  If you can reduce your mortgage payment by refinancing and you’ve met the above criteria, add some extra debt-liquidation juice on top by making the mortgage payment you’re used to.  You’ll have some extra money going directly towards your principal every month that will help you eliminate that mortgage even sooner.

Are you considering refinancing your mortgage? Have any other tips to share?

Are Bonds Safe Investments? – Financial Rules of Thumb series

[This post is part of the Financial Rules of Thumb series.  Check out the rest here!]

“Bonds are safe”.  “You can’t lose money in bonds”.  These and other similar statements are often made about investing in Bonds, but are they true?  Are bonds safe investments?

The Upperline: You can lose money in bonds. They’re not without risk. They have different kinds of risks than stocks, that need to be understood if you’re going to invest in them.

The price of bonds can fluctute up and down. While the prices of bonds may not move as much or as often as stocks, they do still move.  This post explores some of the risks associated with bonds.  While not a list of every risk that bonds face, below are a few basics that should be understood by the general public.

Interest Rates. If I own a bond that is paying 5%, and a similar bond is issued that now pays 6%, who would buy my 5% bond?  Would you rather get paid 5% or 6%?  When interest rates go up, prices on existing bonds tend to go down so that the yield is similar to new bonds.  The opposite is true, too.  If interest rates go down, your existing bond paying a higher interest rate is probably worth more than you initially paid for it.

Default Risk.  When you buy a bond, you’re effectively lending money to a company or government, that they pay you interest on and ultimately they repay the principal to you with the final payment.  If a company (or government) goes bankrupt, they may not be able to repay that principal to you.  Ratings agencies like Fitch and Moody’s asses the risk of a company which then affects the interest rates the company must pay to borrow money (Think of this like a credit score.  If you have a good credit score, you might pay less on your mortgage than somebody with a poor credit score).  The risk right now as interest rates are low, is that some might be tempted to purchase bonds of a lower credit quality to get higher interest payments, when they’re not aware of the extra risk they’re taking.  Risk and return are eternally linked.

Duration.  If you were going to lend somebody money for 10 years, you’d probably want a higher return on your money than if you lent them money for 3 months.  Bonds work the same way.  Bonds that are longer carry higher interest rates, and might be attractive with yields on short-term bonds as low as they are.  The risk here is that we’re near historical lows in the bond market.  It’s at least likely that interest rates will start to rise at some point and longer-term bonds will be affected more than short term bonds.  If you own a bond mutual fund, a measure of portfolio length is “duration”.  The longer the duration, the more risk of price fluctuation inside of that portfolio.

I have add this last paragraph or my friends who are financial planners will lose their mind.  Just because the value of a bond goes up or down doesn’t mean you’ve lost money.  You don’t recognize that loss as long as you don’t sell.  It’s quite possible that you can hold a bond that is trading for less than its face value, and you hold it to maturity and get the entire principal back.  This is certainly true if you own bonds directly, but it’s not as straightforward with bond funds.  If you own a bond fund and interest rates start to rise, the values of the bonds may decline, causing others to sell their shares in the fund.  That fund then may need to sell some of its bonds at lower prices than they might otherwise hope to meet those distribution requests.  It’s not a certainty, but it’s a risk that must be understood.

Want to read more?  Here’s an extensive overview of other Bond Risks from CNNMoney.

Always Take the Match on Your 401(k)?

[This post is part of the Financial Rules of Thumb series.  Check out the rest here!]

The 401k match is incentive offered by many companies to encourage retirement savings by their employees.  During the latest financial downturn, some companies eliminated their match but they’re coming back as corporate earnings recover.  So should you participate in the 401k and take the match that is offered?

The Upperline: Unless you’re severely in debt or unable to meet your regular bills on a monthly basis, I can’t think of a reason why you wouldn’t want to take the 401k match.

I bet you’d probably like a raise, right?  Here’s the easiest one you’ll ever get.  Save in your company’s 401k, at least to the amount of the match.  Whatever they match is money that your employer is willing to pay you, but you’re just not claiming it.  This is as close to a no-brainer that I can think of when it comes to your money.  This money gets saved, for your benefit, with additional contributions from your employer, automatically from your paycheck, without you having to do anything.  What’s not to like?

When should you not take advantage of this?  

  • Overspending - If you’re spending more than you’re taking in every month leading to rising credit card balances, saving for your retirement isn’t going to do you any favors.  Don’t allow this to continue unchecked.  Get your spending under control so this doesn’t continue forever, and then you should start saving.
  • High interest credit card debt – This is a tough call. If you’ve got some high interest debt, I can understand delaying your savings to put additional funds towards eliminating that debt.  This requires discilpine and focus, so make sure that you’re actually putting those funds towards repaying the debt and not just spending it.
A few other questions I’ve heard from retirement plan particpants:

“I don’t know anything about investing so I’ll probably just make bad choices, so what does it matter?”

I’ve actually heard this statement in 401k enrollment meetings for company retirement plans.  There have never been more resources to help you with this decision, from abundant information online, resources from your plan sponsor, and from outside advisors.  We learn best by doing, and starting with your own money will give you incentive to learn.  Even if you make bad decisions, when you factor in the money from the match it’s tough to come out behind.  Who knows, something good might even happen, like being able to retire one day.

“I don’t think I’ll be at this job for very long, so it might not vest”  

I suppose that’s true.  However, the money you contribute is always your own and I’ve never heard anybody regret saving some of their own money.  Maybe you will get a new job and not leave with any of the employer match (each plan is unique with these rules, so talk to your HR team about what the specifics are at your company).  However, it’s harder to find new jobs in this economy.  For plans that use a vesting schedule, you often get a percentage at the end of your first year so even a short stretch can give your savings a boost.  If a few months stretches into a few years, you’re in the habit of saving as well as benefiting from more and more of your employer’s contributions.

What other questions do you have about 401k plans and matching?

Your Summer Vacation Budget – 6 Tips to Make the Most of It.

The summer vacation is a time-honored tradition for many families.  The summer Vacation Budget is a tougher subject.  We all look forward to a break and want to get the most out of our trip without breaking the bank.  Here are 6 tips to help you before, during, and after your vacation.

Anguilla Beach Panorama - Karen Boudreaux All Rights Reserved

1. Pay up front.   A study in the Journal of Consumer Research (April 2011 – Elizabeth Dunn, Daniel Gilbert & Timothy Wilson) shows that we are happier with purchases that we make up front, and then experience later.  If you can, pay for your hotel and other arrangements in advance (from your savings, not on credit!) and then go happily on your trip.  You’ll certainly have expenses while there, but having paid for the trip in advance keeps your account balances from taking a big hit all at once.

2.  Decide what’s important and spend your money on that. Our vacation budgets aren’t unlimited, so how can we make the most of our money?  Spend on what is most important to you.  If you’re a foodie, spend on dinners out and save on your hotel.  If walking around and taking pictures is important, spend on a hotel in a great neighborhood (and a great camera too), and save on meals out by going to the grocery story and making sandwiches in your room or otherwise eating cheaply.

While on your trip:

3. Don’t skip the extras.  It’s easy to think of what you’ve spent on the entire trip and stop yourself from spending another $10 or $20 on an experience. You’ll get more bang for your happiness buck if you make those small extra purchases. Plan and save for them in advance, but don’t skip those extras. Our Emotional Experiential Memory remembers these vacation expenses, often more fondly than everyday expenses.

4. Track what you’re spending.  Every penny. This isn’t to beat yourself up about your spending after the fact. Rather, it serves as a really effective trip journal (what was the name of that great restaurant?) and an important planning tool for your next trip. By getting a sense of how much you’re spending now, you’ll be better able to plan effectively for your next trips.

And when you get home:

5. Pay your travel bills off in full. Just like paying for experiences in advance, then enjoying them later boosts our happiness, having experiences and having to pay for them on our credit cards afterwards decreases our enjoyment. No matter how much fun that trip will be, you’ll beat yourself up about it if you’re stuck paying the bills on it for months afterwards.   Don’t let your summer vacation affect your fall household budget, pay for it now.

6. Go back through that trip journal, total everything up, and make some notes. You may not head back to the same place again, but your friends and family will. Having good notes to share (where to stay/not stay, eat, tips, etc) will make you a happy you wrote everything down. Revisiting those experiences while they’re fresh in your mind will help you cement those family memories for years to come as well. And, you’ll have a good idea of how much you (not some guideline) actually spends on vacation so you can plan and pay for (in advance) next summer’s trip.

Are there any tips you would add to my list of vacation budgeting ideas?

Emergency Fund – Is 3 Months of Expenses the Right Amount?

[This post is part of the Financial Rules of Thumb series.  Check out the rest here!]

I’m sure you’ve heard the term Emergency Fund in the financial media, but might not be certain what it means.  Here’s a quick definition, and then my take on the topic.

Definition: Emergency Fund – Money that you can get your hands on quickly in the event of an emergency.

The Upperline:  An Emergency Fund is one of the best things you can create, financially speaking.  It sets a solid financial foundation and protects you from using high-interest debt.  The question is, how much?

Your Emergency Fund can be in a savings account, money market, extra money in your checking account, whatever works for you. The important thing is that you have money available in case the transmission falls out of your car, the AC for your home goes out, or your home is temporarily damaged by a natural disaster. (But that probably won’t ever happen, right?)

If you don’t have money that you can access easily when bad things happen, you’ll have to

a) rely on friends/family/strangers

or

b) spend on credit cards or lines of credit.

If you’ve got these resources it’s not the end of the world if you rely on them in your time of need, but better for you if you can take care of the problem in advance by having sufficient cash. As I’ve said before, Cash is King not because it’s a great investment, but because it allows you to take advantage of opportunity or survive a small or large catastrophe.

“How much should I have in an emergency fund?”  That’s up to you. This has more to do with you and your comfort with risk than anything else. If you have a stable, steady income and prospects don’t seem to be changing, then 2 to 3 months of expenses might make sense. If you have an income that can fluctuate, own a business, or are generally more conservative, then having 6 months or more of expenses makes sense.

“It’s going to be hard to save that much money.”  Just because it’s hard doesn’t mean it isn’t the right thing to do.   Set aside what you can every month, and create a visual tracking aid (like the thermometer that United Way uses) to chart progress towards your goal.  Find a way to celebrate when you reach your goal.

If you don’t find a way to save small, regular amounts then you’ll never reach your goal without a big windfall of some kind.

But when that windfall comes, there’s another chance to do the right thing. Set aside some money for fun things, and use a big chunk to get closer to (or meet) your emergency fund goal.

With your emergency fund, you’ll have a resource that you can use, without high interest charges to pay for that new air conditioner.  Then, you can then repay yourself rather than your credit cards.

Buying vs Renting a Home? – Financial Rules of Thumb Series

[This post is part of the Financial Rules of Thumb series.  Check out the rest here!]

It’s not uncommon to hear statements like “Renting is throwing your money away” or “A home is your best investment” but are those statements true?  The decision of buying vs renting a home has many factors that should be explored.

The Upperline:  There are lots of reasons to rent rather than buy.  Buying can be a great deal, but only if you plan to stay in the home for quite a while.

Like most financial decisions, this one isn’t really about the money.  It’s more about personal preferences like:

  • How long do you plan to live in this home?  (If less than 5 years, it’s hard to overcome the initial costs of purchasing and early years of financing)
  • How do you feel about renting?  Do you feel like you’re wasting your money?  Do you feel like you need to be able to make permanent changes to the structure or yard?
  • How do you feel about borrowing a large sum of money?  How do you feel about debt in general?
  • Is stability, knowing that you’ll be in once place for a long stretch, important to you?

Now that you’ve checked in with your feelings, here’s a short list of factors you should weigh when considering buying vs renting a home:

  • Costs of buying and selling – There are several expenses that happen with most home sales and purchases.  There are Filing fees (with the banks and local governments), Real Estate Commissions, Title fees, Appraisal Fees, etc.  All of these costs take a bite out of the proceeds of the sale (or add on to the purchase price if you’re the buyer).
  • Financing costs – Most homes in the US are purchased with a traditional 30 year mortgage.  If we assume a $200,000 mortgage and a 5% interest rate, at the end of 5 years you would have paid just over $16,000 in principal and $48,000 in interest.
  • Taxes & Insurance – Typically, the cost of renting is lower than the cost of owning a similar home.  That’s partially due to insurance (renter’s insurance is less expensive than homeowner’s insurance) and property taxes.  Be sure you get a good estimate of the annual property tax bill you’ll need to pay in your new home, and account for that on a monthly basis.
  • Maintenance – This is the hidden cost of home ownership.  Cleaning the gutters, painting the house, and cutting the grass are just a few of the things you’re responsible for as a homeowner.  There’s a financial cost, as well as a time cost to taking care of these chores.
  • Lack of flexibility – This is another hidden cost of ownership.  Once you buy, you’re locked in, and your money is locked in.  Banks are requiring higher down payments than in recent years (which is probably a good thing) but that also means you’ll have to save a healthy sum, and then see that money get swapped for equity in your home limiting your access to it.

Home ownership can still be a great deal, but the math isn’t as clear these days as it has been in the past.  Be sure to have some good conversations about what your home means to you, run the numbers, and make the best decision you can.

I hope this is helpful!  Please let me know if you have any follow-up questions or tips for things I left out in the comments below.

Upperline Financial Planning – News for June 2011

June 2011 was  big month for Upperline!  I was featured in the Wall Street Journal, Journal of Financial Planning, and Financial Planning Magazine, among other places.  We had our strongest month in terms of new clients, and continued providing what I hope is useful content here, including the launch of our first series exploring Financial Rules of Thumb.
Upperline Financial Planning - Words Written June 2011

Upperline Financial Planning - Words in Blog Posts June 2011

Most Viewed Posts for June 2011

  1. Creating a Digital Trust Fund for your Child
  2. Joyful – A Father’s Day Reflection
  3. Financial Rules of Thumb – a Financial Planner’s Perspective – Series
  4. Upperline Financial Planning – Big News Week
  5. How Entrepreneurs can Actually Take a Vacation
  6. Why You Should Work with a Small Financial Planning Firm
  7. 6 Books for Recent College Graduates
  8. Five Years From Now, Five Years Ago. What Advice Would You Give Yourself?
  9. A Difference Between and Employee and an Entrepreneur
  10. 7 Financial Tips for Newlyweds

Financial Rules of Thumb – A Planner’s Perspective

Financial rules of thumb.  We all know several, and have based our decisions off of them for most of our financial lives.  But how much truth is behind the common wisdom?

This post will serve as a table of contents for this series as I write and publish the content for you.  View the list below, and please suggest other rules of thumb in the comments that you’d like to see addressed.  I’ll link each new post back to this one and write one post per week until the series is complete.  If you want to be sure you get all of them, please subscribe to my blog and you can get them as they’re published either by email or in your RSS reader.

One last note – I don’t agree with some most of these the way they’re written.  The problem with general advice is that as my friend Tim Maruer likes to say, “Personal finance is more personal than finance.”

Saving
Spending

Investing

Home Ownership

Retirement

Insurance

  • “Life insurance should equal 5 times your income (or 8 or 12 times)”

What other Financial Rules of Thumb should I address?  Please let me know in the comments!

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