Category Archives: Finance

Credit Lessons From My Dad

If my father has taught me one thing in my life, it is how to properly use credit. Credit cards have a terrible connotation, but they are not evil if used properly. Don’t spend what you don’t have, pay off the card in full every month, and exploit rewards to the fullest.

A lot of people claim that they prefer to use debit cards, because that ensures that they don’t spend what they don’t have. In reality someone can check how much they spent on their credit card just as easily as their checking account online. The difference is that a bank account charges ridiculous fees every time an account is overdraw, but a credit card will just charge a percentage on the amount that isn’t paid.

Credit Cards

Credit: Sean MacEntee

I have heard a rumor that leaving a balance on a credit card helps improve your credit score. Do not leave a balance on your credit card, it does not help your credit score and costs money. One part of increasing your credit score is having more credit available to you than you use. Part of the argument for why the credit card companies want you to carry a balance is that this is how they make money. Credit card companies make money by charging a fee to retailers every time you swipe your card. The primary reason interest rates on credit cards are so high is because it is unsecured debt. Unlike an auto loan or mortgage, the bank has no collateral for the loan.

Credit cards are an extremely lucrative business and because of that, companies are willing to pay you a lot to use their card. You can earn hundreds of dollars in sign up bonuses just for starting to use a particular credit card. In addition to sign-up bonuses many cards offer miles and cash back for continued use. If you do the majority of your spending on credit cards this could mean hundreds or thousands of dollars each year in rewards. Personally, I will sign up for just about any no-fee credit card that offers a sign-up bonus. I have a couple of credit cards that I use for just about everything. A credit card can be a great financial tool if used correctly.

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What is your financial advisor worth?

Post Department of Labor ruling, financial advisors of IRAs are required to be fiduciaries. As I described in A Brave New World with the DoL ruling, the ruling essentially makes it so financial advisors have to manage funds on a fee basis. For example lets say that a financial advisor charges a 1% fee. Is that 1% fee worth it?

1% in vacuum doesn’t sound like a lot, but on $250,000 you would be paying your advisor $2,500 every year. If you meet with you advisor twice a year for about an hour that means they are charging you about $1,250 per hour. That sounds very expensive, but the ways to lower that hourly rate are to manage the money yourself or utilize your financial advisor more to make that fee more worthwhile.

Financial Advisor - April 2014

Credit: Mark Zhu

In my experience, especially in 2008, the people that really got burned were the ones who either didn’t have a financial advisor or disregarded their financial advisor. I haven’t had too many people come to me complaining that their current advisor is charging them too much, but I have had a number of people who did not understand or feel comfortable with what they owned and went to cash near the bottom. If you advisor was able to maintain your confidence and keep you invested through 2008 that 1% fee paid for itself in spades if it meant not realizing a 30%+ loss.

The second option to reduce the hourly rate is to utilize your financial advisor. Any good financial advisor has a lot of experience financial planning. Instead of looking at a financial advisor as the person that handles investments, lean on your advisor for any financial decision like when to take social security, what pension election to take, or what insurance is necessary. Many financial advisors realize the value of each client and would be willing spend the extra time. If you are paying for a financial advisor, don’t be afraid to get your money’s worth.

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F is for Finance

If you are looking for some financial vocabulary or a good book to read to your kids try F is for Finance.

Cover

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It is a great time to be young

Quite often I have older people coming in romanticizing yesteryear and the interest rates they used to get at the bank. At this point it has become a joke with many people, and yet I still see people moving from bank to bank trying to catch an extra 0.10% in interest. Two things that these same people don’t remember is that interest rates work both ways and that inflation plays a big roll in interest rates.

When most people who are now retired or are entering retirement were in their prime working years, we were in a much different interest rate environment. JP Morgan’s Guide to the Markets has a great chart that shows real and nominal yields of the 10-year Treasury bond.

jp-morgan-10-year-yield

In 1981 the 10-Year Treasury yield was 15.84%. That is a great interest rate if you are looking to generate income or grow your savings. Unfortunately for most people that are now around retirement age, in the early 80’s they were just starting to accumulate wealth and buying their first home. Can you imagine if banks tried offering 16+% mortgages nowadays? No one would be buying houses.

The second side of the equation is inflation. Inflation is how much the price of things goes up each year. Generally speaking, when interest rates are high a lot of it is due to inflation. This was the case in the early 80’s. JP Morgan has another great chart showing historic inflation.

jp-morgan-cpi

We see here that inflation in the early 80’s was extremely high along with interest rates. This means that a person back then would have been paying huge mortgage payments while at the same time losing buying power to inflation at an incredible pace in their savings account.

The bright side is that today we have the exact opposite situation. We have super low interest rates that make housing much more affordable. The buying power in our savings accounts is almost flat with such little inflation. For those millennials with substantial invested savings, they can afford to take the risk with equities that provide good long-term returns. So next time you here someone complain about today’s interest rates, remember the benefits that come with it.

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Budgeting for people who can’t budget

Millennials are currently dealing with levels of debt not previously seen in past generations. Yellowbrick created an infographic that illustrates just how bad the debt load is in America right now. Outside of debt consolidation, the next best thing people can do is control their spending. A number of methods are coming out including using automated financial tracking services, creating a budget, or altering payment methods.

Budget

Credit: Hamza Butt

Many services have come out over the years such as Mint or CashBase that are designed to automate the process of tracking spending and saving for financial goals. These have been popular among many people, but I have found that I don’t really learn much about my spending and it is a bit time consuming to track when spending cash. I’m sure for other people though, if enough time is dedicated to them, they can be very helpful.

Creating a budget seems to me like another new year’s resolution. A budget sounds like a good idea, and then a couple weeks later people find that they have only been tracking spending here and there or have given up all together. It takes a certain type of person who doesn’t mind maintaining a spreadsheet before bed every night.

The method I have used for years is to dedicate one evening a month, pay all my bills, and maintain a spreadsheet of all my bills. By paying all my bills in one day at the end of the month it is not very time consuming. I don’t use auto pay on anything. Paying my bills manually every month forces me to asses each bill and take a little time to make sure I am not overpaying something and look for ways to reduce my payments. Recently Motley Fool Answers did a podcast on automating bill pay, but I think that automated bill pay detaches the consumer from their spending. I put pretty much everything on a couple of credit cards. I always go through the charges on my statement to make sure I made the charges, and I review what I am spending money on. As I make my payments I enter them into my spreadsheet, which allows me to compare spending trends. Once my bills are paid I move money into savings. I set a minimum I want to transfer every month, but if I can transfer more I will.

My method works for me, but everyone is different. The important thing is that every family do something to track spending. With the current financial burden that many Americans face, budgeting is more important now than ever before.

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Should Millennials Rent or Buy a Home?

Usually I like to talk about things that I consider myself well qualified to speak on. This week I wanted to discuss a subject that is particularly relevant to millennials. When should someone look at buying instead of renting? I am currently dealing with this dilemma myself and trying to decide if it is worth it for me to make the plunge.

House

Credit: Danny VB 

From purely a dollar and cents point of view, it usually makes more sense for a person’s monthly payments to go towards equity in a home rather than pay someone else’s mortgage. However, buying and selling homes has a lot of short term closing costs including realtor commissions, loan origination fees, and appraisal fees. So essentially what a prospective homebuyer is looking at is a significant negative short-term return coupled with a steady long-term return. “Home ownership, like stock investing, works best as a long-term proposition,” Pollack and Olen explain. “It takes at least five years to have a reasonable chance of breaking even on a housing purchase. For the first few years, your mortgage payments mostly pay off the interest and not the principal.”

Looking at a house like an investible asset creates another risk to think about. When someone buys a stock or mutual fund, they generally purchase without any leverage. If a person buys a stock for $20 they have to pay $20. A house is one of the only assets that someone can purchase for 1/5 of what it actually costs. If we saw a market decline that was a fraction of what we saw in 2008, most new homeowners would have no equity in their home. Real estate is generally not extremely volatile, but that kind of leverage exacerbates the need to focus on purchasing a home for the long-term in-order to ride out short-term fluctuations in home prices.

Millennials are known for moving around quite a bit, so with this tendency does it make sense to rush into purchasing a home? I’m not sure it does make sense to rush into purchasing a home. If someone believes that they are going to be moving around in the next couple years, I think it makes sense to eat the rent payments and wait to purchase the right home at the right time.

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A Brave New World with the DoL ruling

In 2017 financial advisors are now considered fiduciaries regarding IRA accounts. A fiduciary is someone who puts the benefit of the owner/beneficiary of the assets over their own. Ideally, every financial advisor should always be putting their client’s benefit over their own. Unfortunately the financial industry has had a lot of people who take advantage of their clients. So my question is, what does the new Department of Labor ruling accomplish?

retirementEssentially what the ruling does is force financial advisors to manage money on a fee basis. This means that they can’t pitch individual stock, bonds, or mutual funds and charge a commission/load. Advisors now are forced to charge a predefined fee regardless of the asset managed. Charging a predefined fee takes away the conflict of interest advisors have when choosing products that pay the highest commission over what is best for the client.

If forcing financial advisors to be fiduciaries is the best thing for clients, then why not make them fiduciaries for all client accounts? Is it because the Department of Labor isn’t sure if it is the best thing? Are they worried about making such a dramatic change to the financial industry all at once?

In my opinion the ruling does not cover all accounts because they don’t want to make such a radical change all at once. Financial advisors should always be looked at as fiduciaries. That being said, the financial industry has done a good job evolving on its own when it comes to acting as a fiduciary even if it is not written into law. Even in my limited amount of time in the financial industry, I have rarely seen advisors pushing individual securities to clients on a commission basis, front-end loaded mutual funds have become much less popular, and fee based advisory services are becoming much more popular. I hope the Department of Labor ruling helps build additional trust between consumers and advisors and encourages advisors to do the best for their clients.

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