Money Talk: Gary Williams on Finance

Can’t Make a Budget Work? Try Filling Your Buckets

2008-09-04T20:37:00.002-05:00

Whether you are trying to save money or lose weight, there is no one-size-fits-all solution. However, as with dieting, sometimes the financial strategies that work the best are a little bit offbeat, even fun. Consider, for example, the success of Bank of America’s “Keep the Change” program where your debit card purchases are rounded up to the closest dollar and the difference is transferred from your checking to your savings account. Another savings strategy found to be effective is the “bucket concept.” Rather than adhere to the traditional budgeting chore of writing down your expenses and tracking them each month, the bucket concept requires you to divide your spending into six categories and assign a specific percentage to each bucket.

The bucket approach was first encountered in Secrets of the Millionaire Mind: Mastering the Inner Game of Wealth by T. Harv Eker. In his book, a New York Times bestseller, Eker suggests dividing your income this way:

• 50% for necessities such as your mortgage or rent payment, car payments, groceries, utilities, gas, internet, cell phone, etc.

• 10% for long-term savings to fund vacations, car repairs, house maintenance, clothes, etc.

• 10% for retirement accounts such as your 401(k) plan or IRAs.

• 10% for fun.

• 10% for education, from repaying student loans or funding your continuing personal development to saving for your children’s college education.

• 10% for charity.

When making your allocations to each bucket, consider 100% of your total after-tax income. This means that, in addition to income you earn, you also divide inheritances, bonuses, even your tax refund into six categories. Eker’s key is that this money should never be commingled. That is, you cannot borrow from long-term savings to fund a dinner out or forgo your regular deposit into the education bucket when your charity bucket is empty and you want to contribute $100 to your friend’s bike-a-thon.

The easiest way to fund each bucket would be to open separate checking accounts and have the appropriate percentage of your paycheck deposited into each account. This may not be feasible with your employer and could involve significant banking fees. Of course, you can open a 529 college savings plan and an IRA and have your education and retirement accounts funded directly from your checking account. Also, if you have a 401(k) at work, that account is funded automatically before you receive your check.

Interestingly, however, many people report success with substituting jars for checking accounts, particularly for the fun account where it is easy to spend cash. Perhaps that’s because by actually placing money in a jar it encourages them to think about finance more often than at bill-paying time or during an annual review with a financial advisor. Using a jar also can be especially effective if you are trying to save for a family vacation. For example, as your family sees the savings accumulate, they may be more inclined to make sacrifices to stay within your food budget. Of course, if you’d rather keep your long-term savings in a money market account to earn interest, putting a piece of paper noting the amount you invested in that account could also serve to motivate your family.

In discussing the bucket concept with clients, there are some common reactions. Most notably, many say that they spend far more than 50% of their income on necessities. In fact, given the high cost of living in particular parts of the country, surviving on half of what you make may be an impossible goal. Naturally, you can adjust Eker’s percentages to reflect your own circumstances. For example, if you need 65% for necessities, you might drop education, charity, and long-term savings to 5%. However, you are encouraged to at least reflect on the possibility of living on 50% of your income. Often, simply considering the idea can help you start to prioritize your expenses and to think more proactively about what you are spending your money on each month. In fact, quite a few clients have come to the realization that they were living in a house that was too expensive for them.

Debt is another issue that can throw a wrench into Eker’s ideal percentages. If you have significant consumer debt, you may need to direct more than 50% to your necessities bucket in order to help you dig out of that hole as soon as possible. However, once you are out of debt, funding your long-term savings account can help you stay debt-free. That is, as your long-term savings account builds up over time, you’ll have a cushion so that you won’t have to pull out your plastic to manage an unexpected car or home repair bill. In that sense, your long-term savings can also function as the traditional “emergency account.”

Finally, Eker insists that your fun money be spent on a regular basis. Arguing that most budget plans fail because they create a spending plan that is too tight for comfort, Eker stipulates that fun money cannot accumulate for more than 90 days. Think of spending money on yourself as both a reward for saving in other buckets and as a means of re-energizing yourself to save more.

If you are considering implementing the bucket theory, it is suggested you keep in mind another piece of advice from T. Harv Eker. He believes that what we focus on expands and grows. Accordingly, he suggests that for at least seven days after implementing any financial self-improvement plan, you do absolutely no complaining – not out loud, not in a whisper, not even in a passing thought. The positive energy you create – in combination with the structurally sound bucket approach to budgeting – may be just what you need to move further down the road to financial freedom.

What to Consider When Shopping for an Advisor

2008-08-01T17:45:00.002-05:00

How do you find the right financial advisor for you?

With seemingly endless market volatility, more people are looking for a first or a replacement financial advisor. Here are a few questions you should ask a potential advisor to determine if he or she is the right fit for you.

1. "How much experience do you have?"
Seek help from someone who has at least five years experience in the business, preferably much more.

2. "How many clients do you have?"
You should know if you’d be one of 50 or 500 clients.

3. "What services do you provide?"
Is the advisor’s practice limited to investment management? Or, can he or she provide estate, cash flow planning, retirement, or other important services?

4. "What distinguishes you from other advisors?"
The answer can provide insight into the advisor’s strengths, priorities, and values.

5. "Have you had any complaints lodged or disciplinary action taken against you?"
You should confirm this by checking the web sites of the Financial Industry Regulatory Authority, the Central Registration Depository, the Department of Banking, or the Securities and Exchange Commission.

6. "Can you provide the names of three clients who left you in the last five years?"
Any advisor can find satisfied clients for references. You can learn more from those who left the firm. Every advisor has some turnover. If the clients left because of extenuating circumstances, but were satisfied with the service, you are probably on to a good advisor.

7. "What was your biggest mistake in the last five years?"
Be wary of the advisor who says he or she did not make any. We all make mistakes. Admitting to them is one mark of an honest advisor.

8. "How do you get paid?"
Advisors can get paid through commissions or fees. In the latter case, the advisor charges a percentage of assets under management and/or an hourly or flat fee for time. Be comfortable with the way your advisor is paid.

9. "Do you use proprietary products?"
An advisor who works for a company that offers its own investment products may receive a financial incentive to use them. This may influence his or her choice of investments in which to put your money.

10. "What are your professional credentials?"
Anyone can call him or herself a financial advisor. Look for one who has completed a national education program in financial planning and earned credentials such as CERTIFIED FINANCIAL PLANNER™ professional, Personal Financial Specialist (PFS), Chartered Financial Consultant (ChFC), or Chartered Financial Analyst (CFA). In addition to passing a standardized exam, such individuals are required to maintain their status with continuing education courses.

Bogus designations, especially those geared toward seniors, are a red flag.

11. "How do you educate clients?"
Does the advisor provide educational workshops or conference calls to their clients? What book would he or she recommend for learning about finances?

12. Does the advisor articulate a clear investment and wealth-building philosophy?
You need to match up. By understanding your advisor’s beliefs, you can determine if you are compatible. Also, ask, "How do you determine the level of risk in a portfolio? How often do you rebalance the portfolio and using what criteria?"

These questions are just a guide. Asking them will help improve your chances of finding the right advisor for you.

Don’t Let the Declining U.S. Dollar Ruin Your European Vacation

2008-07-08T10:57:00.001-05:00

It’s not a happy story. Between 2002 and 2007, the dollar fell 33.4% against the euro, an average of 6.7% per year. While the large and increasing deficits in the U.S. trade balance are at the root of the long decline, the instability caused this year by the subprime mortgage crisis has hastened the greenback’s plunge. Since the beginning of the year, the value of the dollar already has eroded 7% against the euro which rose above $1.60 in mid April 2008 for the first time ever. Seemingly, the dollar is losing its appeal across the world. For the first time in more than a decade, in mid-April the dollar bought less than 7 yuan, ending the day close to 6.992 yuan.

Surprisingly, however, according to travel agents and industry analysts, the dollar’s steady decline isn’t keeping American vacationers at home. In fact, there’s been an increase in international travel, even to Europe where a cup of coffee can cost nearly ten dollars, making your copy of Europe on $5 a Day look like a real antique. According to a recent New York Times article, 13.25 million Americans visited Europe in 2007, a 2.7% increase over 2006. Looking ahead, industry analysts expect that number will at least remain flat, and perhaps increase slightly through 2008. Travelers are, however, making some changes in their vacation plans. For instance, the number of American visitors to the less expensive Portugal increased 20% in 2007.

If you planned your dream European vacation trip a year ago and are getting nervous about the trip’s rising cost, there are ways to economize so that the unfavorable exchange rate doesn’t ruin your vacation – or put you in major debt upon your return.

• Consider tour packages. Although you would think that having someone else do the legwork and organize your trip would be more expensive than doing the planning on your own, the reverse is true. In fact, packages can easily trim 25% or more off the cost of hotels and airfares. Cruises also can be a surprisingly affordable alternative.

• Avoid downtown hotels. Sure, it’s great to stay in the center of town, but all that convenience can mean a big price tag. Industry experts say hotels away from the tourist centers are usually 15% to 40% cheaper and, because most major European cites offer excellent, affordable public transportation, you won’t compromise your ability to reach the major tourist attractions. Another tip: Choose hotels that quote and guarantee rates in U.S. dollars so there are no surprises when your credit card statement arrives. Renting an apartment or house often gives you more space for less money and having kitchen facilities means you can cook for yourself rather than blowing your budget in overpriced restaurants.

• Use your boots for walking. You can best experience the real flavor of a city on foot. If you do need to travel beyond a city’s network of trains and local buses, rent a car for only as long as you need it rather than for your entire stay. If you plan extensive travel, a Eurail pass may save you money. Also, remember an overnight train ride can save you the cost of a night’s lodging.

• Score on free and discounted entertainment. Many European museums offer free admission on certain days or nights of the week or at certain times of the month. This is especially true for students. Check ahead and schedule your visit accordingly. Also, most major cities offer special cards that include combination discounts for multiple museums and local attractions.

• Go shopping – at the grocery store. Stock up on bottled water and snacks at grocery stores and carry your supplies with you each day rather than falling prey to the tourist traps. Also, if you make lunch your big meal of the day, you can enjoy expensive dinner dishes for half the price. Avoid restaurants that post tourist-friendly English menus and discover places frequented by the locals.

• Manage your money. Bank ATMs are your best bet for a combination of a fair exchange rate and low surcharges and fees. At a bank ATM, your bank likely will charge a transaction fee of 1% to 2%, but you’ll also get the favorable interbank exchange rate rather than the higher rates you’ll find at foreign exchange bureaus. If you must use a currency exchange counter, stay clear of airport or train station kiosks where you are almost guaranteed to get the worst rate available and highest transaction fees. If you plan on swiping your plastic through Europe, keep in mind that although credit card companies generally utilize favorable exchange rates, they sometimes charge fees for purchases made in foreign currencies, usually 1% to 2%. Before you travel, check with your credit card companies to figure out which card has the lowest fees for foreign purchases.

If you are just beginning to plan a European vacation, visit www.XE.com, a popular currency and foreign exchange site with an easy-to-understand tool for determining value. Additionally, the site offers an online tool that tracks historical rates and a travel expenses calculator to help you plan your budget. If you don’t like the numbers you see on the site, remember there are alternatives, even bargain destinations. For example, in the February 2008 issue of Condé Nast’s Traveler, Debra A. Klein’s “Dollar Power,” lists a number of exotic destinations where the U.S. dollar is holding its own. For example, she notes that many Caribbean islands either have their currency pegged to the greenback or accept U.S. dollars as currency. Some of these islands are Antigua; Grenada; St. Kitts and Nevis; St. Lucia; St. Vincent; and the Grenadines. Also, although the currencies of Argentina, Brazil, and Chile are strengthening significantly against the dollar, she urges vacationers to consider the region’s “emerging destinations.” Writes Klein, “Suriname has untrammeled forests, turtle nesting areas, and an economy with a de facto dollar peg. Even closer to home, Belize and Panama, where the currencies are linked to the U.S. dollar, are among the continent's most affordable destinations. Costa Rica's pristine beaches and verdant rain forests seem all the lovelier now that your dollar buys 33% more this year than it did in 2002.”

A final few words of advice: If you’re preparing for your vacation by learning some of the local language, add “Can I get a better price?” to your lexicon. Lastly, remember that your vacation goal is to enjoy some well-deserved rest and relaxation, not to drive yourself crazy working to get the best price on everything.

Don’t Let Your Emotions Cloud Investment Judgment

2008-06-04T07:42:00.002-05:00

Ah … the good old days when an investor would pay anything for a pre-construction condo in Boca Raton. Why? When finished, the condo would presumably be worth a quarter of a million dollars more and you’d carry it with borrowed money.

Wrong, in most cases. This has been a painful lesson for many people.

One of the more common behavioral mistakes that investors make involves euphoria. Nick Murray, author of Simple Wealth, Inevitable Wealth, says this is more than greed – people get completely blissed out and lose all sense of danger.

A definition of risk is the chance that an investment will lose value. When you reach out for higher and higher returns because someone else is getting them – and you forget that higher returns mean taking more risk – you have entered the euphoria zone. You have been blinded to the fact that risk rises along with price.

According to Murray, panic (another behavioral mistake) follows, and sometimes accompanies, the euphoria stage. The higher the euphoria, the deeper the panic or capitulation. When prices start to fall, you lose composure and believe your investment price will never come back. You have to get out at any price.

If panic overtakes you, you’ll need to make two decisions:

• First, you must decide when to sell.

• Second, you must decide when to get back into the market.

Your odds of being right on both decisions are very low.

We make other behavioral mistakes as well, says Murray. They include:

• Under-diversification – This involves the often costly narrowing of a portfolio to essentially one idea. This can be a sector (example, technology stocks) or a company. If you worked for Bear Stearns and invested the majority of your assets in the company stock, you found out the hard way of under-diversification.

"When you own one idea, all the lights go out and … pretty quickly," says Murray.

• Over-diversification – This is when you dilute your investment value by trying to own everything. The root of this mistake is the inability to make choices. The solution is to focus a portfolio with a finite number of meaningful investments.

• Making portfolio decisions based on your cost basis – This means you let your cost basis dictate an investment decision just to avoid paying capital gains taxes. This is seldom prudent. When you let taxes drive the decision, you are bound to crash.

• Investing for yield instead of total return – This is the great behavioral mistake of the American retiree. Many go into retirement mistaking current yield as the only source of income. They end up buying a lot of bonds and not a lot of equities. The recent volatility in the bond market has surprised many investors.

Today, when we go to the gas pump or grocery store, we know costs are rising. According to Morningstar, the compounded annual return (after taxes and inflation) from 1929 to 2007 for large stocks was 5%; for long-term government bonds, 0.4%; and for 30-day Treasury bills, -0.7%.

The great long-term financial risk isn’t loss of principal, but erosion of purchasing power. Many of us greatly overestimate the long-term risk of owning stocks, and more insidiously, underestimate the long-term risk of not owning stocks.

The New Place to Spend Retirement: At Work

2008-05-14T09:16:00.001-05:00

Despite the enduring image that marketers portray of retirees lounging on the beach, the reality is that a greater number of older workers are in the labor force than ever before.

According to the Employee Benefit Research Institute, 45 percent of people age 55 and older are still in the workforce. Twenty-nine percent of people ages 65–69 are still working as well.

Americans of retirement age opt to stay in the working world for many reasons, including to transition their career to part-time, to make extra money, or to start their own companies. Many of us are also living longer and taking better care of ourselves, and we don’t feel like slowing down. In today’s world, retirement can last 20 years or more, so we want something meaningful to do to fill that time.

Some people, however, may not find working into their retirement years a matter of choice. They may need to keep working to add to their savings, keep their insurance coverage, or attain their full retirement age to receive their full social security benefits.

Employers may also find it necessary to hang on to their older workers. Nearly 80 million baby boomers are facing retirement, yet there are only about 50 million Gen-Xers to fill those places in the workforce. Companies are discovering that they need to keep their experienced workers as long as possible and are more amenable to part-time, consultative, or job-sharing arrangements to retain skilled workers.

Regardless of the reasons you may continue working, there are several financial implications you should consider:

You can make more money. According to the Congressional Budget Office, each year that a person of at least age 62 postpones retirement, he or she reduces the need to increase his or her retirement savings by about 5 percent. It also gives that individual more time to earn interest on assets he or she has already accumulated. And getting health coverage, even if an employer only partially subsidizes it, can save you hundreds of dollars a month.

Your social security benefits may be affected. Depending on your financial situation, you may find it best to wait until you reach your full retirement age to start collecting social security. If you start receiving social security before you reach full retirement age, your total benefits may be drastically reduced: for every $2 you earn over $13,560, you will reduce your social security benefits by $1. This applies to work income, not income from investments, pensions, annuities, capital gains, or interest.

If you’re married, your spouse may want to delay receiving his or her benefits to reduce your total income for tax purposes and to provide a future income stream.

The good news is that once you reach your full retirement age, you can work as much as you want without reducing your social security. Visit www.socialsecurity.gov/retire2/agereduction.htm to find your full retirement age.

Being your own boss may have certain benefits. If you set up your own incorporated business, you may be able to deduct everyday expenses like work-related phone usage, a new computer, office space rentals, and travel expenses. Plus, you can open up a new retirement plan and contribute to it.

Simplified Employee Pensions (SEPs), Savings Incentive Match Plans for Employees (SIMPLEs), and qualified plans such as Keoghs are designed to benefit small businesses and sole proprietorships. They have the same advantages of tax-deferred growth plans, like 401(k)s and 403(b)s, and contributions are tax-deductible. Your own business could match the contributions you, as an employee, might make.

Working might result in certain penalties or income reduction. Take care that your extra income from working doesn’t bump you into a higher tax bracket. Chances are, you’re probably paying for your retirement from several sources of income, such as a pension, 401(k), IRA, and social security. If you are older than age 70½, you are likely taking the required minimum distribution (RMD) from your retirement plan accounts as well. Add a paycheck to that mix and you might be making more money than you thought. This can also expose more of your social security benefits to income tax.

In addition, if you are or were a state or public employee, check with your retirement board to see whether you are subject to income restrictions or whether working will impact how much pension money you receive.

Does all this mean that working in retirement is pointless? Of course not; it just requires forethought and careful planning on your part—and the guidance of your trusted financial advisor to address your particular questions and concerns.

Pay Yourself First

2008-04-15T12:19:00.002-05:00

You already pay your bills on time. So, why not treat retirement savings as a regular monthly bill rather than seeing it as optional?

We know we should save, but there are competing priorities; so funding the retirement account often comes last. The kids want to go to college, and you would like a new boat. But treating your retirement savings as another bill that you must pay will keep it at the front of your mind. You won’t miss payments if you realize that, just like with the mortgage or electric bill, getting behind has consequences.

This simple sounding solution comes from the sophisticated world of institutional investing. Pension fund managers, for example, have to treat future obligations (payments to pensioners) as liabilities. That forces them to deal now with something that may be years or decades away. Using actuarial tables, they calculate the cost of future obligations to determine what return they require on their investments and whether the pension fund is adequate.

While you may not use actuarial tables, you can manage your retirement account like a pension fund. First, determine the savings you need to support the lifestyle you want during retirement. Keep in mind that you probably want to fund retirement through age 90 or 95.

Next, determine how many years you have to reach your savings goal. If you are 45 and plan to retire at 62, for example, you have 17 years to fund your retirement account. Finally, determine how much you must save each year and make projections about returns on your investments.

If you’re already funding your retirement goal by contributing to a 401(k) or other plan at work, treating that money along with all of your other retirement savings as a liability may provide you with a more realistic picture about how much you need to put away. It may also help you envision the quality of retirement you should expect and spur you to save more.

A simple way to establish a monthly liability for your retirement obligation is to divide your goal into equal installments. So, if you have 17 years to save $500,000, divide that obligation into 204 monthly payments of just over $2,450 per month. Given the expected growth of your investments, you’re likely to “over-fund” your retirement obligation. If you want to calculate your payments more precisely, include estimates for the impact of inflation, investment returns, and taxes.

By treating your retirement account as a liability, you’ll be paying yourself along with your other debts. Of course, making calculations about how much you need to save today to fund a debt in the future, while also making judgments about inflation, taxes, and selecting the right investments, may require professional help. Create a disciplined system for planning your retirement now and paying yourself first so you can enjoy your leisure years later.

How to Donate Money Effectively

2008-03-06T09:15:00.021-05:00

Whether it’s the holidays or an unexpected disaster, Americans are always willing to donate to those less fortunate. It’s the easiest thing in the world for us to open our checkbooks to a worthy cause without a second thought.

Yet your donation, regardless of size, should make the largest impact possible on your cherished causes and issues. When you support a charity’s best interests, you’re not selfish to support your own as well.

Give to efficient operations

In a perfect world, every cent you donate would go to fulfilling the mission you support. But some portion of every dollar goes to staff salaries, rent, fundraising, mailings, and possibly professional telemarketers. These expenses may leave your cause with very little.

Well-run organizations put most of your money toward their services or programs, not their operational overhead. The American Institute for Philanthropy recommends that no more than 40 percent of your charitable donation should go to overhead expenses; other charity watchdogs advise 25 percent. (This may not apply to newer, smaller, or more obscure causes.)

This percentage can be determined by requesting a charity’s IRS Form 990, required for a nonprofit to prove its tax-exempt status. Federal law requires charities to provide the form for the past three years to anyone who asks. Divide line 13 (Program Services) by line 17 (Total Expenses) to calculate the percentage paid to services and programs versus overhead expenses.

You can research charities with The American Institute of Philanthropy’s www.charitywatch.org, the Better Business Bureau Wise Giving Alliance’s Give.org, or Philanthropic Research, Inc’s. www.guidestar.org. All provide information on charities and their efficiencies.

You can also ask for the charity’s annual reports. The report should include the mission statement, board of directors, and the year’s accomplishments and finances. See if the charity’s goals seem reasonable and achievable. If the charity tells you a report isn’t available, is too expensive to mail, or otherwise discourages your interest, don’t contribute.

Avoid the scam artists

Unfortunately, there are people who try to take advantage of others’ generosity. Here are ways to reduce your chances of falling victim:

• If a solicitor mentions previous pledges you don’t remember, check your records first. Don’t fund donations you didn’t make.

• Don’t provide personal financial information in an e-mail, over the phone, or to door-to-door fundraisers. Use a website like www.networkforgood.org to donate safely with your credit card to over one million organizations. Ignore email solicitations from organizations you don’t support.

• Never give cash, or make checks out to Cash, or to an individual. Write checks out to the charity’s exact name, not initials. Some scammers use names that are similar to well-known ones.

• Don’t be swayed by on-the-spot high-pressure tactics or emotional sad stories. Ask for written information, or check the charity out online first.

• While many representatives for charitable causes are genuine, be aware of swindlers who often pretend to represent causes for missing children, soldiers or veterans, firefighters and police, or whatever disaster is in the news.

Know your tax benefits

Your philanthropy may provide possible tax advantages. Tax exempt organizations are not required to pay taxes. Tax-deductible donations are those you can deduct from your taxes if you itemize. The IRS has a listing of organizations to which deductions are tax-deductible per section 501(c)(3) of the Internal Revenue Code.

The IRS now requires actual receipts for all tax-deductible contributions of $250 or more. You should use an independent appraiser when donating property worth more than $5,000. The IRS won’t take your or the charity’s word for it. Consult your tax advisor for more help.

Reduce your solicitations

Many charities rent or trade their donor lists to other organizations to raise much-needed funds. As a result, you might get more requests in the mail the more you donate. The National Do Not Call Registry doesn’t apply to nonprofit organizations.

You can send a letter, along with your donations, asking that the recipient not rent, sell, or trade your personal information, name, or donation history to anyone. Or ask the recipient to limit its solicitations to only a few times a year. Explain that your future support is contingent on its cooperation.

When your charity complies with your request, consider increasing your donations to reward it and to offset any lost revenue from renting your name.

If you are receiving unsolicited address labels, note cards, pens, pads, or other gifts from charities, you are not obligated to make a donation in return. To stop receiving these mailings, return the charity’s envelope with a note requesting that your name be removed from its list. Be aware, however, that the organization might not be able to remove your name if it rented the list from a list provider.

Politely decline in-person solicitations by saying, “I limit my support to charities that I know well and support the causes that are most important to me.” Consider concentrating your support to singular missions, such as curing cancer; or to helping institutions in your hometown.

Become a stakeholder in the cause you support. You deserve to know how your money is used. With a little research, you can feel confident your donations are being used wisely to better the world.

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Gary Williams is a financial adviser and the President of Williams Asset Management practicing at 8850 Columbia 100 Parkway, Suite 204, Columbia, MD 21045. He offers securities and advisory services as an investment adviser representative of Commonwealth Financial Network®—a member firm of FINRA/SIPC and a Registered Investment Adviser. He can be reached at (410) 740-0220 or at Gary@WilliamsAssetManagement.com.

Is Your Credit Score as High as You Think?

2008-01-29T15:37:00.000-05:00

It is common to assume that paying bills on time automatically means having a high credit score. Unfortunately, that’s not always the case. There are many misperceptions about how scores are calculated—and yours could be lower than you might expect.

Credit scores are used by financial institutions to determine whether they should lend money to a potential borrower and, if so, what interest rate should be charged. A higher score means an applicant is statistically less likely to default on the loan so they get a lower interest rate.

Ignoring your credit score could be a costly mistake. As an example, let’s say you bought a $400,000 house with a 30-year fixed-rate mortgage at a 6-percent interest rate. Over the term of the loan, you would pay interest charges of $463,354. If, however, you had a lower score and your bank bumped your interest rate up to 8 percent, you would pay interest charges of $656,619. That’s a hefty difference of $193,265.

There are many credit scoring systems available to lenders, but FICO scores are by far the most commonly used. The system was developed by the Fair Isaac Corporation back in the 1960s. Technically, you have three different FICO scores—one for each of the three major credit reporting agencies.

Knowing how FICO scores are calculated can help you make better decisions about your credit. At a minimum, you should be aware of some of the most common misperceptions:

I always pay my bills on time so I must have a high credit score.
Paying your bills on time is clearly a critical factor, but it only accounts for 35 percent of your overall FICO score. It also looks at four other components: the amount of debt you owe (30 percent), the length of your credit history (15 percent), the number of credit accounts you’ve recently opened (10 percent), and the types of credit you use (10 percent).

Consolidating multiple credit cards will increase my score.
Consolidating credit cards could make it easier to pay down debt, but your FICO score could actually decrease if you consolidate to fewer accounts with balances that are closer to the maximum available credit. FICO considers you a lower risk if you have multiple credit accounts, keep the payments up-to-date, and maintain balances between 25 percent and 35 percent of the available credit.

I don’t have any credit cards or other major debt so I can’t have a low score.
Your FICO score doesn’t take into account your net worth or your income level—it only looks at your past borrowing history. Your FICO score will be lower if you haven’t established a long-term borrowing history with multiple creditors.

Closing a credit card is better for my score than keeping it open.
Closing a credit card will not necessarily hurt your score in the short term, but you will eventually lose the positive effects of the long-term credit history that you’ve established with that lender.

I shouldn’t shop around for a mortgage or other large loan because credit inquiries hurt my score.
A large number of credit inquiries will lower your score, but FICO is smart enough to know when you are rate shopping. Inquiries for similar types of credit are bundled if they’re made within the same 14-day period.

I shouldn’t check my credit report more than once a year because credit inquiries hurt my score.
Checking your own credit report does not affect your score, so feel free to check it as many times as you’d like.

If you want to learn more about how FICO scores are calculated, visit Fair Isaac’s web site at www.myfico.com. They offer a host of informational materials and credit score tips. And while you’re at it, you can also order your three scores for a small fee.

Becoming more knowledgeable about FICO scores could help you to keep those pesky interest rates at a minimum. With just a small investment of time, you will be able to make smarter credit decisions and take proactive steps to increase your score.

Investments Should Be Guided By Reason, Not Emotion

2008-01-09T13:15:00.000-05:00

What makes for a good investor?

Driven by emotions more than logic, we typically buy high and sell low. What may surprise you is how big a penalty you can pay in the long run if fear and greed dictate your investment decisions. People in or near retirement seem particularly prone to such temptations. The financial media had plenty to talk about this spring and summer. How did you react to all the news?

As you ponder your own investor behavior, keep in mind this observation from the Dalbar report: "It is easier to make the right decision when the markets are rising and the fear of loss is on the back burner. The really smart decision, that most investors get wrong, is to invest when the market is down. If you don't know when to get out, it is better to stay in."

Most investors do not clearly understand their own risk tolerance. According to Nick Murray, author of several books including Simple Wealth, Inevitable Wealth, there are three great truths about risk tolerance.

First, far from being fixed, immutable, knowledgeable, and even quantifiable, risk tolerance in the individual investor is as volatile as are all his other emotions, because it is from his emotions, and not his intellect, that his risk tolerance is derived at any given moment.

Second, people change their risk tolerance in reaction to, rather than in anticipation of, market movements. That is, risk tolerance is essentially a lagged response. Thus, changing one's risk tolerance in response to market events, regardless of how one is changing it, must be a losing strategy, and a formula for substandard returns.

Third, the individual investor reacts to market movements by altering his risk tolerance pro-cyclically rather than counter-cyclically. That is, as prices rise, and especially if they rise sharply thus extinguishing value, the investor perceives that risk in those assets/markets is actually declining, when in fact it is rising.

The best approach for most investors is to have a well-diversified portfolio, ignore the noise from the media, continue to educate themselves about their finances, and be patient. By doing so you are on your way to being a good investor.

Does Your Money Buy You Happiness?

2007-12-05T13:42:00.000-05:00

Another Thanksgiving has come and gone. As a financial professional, I always count on two things: the stores open for the after-Thanksgiving sales earlier than they do the previous year, and the TV news always try to predict how retailers will fare during the holiday shopping season. This year is running true to form.

Now, granted, a healthy retail sector is good for the stock market. And it certainly makes my job easier when my clients are satisfied with how the Dow is doing.

But it’s also part of my job to talk with my clients about their goals in life and about their values and feelings about money. It helps me pinpoint their financial destination and how able they are to get there.

I work with many people who are, by most standards, financially successful. They make decent or comfortable salaries. They have lovely homes, stable marriages, and wonderful families. But they can feel stressed or dissatisfied. Some work jobs that give them little personal satisfaction or less family time. They’re concerned they won’t ever have enough for their own or their children’s futures.

When we examine their spending habits, we often make some crucial discoveries. Some spend more money than they should on things they don’t need. When they realize this, we make significant progress toward reducing their concerns.

Now I’m not suggesting that we give away our belongings and live in the mountains. And not all purchases are bad: we all have hobbies and interests that give us sustained and long-lasting pleasure and make us well-rounded and interesting people. But some careful consideration of our spending may pay off in greater levels of personal happiness and financial security.

Think before you buy.
With all the online shopping, shopping malls, shopping channels, and catalog shopping, it’s not surprising that Americans are carrying a record level of credit card debt. We often forget that what we can pay for and what we can afford can be two separate, very different, things.

So I propose a little experiment: for two weeks, pause before you buy anything that’s not related to a true human need like food, health care, or shelter. It can have a great impact on your personal finances.

Some people make a list of what they want and wait a month before they buy it. Or they freeze their credit cards in a bowl of water and buy things only when the ice defrosts. Or they leave the store immediately to think, giving themselves time to let their urge to splurge cool off.

Next time you have an impulse to purchase, ask yourself if the item you crave fulfills a want or a need. If you carry a credit card balance, how many months of additional minimum payments will purchasing this item obligate you to? Does this purchase get you closer to accomplishing the most cherished dreams you have for your life?

Don’t buy more things, buy more experiences.
According to the National Association of Home Builders, the average American home size has increased by 40 percent since 1970. We’ve got more closets, bathrooms, and kitchen cupboards than ever before. But the size of the average American family has decreased.

What happens with all that extra space? We fill it with possessions, many of which we upgrade or trade in far before they outlive their usefulness. If we charge these purchases, we may pay for them long after we’ve gotten rid of them. If we’ve bought too much house, we may be tied to more mortgage, utility, and upkeep payments than necessary. These can add to our stress level and our worries about financial security.

So instead of a flat-screen TV in your mud room, for instance, take a family vacation—you’ll have photographs and memories you’ll treasure far longer.

Better yet, buy your freedom.
Our retirement years are supposed to be our “golden years”—the reward we finally earn after working hard for decades. It’s our time to call the shots and live our life the way we want. But is golden really good enough in this age of platinum and titanium credit cards?

Many of us put our desire for instant gratification ahead of our need to live a financially secure life. We don’t pay enough attention to funding our retirement until it manages to sneak up on us. And then we get worried.

Many of us work to maintain a lifestyle, not a life. When we know the difference between the two, we can make sounder financial choices that reduce worry.

If you do well, spend some money on doing good.
We’re lucky to live in a great country, but there are people across the globe—or even across the street—who are not so blessed. Helping the less fortunate can give our personal wealth and the sacrifices we make for it much greater meaning than buying a new car every three years. And, in many cases, charitable giving can reap tax benefits for you, too.

Be happy with what you have.
Some experts suggest making a list of all of the things that make us truly happy, paying specific attention to those things you can’t buy—like the love of our families and our good health. When we refer to that list regularly, it helps us stay focused on what’s really important.

And maybe a little thanksgiving every day, instead of once a year, can help us eliminate our emptiness and empower us to make smarter financial choices.

Don’t have an IRA? Maybe now’s the time to start saving.

2007-11-26T13:42:00.000-05:00

Can you believe that individual retirement accounts (IRAs) have been helping individuals save for retirement for more than 30 years? These accounts extend the tax advantages of employer-provided retirement plans to many people who either don’t have retirement plans at work or who want to supplement their other plans.

Since their inception, however, IRAs have changed in many ways, including restrictions on who can contribute, as well as the types of accounts you can contribute to. Given this evolution, you may not be familiar with all the options and benefits available to you. To help bring you up to speed, I’ll highlight three primary types of IRAs:

• Nondeductible IRAs
• Deductible IRAs
• Roth IRAs

The one thing that remains consistent, regardless of the type of IRA, is the contribution limit allowed. In 2007, it is $4,000 ($1,000 more if you are age 50 or older); in 2008, the limit increases to $5,000.

Nondeductible IRAs

This IRA is perhaps the simplest to understand—you contribute after-tax income to the IRA, and your assets grow on a tax-deferred basis. When the money is withdrawn, you don’t have to pay taxes on your original contribution, but any earnings will be taxed at your ordinary income tax rate at that time.* Nondeductible IRA owners are required to take minimum distributions starting at age 70½.

Deductible IRAs

This type of account has more variables for consideration than the nondeductible IRA. Individuals meeting IRS deductibility requirements can deduct any IRA contributions from their income for tax purposes. In addition, earnings in the account accumulate on a tax-deferred basis. So, when you meet a qualifying event, your total distribution amount will be fully taxable at whatever your marginal tax rate is at that time.* Deductible IRA owners are required to take minimum distributions starting at age 70½.

Roth IRAs

Roth IRAs, which were introduced in 1998, allow for after-tax contributions, as well as potentially tax-free distributions when you meet a qualifying event. The IRS has set specific eligibility requirements for individuals to contribute, but those who are eligible benefit from tax-free access to their contributions at any time.* Roth IRAs are generally considered the most tax-advantageous of the IRA options, and they can play a significant role in your retirement savings strategy. Roth IRA owners are not required to take distributions.

As the end of 2007 approaches, it may be helpful for you to use IRAs to your maximum advantage. As a starting point, you should first evaluate whether you are eligible for a Roth IRA this year. If you are, I hope you seriously consider making a contribution. If, however, your income level makes you ineligible for a Roth IRA, a traditional IRA may be best for you. Your financial advisor can provide more information and help you evaluate which IRA makes the most sense for your individual needs.

*Withdrawals of taxable amounts are subject to ordinary income tax and, if made before age 59 ½ , may be subject to an additional 10% federal income tax penalty.

FICO Scores: Why They’re Important, How They’re Calculated, and What You Can Do to Improve Them

2007-11-12T17:50:00.000-05:00

Whether you’re applying for a credit card, a personal loan, or a mortgage, the lender you choose looks at many things when deciding what type of offer to make to you, including your income, how long you have worked at your present job, and the kind of credit you are requesting. To help them gain a better understanding of your credit risk level, lenders often start by looking at your FICO scores.

You have three FICO scores, one from each of the three credit bureaus: Experian, TransUnion, and Equifax. Each score is based on information the credit bureau keeps on file about you. In the simplest terms, good FICO scores generally result in your receiving the best interest rates on all types of loans. Bad FICO scores, on the other hand, can cost you thousands of dollars over the life of a loan.

How your score is calculated

FICO stands for the Fair Isaac Corporation, which is a leading monitor of consumer credit. Fair Isaac develops FICO scores based solely on information in consumer credit reports maintained at the three major credit reporting agencies.

An individual’s FICO score can range from 350 to 850—850 being the best. In determining your FICO score, the corporation evaluates information in five categories:

• Payment history (35%): This includes information on specific types of accounts, such as credit cards, retail accounts, student loans, installment loans, finance company accounts, and mortgages. It also captures any presence of adverse public records, such as bankruptcy, judgments, suits, liens, wage attachments, collection items, and any delinquent or past-due items.

• Amounts owed (30%): This category assesses the number of accounts you have and the amount you owe on each. Additionally, the proportion of balances to total credit limits on certain types of revolving accounts is considered.

• Length of credit history (15%): This information examines the time that has elapsed since a specific type of account has been opened.

• Types of credit used (10%): This data relies upon recent information about the number of credit cards, retail accounts, installment loans, mortgages, and consumer finance accounts you have.

• New credit (10%): This category includes the number of accounts you have recently opened.

Keep in mind, your FICO score considers all of the above categories of information. No one piece of information or factor alone will determine your FICO score. For some people, one factor may be more important than it is for others with a different credit history. As the information in your credit report changes, so does the importance of any factor in determining your FICO score. What matters is the mix of information, which varies from person to person.

Good and bad breaks

If your FICO score is 720 or higher, you are likely in good shape. If it’s lower than 720, you may need to brace yourself for some frustration. Most mortgage lenders have firm breakpoints. For example, if your FICO score is 699 and the lender’s breakpoint is 700, that minute difference could mean an extra half-point on a mortgage loan.

How can you improve your score?

Your FICO score considers both positive and negative information in your credit report. Late payments will lower your score, but establishing or reestablishing a good track record of making payments on time will raise your FICO score.

You can also do the following to help increase your score:

• Pay down your credit card debt to zero and your score can go up by as much as 20 points in 60 days.

• Get a copy of your credit report and look for errors. This may include payments that appear as late but you can prove were paid on time, accounts that aren’t yours, and old debts that shouldn’t be on your report anymore (i.e., negative debts that should be taken off your report after seven years and bankruptcies that should be removed after ten years).

• Maintaining multiple credit cards may help you in some circumstances. It is better to have four cards at 20-percent to 30-percent capacity than to have one card that’s maxed out.

Rapid rescoring

If you’re applying for a mortgage, ask whether your lender uses a rapid rescoring service. If so, you can have your credit score rescored in 72 hours; if you’ve recently improved your score, rescoring may save you money. Rescoring generally costs about $50 per credit account.

Even if you’re not in the market for a mortgage or another loan, it is always wise to have a good handle on your FICO scores. It is easier to correct mistakes and improve your score when you don’t have an immediate deadline to meet. For more information or to obtain your FICO scores, visit www.myfico.com.

Streamlining Retirement Accounts—Less Can Definitely Be More

2007-09-17T10:18:00.000-05:00

When was the last time you met someone who has worked for one employer for his or her entire career? If you can’t remember, you’re not alone. In fact, recent data compiled by the U.S. Department of Labor indicates that wage and salary workers have averaged just four years with their current employer. Not surprisingly, older workers tend to have more years of tenure than their younger counterparts. For example, employees between ages 55 and 64 have 9.3 years of tenure—about three times that of workers between ages 25 and 34, who have 2.9 years.1

If it is common for today’s work force to switch jobs voluntarily or involuntarily, what is the side effect of this cultural shift? For starters, many people find that they have retirement plan accounts and IRAs scattered among multiple custodians, such as banks, investment companies, and former employers.

It’s challenging to keep track of assets that are so widely scattered. If you find yourself in this position, regardless of how many accounts you have and where they’re held, you may want to consider the benefits of consolidating your retirement assets.

Simplify your IRAs and retirement assets through consolidation.
Whether you have a 403(b), 401(k), 457 plan, your own IRA, or some combination thereof, you may find that consolidating your retirement assets into a single account is a good choice if you want to:

Avoid paying multiple custodial fees.
Many mutual fund companies and brokerages charge an annual fee of $10 or more on IRAs worth less than $5,000. If you transfer all your IRAs into one retirement account and add in your old 401(k), you may have a big enough balance to earn a fee waiver.

Simplify tracking on one statement.
If all your retirement assets are in one place, you’ll find it easier to monitor your progress and investment results. You’ll receive a single statement that eliminates the need to keep track of multiple accounts from a variety of sources. You’ll also have the benefit of accessing your information through one website and one phone number.

Get a clearer picture of your asset allocation.
With a full view of your retirement picture, you are more likely to receive appropriate guidance whenever you think allocations should change or investment opportunities should be considered. Plus, if you have an old 401(k) that only offers expensive, underperforming mutual funds, you‘ll have the chance to roll it into an account that offers a variety of investment choices to help increase your bottom line.

Manage risk exposure.
With several accounts invested in different funds, you may become over-invested in certain sectors or companies through overlapping investments. With one consolidated account, you can more easily track underlying investments and manage your risk exposure.

Simplify your required minimum distribution (RMD) calculations.
When you reach age 70½, you must begin taking RMDs from IRAs and other retirement accounts, such as a 401(k)s. It’s typically easier to calculate and take withdrawals from a single account.

Do your homework before taking action.
For many people, consolidating their retirement assets makes life easier and provides financial comfort. To avoid costly mistakes, however, be sure you fully understand each retirement account you own and the tax rules that apply to it before doing anything. Keep in mind the following:

Review your current holdings.
If you have worked for awhile, this process may take some time, but it is important to have a clear picture of all your accounts. You should determine where each account is located and what it is worth.

Avoid hidden charges or fees.
Some financial institutions charge egregious fees to let you go. Consolidate only if the payoff outweighs any fee. Some firms may assess charges, such as service and transaction fees, on some or all of your assets when you roll them over.

Avoid directly receiving a check.
Have all the retirement assets from another firm sent directly to the new account, in what is called a direct rollover. A direct rollover allows you to preserve your entire accumulation without having taxes withheld from the funds you are moving. Always remember that you should never take possession of the money. If you do and then fail to reinvest it in an IRA within 60 days, you’re looking at an income tax bill, as well as a 10-percent early withdrawal penalty.

Even if you’re far from retirement at this point in your career, starting to consolidate your assets now may help you in the long run to develop an effective overall financial plan that provides the maximum benefit to you and your family. A financial professional can provide more information on consolidation and help you determine if it may be a good choice for you.

1. Bureau of Labor Statistics of the U.S. Department of Labor, Current Population Survey (CPS), January 2006.

Cutting Energy Costs Benefits Wallet

2007-09-14T10:19:00.000-05:00

As gas and home energy costs continue to rise this summer, curbing them becomes increasingly important to your financial health.

Recently, I was buying gas at one of those rare stations that does not have self-serve pumps. As the attendant was filling my tank, I noticed several people just getting $5 or $10 worth of gas. "This is the fourth time this woman has been here this week," said the attendant, after she handed him a $10 bill. The attendant has worked there for more than 10 years and has noticed a change over the last year. "You would not believe how many people do the same thing…it was never like this,” he said.

While we cannot control gas prices, we can control gas mileage and reduce costly trips to the pump. The Alliance to Save Energy offers some tips:

■ Maintain your vehicle. Replacing a faulty oxygen sensor can improve mileage by up to 40 percent.

■ Keep tires properly inflated. This improves gas mileage by about 3.3 percent, increases safety, and prolongs tire life.

■ Don’t Speed! Speeding, rapid acceleration and braking can lower gas mileage by 33 percent at highway speeds and by 5 percent around town.

■ Buy, lease, or rent smart. Select a model with good fuel economy. Check www.fueleconomy.gov for information on fuel efficient vehicles.

■ Tune up on time. Fixing a car that is noticeably out of tune, or has failed an emissions test, can improve gas mileage by an average 4 percent.

Another way to save money is by conserving energy at home. Here are some ways to do that:

■ Watch the temperature. Changing your thermostat settings by a few degrees makes a big difference on your energy bills. You can save up to 10 percent a year with a programmable thermostat that automatically adjusts the temperature by 10 to 15 percent for the hours that the house is unoccupied.

■ Use fans. A ceiling fan can lower room temperature allowing you to turn down the air conditioner.

■ Audit your home energy. Have a qualified firm do a home energy audit. A professional will inspect your home and probably find some surprising things. The cost is reasonable, especially if your energy company picks up part of the tab.

■ Shift energy-intensive tasks. Use your washing machine, dryer, and dishwasher during off-peak energy demand hours. This also increases electricity reliability during heat waves. Do full loads when you run appliances.

■ Turn off your computer. Also, power down the monitor when you are done. Activate the “sleep” feature so the machine powers down when it’s on but not in use for a while. When you leave a room, turn off the lights and other energy using equipment.

Most important: If you are going to save on energy costs, everyone in your household must participate. Regardless of your financial situation, this sends a good message to your children and teaches them the importance of conserving energy and money.

Can Your Child Afford Not to Go to College?

2007-08-07T12:22:00.000-05:00

Every so often, while helping one of my clients fill out forms for college savings accounts or financial aid for his or her son or daughter, the client confides that his or her child is reluctant to go to college. Given my line of work, I believe my clients expect me to provide guidance as to why their child should pursue a bachelor’s degree.

While I know a good education is the foundation of a child’s financial security, I don’t believe it’s my place to demonstrate the personal, social, and intellectual exploration that awaits them on a college campus. I can, however, provide my clients with some cold, hard facts about the current and future costs of college, as well as the salary gap that exists between college graduates and nongraduates.

How many zeroes was that?

According to the College Board,1 the tuition, fees, and room and board charges for in-state students at public colleges averaged $12,796 for the 2006–2007 school year. At a private university during that same year, those charges averaged $30,367.

The sobering reality for parents is that the cost of four years of college for their children will run four to seven times as much as their own education cost For a child born today, a college education will probably cost three to four times as much as it costs now.

If you’ve heard statements that suggest the cost of a four-year college education for a child born today will be in excess of $300,000, don’t go into shock. While this may be true for some, keep in mind that this number is based on the costs of the highest priced institutions. It also assumes gross prices, without taking into consideration that grants lower costs by 25 percent. If your child is bound for an expensive school, the good news is that the higher the cost of the institution, the more potential the student has to receive aid.

In any situation, however, with these large numbers staring at you it’s understandable why some parents and children may be reluctant to take on student loans, apply for financial aid assistance that seems to decrease each year, or commit to four years of learning that the child may not wholeheartedly want.

Think of it as a long-term investment, not an expense

While some students may look at college as a four-year vacation on Mom and Dad’s dime, they should be encouraged to look at it as a crucial key to their financial independence and one key to their ability to participate fully in today’s knowledge-based economy. Experts have measured the salary gap between high school graduates and college graduates, and the numbers are telling.

The U.S. Census Bureau conducts annual surveys of educational attainment. The following table illustrates some findings that can be derived from the 2006 survey data.2

Degree Annual Income
Age 18+:
All Workers
Lifetime Income
Age 25–64:
Full-Time Year-Round Workers

High School Graduate $26,933 $1,531,400
Associate’s Degree $36,645 $1,920,680
Bachelor’s Degree $52,671 $2,742,160
Master’s Degree $66,754 $3,337,800
Doctoral Degree $91,370 $4,449,440
Professional Degree $112,902$5,612,760

This shows that a bachelor’s degree recipient has lifetime earnings that exceed someone with just a high school diploma by $1.2 million, and a doctoral degree recipient has earnings that exceed someone with only a bachelor’s degree by $1.7 million.

With numbers like these, I believe it’s safe to say that education has never been more important to future financial independence.

1. Trends in College Pricing 2006 is based on data collected in the College Board’s Annual Survey of Colleges, 2006–07. It reports tuition, fees, and other charges for the current academic year, 2006–2007.
2. Educational Attainment in the United States: March 2006 published in March 2007, using 2005 income data. This data is collected as part of the national Current Population Survey.

What Should You Do With Your Old 401(k)?

2007-07-17T12:47:00.000-05:00

A Rollover IRA Has Its Advantages

If you have changed jobs several times during the course of your career, you probably have an interesting collection of retirement savings accounts from your previous employers. In fact, according to the Department of Labor, Americans move to a new employer once every four years and our collective trail of old 401(k) and 403(b) plans totals in the trillions of dollars.
While leaving your retirement account with a former employer is a better decision than cashing out your account and splurging on a boat, it may be more beneficial to consolidate your retirement savings by rolling your old 401(k) or similar employer-sponsored retirement plan into an IRA.

A Rollover IRA offers you four major benefits:

· Increased Investment Options. The biggest advantage of rolling over your 401(k) into an IRA is the wider universe of investment choices, a benefit that’s more valuable to you if the choices in your old 401(k) plan are limited or performing poorly. Most employer-sponsored retirement savings plans offer a choice of several mutual funds and/or company stock. However, with an IRA you can invest in mutual funds, stocks, bonds, and even non-traditional retirement investing options, such as real estate and venture capital, if these are suitable for your individual situation.

What’s more, if you keep your rollover IRA separate from other IRAs you may own, and if you qualify to open a Roth IRA, you can decide to convert the traditional rollover IRA to a Roth IRA where future earnings on the account are income tax free. Note that whether you qualify for the Roth IRA conversion depends upon your annual modified adjusted gross income. In addition, current taxes will be due on the conversion amount.

· Easier Record Keeping and Account Maintenance. There’s no question receiving 401(k) statements from various employers makes it difficult to monitor what you own and ensure each investment is playing the role you intended in your portfolio. By consolidating your retirement accounts into a Rollover IRA, you facilitate the process of reviewing and rebalancing your portfolio. And, of course, you gain this greater convenience and control without tax consequences or other penalties.

· Greater access. If, for example, your previous employer changes 401(k) providers, your plan assets will be temporarily unavailable to you due to a “blackout” period that occurs as funds are transferred from one plan provider to the other. That time frame can stretch from a few days to a few months. In addition, you can tap your IRA penalty-free before age 59 ½ for the purchase of a first home or college expenses. Current taxes will still be due at the time of withdrawal.

· Flexible Estate Planning. IRAs also offer more freedom, as well as the potential for tax savings, in the estate planning department. If you want to name multiple beneficiaries or a charitable organization as your beneficiary it is best done with an IRA. Many employer-sponsored plans do not accommodate sophisticated beneficiary designations.

An IRA also affords your heirs more flexibility. For example, if you have named a non-spouse as the beneficiary of your 401(k) plan, it is likely that your former company’s plan administrator will insist that the account be cashed out immediately resulting in a potentially larger tax bill and loss of the benefits of ongoing tax deferral. With an IRA, you can designate a younger non-spouse as your beneficiary and that individual can stretch out the minimum withdrawals over his or her lifetime.

Also, when your assets are invested in an IRA, your beneficiaries can get the information they need easily rather than tracking down your former employers and completing multiple forms.
Ironically, while a Rollover IRA may certainly increase your flexibility in terms of investment options and planning for the future, the rules governing the rollover are anything but flexible. And if you don’t play by the rules, you could face an unexpected tax bill.

Generally, when you take a distribution from a 401(k) plan that you intend to rollover, you must contribute it back into another IRA or other tax-deferred retirement plan within 60 days. If you do not rollover the funds within 60 days the distribution is taxable. Also, in most cases, a 10% penalty for early withdrawal applies if you are younger than 59 ½ years of age.

To keep it simple and avoid careless mistakes, a direct rollover, also referred to as a trustee-to-trustee rollover, is often a better choice than cashing out and receiving a check from your former employer. With a direct rollover, your current plan sends a check not to you, but to the firm that serves as the custodian for your new IRA.

Plan sponsors are required to withhold 20% of the proceeds from your 401(k) as prepayment of federal income taxes if you ask your plan for a check. If you eventually roll over these assets, you will have to make up the 20% that was withheld by your plan sponsor or that amount will be taxed as income and could be subject to an early withdrawal penalty.

Note that it is possible to petition the Internal Revenue Service (IRS) to extend the 60-day re-investment rule in certain circumstances, particularly if you need time to correct errors made by financial institutions or time to deal with health issues or family problems. However, if you first consult with your financial advisor, you can be confident that your IRA rollover will go smoothly.

Are Charitable Gift Accounts Right for You?

2007-06-26T09:28:00.000-05:00

Charitable gift accounts may be a good idea for individuals looking for a tax-advantaged way to support their favorite charities, improve their estate tax situation or bring more order to their gift-giving strategy. These are not necessarily inventions for the rich – some of these accounts can start with an initial contribution of $10,000 and allow additional contributions of as little as $1,000.

Charitable gift accounts offered by financial institutions come in two varieties -- donor-advised funds or pooled-income funds. Donor-advised funds allow a donor to deposit a specific amount in the fund, take an immediate tax deduction up to the full value of the contribution, select investments among the choices provided by the investment company and then recommend which charities will receive money from the account over time. Pooled-income funds, meanwhile, pay the donors a fixed income for life from the fund. The balance of the account is paid to the donor’s designated charities after the last designated income beneficiary dies.

Depending on a donor’s particular situation, these two options can be an attractive idea depending on whether the donor’s focus is maximum tax deduction or income for life. That’s why it’s a good idea to discuss either option with a trusted financial adviser such as a CERTIFIED FINANCIAL PLANNER® professional or a trained tax advisor to see if either of these or other tax advantaged charitable options are right for you.

Some general points about these options:

Know the kinds of assets you can deposit: Most funds will allow you to deposit cash (by check), publicly traded stocks, bonds and mutual fund shares and, in some cases, life insurance policies. Your tax deduction will depend on the type of asset you donate. Gifts of cash are limited to 50% of your adjusted gross income while gifts of stock are limited to 30% of AGI. Unused charitable deductions in one year may be deductible within the following five tax years.

You can reduce the overall size of your estate: In 2009, the federal estate tax exclusion amount is scheduled to be $3.5 million, but federal estate taxes are will be repealed in 2010 for one year only. Unless Congress enacts new laws, the estate tax exclusion will be re-set to $1 million in 2011. No one can know the future, but for taxpayers with significant estates, charitable gift funds might be a good way to reduce the size of a taxable estate.

You need to keep an eye on fees: Always consider management fees when considering any potential benefits. You will probably be paying higher fees than the average index investment or similar pooled investment. The organization that offers the charitable gift account handles any legal, administrative, and filing requirements (including tax returns). These costs are factored into the fees. However, because the charitable gift account is administered as part of a larger organization, the fees are generally lower than those incurred by a family foundation.

This decision is irrevocable: Understand that your gift is final. Because of the tax-advantaged treatment, you’re not going to be able to reverse this decision if you find you need the money later. Give careful consideration to how prepared you are for retirement and long-term care spending before you make this choice.

Watch the IRS: The Pension Protection Act of 2006 mandated the Treasury Department to study donor advised funds and make recommendations to Congress about the tax deductibility of donor contributions and the donor’s ability to make recommendations as to which charities will benefit and when.

It’s Wise to Plan for the Unexpected

2007-06-05T16:59:00.000-05:00

Sometimes the unexpected happens. What if your house and personal possessions suddenly were destroyed by fire, weather or other disaster? How much would your insurance pay?

If you need time to think about it, you probably should address this issue.

Ralph Freibert led a privileged life in an upscale New Orleans neighborhood adjacent to the now famous 17th Street Canal. When the levee broke, he didn't completely understand what was happening or comprehend the magnitude of the growing devastation. Things changed by the minute, and he and his family had to adjust quickly.

Ralph's children relocated to Texas, then Atlanta, and finally to a school in the Northeast. The kids were not allowed to attend school at first because they lost their immunization papers, and there was no place to get copies. The only way the school would allow the children to attend classes was to consider the family as homeless people. He and his wife cried when they heard this news …how quickly their lives had changed.

Natural and man-made disasters, like the hurricane and flooding in New Orleans, can happen anywhere. If you are like most people, you have spent little or no time preparing an emergency plan. The reality is this can happen to you.

How can you prepare for the unexpected? Here are some steps to consider.

■ Review your property and casualty insurance. Read your policy to understand what it does and does not cover. Consider the improvements you have made to the house. What would rebuilding, or replacing items, cost? Is your current coverage enough? Most people find out too late that they failed to increase coverage to keep up with improvements.

■ Find a knowledgeable insurance agent. Have you ever met your property casualty agent? Many people think their agent will give them the best coverage. Unfortunately, as in any profession, there are insurance agents with whom you really don't want to deal. Find one who is knowledgeable, proactive and ethical, and will always place you and your family's interests first.

■ Make sure you have enough savings reserves. “Three months of monthly expenses is not enough  have at least six months,” says Freibert. "Many places only accept cash; you would be surprised how fast you can spend it."

■ Inventory all your assets and property. Sit down and make a list of everything in each room: furniture, carpeting, light fixtures, window coverings, appliances, personal items, paintings etc. Better yet, go through each room with a video camera and record a narrative. Keep the tape in a secure location outside of your home.

Also, consider storing important documents including wills, tax returns, birth certificates and immunization records “inside” an online vault. The right service will allow you to access these documents immediately, and most importantly, will have sophisticated security systems to alleviate concerns that others could obtain access to your confidential information

Fortunately, Ralph kept great records, stored them outside his home, and fared better than most of his neighbors. Still, he could and would have purchased additional flood coverage if he had known about that option. In retrospect, the move would have saved him a substantial amount of money.

Before Hurricane Katrina, Ralph, like many people, was never satisfied or really appreciated the things he owned or accomplished. After Katrina, he and his family and many others have had to rethink their entire life plan.

Sometimes the unexpected happens.

Financial Considerations for Remarriages

2007-05-29T08:43:00.000-05:00

Whether this is the first marriage for one of you or both of you are veteran marrieds, it’s likely that each of you is entering your new partnership with assets much greater in value than toasters and vacuums.

Many couples create pre-nuptial agreements (PNA) to legally sort out the issues listed below. Yes, I know a PNA is not romantic. But if you have significantly more assets than your new spouse, if you have children, or if you own or expect to inherit a business, a PNA makes eminent sense. It’s the best way to ensure that what you bring to the marriage is passed on according to your wishes in the event of your death or a divorce.

When it comes to another trip down the aisle, it makes sense for both of you to be forthcoming about:

Full disclosure of credit histories and ongoing debt. Be open about credit card debt. Disclose credit judgments or bankruptcies. Be honest about what you owe on mortgages or for parental care or medical bills. Sometimes, marriage can make you a co-debtor.

Extent of total assets. Itemize real estate, homes, incomes, pensions, savings, cars, collectibles, business interests, investment portfolios, life insurance policies, and so forth. If you live in a community property state, you may want to title specific assets in your name or jointly with your child, not with your new spouse. Your attorney can advise you on the best path here.

Financial support of the marriage. Determine whether you will both keep separate bank accounts or create joint accounts. One compromise is that each of you contributes to a joint account for the new marriage’s expenses and retains a separate account for individual discretionary or obligatory expenses.

Obligations from previous unions. Discuss your alimony or child support payments and when they end. Do you have preexisting business debts that you incurred with a former spouse? Are either of you required to provide insurance coverage for an ex-spouse? Does a previous spouse have legal claim to your employer-sponsored retirement plan savings?

On the other hand, if you receive assets from a former spouse, will remarrying stop the receipt of a particular inheritance or discontinue financial consideration? Often, if a woman remarries, she loses alimony or social security benefits from a previous husband.

Property issues. When uniting two households, decide whose house becomes the marital home and what should be done about the other. Figure out who will own or live in the house if the owner dies, if the marriage ends, or if a widowed spouse remarries. Decide whether or not the non-owner spouse should be put on the deed or compensated for contributing to the mortgage or home improvements.

If you want to leave the house to children, remove the home from consideration as a joint marital asset. This is often done via a PNA or a trust. But beware that, despite the best preventative measures, you still risk losing the home—all it takes is a judge or an aggressive divorce attorney.

Supporting children. Second marriages often involve blended families or the creation of a new family. You both should establish how much financial support each child will receive—and here I mean for nonobligatory expenses not mandated by a court. Decide whether the child’s biological parent will be responsible for this support, whether it will be a joint expense, or whether it will come from the proceeds of past marriages and/or from future marital assets.

You should also be aware that federal financial aid forms require that a stepparent’s income be listed. Even if the stepparent has no legal obligation to contribute to the child’s education, his or her income will likely affect the amount of financial aid the child receives from the government.

Letting your children know upfront that you’ve made provisions to protect their inheritance may also make them more supportive of your new union, especially if it has created a stepfamily or half-siblings. Similarly, specifically naming your stepchildren in your will as beneficiaries—if you wish to leave them assets—is essential. They may not automatically inherit from your estate.

As the children grow up and build lives and families of their own, this conversation may have to continue. The topic may be especially sensitive if you have significantly more assets than your spouse. The importance of clear communication with your spouse and all of the children cannot be overstated.

Estate planning. Remarriage is an excellent opportunity to review your will and the beneficiaries of your assets. Many former spouses have inherited life insurance policies that were not part of a divorce settlement!

The laws in some states may entitle your spouse to a portion of your estate, even if your will or trust deems otherwise. If keeping assets “in the family” is mandatory, work with your financial advisor and/or attorney to establish trusts that preserve assets in the way in which you intend. Many people who want both to support a spouse and to pass wealth on to the next generation (instead of to a subsequent spouse) consider Qualified Terminal Interest Property (QTIP) trusts. QTIPs allow for flexibility in treating beneficiaries, preserve assets for children of previous marriages, and generate tax savings and estate tax deferrals.

Seek professional guidance, if needed. While your marriage is your commitment to support and rely on each other above everyone else, seeking professional financial help neither undermines this bond nor pre-destines it to failure. If certain issues seem contentious, you and your future spouse may benefit from engaging an outside professional to help navigate them.

This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Investors may wish to consult a professional tax advisor or a lawyer.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

The Economics of Happiness

2007-05-23T15:05:00.000-05:00

Society and the media lead us to believe that having lots of money and material things is the ticket to happiness. Recent research suggests otherwise. Let’s look at money as an example.

Since Elvis made his first appearance on the Ed Sullivan show in 1956, the average American’s disposable income (in 2000 dollars) has tripled from $9,431 to $27,792, according to data from the Bureau of Economic Analysis. However, as reported in the book “Happiness” by Richard Layard, our level of happiness hasn’t increased at all during that time.

Money does factor into the happiness equation but only to a certain degree. Studies have shown that if we go from making $20,000 per year to $50,000 per year, our happiness will just about double, according to Harvard professor Dan Gilbert. However, going from $50,000 to $90,000 will only yield a slight increase.

Quiz time. Which would you prefer; getting paid $50,000 per year while other people get paid $25,000 or getting paid $100,000 per year while others get paid $250,000? According to one survey, more people preferred the first option.

Happiness from money is relative. As long as we make more than our “comparison” group, money makes us happy. It turns out happiness is partially based on “staying ahead of the Joneses.”

Even our young people are money focused. The latest UCLA annual survey of college freshmen indicated that nearly 75% of them said it was essential or very important to be “very well-off financially.” That’s up from 42 percent in 1966, the study’s first year.

Don’t get me wrong. Money per se is not bad. It’s what we do with it that counts.

It’s a similar story with material goods. Just as a shiny new coin dulls with use, so does our happiness with the goods and services increased wealth can buy. Over time, we become used to our new standard of living and our happiness level flat lines. Continually buying bigger and better things may just lead to what researchers call the “hedonistic treadmill.”

Okay, so if becoming a millionaire is not the passport to happiness, what is? According to various studies, here are seven keys that can make us happier.

First, build strong family relationships. We need the closeness and love of a family. By contrast, (not surprisingly) divorce and separation are two situations that can cause the largest drop in personal happiness.

Second, secure an adequate financial situation. As described above, a certain level of income is necessary for a base level of happiness.

Third, find rewarding and meaningful work. A job pays the bills but finding work that makes us feel like we are contributing to society and helping others is also very important.

Fourth, cultivate friends and a local community. Research from the University of Chicago's National Opinion Research Center indicates that people with five or more close friends are 50 percent more likely to describe themselves as "very happy" compared to people with fewer friends.

Fifth, focus on health. We tend to ignore our health—until we don’t have it. By proactively trying to stay in shape, we can feel better, live longer and be happier.

Sixth, find the “zone.” Whether it’s work or leisure, happiness ensues from being “in the zone;” that state where we are totally engaged in an activity and absorbed in the moment.

Seventh, be grateful. It’s easy to lament what we don’t have but it’s better to focus on appreciating what we do have.

Yes, life can be difficult and unfair; however, by consciously focusing on the seven items above, we can improve our odds of living the good life and experiencing happiness.