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April 15, 2007, 7:36 am PDT
Financial Planning 101
What is your car; it's your lifeline. What's your home; it's
theplace you live? Lose it and your standard of living might go down in
ahurry. How do you protect your two most important assets; the key is
toplan.
1) Cars always have a limited life. You must always
count autodepreciation into your budget. $3,000 per year should either
go towardsrepairs, maintenance, or a new car. If after 6 years, you
have$14,000-18,000 and your car is still running well, keep it and
keepsaving; you will have what is called surplus income (a good start
forlong-term saving). However, if you drive your car whereby it wears
outand will run no more, you'll be prepared. We are driving longer
andlonger commutes; an hour commute each way would result in 150,000
milesat the end of 6 years. This is on top of the insurance, fuel,
andauto-financing (you wouldn't have to finance or lease your car if
youhad depreciated the last purchase in the first place). You should
alsobudget $2,000-5,000 for fuel for a small car, $3,000-7,500 for a
mediumsized car, and $6,000-$15,000 for an SUV depending on
distance.If you're falling short of that $3,000 saving mark per year,
you mayneed to get additional income from another job or have to reduce
yourexpenditures elsewhere. In other words, you must do everything you
canto come up with that $250 per month so that the next car you buy,
youdon't need to finance it. You can choose to finance it if its at a
lowenough interest rate (<5%) and that your investments can return
youmore than 5% after-tax. If you're in the 25% tax bracket and live in
CA(very high state income tax, lets say 9%), you'll need to earn 7.6%
onyour money just to achieve the 5% rate of return. Also, any
discountsyou lose as a result of taking the loan from the dealer must
be addedto the interest rate.
2) Expenses always occur when you
are least ready or you just have the"cash" necessary to pay the
expense. This is the individual who livespaycheck to paycheck. You can
avoid this by understanding what are yourfixed costs and your variable
costs. What do you really need to spendmoney on and what can you skimp
out of the budget? Again, using the$3,000 per year should help. Under
no circumstances should you take a payday loan or accept a loan from a
furniture store. If you do have one of those crazy loans, consider a
cash advance on a credit card as it will either lower your interest
rate from the triple digit interest rate of a payday loan or will delay
your interest as in the case of a furniture store contract. Make sure
to always pay it at least a month a day before it is due. Also, be sure
to write down the day that you bought the furniture as the store may
send you a false day hoping that you will be stuck paying the 21%
interest accrued for up to 3 years and thus end up paying double or
more for your furniture.
3) A RothIRA or Traditional 401k is the place to put your money.
I'm a financial planner and CPA eligible having taken a total of four
tax classes and one at the graduate level. In most cases, a
Traditional IRA or Roth 401k is not the best place to putyour money.
The Traditional IRA is only good if you don't have a workplace
retirement plan and if you're at least in the 25% federal taxbracket. A
RothIRA allows you to put in after-tax contributions and pull the money after-tax tax free.
If you lose your job, you can pullmoney out of the 401k at a 10% tax
penalty, but you benefited from thededuction. A Roth 401k, you don't
benefit from the deduction and youget taxed on your earnings percentage
no matter how much you liquidate.Thus, even if you moved from the 25%
tax bracket to the 33% taxbracket, it would be better to pay the 10%
penalty + Traditional 401ktax of 33% than the Roth 401k tax of 25% +
Earnings Percentage Roth401k tax of 33% and the 10% penalty (equivalent
to a 35% tax rate + 10%penalty)
.Use
a RothIRA to put your $3,000annually per year (if you want a $14,000
automobile). If you want a$30,000 automobile, you'll need to put away
$5,500 per year, $5,000 peryear($4,000 in 2007) in a Roth account and
$500 ($1,500 for 2007 in asavings account). All contributions can be
taken out tax free and ifyou are 55 or older, in 5 years you can
totally liquidate the Roth taxfree after 5 years. No matter what your
tax adviser says, don't open upan IRA; it only causes a current year
refund (you'll pay the taxthrough the behind or later in life).
Ideally, you will save 20% of your income or 75% of your disposable
income, whichever is more. If you cannot save the $3,000 per year, save
as much as you can as every dollar you save will make you less
dependent on auto loans in the future. In other words, you can choose
to have an auto loan because you can make a higher rate of return
investing the money after tax rather than being forced to take an auto
loan because you cannot afford the car. The bank/credit union/dealer
will prefer you (unless their a subprime lender) if you have the cash
to pay off the loan at anytime as you have less credit risk. However,
they're hoping that you'll continue to invest the money at a higher
interest rate so they can collect interest from you with minimal
default risk.
Some plausible investments to use in your Roth:
FSICX - Fidelity Strategic Income (put $200 per month for 11 months or put in $2,500 and withdraw $500).
FASIX - Fidelity Asset Manager 20% - the best conservative fund in its class
FGBLX - Fidelity Global Balanced Fund (very safe, loss of 8% during 2002)
FTHRX - Fidelity Intermediate Bond Fund - a great fund to choose
FTBFX - consider this investment as well
TIPS - a great 3 or 5 year investment vehicle to hold to maturity; these fluctuate with inflation
T-Bills
- provides 1 month, 3 month, and 6 month options in yourFidelity
brokerage account ($1,000 minimum investment; hold to maturityas a $20
fee applies for trading if you trade prior to maturity; atcurrent
rates, that's about a 4-month interest penalty).
VGSTX -
Vanguard Star Fund (low fees and only a $1,000 minimuminvestment) (use
Vanguard if you wish to switch investments, Scottradeif you wish to
keep it more than 3 years and have less than the minimumbalance to
avoid the $10 per year maintenance fee). Simply add themaintenance fee
as a percentage of the expense ratio.
VALIX - slightly higher risk than either FGBLX or VGSTX; very good fund family (use Scottrade)
PAXWX - great balanced fund with a $250 minimum investmetn (use Scottrade)
These
are more aggressiveinvestments; don't use these as part of your saving
for a new car afteronly a 6 year period. Because of market volatility,
these investmentsare designed for people with a minimum of 12-20 year
investment horizon.
VLEOX - applies only to money that you won't need for at least 20 years
VGTSX - applies only to money that you won't need for at least 15-20 years
VTMSX - applies only to money that you won't need for at least 15-20 years
FIGRX - applies only to money that you won't need for at least 15-20 years
FDVLX - applies only to money that you won't need for at least 10-12 years
FIVLX - applies only to money that you won't need for at least 10-12 years
4)Life
happens. Everyone here should have a prenup unless you won't
havesignificant assets until at least 5 years into your marriage
andneither individual has any outstanding debt (whether known or
unknown).You may have twins or multiple births or need to adopt a child
or gothrough fertility treatments that aren't covered by insurance and
aslush fund can make these goals become realities. We spend for
todayforgetting what our true goals are; the things we buy will not
bring us eternal happiness particularly if we never use them.
5) Never get a mortgage with a
prepayment penalty attached to it. And I repeat NEVER! I don't care how
low the interest rate is. It's a ripoff in that if you pay off your
loan to refinance or because you move, you might have to pay as much as
$10,000 just to cancel your loan. Also make sure that the loan has a
fixed interest rate, unless you have the proceeds to pay off the
mortgage in one swoop (not very likely).
6) If you're going to save your money out of a Roth, make sure that you
get the best deal; there's no excuse for not getting the best deal with
the Internet. Check out www.bankrate.com and www.cardweb.com
Cardweb.com gives you a credit card with a 7.25% and 7.9% interest
rate; these are great rates if you are really in a jam. Look out for up
to 3% balance transfer fees (as it takes three months at 18-21%
interest to make up for the fee).
7) You don't need a broker for advice; they have walk-in services at
Fidelity and TD Ameritrade. At most the fee would be around $600 (it's
worth it); they will provide objective advice on how to best create a
budget, invest in funds that best suit your needs, etc. $600-800 buys
you a year of unlimited financial advice. If you start early, this can
help build habits for a lifetime. More importantly, consider
sitting down with a NFCC (www.nfcc.org) counselor for free or a very
low fee ($15-$30 for example).
Fidelity and Vanguard are probably the best brokers in the world.
Vanguard's products are less expensive. If you're a teacher, demand
your HR office use TIAA Cref as these variable annuity products are
only about 0.5% in cost as opposed to the 5% per year that some annuity
products charge. Scottrade, Ameritrade (offering a savings promotion of
$100 if you save $50 or $100 per month for 12 consecutive months
without missing a month), ETrade, and T Rowe Price are some other
excellent considerations.
8) INGDirect is great for a checking account, not for investing. They
have large fees (up to and exceeding 2% of net assets). Emigrant and
HSBC Direct as well as many other players are great for a savings
account. INGDirect provides free bounce protection with a line of
credit of up to $250. That line of credit has a 12% interest rate
(about a .9% interest rate per month). That isn't too shabby when
you're in a pickle.
The key is to plan; planning allows you to handle situations better and
not go broke. It allows you not be scared about the future, but rather
to embrace it. Good luck to all.
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