Posted By Paul
Hi Everyone,
How, I found this very old posting about personal lending just sitting in my drafts folder.
I'm posting it now even though I wrote this about 18 months ago.
So stay tuned for the epilogue on how it went.
-----
I recently learned a little about personal lending sites. They had me intrigued to the point where I decided to dip my toe in the world of personal lending.
I decided to open an account at Prosper.com and see what it was like lending money to random people.
First of all, it seemed very strange to be browsing listings of total strangers. There was a voyeuristic quality of perusing the loan listings of these people. It was fascinating to see how much money they needed and why (not to mention the interest rate they were willing to pay).
Since I was very new to this whole concept I decided to choose three different loans and loan each $25. The way these pages work is that a person who wants a loan asks for a certain amount, for a certain payback term with a certain interest rate. If the loan looks good you can contribute to the loan.
I chose two loans that were considered lower risk by prosper (with a correspondingly lower interest rate) and one high risk loan (with an interest rate of 31%). All three loans have a 3 year term.
It is kind of cool that you can just contribute $25 to a loan, so the total you need to play around is actually very small. The idea is that if someone wants to borrow $1000 they need to have enough lenders willing to contribute to their loan so that they reach their goal.
There are many strange aspects of this process. Some of the obvious ones:
-I don't honestly know if these people are using the money for what they say they are using it for (the listing says 'to payoff a credit card' but for all I know it could be going to a gambling habit)
-There is the risk that one (or more) of your borrowers will stop paying/declare bankruptcy/move off the grid, or who knows what.
My overall impression of personal lending? When I loaned out the money and every month when I get my payments (so far all three loans are being paid off on schedule) I feel like I'm playing some sort of game. I know that any form of investment can be viewed as gambling, but lending money to strangers using their internet posts to judge the likelihood of being paid back REALLY feels like gambling.
So for me, I think personal lending will just be a fun little hobby. Picking loans and watching the payments come in IS fun, but I don't think I will ever put anything more than "fun money" into one of these sites.
For some of the loans I contributed to I saw people that had made contributions in excess of $1500! I really don't see myself ever doing that. There seems to be so much uncertainty in the process that I would feel uncomfortable committing any significant amount of money to it.
Showing posts with label investment. Show all posts
Showing posts with label investment. Show all posts
Wednesday, August 22, 2012
Friday, February 18, 2011
Diversification In Action, Another Plug For Tracking Net Worth
Posted By Paul
Long time readers of Frugalize will know that I watch my net worth very closely. (see a posting from 3 years ago tracking your net worth)
One thing I didn't mention in that article was that another advantage of tracking your net worth is that you automatically get an idea of how diversified you are (or aren't), and how that's working out.
About 7 years ago I started noticing that A LOT of my net worth was in real estate (i.e. my house). That was to be expected in that my house (like many houses at the time) was growing in value quickly. As my house became more valuable it became a bigger and bigger part of my total net worth. My other investments were doing fine as well, but they just couldn't keep pace with the crazy real estate market.
My reaction to this was to make it a point to focus more on OTHER types of savings. I wasn't someone who thought that real estate was going to just keep going up forever, so I decided I didn't want to have too much of my net worth tied up in real estate. Instead I focused on my emergency fund, and other types of investments. They weren't quite as exciting as the real estate market at the time, but I figured that since I'd already gotten a piece of that I didn't need to put all of my eggs in that one basket.
So today I realized one consequence of this choice was that in the last year or so my net worth has been tracking steadily up, even though the value of my home has been steadily trending down (Of course knowing the value of your home is always tricky, but I just use zillow for simplicity, and figure it is at least in the ballpark).
So even though my house is losing value, overall my net worth is continuing to grow. This is a direct consequence of having made other investments years back that offset the cooling real estate market now.
It's nice to know that my net worth isn't completely driven by the value of my home.
I think I'm going to stick with this strategy of always trying to stay diversified. I get a piece of every boom, and of course every bust as well. Thanks to the fact that I track my net worth I can honestly say that so far the strategy is working for me and overall I'm coming out ahead.
Long time readers of Frugalize will know that I watch my net worth very closely. (see a posting from 3 years ago tracking your net worth)
One thing I didn't mention in that article was that another advantage of tracking your net worth is that you automatically get an idea of how diversified you are (or aren't), and how that's working out.
About 7 years ago I started noticing that A LOT of my net worth was in real estate (i.e. my house). That was to be expected in that my house (like many houses at the time) was growing in value quickly. As my house became more valuable it became a bigger and bigger part of my total net worth. My other investments were doing fine as well, but they just couldn't keep pace with the crazy real estate market.
My reaction to this was to make it a point to focus more on OTHER types of savings. I wasn't someone who thought that real estate was going to just keep going up forever, so I decided I didn't want to have too much of my net worth tied up in real estate. Instead I focused on my emergency fund, and other types of investments. They weren't quite as exciting as the real estate market at the time, but I figured that since I'd already gotten a piece of that I didn't need to put all of my eggs in that one basket.
So today I realized one consequence of this choice was that in the last year or so my net worth has been tracking steadily up, even though the value of my home has been steadily trending down (Of course knowing the value of your home is always tricky, but I just use zillow for simplicity, and figure it is at least in the ballpark).
So even though my house is losing value, overall my net worth is continuing to grow. This is a direct consequence of having made other investments years back that offset the cooling real estate market now.
It's nice to know that my net worth isn't completely driven by the value of my home.
I think I'm going to stick with this strategy of always trying to stay diversified. I get a piece of every boom, and of course every bust as well. Thanks to the fact that I track my net worth I can honestly say that so far the strategy is working for me and overall I'm coming out ahead.
Sunday, October 18, 2009
Links: Good info sources for annuities.
Posted By Paul
As I did my research on annuities I found some links that I wanted to pass on:
AnnuityTruth.org - specializes in info for annuities for seniors
Ultimate Guide to Retirement: Annuities - A great page from CNNMoney with all kinds of info about the different types of annuities. A must read for anyone thinking of purchasing an annuity.
Useful info to find out more about annuities.
As I did my research on annuities I found some links that I wanted to pass on:
AnnuityTruth.org - specializes in info for annuities for seniors
Ultimate Guide to Retirement: Annuities - A great page from CNNMoney with all kinds of info about the different types of annuities. A must read for anyone thinking of purchasing an annuity.
Useful info to find out more about annuities.
Wednesday, October 14, 2009
What the heck is an annuity part 4: Variable with Life
Posted By Paul
This is going to be my next to last posting in the annuity series (my final posting will be a collection of useful info sources I found on annuities). I'm going to talk about the most controversial member of the annuity family, the variable annuity with life.
This is a very strange investment vehicle in that it is a mix of life insurance and fund investment. Essentially you put money every month into the variable annuity, part of that payment goes into the insurance component of your account (essentially like a life insurance premium) and the other part goes into "sub accounts" (mutual funds that you can choose from a family).
So what is the appeal? Well a common argument is that you get life insurance AND a retirement vehicle. You often hear of the idea that down the road you borrow against the cash value of your annuity which means you get your money tax free. I've heard of financial advisers presenting this idea as if it were something they had thought of.
What is the downside? Here are two of the most basic arguments against variable annuities with life insurance:
1) If you want life insurance, just go and buy life insurance - my research into this mentions that generally if you compare the money you pay for life insurance through a variable annuity to just getting a normal life insurance policy you'll discover that the life insurance through the annuity is MUCH more expensive.
2) Just as with regular variable annuities, watch out for fees. Brokerage fees, fund fees, commissions, maintenance fees. They can eat up your investment quickly.
I also found in my research that when you hear about "life insurance scams" that most often it is in the form of a variable annuity with life insurance product. This doesn't surprise me since the whole variable annuity with life insurance is a great product if you want to confuse and deceive someone since you have a variable annuity (which is already a complicated and poorly defined product) and you toss in life insurance (which is a complicated thing unto itself). A variable annuity with life insurance takes these two complicated things and mashes them together into a product that is almost impossible to understand, and makes it VERY easy to hide fees.
To give a personal slant to this, I had a variable annuity/life insurance policy for a short time. I opened it and then later closed it and luckily I didn't lose much.
So what did I learn from my brush with variable annuity/life insurance policies?
-They are confusing. When I first invested I THOUGHT I knew how it all worked but only after watching it closely did I see the fees and how the affected my return on investment.
-There is inertia and psychology involved. For example when I opened my annuity I put in a small amount of money and I watched it closely. I shudder to think what would have happened if I had put my whole nest egg in there and just stopped checking it and figured it was doing fine.
-They have all kinds if little ways to keep the money rolling in. With my annuity I would get a letter every few months saying that I had been offered an increase in my life insurance death benefit, and that for just X dollars more a month I would get an additional coverage of Y dollars in death benefit. The worst part was that the letters said that unless I contacted them they would assume I wanted the increase in benefit (and premium). It got to be annoying to have to write or call them every few month and tell them NOT to raise my premium. Imagine if I had just ignored the letters? Then every few months my premium would have gone up a little and who knows where it would have ended up.
It sounds like I'm pretty down on this type of product, and I would have to say that for the most part I am.
If you read my previous article on variable annuities you may recall that I suggested going into it ASSUMING it's a bad investment and then see if you can be convinced otherwise. For the variable annuity with life insurance it's so complicated and easily prone to hidden fees and catches that I would take my warning even further.
For a variable annuity/life insurance product I would suggest the following rules:
1) If you aren't taking full advantage of 401k/Roth IRA options then don't even think of looking at this product.
2) If someone offers you an annuity life insurance product, find out what it would cost to get the equivalent death benefit with out the annuity part.
3) Take some time to find the fees. They are in there, so see where they are and how much they are, ask about broker commissions, fund fees, maintenance fees and so on.
4) Do not invest in this product unless you can get an impartial knowledgeable person to think it's a good idea. When I say impartial I mean someone who is not making or losing money based on whether or not you invest in this product. This is NOT the type of product where you should trust the person who is selling you the product.
5) Do the research. This is also NOT the type of product where you should think: "well my aunt has one and she likes it, so mine's probably okay". There is so much variety among these products that your aunt could have a totally different TYPE of product, and maybe your aunt has one but doesn't really understand how it works either.
6) If anyone suggests that you invest in this type of product, ask yourself: "Would this person make money off of my investment?" If the answer is yes, then take EVERYTHING they say with a huge grain of salt.
There might be people in situations where this type of product is a good idea, but I would predict that this type of investment is probably the most commonly owned "bad" investment.
If you are someone who has this type of product and you don't really understand it I would do some serious research into your product, just some basic things like:
1) Find out what your death benefit is and do a little research to see what it cost you to get the same benefit from a reputable insurance company without all of the annuity stuff.
2) Check your subaccounts, find out what their maintenance fees are, compare them to mutual funds at Vanguard.
If you are at all worried after doing the above, then consider finding a financial adviser that is paid by the hour and seeing what they think, or perhaps just find a trusted friend or family member that is "into investing" and have them look over the account and see what they think. The worst thing to do is to be in a bad investment and continually paying month after month.
This is going to be my next to last posting in the annuity series (my final posting will be a collection of useful info sources I found on annuities). I'm going to talk about the most controversial member of the annuity family, the variable annuity with life.
This is a very strange investment vehicle in that it is a mix of life insurance and fund investment. Essentially you put money every month into the variable annuity, part of that payment goes into the insurance component of your account (essentially like a life insurance premium) and the other part goes into "sub accounts" (mutual funds that you can choose from a family).
So what is the appeal? Well a common argument is that you get life insurance AND a retirement vehicle. You often hear of the idea that down the road you borrow against the cash value of your annuity which means you get your money tax free. I've heard of financial advisers presenting this idea as if it were something they had thought of.
What is the downside? Here are two of the most basic arguments against variable annuities with life insurance:
1) If you want life insurance, just go and buy life insurance - my research into this mentions that generally if you compare the money you pay for life insurance through a variable annuity to just getting a normal life insurance policy you'll discover that the life insurance through the annuity is MUCH more expensive.
2) Just as with regular variable annuities, watch out for fees. Brokerage fees, fund fees, commissions, maintenance fees. They can eat up your investment quickly.
I also found in my research that when you hear about "life insurance scams" that most often it is in the form of a variable annuity with life insurance product. This doesn't surprise me since the whole variable annuity with life insurance is a great product if you want to confuse and deceive someone since you have a variable annuity (which is already a complicated and poorly defined product) and you toss in life insurance (which is a complicated thing unto itself). A variable annuity with life insurance takes these two complicated things and mashes them together into a product that is almost impossible to understand, and makes it VERY easy to hide fees.
To give a personal slant to this, I had a variable annuity/life insurance policy for a short time. I opened it and then later closed it and luckily I didn't lose much.
So what did I learn from my brush with variable annuity/life insurance policies?
-They are confusing. When I first invested I THOUGHT I knew how it all worked but only after watching it closely did I see the fees and how the affected my return on investment.
-There is inertia and psychology involved. For example when I opened my annuity I put in a small amount of money and I watched it closely. I shudder to think what would have happened if I had put my whole nest egg in there and just stopped checking it and figured it was doing fine.
-They have all kinds if little ways to keep the money rolling in. With my annuity I would get a letter every few months saying that I had been offered an increase in my life insurance death benefit, and that for just X dollars more a month I would get an additional coverage of Y dollars in death benefit. The worst part was that the letters said that unless I contacted them they would assume I wanted the increase in benefit (and premium). It got to be annoying to have to write or call them every few month and tell them NOT to raise my premium. Imagine if I had just ignored the letters? Then every few months my premium would have gone up a little and who knows where it would have ended up.
It sounds like I'm pretty down on this type of product, and I would have to say that for the most part I am.
If you read my previous article on variable annuities you may recall that I suggested going into it ASSUMING it's a bad investment and then see if you can be convinced otherwise. For the variable annuity with life insurance it's so complicated and easily prone to hidden fees and catches that I would take my warning even further.
For a variable annuity/life insurance product I would suggest the following rules:
1) If you aren't taking full advantage of 401k/Roth IRA options then don't even think of looking at this product.
2) If someone offers you an annuity life insurance product, find out what it would cost to get the equivalent death benefit with out the annuity part.
3) Take some time to find the fees. They are in there, so see where they are and how much they are, ask about broker commissions, fund fees, maintenance fees and so on.
4) Do not invest in this product unless you can get an impartial knowledgeable person to think it's a good idea. When I say impartial I mean someone who is not making or losing money based on whether or not you invest in this product. This is NOT the type of product where you should trust the person who is selling you the product.
5) Do the research. This is also NOT the type of product where you should think: "well my aunt has one and she likes it, so mine's probably okay". There is so much variety among these products that your aunt could have a totally different TYPE of product, and maybe your aunt has one but doesn't really understand how it works either.
6) If anyone suggests that you invest in this type of product, ask yourself: "Would this person make money off of my investment?" If the answer is yes, then take EVERYTHING they say with a huge grain of salt.
There might be people in situations where this type of product is a good idea, but I would predict that this type of investment is probably the most commonly owned "bad" investment.
If you are someone who has this type of product and you don't really understand it I would do some serious research into your product, just some basic things like:
1) Find out what your death benefit is and do a little research to see what it cost you to get the same benefit from a reputable insurance company without all of the annuity stuff.
2) Check your subaccounts, find out what their maintenance fees are, compare them to mutual funds at Vanguard.
If you are at all worried after doing the above, then consider finding a financial adviser that is paid by the hour and seeing what they think, or perhaps just find a trusted friend or family member that is "into investing" and have them look over the account and see what they think. The worst thing to do is to be in a bad investment and continually paying month after month.
Sunday, October 11, 2009
What the heck is an annuity part 3: Variable
Posted By Paul
As I go through the various types of annuities I seem to be gradually moving towards the more controversial types of annuities, and that brings us to one of the more controversial members of the annuity family, the variable annuity.
So what's a variable annuity? Here are the basic characteristics of a variable annuity:
1) Tax deferred - gains are only taxed when you withdraw them.
2) Fund based - your money is going into some sort of mutual or bond fund that you select (generally an annuity offers 6-12 funds that you choose from).
The variable part just means that your money is going into an investment, your return is based on how well those investments do. There is no guaranteed return.
I'm guessing that a lot of you are thinking: "This sort of sounds like a 401k." and you're right. It is SORT OF like a 401k, but that SORT OF is important.
In my research the main thing to watch in this sort of annuity is the fees. There are often high management fees, commissions for the agent who sold it to you, and other little fees like that. The fees may seem like a minor thing, but imagine if the fees end up being 2% of your total investment, you need to make 2% to just break even, and even more to beat inflation.
It seems that these fees are what typically give these types of investments a bad name. Even if you don't see any specific up front fees, the funds themselves might have a very high expense ratio. To see what that means go to my earlier post:
A Few Quick Tips On Mutual Funds
The question now is, are variable annuities something to avoid at all costs? Well I'd say that you should ONLY look at a variable annuity if you are already taking full advantage of your allowed contributions for your 401k AND Roth IRA.
If you decide to look into a variable annuity I would be VERY careful. I hate to recommend paranoia but this is one of those situations where I would suggest going into the situation with a very skeptical eye. Assume that the variable annuity is of the "bad" type (high commissions, high fees, etc.) and only invest if you are convinced this isn't the case.
Also, I would suggest that you observe the agent you are dealing with very closely. If they seem to be trying to conceal or downplay various fees and commissions, I would be VERY careful.
Finally, if anyone tells you that you should take your IRA or 401k and roll it into a variable annuity, consider this a HUGE RED FLAG! I found several articles that said that this sort of suggestion is essentially like saying:
"Hey let's take your big pile of money in a low fee environment and roll it into an investment with high fees and commissions without any added tax benefits."
If you have money in a variable annuity, I would suggest that you take a very hard look at it and see just how much you are paying in fees and then see how that is affecting your investments.
As I go through the various types of annuities I seem to be gradually moving towards the more controversial types of annuities, and that brings us to one of the more controversial members of the annuity family, the variable annuity.
So what's a variable annuity? Here are the basic characteristics of a variable annuity:
1) Tax deferred - gains are only taxed when you withdraw them.
2) Fund based - your money is going into some sort of mutual or bond fund that you select (generally an annuity offers 6-12 funds that you choose from).
The variable part just means that your money is going into an investment, your return is based on how well those investments do. There is no guaranteed return.
I'm guessing that a lot of you are thinking: "This sort of sounds like a 401k." and you're right. It is SORT OF like a 401k, but that SORT OF is important.
In my research the main thing to watch in this sort of annuity is the fees. There are often high management fees, commissions for the agent who sold it to you, and other little fees like that. The fees may seem like a minor thing, but imagine if the fees end up being 2% of your total investment, you need to make 2% to just break even, and even more to beat inflation.
It seems that these fees are what typically give these types of investments a bad name. Even if you don't see any specific up front fees, the funds themselves might have a very high expense ratio. To see what that means go to my earlier post:
A Few Quick Tips On Mutual Funds
The question now is, are variable annuities something to avoid at all costs? Well I'd say that you should ONLY look at a variable annuity if you are already taking full advantage of your allowed contributions for your 401k AND Roth IRA.
If you decide to look into a variable annuity I would be VERY careful. I hate to recommend paranoia but this is one of those situations where I would suggest going into the situation with a very skeptical eye. Assume that the variable annuity is of the "bad" type (high commissions, high fees, etc.) and only invest if you are convinced this isn't the case.
Also, I would suggest that you observe the agent you are dealing with very closely. If they seem to be trying to conceal or downplay various fees and commissions, I would be VERY careful.
Finally, if anyone tells you that you should take your IRA or 401k and roll it into a variable annuity, consider this a HUGE RED FLAG! I found several articles that said that this sort of suggestion is essentially like saying:
"Hey let's take your big pile of money in a low fee environment and roll it into an investment with high fees and commissions without any added tax benefits."
If you have money in a variable annuity, I would suggest that you take a very hard look at it and see just how much you are paying in fees and then see how that is affecting your investments.
Saturday, September 26, 2009
What the heck is an annuity part 2: fixed deferred
Posted By Paul
I came across another major annuity type called the "fixed deferred" or "fixed interest deferred" annuity that I wanted to talk about.
A fixed interest deferred annuity is kind of like a savings account, so I'm going to assume we all know what a savings account is and describe the annuity in contrast to that.
1) Like a savings account a fixed annuity gives you a known return on your money. In fact with fixed annuities you generally "lock in" an interest rate for some amount of time (like 5 years) and then after that interval has expired you "lock in" a rate again. One example is that Vanguard has a fixed annuity where if you open today you get a rate of 2.65% for the next 5 years. Note that this isn't a bad rate, in fact it's better than most CD's you can find right now.
BEWARE: I read about places where you get some awesome rate for the first year and then after that it resets to something lame, only now they have your money and you have to go through all kinds of hassle to move it.
2) Unlike a savings account, any interest you get is tax deferred. You don't pay taxes on it until you take it out.
3) Unlike a savings account, you can't just deposit and withdraw money whenever you feel like it. They vary, but it seems like most places have rules about how and when you can withdraw your money. The one through Vanguard for example says you can take out 10% of your savings in a year without penalty (but be careful, as with all tax deferred vehicles there can be tax consequences for getting your money out early). From my research it also seems that in most cases to add money you have to open a whole new annuity.
The above points generally capture what this type of annuity is. It's sort of like a 401k (you get the tax deferred part) and kind of like a savings account or CD (guaranteed interest).
So what are the pros and cons? Here is what I was able to come up with:
Pros: You get all the perks of a savings account PLUS tax deferral.
Cons: This is money you shouldn't plan on touching until the terms of the annuity are met. If you needed to "break open the piggy bank" early then tax and penalties could eat in to your money fast.
Overall, I think that this sort of annuity isn't a bad thing to consider if you've already given all you can to your 401k AND Roth IRA and still have money to sock away. When considering this sort of annuity BE SURE TO READ THE FINE PRINT and make sure you know what you're getting. Key questions to ask are:
1) What is my rate and how long does it lock in?
2) Is this rate an introductory rate?
3) How can I withdraw my money and what kind of withdrawal limits/penalties are there?
4) Is there any way to deposit additional money?
One interesting point is that when you compare this to my previous post:
What the heck is an annuity? Part 1
You'll see that this type of annuity is VERY different from the type I describe in my earlier post. As I mentioned before (and will mention again) that's one thing I REALLY don't like about annuities, it's such a broad term.
Once again I'll close with a quote from Warren Buffett about business investing, but it applies just as well to investment vehicles:
"Never invest in a business you cannot understand. "
I came across another major annuity type called the "fixed deferred" or "fixed interest deferred" annuity that I wanted to talk about.
A fixed interest deferred annuity is kind of like a savings account, so I'm going to assume we all know what a savings account is and describe the annuity in contrast to that.
1) Like a savings account a fixed annuity gives you a known return on your money. In fact with fixed annuities you generally "lock in" an interest rate for some amount of time (like 5 years) and then after that interval has expired you "lock in" a rate again. One example is that Vanguard has a fixed annuity where if you open today you get a rate of 2.65% for the next 5 years. Note that this isn't a bad rate, in fact it's better than most CD's you can find right now.
BEWARE: I read about places where you get some awesome rate for the first year and then after that it resets to something lame, only now they have your money and you have to go through all kinds of hassle to move it.
2) Unlike a savings account, any interest you get is tax deferred. You don't pay taxes on it until you take it out.
3) Unlike a savings account, you can't just deposit and withdraw money whenever you feel like it. They vary, but it seems like most places have rules about how and when you can withdraw your money. The one through Vanguard for example says you can take out 10% of your savings in a year without penalty (but be careful, as with all tax deferred vehicles there can be tax consequences for getting your money out early). From my research it also seems that in most cases to add money you have to open a whole new annuity.
The above points generally capture what this type of annuity is. It's sort of like a 401k (you get the tax deferred part) and kind of like a savings account or CD (guaranteed interest).
So what are the pros and cons? Here is what I was able to come up with:
Pros: You get all the perks of a savings account PLUS tax deferral.
Cons: This is money you shouldn't plan on touching until the terms of the annuity are met. If you needed to "break open the piggy bank" early then tax and penalties could eat in to your money fast.
Overall, I think that this sort of annuity isn't a bad thing to consider if you've already given all you can to your 401k AND Roth IRA and still have money to sock away. When considering this sort of annuity BE SURE TO READ THE FINE PRINT and make sure you know what you're getting. Key questions to ask are:
1) What is my rate and how long does it lock in?
2) Is this rate an introductory rate?
3) How can I withdraw my money and what kind of withdrawal limits/penalties are there?
4) Is there any way to deposit additional money?
One interesting point is that when you compare this to my previous post:
What the heck is an annuity? Part 1
You'll see that this type of annuity is VERY different from the type I describe in my earlier post. As I mentioned before (and will mention again) that's one thing I REALLY don't like about annuities, it's such a broad term.
Once again I'll close with a quote from Warren Buffett about business investing, but it applies just as well to investment vehicles:
"Never invest in a business you cannot understand. "
Tuesday, September 22, 2009
The 100 Rule For Investment Allocation
Posted By Paul
Have you ever heard of the '100 Rule' for asset allocation? The idea is that you subtract your age from 100 and the result is the percentage of your investments that should be in stocks (as opposed to less aggressive bond funds or the like).
Well I'd heard of it and recently decided to see if I was adhering well to that rule. Well imagine my surprise when I saw that my Vanguard fund (designed to automatically transition to more conservative funds as time goes by) wasn't even close.
A little research took me this article:
Money Savvy Rules of Thumb
Which specifically mentions the '100 Rule' (rule number 3) and says that this formula is too conservative considering the current longer lifespans of people. They suggest using a '120 Rule' which is right in line with my Vanguard fund, but unfortunately not as catchy.
Have you ever heard of the '100 Rule' for asset allocation? The idea is that you subtract your age from 100 and the result is the percentage of your investments that should be in stocks (as opposed to less aggressive bond funds or the like).
Well I'd heard of it and recently decided to see if I was adhering well to that rule. Well imagine my surprise when I saw that my Vanguard fund (designed to automatically transition to more conservative funds as time goes by) wasn't even close.
A little research took me this article:
Money Savvy Rules of Thumb
Which specifically mentions the '100 Rule' (rule number 3) and says that this formula is too conservative considering the current longer lifespans of people. They suggest using a '120 Rule' which is right in line with my Vanguard fund, but unfortunately not as catchy.
Friday, September 18, 2009
What the heck is an annuity? Part 1 - Single Premium Fixed Immediate Lifetime
Posted By Paul
As I try to become better at understanding the financial world, one word that pops up every now and then is 'annuity'.
I realized recently that I really don't have any idea what one is. I have this vague sense that I'm not interested in them, but that's not really based on anything rational, so I thought I'd do some research and share what I've found.
Here's what I've learned:
First of all, annuity is a REALLY broad term. To define it in terms that apply to all of the different flavors you end up with something like:
An annuity is an agreement (generally with an insurance company) to pay out money for a period of time.
Pretty general huh? Well it is, and that's probably why annuities get such a bad reputation, there are so many different flavors of annuity (not to mention many providers) that it's really easy to end up with a bad one.
So I'm going to start off with what I consider to be the simplest type of annuity: the single premium fixed immediate lifetime annuity.
Quite a long name, but the terms make sense if you take them individually:
Singe Premium - means there is one premium (essentially you buy it with a lump sum)
Fixed - means the payments don't vary
Immediate - means that the payments start immediately
Lifetime - means the payments continue for as long as you are alive
This type of annuity is essentially a policy that you buy with an insurance company that says that the insurance company will pay you a certain amount of money for the rest of your life.
A hypothetical example, if I were an insurance company, I might say that if you pay me $50,000 today then I will pay you $100 a month for the rest of your life.
I found a very simple web annuity quote calculator and asked it the question:
If I were age 40 (the calculator had 40 as the minimum age) and wanted an annuity that paid me $200 a month until I died, what would it cost me?
The answer? About $41k. So the question then is, is it worth it? If I just took my $41k and stuck it under the mattress and took out $200 a month, how long would that last? The quick math says I would run out of money in about 17 years. So from that calculation it seems like a pretty good deal since I plan on living longer than 17 years.
But of course if you didn't buy the annuity you probably wouldn't just put the money in your mattress, so how best to compare that?
That gets difficult, but luckily I found a savings calculator that you can use to see how long savings will last assuming a certain APR and monthly withdrawal.
If you're curious the savings calculator is here.
Using this calculator, if I start with $41k and take out $200 a month then the amount it will last depends on the APR, but for a few values comes to:
24 years at 3% interest
28.8 years at 4% interest
38.6 years at 5% interest
Interesting. At this point you start to see the trade off between having the annuity and keeping the money for yourself. Here are some of the pros and cons of the annuity:
Pros:
1) Takes some of the uncertainty out of retirement savings, with this sort of annuity you know exactly how much you'll having coming in for the rest of your life.
2) Low risk, assuming the insurance company stays solvent, you'll get your money.
Cons:
1) It's possible that you could meet or beat the returns by just managing the money yourself.
2) If you die an early and untimely death, no money is paid to beneficiaries the money is just gone (note that there ARE annuities that include a death benefit but they cost more).
3) Your lump sum is gone, so if something happens where you wanted that lump sum back, you're out of luck.
Overall, this type of annuity doesn't seem like a terrible thing from an investment standpoint, but remember, this is just ONE type of annuity, there are so many types of annuities out there that you REALLY need to be careful to make sure you're getting what you're expecting.
I'll close this (and probably all my annuity related posts) with a quote from Warren Buffett (he uses it to refer to investing it in a particular business, but I think it applies just as well to any investment vehicle):
"Never invest in a business you cannot understand. "
As I try to become better at understanding the financial world, one word that pops up every now and then is 'annuity'.
I realized recently that I really don't have any idea what one is. I have this vague sense that I'm not interested in them, but that's not really based on anything rational, so I thought I'd do some research and share what I've found.
Here's what I've learned:
First of all, annuity is a REALLY broad term. To define it in terms that apply to all of the different flavors you end up with something like:
An annuity is an agreement (generally with an insurance company) to pay out money for a period of time.
Pretty general huh? Well it is, and that's probably why annuities get such a bad reputation, there are so many different flavors of annuity (not to mention many providers) that it's really easy to end up with a bad one.
So I'm going to start off with what I consider to be the simplest type of annuity: the single premium fixed immediate lifetime annuity.
Quite a long name, but the terms make sense if you take them individually:
Singe Premium - means there is one premium (essentially you buy it with a lump sum)
Fixed - means the payments don't vary
Immediate - means that the payments start immediately
Lifetime - means the payments continue for as long as you are alive
This type of annuity is essentially a policy that you buy with an insurance company that says that the insurance company will pay you a certain amount of money for the rest of your life.
A hypothetical example, if I were an insurance company, I might say that if you pay me $50,000 today then I will pay you $100 a month for the rest of your life.
I found a very simple web annuity quote calculator and asked it the question:
If I were age 40 (the calculator had 40 as the minimum age) and wanted an annuity that paid me $200 a month until I died, what would it cost me?
The answer? About $41k. So the question then is, is it worth it? If I just took my $41k and stuck it under the mattress and took out $200 a month, how long would that last? The quick math says I would run out of money in about 17 years. So from that calculation it seems like a pretty good deal since I plan on living longer than 17 years.
But of course if you didn't buy the annuity you probably wouldn't just put the money in your mattress, so how best to compare that?
That gets difficult, but luckily I found a savings calculator that you can use to see how long savings will last assuming a certain APR and monthly withdrawal.
If you're curious the savings calculator is here.
Using this calculator, if I start with $41k and take out $200 a month then the amount it will last depends on the APR, but for a few values comes to:
24 years at 3% interest
28.8 years at 4% interest
38.6 years at 5% interest
Interesting. At this point you start to see the trade off between having the annuity and keeping the money for yourself. Here are some of the pros and cons of the annuity:
Pros:
1) Takes some of the uncertainty out of retirement savings, with this sort of annuity you know exactly how much you'll having coming in for the rest of your life.
2) Low risk, assuming the insurance company stays solvent, you'll get your money.
Cons:
1) It's possible that you could meet or beat the returns by just managing the money yourself.
2) If you die an early and untimely death, no money is paid to beneficiaries the money is just gone (note that there ARE annuities that include a death benefit but they cost more).
3) Your lump sum is gone, so if something happens where you wanted that lump sum back, you're out of luck.
Overall, this type of annuity doesn't seem like a terrible thing from an investment standpoint, but remember, this is just ONE type of annuity, there are so many types of annuities out there that you REALLY need to be careful to make sure you're getting what you're expecting.
I'll close this (and probably all my annuity related posts) with a quote from Warren Buffett (he uses it to refer to investing it in a particular business, but I think it applies just as well to any investment vehicle):
"Never invest in a business you cannot understand. "
Tuesday, May 12, 2009
0% return?!?! - Update on Series I Savings Bonds
Posted by Paul
(for more detailed info on savings bonds see previous posts on savings bonds: Savings Bonds 8/27/07 and Savings Bonds Revisited 8/22/08)
Those of us who have purchased or who have been following the Series I savings bond got to see some history as the interest rate for a new Series I bond went to 0% for the first time since the I Bond was created over 10 years ago.
What happened? Well the quick summary is that the I bond return is tied to the inflation rate, and for the first time since the bond was created the inflation rate (which is published twice a year in November and May) was negative (specifically -2.78%). If you do the math, this means that the return rate of your bond is negative (even if you bought I bonds when their rate was highest back in 2000 the calculation results in a negative number). Luckily it is made clear that when the rate of the bond goes below 0 it just gets set to 0.
So what does this all mean? Well there is a whole article talking about it here:
Yikes! Series I Savings Bonds paying 0.0%
To summarize some specific points from the article:
"That means your money is still safe from inflation, but you’re getting the same return you’d get by burying it in a coffee can in the back yard."
The article managed to find a small silver lining in all this:
"If you do decide to dump your Series I bonds, you’re in luck. Normally, if you sell a bond less than five years after you bought it, you have to pay a penalty equal to three months interest. Since you’re getting no interest, you’ll owe no penalty."(Hooray?)
For me, I'm just going to hold onto my bonds and see what happens when the rates reset again in six months.
(for more detailed info on savings bonds see previous posts on savings bonds: Savings Bonds 8/27/07 and Savings Bonds Revisited 8/22/08)
Those of us who have purchased or who have been following the Series I savings bond got to see some history as the interest rate for a new Series I bond went to 0% for the first time since the I Bond was created over 10 years ago.
What happened? Well the quick summary is that the I bond return is tied to the inflation rate, and for the first time since the bond was created the inflation rate (which is published twice a year in November and May) was negative (specifically -2.78%). If you do the math, this means that the return rate of your bond is negative (even if you bought I bonds when their rate was highest back in 2000 the calculation results in a negative number). Luckily it is made clear that when the rate of the bond goes below 0 it just gets set to 0.
So what does this all mean? Well there is a whole article talking about it here:
Yikes! Series I Savings Bonds paying 0.0%
To summarize some specific points from the article:
"That means your money is still safe from inflation, but you’re getting the same return you’d get by burying it in a coffee can in the back yard."
The article managed to find a small silver lining in all this:
"If you do decide to dump your Series I bonds, you’re in luck. Normally, if you sell a bond less than five years after you bought it, you have to pay a penalty equal to three months interest. Since you’re getting no interest, you’ll owe no penalty."(Hooray?)
For me, I'm just going to hold onto my bonds and see what happens when the rates reset again in six months.
Tuesday, March 17, 2009
Article: 7 New Rules of Financial Security
Posted By Paul
A great article listing new rules for financial security.
You can read the full article at:
The 7 new rules of financial security
I also thought I'd summarize them here:
Rule 1: Risk
It essentially says that you need to be very careful to make sure that invested money is available when you need it. There have been many stories of people with college or retirement funds invested in high-risk stocks that collapsed right when they needed the money.
Rule 2: Cash
This talks about having a nice rainy day fund of cash available quickly when you need it. Matt and I talk about this all the time.
Rule 3: Human capital
This was interesting, the article suggests that you not only look at risk but also the stability of your job when considering investment risk.
Rule 4: Borrowing
It essentially says to borrow cautiously. View debt as a necessary evil.
Rule 5: Housing
Says to not fall into the trap of viewing your house as a no-risk investment.
Rule 6: Diversification
Suggest a really close look at diversification.
Rule 7: Retirement
Retiring early is NOT easy to do.
A great article listing new rules for financial security.
You can read the full article at:
The 7 new rules of financial security
I also thought I'd summarize them here:
Rule 1: Risk
It essentially says that you need to be very careful to make sure that invested money is available when you need it. There have been many stories of people with college or retirement funds invested in high-risk stocks that collapsed right when they needed the money.
Rule 2: Cash
This talks about having a nice rainy day fund of cash available quickly when you need it. Matt and I talk about this all the time.
Rule 3: Human capital
This was interesting, the article suggests that you not only look at risk but also the stability of your job when considering investment risk.
Rule 4: Borrowing
It essentially says to borrow cautiously. View debt as a necessary evil.
Rule 5: Housing
Says to not fall into the trap of viewing your house as a no-risk investment.
Rule 6: Diversification
Suggest a really close look at diversification.
Rule 7: Retirement
Retiring early is NOT easy to do.
Wednesday, December 3, 2008
Article: Beware of free financial advice.
Posted By Paul
Great article today on some of the things to watch out for when considering financial planners.
First some excerpts that I found interesting:
"Your bank may be very good and you may even play golf with your banker. Make no mistake that a bank is also in business to make money. So if your bank is giving investment advice, you can be pretty sure there is something in it for them. They may not charge you by the hour but they are making money nonetheless." -and- "What I consider to be abuses fall under two categories:
Beware of free financial advice
To add a little advice of my own:
I have heard people say that their financial planners are great, and best of all, they work for free. This reminds me of an earlier post:
Know Their Agenda: Some great advice I got.
The short version: OF COURSE they aren't working for free, the question is HOW are they getting paid.
I think that the most common way that financial advisers make their money is by recommending funds that have loads and fees associated with them.
What bothers me is that it is SO easy to check mutual funds to see if their fees are excessive or not.
I don't think there's anything wrong with having an adviser, knowing that you are paying them through mutual fund fees, and being okay with that. I just worry that people out there think that somehow the adviser really is working for free.
If you have an adviser that you think is working "for free" then you might want to take a look at the following articles:
A Few Quick Tips On Mutual Funds
What are you really paying for advice?
Paying an adviser doesn't mean you are getting swindled, but paying an adviser AND NOT KNOWING IT seems like a bad idea all around.
Great article today on some of the things to watch out for when considering financial planners.
First some excerpts that I found interesting:
"Your bank may be very good and you may even play golf with your banker. Make no mistake that a bank is also in business to make money. So if your bank is giving investment advice, you can be pretty sure there is something in it for them. They may not charge you by the hour but they are making money nonetheless." -and- "What I consider to be abuses fall under two categories:
First, there are the expensive mutual funds with front-end or back-end loads. These pay handsome commissions to the banks and, of course, have a great track record of under performing no-load mutual funds.
Second, there are the ever-popular permanent insurance policies that come in flavors such as whole life, variable annuities and universal life. These are even bigger cash cows to the banks that partner to sell them."
Here is the full article:Beware of free financial advice
To add a little advice of my own:
I have heard people say that their financial planners are great, and best of all, they work for free. This reminds me of an earlier post:
Know Their Agenda: Some great advice I got.
The short version: OF COURSE they aren't working for free, the question is HOW are they getting paid.
I think that the most common way that financial advisers make their money is by recommending funds that have loads and fees associated with them.
What bothers me is that it is SO easy to check mutual funds to see if their fees are excessive or not.
I don't think there's anything wrong with having an adviser, knowing that you are paying them through mutual fund fees, and being okay with that. I just worry that people out there think that somehow the adviser really is working for free.
If you have an adviser that you think is working "for free" then you might want to take a look at the following articles:
A Few Quick Tips On Mutual Funds
What are you really paying for advice?
Paying an adviser doesn't mean you are getting swindled, but paying an adviser AND NOT KNOWING IT seems like a bad idea all around.
Thursday, November 6, 2008
Topic Revisited: Investing In Gold
Posted By Paul
My next revisiting of an earlier post is an article I wrote on August 24, 2007 entitled:
Investing in gold
So now that it is over a year since that first post, have my feelings on gold changed?
In some ways they have quite a bit. I still feel like gold should be viewed as an investment with its own risks, and that these risks really aren't all that different from investing in individual securities.
It seems like recently there has been a lot of talk of using a gold as a way to avoid the craziness of the stock market.
I would have to agree with this article:
Buying gold as a safe haven
Which essentially says that buying gold as a way to avoid crazy fluctuations in your investment doesn't make much sense.
Also, after buying a few ounces of gold I seem to have noticed that at least for me the gold I have purchased has become less and less of an investment.
For example, when my son was born I decided to go out and buy a gold coin minted in the year of his birth. My hope is to some day give it to him as an heirloom gift.
This essentially means that I never plan on selling the coin, and more importantly I hope that my son values the history of it and doesn't view it as a savings bond that should be cashed in when he needs a few extra bucks.
So by not planning on ever selling this coin, it has ceased to become a financial investment. I suppose that if things ever got so dire that I needed the money I could sell the coin, but I really don't plan to do that.
Here is another example: The first gold coin that I bought (which I purchased after writing the first gold post) has no historical or sentimental value to me. So I could consider that an investment in that I could sell it at a moment's notice without any feeling of loss. However as time goes by the coins interest to me as an investment and its interest to me as a collectible gets blurry.
This to me is one danger of investing in gold coins or other precious metals. They are pretty, and kinda cool looking, so it's not hard to start thinking of them as collectibles, not investments.
After reading the final paragraph of my first post on gold:
"Overall, my advice is that if you are interested in gold and have a little extra cash and want to buy a coin or two, go for it. I'd suggest that you view gold (or any other precious metal) as more of a hobby than an investment. If you want to take all of your savings and put it into gold, think twice, and then if it still seems like a good idea think a third time. "
I think that advice has held up well. I have purchased some coins (mostly silver and a little gold) and consider it more of a hobby than an investment. I would definitely not recommend sinking your life savings into a chest of coins as a way to avoid a crazy market (you'll just end up agonizing over the price of gold instead of agonizing over the stock market).
If you ever do want to put some money into gold purely as an investment I would suggest purchasing shares in a gold fund (see my earlier post for info on that). You don't have to store the gold anywhere, you don't have to worry about your investment turning into collectibles that you end up keeping forever and when you want to sell them you don't have to find a coin store.
I might try buying a few shares in a gold fund at some point, but I would definitely say that my days of purchasing gold coins "as a pure investment" are over.
My next revisiting of an earlier post is an article I wrote on August 24, 2007 entitled:
Investing in gold
So now that it is over a year since that first post, have my feelings on gold changed?
In some ways they have quite a bit. I still feel like gold should be viewed as an investment with its own risks, and that these risks really aren't all that different from investing in individual securities.
It seems like recently there has been a lot of talk of using a gold as a way to avoid the craziness of the stock market.
I would have to agree with this article:
Buying gold as a safe haven
Which essentially says that buying gold as a way to avoid crazy fluctuations in your investment doesn't make much sense.
Also, after buying a few ounces of gold I seem to have noticed that at least for me the gold I have purchased has become less and less of an investment.
For example, when my son was born I decided to go out and buy a gold coin minted in the year of his birth. My hope is to some day give it to him as an heirloom gift.
This essentially means that I never plan on selling the coin, and more importantly I hope that my son values the history of it and doesn't view it as a savings bond that should be cashed in when he needs a few extra bucks.
So by not planning on ever selling this coin, it has ceased to become a financial investment. I suppose that if things ever got so dire that I needed the money I could sell the coin, but I really don't plan to do that.
Here is another example: The first gold coin that I bought (which I purchased after writing the first gold post) has no historical or sentimental value to me. So I could consider that an investment in that I could sell it at a moment's notice without any feeling of loss. However as time goes by the coins interest to me as an investment and its interest to me as a collectible gets blurry.
This to me is one danger of investing in gold coins or other precious metals. They are pretty, and kinda cool looking, so it's not hard to start thinking of them as collectibles, not investments.
After reading the final paragraph of my first post on gold:
"Overall, my advice is that if you are interested in gold and have a little extra cash and want to buy a coin or two, go for it. I'd suggest that you view gold (or any other precious metal) as more of a hobby than an investment. If you want to take all of your savings and put it into gold, think twice, and then if it still seems like a good idea think a third time. "
I think that advice has held up well. I have purchased some coins (mostly silver and a little gold) and consider it more of a hobby than an investment. I would definitely not recommend sinking your life savings into a chest of coins as a way to avoid a crazy market (you'll just end up agonizing over the price of gold instead of agonizing over the stock market).
If you ever do want to put some money into gold purely as an investment I would suggest purchasing shares in a gold fund (see my earlier post for info on that). You don't have to store the gold anywhere, you don't have to worry about your investment turning into collectibles that you end up keeping forever and when you want to sell them you don't have to find a coin store.
I might try buying a few shares in a gold fund at some point, but I would definitely say that my days of purchasing gold coins "as a pure investment" are over.
Friday, October 31, 2008
Topic Revisited: Mortage Backed Securities
Posted By Paul
Considering the recent economic times I thought it would be a good exercise to revisit some of the earlier Frugalize posts regarding various investment vehicles. My goal is to look at the post and see if the information in it is still accurate considering the very different economic landscape from just a short year ago.
I thought I would start with the posting about:
Mortgage Backed Securities
If you've read the earlier post, one specific item I mentioned was:
"One problem is what if Joe B can't pay his mortgage? Well you have the house as collateral so that helps, and of course in a real MBS you are just one small part of a large conglomeration of mortgages so the risk of any one person defaulting on their loan is diluted."
This statement seems especially interesting in current times.
When I wrote the first article I found my information by doing some simple research on google. I did a similar thing today and an article on riskglossary.com had a very interesting paragraph that specifically mentioned how MBS were behaving in the last 8 years:
"Starting in the early 2000s, private label MBS were increasingly issued with little or no credit enhancement and on pools of risky sub-prime mortgages. For the first time, MBS posed significant credit risk. Because credit risk made these instruments fundamentally different from earlier mortgage pass-throughs, many market participants avoided calling them MBS, preferring to label them asset-backed securities instead. Volume in these risky instruments grew rapidly until 2007, when defaults accelerated and the market values of the instruments plunged. This caused a liquidity crisis that spilled into other segments of the capital markets. A number of hedge funds with leveraged exposures to sub-prime mortgages folded."
(for the full article that this came from click here)
It seems that the risk level of MBS were in some cases much higher than people suspected. I never invested in MBS but it would seem that people who did would have had a very rough time in the last year. I guess it just goes to show you that one year can make a big difference in the perceived risk of a particular investment.
If anyone out there has experienced the MBS roller-coaster first hand I would be very interested in hearing about it.
Considering the recent economic times I thought it would be a good exercise to revisit some of the earlier Frugalize posts regarding various investment vehicles. My goal is to look at the post and see if the information in it is still accurate considering the very different economic landscape from just a short year ago.
I thought I would start with the posting about:
Mortgage Backed Securities
If you've read the earlier post, one specific item I mentioned was:
"One problem is what if Joe B can't pay his mortgage? Well you have the house as collateral so that helps, and of course in a real MBS you are just one small part of a large conglomeration of mortgages so the risk of any one person defaulting on their loan is diluted."
This statement seems especially interesting in current times.
When I wrote the first article I found my information by doing some simple research on google. I did a similar thing today and an article on riskglossary.com had a very interesting paragraph that specifically mentioned how MBS were behaving in the last 8 years:
"Starting in the early 2000s, private label MBS were increasingly issued with little or no credit enhancement and on pools of risky sub-prime mortgages. For the first time, MBS posed significant credit risk. Because credit risk made these instruments fundamentally different from earlier mortgage pass-throughs, many market participants avoided calling them MBS, preferring to label them asset-backed securities instead. Volume in these risky instruments grew rapidly until 2007, when defaults accelerated and the market values of the instruments plunged. This caused a liquidity crisis that spilled into other segments of the capital markets. A number of hedge funds with leveraged exposures to sub-prime mortgages folded."
(for the full article that this came from click here)
It seems that the risk level of MBS were in some cases much higher than people suspected. I never invested in MBS but it would seem that people who did would have had a very rough time in the last year. I guess it just goes to show you that one year can make a big difference in the perceived risk of a particular investment.
If anyone out there has experienced the MBS roller-coaster first hand I would be very interested in hearing about it.
Sunday, October 19, 2008
Is Your Money Where It Should Be?
Posted By Paul
If I can find any silver lining in the current crazy economic times it is the fact that it has provided me with a reminder that I need to be careful about where my money is.
Here are some examples I've been hearing about where people learned lessons by the current fall in the market:
1) I have friends who were hoping to retire soon, but their nest egg was in very aggressive funds. When the stock market dropped, their nest egg shrunk, so now they need to postpone retirement until they can afford it.
2) I have other friends who have a 529 college savings plan for their child. Their child will be off to college soon so they were surprised when their college savings shrunk dramatically right when they were hoping to use it.
3) As I have mentioned in earlier posts, I keep part of my "rainy day fund" in what I view as pretty conservative stocks. Though conservative, these equities are still part of the stock market and they have not been immune to the recent drops.
It's one thing to fill out questionnaires about 'risk tolerance' and quite another to actually watch your investment shrink day after day.
So here are some things that I've been looking at as I do a risk tolerance gut-check for my investments.
1) For retirement funds, I'm where I should be. Sure it's hard to watch the balance of my retirement accounts fall, but I am going to try to keep in mind that it's not like I have plans to access that money any time soon. I need to think long term. One way to make sure that your investments match your retirement timeline is to use a target date retirement fund. Another choice is to periodically view and re-evaluate where your money is relative to your retirement timeline.
2) As a new father I've been looking into 529 savings plans. I noticed that the 529 plan that I'm looking into has a target date fund as well. You give it the expected years until college and it transitions the contents of the funds to less aggressive investments as the years go by. I plan on trying this as a way to make sure that my risk tapers off as we get closer to the time where we'll need the money.
3) There was a great comment on a previous post: Economic Chaos: So Now What? The comment was that it wasn't a very good idea to count securities as part of my rainy day fund. I can't argue with the sense that the whole point of a rainy day fund is to have money available at a moment's notice when you need it, which means that you should have it in a very low risk investment. So I'm going to stop viewing my stocks as part of my rainy day fund, and instead I'm going to work on increasing my rainy day fund by adding to my savings account and CD's. I'm going to keep my stocks because they are still doing fine for me, I'm just not going to count them as part of my rainy day fund.
So hopefully no one out there has been burned too badly by the stock market drop, but if nothing else this drop has been a great object lesson on making sure that your investments REALLY match your risk tolerance.
If I can find any silver lining in the current crazy economic times it is the fact that it has provided me with a reminder that I need to be careful about where my money is.
Here are some examples I've been hearing about where people learned lessons by the current fall in the market:
1) I have friends who were hoping to retire soon, but their nest egg was in very aggressive funds. When the stock market dropped, their nest egg shrunk, so now they need to postpone retirement until they can afford it.
2) I have other friends who have a 529 college savings plan for their child. Their child will be off to college soon so they were surprised when their college savings shrunk dramatically right when they were hoping to use it.
3) As I have mentioned in earlier posts, I keep part of my "rainy day fund" in what I view as pretty conservative stocks. Though conservative, these equities are still part of the stock market and they have not been immune to the recent drops.
It's one thing to fill out questionnaires about 'risk tolerance' and quite another to actually watch your investment shrink day after day.
So here are some things that I've been looking at as I do a risk tolerance gut-check for my investments.
1) For retirement funds, I'm where I should be. Sure it's hard to watch the balance of my retirement accounts fall, but I am going to try to keep in mind that it's not like I have plans to access that money any time soon. I need to think long term. One way to make sure that your investments match your retirement timeline is to use a target date retirement fund. Another choice is to periodically view and re-evaluate where your money is relative to your retirement timeline.
2) As a new father I've been looking into 529 savings plans. I noticed that the 529 plan that I'm looking into has a target date fund as well. You give it the expected years until college and it transitions the contents of the funds to less aggressive investments as the years go by. I plan on trying this as a way to make sure that my risk tapers off as we get closer to the time where we'll need the money.
3) There was a great comment on a previous post: Economic Chaos: So Now What? The comment was that it wasn't a very good idea to count securities as part of my rainy day fund. I can't argue with the sense that the whole point of a rainy day fund is to have money available at a moment's notice when you need it, which means that you should have it in a very low risk investment. So I'm going to stop viewing my stocks as part of my rainy day fund, and instead I'm going to work on increasing my rainy day fund by adding to my savings account and CD's. I'm going to keep my stocks because they are still doing fine for me, I'm just not going to count them as part of my rainy day fund.
So hopefully no one out there has been burned too badly by the stock market drop, but if nothing else this drop has been a great object lesson on making sure that your investments REALLY match your risk tolerance.
Tuesday, October 7, 2008
Economic Chaos: So Now What?
Posted By Paul
I'm sure I don't have to tell all of you about the crazy things going on in the economy right now.
The stock market is going crazy, mutual funds are all over the place (mostly down). I had one of my funds drop nearly 8% in one day! That is a tough thing to see and not do something!
So I keep trying to think of something useful to put in this blog to address this. So here is my best two-bit opinion of what's going on:
1) The economy in general is in a crazy time.
2) No one knows how long it will last (least of all me).
So based on those two facts here is my plan for dealing with the current landscape:
1) I'm not going to make a run on the banks. Currently my money is in financial institutions that seem stable, so I'm not going to rush out and try to take all my money out in cash.
2) I'm not going to dash out of the stock market. I COULD take everything I have invested in mutual funds through my 401k and sell them all immediately. The problem with this is that I'd be selling my funds at a low based on what is hopefully a short term situation (see my earlier post Article: Don't let the crisis spook your 401k).
3) I'm going to try to view this as an opportunity. Warren Buffet is a big believer in the idea that when the market is down its a great time to buy stuff (since everything is cheap). Of course this assumes that the market eventually recovers, but this is the risk inherent in the stock market. I'm going to try to view the stock market with this attitude.
4) I'm going to make sure that my investments are where I want them to be. If there's a bright side to this crisis, it's a great reminder that you should make sure your money in where it should be based on your plans for accessing it. For example...I have most of my rainy day fund in low-risk savings bonds, CD's, and savings accounts. Since this is money that I might need to access at any time, I don't want it in anything high risk. Part of my rainy day fund (about 15%) is also invested in the stock market, in what I consider to be some pretty conservative stocks. This for me is just fine. In all of this turmoil 85% of my rainy day fund continues to collect it's small but no-risk interest. The other 15% still fluctuates, but the fluctuations are small enough that I can live with it. Also with my retirement funds I need to remember that I don't plan on touching this money for decades so I shouldn't worry too much about market fluctuations. Yes, things are going crazy now, but I REALLY hope that in 20 years it's all an unpleasant memory.
5) I'm going to try to beef up my rainy day fund. Even though the value of my rainy day fund is pretty stable, I'm hoping to add a little more to it for a while, just for my own peace of mind.
Not the most dramatic plan. Essentially I plan to bulk up the savings if I can, but I will continue to invest in my 401k in anticipation of a stock market rebound.
How are other people out there dealing with the craziness?
I'm sure I don't have to tell all of you about the crazy things going on in the economy right now.
The stock market is going crazy, mutual funds are all over the place (mostly down). I had one of my funds drop nearly 8% in one day! That is a tough thing to see and not do something!
So I keep trying to think of something useful to put in this blog to address this. So here is my best two-bit opinion of what's going on:
1) The economy in general is in a crazy time.
2) No one knows how long it will last (least of all me).
So based on those two facts here is my plan for dealing with the current landscape:
1) I'm not going to make a run on the banks. Currently my money is in financial institutions that seem stable, so I'm not going to rush out and try to take all my money out in cash.
2) I'm not going to dash out of the stock market. I COULD take everything I have invested in mutual funds through my 401k and sell them all immediately. The problem with this is that I'd be selling my funds at a low based on what is hopefully a short term situation (see my earlier post Article: Don't let the crisis spook your 401k).
3) I'm going to try to view this as an opportunity. Warren Buffet is a big believer in the idea that when the market is down its a great time to buy stuff (since everything is cheap). Of course this assumes that the market eventually recovers, but this is the risk inherent in the stock market. I'm going to try to view the stock market with this attitude.
4) I'm going to make sure that my investments are where I want them to be. If there's a bright side to this crisis, it's a great reminder that you should make sure your money in where it should be based on your plans for accessing it. For example...I have most of my rainy day fund in low-risk savings bonds, CD's, and savings accounts. Since this is money that I might need to access at any time, I don't want it in anything high risk. Part of my rainy day fund (about 15%) is also invested in the stock market, in what I consider to be some pretty conservative stocks. This for me is just fine. In all of this turmoil 85% of my rainy day fund continues to collect it's small but no-risk interest. The other 15% still fluctuates, but the fluctuations are small enough that I can live with it. Also with my retirement funds I need to remember that I don't plan on touching this money for decades so I shouldn't worry too much about market fluctuations. Yes, things are going crazy now, but I REALLY hope that in 20 years it's all an unpleasant memory.
5) I'm going to try to beef up my rainy day fund. Even though the value of my rainy day fund is pretty stable, I'm hoping to add a little more to it for a while, just for my own peace of mind.
Not the most dramatic plan. Essentially I plan to bulk up the savings if I can, but I will continue to invest in my 401k in anticipation of a stock market rebound.
How are other people out there dealing with the craziness?
Friday, August 22, 2008
Savings Bonds Revisited
Posted by Paul
If any readers recall my earlier post from 2007 on savings bonds they'll recall that I purchased some and that I wasn't too excited about them at the time.
Well imagine my surprise to discover that currently my savings bonds have an interest rate of over 6%. This is far better than my savings accounts or even my CD's!
I wanted to double check the program that I downloaded that tells me the current rate of my savings bonds, so I went to the page on Series I bonds and confirmed the numbers.
Currently the determined inflation rate is 2.42%, and the bonds that I bought back in 2006 have a fixed rate of 1.4%.
Using the formula we get:
Composite rate = Fixed rate + (2 x Semiannual inflation rate) + (Fixed rate x Semiannual inflation rate)
Composite rate = 0.016 + (2 x 0.0242) + (0.016 x 0.0242)
Composite rate = 0.016 + 0.0484 + 0.0003872
Composite rate = 0.0647
Composite rate = 6.47%
So currently my bonds are earining almost 6.5%. Wow! Pretty good for such a low risk investment!
So what does this all mean? Well I guess it means that if you purchase I-Bonds when the fixed rate is high (the fixed rate doesn't change for the life of the bond), then you can make a great return when the conditions are right.
As an example, let's pretend that I had purchased some I-Bonds back in May of 2000 when the fixed rate was 3.6, their current interest rate would be:
Composite rate = 0.036 + (2 x 0.0242) + (0.036 x 0.0242)
Composite rate = 0.036 + 0.0484 + 0.0008712
Composite rate = 0.0844
Composite rate = 8.4%
That'd be a pretty amazing return for a no risk investment.
I plan on continuing to watch the I-Bond rates and purchase some more bonds once the fixed rate gets up to a decent amount. It's nice to have part of my money in a low risk investment that has a built in guard against inflation.
If any readers recall my earlier post from 2007 on savings bonds they'll recall that I purchased some and that I wasn't too excited about them at the time.
Well imagine my surprise to discover that currently my savings bonds have an interest rate of over 6%. This is far better than my savings accounts or even my CD's!
I wanted to double check the program that I downloaded that tells me the current rate of my savings bonds, so I went to the page on Series I bonds and confirmed the numbers.
Currently the determined inflation rate is 2.42%, and the bonds that I bought back in 2006 have a fixed rate of 1.4%.
Using the formula we get:
Composite rate = Fixed rate + (2 x Semiannual inflation rate) + (Fixed rate x Semiannual inflation rate)
Composite rate = 0.016 + (2 x 0.0242) + (0.016 x 0.0242)
Composite rate = 0.016 + 0.0484 + 0.0003872
Composite rate = 0.0647
Composite rate = 6.47%
So currently my bonds are earining almost 6.5%. Wow! Pretty good for such a low risk investment!
So what does this all mean? Well I guess it means that if you purchase I-Bonds when the fixed rate is high (the fixed rate doesn't change for the life of the bond), then you can make a great return when the conditions are right.
As an example, let's pretend that I had purchased some I-Bonds back in May of 2000 when the fixed rate was 3.6, their current interest rate would be:
Composite rate = 0.036 + (2 x 0.0242) + (0.036 x 0.0242)
Composite rate = 0.036 + 0.0484 + 0.0008712
Composite rate = 0.0844
Composite rate = 8.4%
That'd be a pretty amazing return for a no risk investment.
I plan on continuing to watch the I-Bond rates and purchase some more bonds once the fixed rate gets up to a decent amount. It's nice to have part of my money in a low risk investment that has a built in guard against inflation.
Thursday, August 14, 2008
Shrinking the mortgage
Posted by MattWhen my wife and I first bought our house, I posted some thoughts about whether we should make any additional payments to the mortgage principal. We deferred, electing instead to focus our savings efforts on retirement and our son's education savings account.
Those efforts have been going along just fine; we've been making regular, automatic contributions to the 529 and I'm maximally funding my 401k, but still we had a little extra and felt like our emergency savings accounts were adequate for now.
So, that brought us back to the question: "Should we use the extra cash to reduce our mortgage?"
The arguments against:
- The additional capital that we convert to home equity becomes inaccessible (well, OK, less accessible anyway; we could take out a HELOC, but that brings us right back to paying interest again.)
- The extra money could effectively earn a greater return invested elsewhere.
These are both valid arguments that Paul and I have explored the pros and cons of previously. Now that we have "adequate" (debatable; the term is relative and you could make the case that more is ALWAYS better) cash on hand for emergencies, I wasn't too worried about the first argument, but I had a hard time getting past the second. What finally sold me is that the payoff scenarios I sketched out revealed that we could pay off the mortgage in a much shorter period than I had originally guessed.
I still have some confidence that the stock market will outperform my other investments over the long term, but over the short term, I'm much less optimistic. In the short term, I decided to go for the guaranteed return of reducing our total interest expense on the mortgage. So toward that end, we transferred our first extra principal payment (a very easy online option since our mortgage and checking accounts are held by the same bank) this month. Because we just bought this house last year, we're still in that frustrating stage of mortgage repayment where most of the payment gets applied toward interest (read this if you're not familiar with how amortization works). Now I'll be watching much more intently for our principal balance to drop off more and more steeply.
Another part of the plan that I like is that we've got an easy out. I didn't automate the extra payments (which is unusual for me), but this allows us to be flexible in how much extra we pay. I'll target a set amount each month, but there will certainly be months where we need to adjust it up or down, e.g. during the holidays or months when we have travel expenses.
In case that isn't enough for you, here's another bonus I thought of: we'll be able to reduce our life insurance coverage eventually. When I was evaluating life insurance, I decided to pay for adequate coverage to pay off our mortgage if I die. As our principal drops, I can periodically reduce my insurance payments until I get to the point where the basic coverage that my employer provides will cover the remainder. Okay, this one is less significant than the other benefits, providing maybe 4-digit savings as opposed to 6-digit savings achieved through reduction of interest payments, but every little bit helps!
Let me end by acknowledging that this strategy isn't going to apply for everyone. My wife and I are grateful that we are fortunate enough to be in a position to even have to consider where to put our "extra" money each month. But I hope that everyone who reads this, whether they have a little extra money each month or a lot, will at least appreciate the benefits of prioritizing spending. As I mentioned above, this strategy only achieved priority after we'd eliminated car and student loan debt, carefully filled up our emergency funds and ensured that we are saving adequately for retirement and our son's education.
Wednesday, July 16, 2008
What you can learn from the banks.
Posted By Paul
I am always interested when a business article makes the front page of the paper, so I couldn't pass up reading an article about how banks in the northwest were on shaky ground.
What intrigued me most was how several points made in the article were mistakes that the banks made that people could learn from:
Banks' Mistake 1: Jumped into the housing boom like it would never end
I know that the current housing boom is over, but this lesson applies to any investment boom. I learned this lesson from my experiences in the dot-com boom. During that time you were hearing stories every day from people becoming overnight millionaires by pouring all of their money into the dot-com company that was the next big thing. You seldom heard the stories about the people who put all of their money into an IPO, only to have the company go nowhere. There was so much fervor about getting rich and so much certainty that the investments couldn't fail that people got carried away. Whenever there is an explosive boom like this I try to keep in mind that super accelerated growth can't last forever, and when a boom ends it usually ends quickly and dramatically. There is no harm in trying to get your piece of the dot-com boom, or the housing boom, but if you go in too deep you could lose it all when the boom finally ends.
Banks' Mistake 2: Too much debt, not enough cash.
In the banks' case this was from approving crazy no down payment mortgages to people who couldn't afford them, but the people who signed up for these mortgages aren't without blame. When I was shopping for my first house the mortgage company wanted to sign me up for a BIG mortgage with a monthly payment that I could swing as long as I never lost my job and never had a financial emergency. Don't let yourself be one of those people living in a big beautiful house but eating peanut butter and jelly three meals a day because you can't afford anything else.
Banks' Mistake 3: Went too deep into a single investment.
When the housing market cooled the banks that had all of their money invested in crazy mortgages and property development loans were hit the hardest. This is no different from putting all of your financial eggs in one basket. I don't just mean tying up all your money in your house, but in ANY single investment. Just think of the people from Enron who lost most of their nest eggs when the scandal broke.
It just goes to show that financial institutions are susceptible to the same greed and poor judgement that people are when faced with a financial boom.
Thursday, May 1, 2008
I-Bonds Now at 0% Fixed Rate?
Posted By Paul
If any of you follow I-Bond rates you may have noticed that today the new rates for the I-Bond came out.
For those of you not familiar with the I-Bond (or savings bonds in general) you can read my original post:
Savings Bonds
The interesting thing is that the fixed rate for any I-Bond purchased in the next 6 months is 0%. I thought that was perhaps a typo or they hadn't updated the info correctly, but it would appear that this is really the case.
So what does this mean? They probably dropped the fixed rate because the inflation rate is so high right now. With the factored in inflation rate that was also published today (2.42%) an I-Bond that you buy today would still earn 4.84% (at least for the next six months until the inflation rate changes).
It also means that the bonds that I bought not too long ago are now making over 6%!
I'm going to keep watching the I-bond rates and once the fixed rate gets up to a decent number again (which might very well be several years) I plan on buying some more. They seem like a pretty decent low-risk place to keep your money, and at least for now they are providing a great return.
If any of you follow I-Bond rates you may have noticed that today the new rates for the I-Bond came out.
For those of you not familiar with the I-Bond (or savings bonds in general) you can read my original post:
Savings Bonds
The interesting thing is that the fixed rate for any I-Bond purchased in the next 6 months is 0%. I thought that was perhaps a typo or they hadn't updated the info correctly, but it would appear that this is really the case.
So what does this mean? They probably dropped the fixed rate because the inflation rate is so high right now. With the factored in inflation rate that was also published today (2.42%) an I-Bond that you buy today would still earn 4.84% (at least for the next six months until the inflation rate changes).
It also means that the bonds that I bought not too long ago are now making over 6%!
I'm going to keep watching the I-bond rates and once the fixed rate gets up to a decent number again (which might very well be several years) I plan on buying some more. They seem like a pretty decent low-risk place to keep your money, and at least for now they are providing a great return.
Tuesday, April 22, 2008
What things are FDIC insured?
Posted By Paul
Most people out there are familiar with the concept of savings that are insured by the FDIC (Federal Deposit Insurance Corporation) and for those deposits:
"The FDIC protects depositors against the loss of their deposits if an FDIC-insured bank or savings association fails. FDIC insurance is backed by the full faith and credit of the United States government."
Which essentially means that your deposits are guaranteed by the US Government.
Matt posted some FDIC info in his post:
Money insurance and POD Accounts
But I decided to look around and see if there was a good summary of what kind of accounts are FDIC insured and what exactly that means. I found this page at the FDIC.gov website that has a good summary if you're every wondering if your deposits qualify:
http://www.fdic.gov/consumers/consumer/information/fdiciorn.html
Most people out there are familiar with the concept of savings that are insured by the FDIC (Federal Deposit Insurance Corporation) and for those deposits:
"The FDIC protects depositors against the loss of their deposits if an FDIC-insured bank or savings association fails. FDIC insurance is backed by the full faith and credit of the United States government."
Which essentially means that your deposits are guaranteed by the US Government.
Matt posted some FDIC info in his post:
Money insurance and POD Accounts
But I decided to look around and see if there was a good summary of what kind of accounts are FDIC insured and what exactly that means. I found this page at the FDIC.gov website that has a good summary if you're every wondering if your deposits qualify:
http://www.fdic.gov/consumers/consumer/information/fdiciorn.html
Subscribe to:
Posts (Atom)
