How to Invest in the Market

Hello, Jaye here again. Today I would like to discuss how to invest in the market. If you have been following the savings advice outlined in this blog, you now have a pot of money to invest. So what do you do now?

First things first- have a heart to heart with yourself about your investor type. Be honest. Are you really an aggressive investor, or does the thought of seeing losses in your account make your stomach turn? Stocks and mutual funds do not go straight up, and you can expect short-term losses from any investment. If you are a conservative investor, do not buy the hot tech IPO that just hit the market. Do not buy on your cousin's stock tip, or "play" penny stocks. Pick investment vehicles with a proven investment record, and look at bull market performance (2003-2006, 2009-2010) and bear market performance (2000-2002, 2007-2008). Do the gains justify the losses? Make investment choices based on a long-term view, not just the stock with the highest return last year.

The next consideration for investors is research time, interest, and know-how. Do you enjoy knowing how things work and digging into the company balance sheets or looking at technical charts? Are you really going to spend 5 hours a week researching your stocks? If yes, then open an investment account with low trading costs and a large investment universe and trade away. If you are a hands-off investor with better things to do in your day than track the market, consider using a balanced mutual fund whose manager will change the asset mix based on market conditions. One of my favorites is Permanent Portfolio (PRPFX). There are a lot of them out there, so do your homework before choosing one, and be sure to re-evaluate every so often.

Finally, be systematic with your investing. Put new money in on a regular basis to dollar-cost average into the market. Reinvesting dividends also allows you to catch the market at regular intervals.

Happy investing!

Jaye Weiland, CFP®

Disclaimer- I own shares of  PRPFX

Systematic Saving

Hello Everyone!

Today I would like to discuss the best way to ensure that you will get rich. Unfortunately I do not have a get rich quick scheme, but I do have a guaranteed method in systematic savings. There is an important saying "pay yourself first". You should think about your savings in three buckets. The first bucket is short-term savings, or funds that you may need in less than one year. The second bucket is medium-term savings, or funds you may need in one to five years. The final bucket is long-term savings, or funds you will need in more than five years. Here are some examples of each:

             1. Short-term: You should think of this as your emergency fund for unexpected purchases. Some examples would include car repairs, medical bills, and home repairs. Depending on your situation a good rule of thumb is to have between 3 and 6 months of your income in your short-term savings account. So if you make $50,000 per year you should have around $15,000 in your short-term bucket.

             2. Medium-term: This bucket will contain funds for events you expect to occur in the near future such as a vacation, a new car, a wedding, or a down payment for a house.

             3. Long-term: This bucket will contain funds for items such as your children's education and retirement.

Fortunately because you are young the best thing you have on your side is time (see blogs on compounding interest), and if you can systematically save into accounts that you have designated for each of these buckets you will be guaranteed to acquire wealth. You may wonder how much you should be saving. A good rule of thumb is 10-15% of your income per month. Therefore if you make $50,000 per year, you are making about $4,100 (gross) per month and you should be saving between $400 and $600 each month.

Determining which bucket you should put your savings into is the next factor to consider. As a general rule, the first place you should save you money is into a 401(k) if you have one, up to the match. If you are not saving in your 401(k) up to the match you are throwing away money. Then next most important place to save is in your short-term emergency bucket. After you have accumulated your desired 3-6 months of income in your short-term bucket you can start saving in either your medium-term and long-term buckets. Just remember that it is very dangerous to put off saving for retirement because you are young. I would recommend that after you have your emergency fund accumulated try to save into both the medium-term and long-term buckets.

I hope this is helpful. Please feel free to ask any questions. There is a new feature to my blog, you can sign-up for email notifications on the right column so that you will be notified when I have new postings.

Cheers,

Bre

Follow By Email!!!

Hello Everyone!

I have exciting news that you can now follow my blog via email. By using this feature you will receive email notifications when new content is posted. You can sign-up for this cool new feature on the right hand-side toolbar.

Cheers,

Breana

Do You Want a Roth or Traditional IRA?

Hello. This is Jaye again, and today we are going to talk about the choice between a traditional and a Roth IRA. We all like options: Vanilla or chocolate? Regular or decaf? In the individual retirement account space, the choice is between a traditional IRA and a Roth IRA. Both can be powerful tools in saving for retirement, but key differences make each one optimal for different investors.

Contributions: While both traditional IRAs and Roth IRAs offer tax-advantaged solution for retirement savings, they work as an essential inverse of each other. With a traditional IRA, you typically do not pay any income tax on your contribution, and your account grows tax-deferred (IRAs). With a Roth IRA, you pay the income tax now, and your account grows tax-free (Roth IRA). So do you want to pay tax now or later?

Income limitations: Anyone can contribute to a traditional IRA, but if you are eligible for a company retirement plan there are income limits to deducting your contribution. If you are eligible for a company retirement plan and your income is above these limits, your contribution will be subject to income tax. Your account will still grow tax-deferred, and you will not be subject to any income tax on withdrawals of the original contribution amount. With a Roth IRA, you are not allowed to contribute at all if your income is higher than the phaseout limits, although you are still eligible for a Roth conversion.

Withdrawals: In a traditional IRA, you owe income tax when you withdraw funds in retirement (although some exceptions apply to non-deductable contributions). The idea is that a retiree’s income tax bracket is less in retirement, and therefore your tax liability will be less when you withdraw your retirement funds. One important note is that you are required to pull out minimum withdrawals (RMD) each year after age 70½. Since you pay taxes on withdrawals from a traditional IRA, after age 70½ you can expect that you will have a portion of your account taxed each year. A Roth IRA withdrawal, in comparison, is not taxed as long as it is a qualified withdrawal.This is because you already paid taxes on your funds before contributing them to your account. So again, do you want to pay taxes now or later?

Early Withdrawals: The general rule for IRAs is that you pay a penalty and tax on any withdrawals taken before age 59½. However, like all tax rules there are exceptions, including education and first-time home purchase. With a Roth IRA, you are also eligible to withdraw your taxed contributions at any time. This added flexibility can be a huge benefit for anyone who finds their emergency fund depleted and needs access to other monies.

So which is right for you? Generally, the rule of which IRA to use depends on your current and expected future tax bracket. If you expect your tax bracket to be higher in retirement, you contribute to a Roth IRA, and if you expect your tax bracket to be lower, you contribute to a traditional IRA. This reasoning leads one to conclude that savers in the beginning of their careers, when earnings are typically lower, should use a Roth IRA and savers at the peak of their careers, when earnings are typically at their highest, should utilize a traditional IRA. However, uncertainty about future tax rates has complicated that rule of thumb. If you believe that tax rates will not remain at the current historic lows, a Roth IRA may be appropriate even if you do not expect your earnings to increase.

Like everything else in finance, the best answer may be to diversify. You are eligible to place a total of $5,000 a year ($6,000 if 50 or over) of earned income into either IRA, or you can split that contribution in any way between the two. This means that you can hedge against future tax rates by placing $2,500 in a Roth IRA and $2,500 in a traditional IRA. As your expectations about the future change, so can your contribution percentages. Each year you are able to decide into which IRA you should contribute, or how much into both. The most important thing is to take advantage of the government’s offer to let your long-term retirement savings grow tax-advantaged, and to contribute every year.

 Best regards,

Jaye

Debt vs Deficit

Hello. While we are talking about the debt ceiling, I'd like to elaborate about the difference between our country's debt and the deficit. A deficit or surplus in the budget has to do with cash flow. When the country's revenue (taxes) are more than our expenses (spending), we have a surplus. When our spending is more than our tax revenue, we have a deficit. A perfectly balanced budget would produce no surplus and no deficit.

Our debt is the amount that we have already borrowed. This is the accumulated amount that we owe to our creditors, or bondholders. When we have a deficit we add to our national debt.

A good way to distinguish between debt and deficit is to think of an individual. When you spend more than your income, you have to borrow. Imagine you have to borrow using your credit cards for many years. You then are able to increase your income and cut your spending, and actually have a surplus. However, your credit card debt is still there, and still increasing due to interest. The only way to pay down your debt is to have more income than expenses for a sustained period of time.

Best regards,

Jaye

What is the Debt Ceiling?

Hello Everyone! As I am sure you are aware, there has been a lot of talk about the debt ceiling lately. In this blog I would like to talk about the debt ceiling and the government budget and try to make this confusing subject a little more clear. The debate that has been going on, and which was resolved (for the short-term at least) today, was whether or not the government would raise the debt ceiling in order to prevent our country from defaulting on its debt obligations for the first time in US history. In addition to raising the debt ceiling, the government was also making decisions on how they want to adjust current spending and taxation. 

What is the debt ceiling you might ask? The debt ceiling is essentially a limit set by congress on the amount of public debt that the US can have outstanding. Originally the idea for the debt ceiling was to help the government from incurring too much debt and to control spending, but there is debate about how well this tactic actually works. Since 1962 the debt ceiling has been raised 74 times. Let's define some important terms. 

Deficit- a budget deficit occurs when an entity spends more money than it makes. So in the context of this debate the US Government spends more money than it takes in in taxes (revenues). But we knew that already!

Debt- in order to pay for the spending that exceeds revenues, the government must borrow money. The government borrows money from other country's governments, and investors through treasury securities. For example, if an investor buys a treasury bond for $1,000, that investor is loaning their money to the government. In return the government pays them a stated annual interest rate every 6 months. Then when the bond matures, say in 5 years, the investor will get their $1,000 back plus the interest they made. While many individual investors own US Treasury securities, countries such as China control a majority of our debt.

Surplus- a budget surplus occurs when an entity makes more money than it spends. The only time that this has occurred in recent US history was when Clinton was in office. However, even though the US had a budget surplus in the late 1990's, it still had outstanding debt, don't confuse the deficit and the debt.

As a voting and tax paying citizen you may want to know where all of this debt comes from and why? There are a number of different areas of spending for the government including: Medicare and Medicaid, Social Security, Defense, and Non-Defense Discretionary. Currently the government does not bring in enough revenue to cover all of this spending, in fact we currently have to borrow 40 cents on every dollar spent (see chart below). 

Before today, the debt ceiling was set at $14.3 trillion which was hit earlier this year. See chart below for a history of US debt levels. Today as part of the new debt ceiling deal, the government decided to not only to raise the debt ceiling, but also to cut $2.4 trillion in spending. The deal contained no increase in revenues.

* Source: Investopedia

A lot of the concern over this debt ceiling deal was whether or not the US would default on its debt obligations for the first time in US history, and be downgraded from its AAA rating. A default would have occurred if the government had not come to a deal, and it could no longer borrow to meet its obligations because of the restrictions of the stated debt ceiling. This wold have had profound impacts on investments in US Treasuries, which have been long perceived as being risk free. This would have also had significant impact on other countries' decision to invest in US Treasuries, which we rely on to continue to fund our spending. 

Unfortunately, the deal that was met today was only a short-term solution to our perpetuating debt problem. Even with the cuts to spending, we will continue to have to borrow to balance our budget. I do not want to express my views on this issue, I would only like to impart the facts, however I would love to hear your input. If you would like more information check out the white paper posted on my firm's website http://www.investps.com/index.php?option=com_content&view=article&id=74&Itemid=473 under "White Paper Links".

Cheers,

Bre

*This is not a recommendation for investing. Please consult an investment professional before making an investment decision. I am in no way compensated for the content of this blog, this information is for educational purposes only.

Assumed Interest Rate

Thank you DS for your comment. I am sorry that you are so pessimistic about the financial markets, but I can't say that I blame you. However I do believe that your view is a bit off. Prior to 2008 the average historical annual return of the S&P 500 was 10.36%, and even after 2008 the average historical annual return was 9.57%. In fact, the S&P 500 returned 23.5% in 2009 and 12.8% in 2010. So there is definitely opportunity to return 9%, especially over a long period of time. Now, you might argue what about 2001, 2002, 2008 which returned -11.9%, -22.1% and -39.3% respectively? There are certainly times of below mean performance and above mean performance such as  1996, 1997, and 1998 which returned 23%, 33.7%, and 28.6% respectively. However the tendency of the market is to mean revert, displayed by the average annual return only ranging from 8.85% to 11.35% over the last 30 yearsS&P 500 Historical Returns. Therefore one may argue that if you have a long investment horizon, you are very likely to return right around 9%.

Now there are a few problems with my argument, the first being timing. The timing of when you have above mean returns and below mean returns in portfolio can have a very significant impact on your worth. The second problem with my argument is that the returns mentioned above are not adjusted for inflation. The third problem is that historical performance is no indication of future performance, but it is the best thing we have.

There are a lot of other asset classes that have had much better returns in the past few years than the stock market. Let's consider commodities; gold has returned over 40% since the beginning of 2010, cotton has returned over 132% since the beginning of 2010 and coal is up over 37% since the beginning of 2010. Even emerging markets have returned over 22% since the beginning 2010. My point is that there are plenty of opportunities to find fantastic returns in today's market. In fact, even in today's environment of extremely low interest rates, treasuries are returning more than 2% (today the 10- yr Treasury is returning 2.94%).

Today's young investor have a right to be fearful of the stock market and the returns they may receive. Why wouldn't we? However don't be so fearful that you give up opportunities to grow your wealth.

Cheers,

Breana

*Please note none of the assets discussed are a recommendation for investing. Please consult an investment professional before making an investment decision.

How to Start Saving

Hello. I am a co-worker of Bre's, and she asked me to share my opinion about saving for retirement as a 20-something (or 30-something!). Your greatest asset in your 20s and 30s is time (see Bre's past discussion on compounding interest). However, it is also the number one reason young professionals put off saving for retirement. You are barely scraping by with the paycheck from your first job and paying down student loan debt, why worry about saving for retirement now when you can save later?

Again, compounding interest. Let's say you want to make sure you have over $1 million at retirement, and you are starting at 0. If you begin at 22 to put away $2400 a year, only $200 per month, until age 65, you will have approximately $1.06 million at retirement (at 9% growth). If you wait ten years until you are 32 to start saving, you will have to save $5,885 a year (almost $500 per month) until age 65 to retire with the SAME amount of money, and you will have put in an additional $90,000. See why time is such an asset?

Where do you find $200 per month to save? Let's spend a minute discussing savings. You should save at least 20% of your income. Always. If your monthly expenses are over 80% of your monthly income, you need to cut your expenses or find a way to make additional income. The saying "pay yourself first" refers to the inclusion of your savings as a line item in your budget that gets paid every month. And happy hour with the ladies or a game with the guys does not constitute an expense, so if you don't have enough money for that and savings, the spending gets the boot. So pay yourself first and put 20% of each paycheck into savings.

The 20% into savings typically goes into one of four savings buckets when you are a recent graduate- pay down debt, build an emergency fund, retirement savings, and specific savings (house, wedding, car). Priorities? Credit card debt and emergency fund should be your first priorities. If your employer offers a 401(k) match, this is free money which is always a priority. Initially you want to pay down credit card debt (in the order of the highest interest rate), save a minimum of 3 months of living expenses in a liquid account, and contribute to your 401(k) at least to the match. Once you have paid off your credit cards and funded your emergency account, increase your retirement funding above your employers match limit by contributing to a Roth IRA. As Bre has mentioned previously, one of the beauties of the Roth IRA is the ability to pull your contributions penalty-free if absolutely necessary and it can also double as your house savings. Once you are contributing to your Roth IRA in addition to contributing to your 401(k) to the max, you can begin to put extra savings amounts towards your student loan principal payments. Note that student loan interest is tax-deductible, however, if your student loan interest is greater than 8% your should make paying down your loans the same priority as credit card debt.

Sound like a lot? It all goes back to time. This is not a short-term plan, but rather a life-long plan. Make a plan and stick with it. Each time you get a raise, your 20% savings amount increases. Everyone's situation is different, so you may find that your savings priorities look different. Most important is to make saving a regular part of  your budgeting and to start saving early.

Jaye Weiland

Income Taxes

Hello Everyone!  It is tax season, so I thought I would talk a bit about taxes. One of the most important aspects of investing and saving is tax deferment. This is because if you can defer paying taxes and earn interest on the money that would have gone to Uncle Sam, you can significantly increase you net worth. However taxes are confusing so let's start at the beginning.

As we all know when we get our paycheck there is a nice chunk that goes to taxes, and if you don't pay it out of each paycheck, then you owe a pretty penny on April 15th. And maybe if you are lucky you get a refund, but how much are you paying and how is it determined? Let's start answering this question by looking at tax brackets. With the extension of the Bush tax cuts, these are the 2011 tax brackets.

These income values are based on your adjusted gross income (AGI) not your net income. So if you make $35,000 don't go running to your boss and ask him if you can make $500 less each year because you don't want to be bumped up a tax bracket. There are ways that you can shelter some of you income so that it does not appear in your AGI. Some of the most common ways are: deducting business expenses, putting money into a health savings account (HSA), or contributing to a tax deferred retirement account such as a traditional IRA or 401(k). These are just a few ways to defer taxes and reduce your AGI, there are many others. Therefore, the key to making sure that you don't pay too much in taxes is by putting your money in places that you would prefer to see it going and reducing your AGI.

Hopefully you are all as pleasantly surprised with your refund this year as I was!


Cheers,


Bre

Tax Bracket	Married Filing Jointly	Single
10% Bracket	$0 – $17,000	$0 – $8,500
15% Bracket	$17,001 – $69,000	$8,501 – $34,500
25% Bracket	$69,001 – $139,350	$34,501 – $83,600
28% Bracket	$139,351 – $212,300	$83,601 – $174,400
33% Bracket	$212,301 – $379,150	$174,401 – $379,150
35% Bracket	Over $379,150	Over $379,150

Compounding Interest and the Rule of 72

Hello Everyone! So here I am blogging again! Today I am going to talk about compounding interest again, and the nifty rule of 72. Most of you know that the main motive for investing is to make your money work for you, or to create "passive" income. But how much money can your money make you? Well, it can make you a lot, but it can also lose you a lot. But let's be optimists here, and talk about the positive side of compounding interest.

The Rule of 72: This is a quick and dirty way to calculate how long it will take for money to double given a specific interest rate. For example, if you have $10,000 and you invest it at a flat interest rate of 7% per year, it will take a little over 10 years for your money to double (72/7= 10.3). If your $10,000 is invested at a flat 9% it will take 8 years for you money to double (72/9= 8). Let's look at the power of doubling your money. If you are currently 25 years old and you invest $10,000 at 9% and never make another contribution, how much money will you have when you retire at age 65? In this situation you have a 40 year investment time horizon, and your money will double every 8, therefore your money will double 5 times. Consider how much you will have at each of the following ages:

Age            Value

25               $10,000

33               $20,000

41               $40,000

49               $80,000

57               $160,000

65               $320,000

Wow! Not too bad considering you didn't have to lift a finger to make $310,000! 

Now let's make this just a little more complicated. Let's assume that through out your life you are going to be able to add to your savings at a rate of $100 per month. Let's see what our table from above now looks like:

Age            Value

25               $10,000

33               $34,580

41               $84,942

49               $188,130

57               $399,554

65               $832,745

Wow! Now we are talking! I think that most of use could spare a pair of jeans or a night out each month to be able to save just $100 per month! In fact, if you start with $10,000 and contribute just $140 per month and invest at 9%, you will have over $1 million dollars when you retire at age 65! Who would have thought it could be so easy to become a millionaire.

Of course there are some fundamental problems with our scenarios. First, if you can find any investment with a guaranteed 9% interest rate for the next 40 years, please let me know. Interest rates fluctuate, there are periods of very high interest rates such as  the late 1980's, when you could invest in a 10 year treasury bond at 8-9%. In fact in 1981 the 10 year treasury bond was paying 15%! Today the 10 year treasury is just over 3%, this is barely enough to cover the inflation on your money. I use the treasury as an example because this is often used to represent a "risk-free" investment. Meaning that the only way that you would not get the said interest rate would be if the US government defaulted on the bond, which has never happened in US history.

Therefore, in order to find interest rates around 9% today you need to take considerably more risk with your money, such as invest it in the stock market. However there is no way you are going to get a guarantee on your interest rate in the stock market. I have seen people earn 51% in a year in the stock market, and I have seen people lose -40% in a year in the stock market. And don't forget about negative compound interest! If you lose 50% you have to make 100% to get back to even, and if you lose -62% you have to make 174% to get back to even.  In general, people will assume that you can average about 7-8% per year when investing conservatively in the stoke market. However if you had been investing in the 1980s and 1990s you would have done much better than this, and if you had been investing in the 2000's you would have done much worse.

 

Cheers,

Bre

YouTube Videos

Hello Everyone!

I know that it has been a really really long time since my last post. I have been rediculously busy the last two months, but I promise I will start posting regularly again. I wanted to share a couple of YouTube videos of my boss giving some talks. I think that they are very interesting, however they are at a much higher level of finance that we have been discussing here. If you have some time check them out.

http://www.youtube.com/watch?v=ZBhoqlXRCDE

http://www.youtube.com/watch?v=ma1GowuDhb8

I will continue my discussion on finance and compounding interest in the next couple of days.

Cheers,
Bre

Investing 101 Continued...

Hello Everyone! It has been a while since my last post... things have been crazy! Anyway, as I promised I am going to continue my discussion on investing. Tonight we are going to talk about mutual funds an ETFs.

3. Mutual Funds: Mutual funds became popular because of the power that they gave small individual investors in the market place, for a relatively low cost. Essentially a mutual fund company is headed by a fund manager that actively manages a portfolio by investing in a diversified mix of assets. They create pre-packaged “portfolios” within a specific asset class, sector, or risk measure that an individual can buy into. Individual funds have the buying power to create diversification within whatever sector they are aiming to own. In addition mutual funds are also considered to be incredibly efficient because they are only priced once daily at the end of the trading day, therefore they are said to trade at their true net asset value (NAV). Individuals can then buy into these mutual funds per share, achieving both diversification and professional management for a fee. Mutual funds really opened the world of investing to small individual investors. Mutual funds are now the most dominant investment tool in the U.S. They account for 90% of all investment companies, with more than $10 trillion under management in 2007.

4. ETFs: Exchange Traded Funds (ETFs) have been said to be “The new face of investing, changing the way that people will invest from now on.” ETFs are an investment vehicle that evolved out of the structure of mutual funds, although they differ in many ways. ETFs are investment portfolios that are comprised of stocks and other securities that are designed to closely mimic the structure of a particular index such as the S&P 500 or the Dow Jones Industrial Average. The most common types of ETFs are: Indexed ETFs that track different indexes such as the S&P 500, Commodity ETFs that track different commodities such as oil, Currency ETFs that track different currencies such as the dollar, Actively Managed ETFs that track different asset classes creating diversity, Hedge Fund ETFs that track the assets of different hedge funds, and leveraged ETFs. Unlike mutual funds, ETFs do not have fees and trade more like equities, meaning that there is a usually a ticket charge associated with each buy and sell, and are priced immediate when they are bought and sold. Just like equities you can place limits and stops on ETFs. ETFs are amazing because they give you access and cost efficiency of mutual funds and the transparency and flexibility of a stock.

Next time I will talk more about compounding interest and the rule of 72 due to popular demand. I guess that you are interested in knowing how investing will grow your money!! 

Until next time...

Bre

*This blog is strictly informational. The views are my own, and you should contact a financial professional before making any decisions. I am not paid or in anyway endorsed for the content of this blog.

Investing 101

Hello Everyone! I have finished talking about different savings options for now. I will revisit this topic later. Now I am going to talk about the basics of investing. There are a lot of different types of invests and I can't tell you how often I see people so confused that they think when they are invested in mutual funds they think they are invested in cash! Tonight I am going to start with some definitions.

1. Stocks: Often referred to as equities, stocks are ownership shares in a corporation. When you invest in equities you are investing in the unlimited gain and loss potential of the company. There are many types of stocks that can be characterized by many different "buzz" words. Some of the buzz words you may have heard are small-cap, mid-cap and large-cap. Cap stands for capitalization and this is referring to the size of the company by the market capitalization of it's shares outstanding. Small-cap companies are those with between $300m and $2b in market cap. Mid-cap companies are those with between $2b and $10b in market cap. Large-cap are companies are those with more than $10b in market cap. Other buzz words you may have heard are growth and value. Growth companies are smaller companies that have potential for a lot of growth, and investors will try to invest in these companies and ride the wave of return that is produced from the company's growth. Value companies are those whose stock price is considered to be under priced, therefore investors will invest in them because they think that the stock is "cheap". Investors have different philosophies about how investing in different types of stocks will make them the most money.

2. Bonds: Often referred to as fixed income or debt. When you invest in a bond you are actually loaning your money to the company or government that is issuing the bond. In return for the loan the issuing company gives you an interest payment. At the maturity date of the bond the investor receives the par value of the bond usually $1,000. You can buy bonds at a discount or at a premium. A discount means that you purchase the bond for less than par and a premium means you purchase it for more than par. Let's use an example, say you buy a bond that is priced at a discount at 90 (which really means $900 but  when pricing bonds the last zero is not shown). The maturity date of the bond is four years from now and the annual coupon (interest) payment is 8%. Usually bonds pay a coupon every six months, therefore you will receive a coupon payment twice a year at 4% for the next four years (8 payments total). At the end of the four years on the maturity date you will receive par for your bond, $1,000. Therefore, by the end of the maturity date you will have received 8 payments of $40 plus an additional $100 for the par payment (your paid $900 and then you received $1,000). You can sell your bond before the maturity date on a secondary market, however once you sell it you forgo any future coupon payments and the price that you sell it for is subject to the market and therefore may be below par. In general bonds are considered to be less risky than equity because you are guaranteed the income stream from the coupon payments and the par at maturity. However, if the company that you are loaning your money to goes into bankruptcy then you have the potential to lose the money that you loaned. This is called default risk. There is another form of risk associated with bonds called interest rate risk. If you were to invest in a bond today that is paying 4% per year, and then in two years interest rates are much higher and you could invest in a bond at the same price at 6% per year, but you cannot get this higher interest rate because your money is tied up in the lower interest rate bond then you are losing out in a potentially higher interest rate. This is what is called interest rate risk.


Next time I will talk about mutual funds and exchange traded funds.


Cheers,
Bre


*This blog is strictly informational. The views are my own, and you should contact a financial professional before making any decisions. I am not paid or in anyway endorsed for the content of this blog.

IRAs and Return

Hello Everyone! After my last post I got a great question about IRAs and returns. The question was that there seems to be a lot of IRA CDs that are returning less than 4.5%, and have maturity dates, which makes them fairly illiquid. Where can you find IRAs that will give higher returns? The first thing that I want to clarify is that an IRA is a type of account, not a type of investment. An IRA account can be invested in many different types of investments. You can by investments with levels of downside protection and maturity dates such as a CD or an annuity. However, due to the current low interest rate environment these types of investments are lucky to return 4% per year and are very illiquid. But you can buy many other types of investments in your IRA such as stocks, bonds, mutual funds, ETFs and  options. As I previously mentioned, the stock market returned about 13% in 2010. Therefore there are definitely places where you can find higher returns in your IRA. You can even buy real estate with IRA money, however there are some limitations to this, so I recommend consulting an expert before purchasing real estate with IRA money.  Therefore, if you are looking for higher returns in your IRA you will need to move away from the "risk less" investment such as CDs and fixed annuities and invest in riskier investments such as stock, bonds and mutual funds... Be aware that there is a potential for great losses in these types of investments, therefore if you are not sure what you are investing in make sure that you hire a professional. I will continue to talk about different investment types in later blogs. 

I hope that this helps to clarify investing and IRAs.

Cheers,

Bre


*This blog is strictly informational. The views are my own, and you should contact a financial professional before making any decisions. I am not paid or in anyway endorsed for the content of this blog.

Roths

Hello Everyone! Tonight I am going to finish our discussion on retirement savings. Last time we talked about IRAs and 401(k)s. Now we are going to talk about another type of IRA and 401(k) called a Roth. A Roth IRA has many similar characteristics to a traditional IRA except that it is funded with after-tax earned income. You may remember that one of the main benefits of an IRA is the tax-deferment (your money grows tax-deferred, no taxes are paid until it is withdrawn), so then why a Roth? The first benefit of a Roth is that the interest is tax-free. Therefore when you take a withdrawal you will owe no taxes because the principal was already taxed as income and the interest is tax-free! The second major benefit of a Roth is that it has more liquidity than a traditional IRA. You can withdraw the principal (the money that is contributed to the account, not the interest) at any time penalty free. This can be a big factor for young professionals, if you do not already have a lot of savings you may not want to tie of your money in an illiquid account in case of an emergency. There is a 10% penalty on early withdrawals of interest before the age of 59.5. You can also use Roth funds for some education, buying a home and health care. Therefore a Roth can be a great way to save for children's education. Another fact that you want to consider when you contribute to a Roth is your current tax bracket. If you are currently in a low tax bracket it may be a good time to contribute to a Roth instead of a traditional IRA, because hopefully when you retire you will have more income (and therefore a higher tax bracket) than you currently have! If you are currently in a high tax bracket, the tax-deferment of a traditional IRA may be better. However you never know what taxes are going to look like in 30 to 40 years from now when you retire. Therefore a good idea may be to have both a Roth and a traditional IRA so that you can diversify your tax liability. The annual contribution limit for a Roth is the same as a traditional ($5,000), but remember that this is for all of your IRAs. Therefore if you have a Roth and a traditional your totally contribution will be $5,000 per year NOT $10,000.

There are also Roth 401(k)s. In the case of a Roth 401(k) there will be two "buckets" of funds.    There is the traditional 401(k) "bucket" that the employer contributes to, and there is the Roth "bucket" that the employee contributes to. I am not going to get too much into this because you should have all the pieces to understand how this works. The contributions and employer match will be the same in a traditional 401(k), and the tax-free interest and after-tax principal is the same as the Roth IRA.

I hope that this is enough information to help you decide how you want to start saving for retirement. Remember it is never too early to start saving for retirement. 

Cheers,

Bre

*This blog is strictly informational. The views are my own, and you should contact a financial professional before making any decisions. I am not paid or in anyway endorsed for the content of this blog.

Savings Accounts

Hello everyone! Tonight I am going to talk about what options you have for savings accounts. Depending on what your expectations for interest returns are, your risk tolerance, your need for liquidity and the reason that you are saving, there are many options for savings accounts. 

Let's start with retirement accounts. In the "good old days" people got their retirement through pensions. Pensions are a form of Defined Benefit plans where upon retirement the retiree gets a guaranteed annual cash flow. The benefit varies from company to company, however it can look something like 75% of your top three paying years. Even though pensions still exist in some industries such as education, government and the airlines, very few people can rely on the benefits that a pension provides. More common now are Defined Contribution plans such as a 401(k). A 401(k) is a retirement savings plan provided by an employer. Although the structures can vary greatly, in general, the employee contributes to the plan, and then the employer matches the contributions. The match will vary, but an example could be up to 4% of your annual salary, or 30% of every dollar contributed. There are limits on the contributions. The employee can contribute a maximum of $16,500 per year (2011) and the combined contribution between the employee and the employer cannot exceed the employees annual salary. The money in a 401(k) is pre-tax, and the interest grows tax deferred. You cannot access the funds in your retirement accounts until you are age 59.5 penalty free. When you do withdraw the funds at retirement, withdrawals are treated as ordinary income for tax purposes. These tax benefits allow you to earn interest on funds that would ordinarily be going to Uncle Sam. There are a lot of details involved with 401(k)s and this was a pretty basic explanation, however some of the highlights of 401(k)s include firstly, the employer match. This is basically free money, therefore if you are lucky enough to have a 401(k) you should always try to contribute at least as much as the employer will match. The second significant benefit is the tax deferment. There are a couple of things to be aware of when participating in a 401(k), the first being the illiquidity of a 401(k). This is money that you should not expect to need until retirement. The second thing to be aware of is the investment choices within a 401(k). They are often very limited therefore you want to make sure that your savings is properly diversified.

The second type of retirement account that I will talk about tonight is an IRA. If you are not fortunate enough to have a 401(k) there are options for you to save for retirement. An IRA is a retirement savings account that an individual can open outside of their employment, however if does have to be funded with earned income. The primary benefit of an IRA over an ordinary brokerage account are the tax savings. In a traditional IRA all contributions are pre-tax. Therefore, similar to a 401(k) you can be earning interest on the money that you would ordinarily pay to the government. The interest is also tax-deferred. The contribution limit on an IRA is $5,000 per year, therefore there is a lot more opportunity for savings in a 401(k) with a contribution limit of $16,500. Another benefit of an IRA is that it can be invested outside of the investment constraints of a 401(k).  Again, any withdrawals will be penalized at 10% plus the taxes you owe if withdrawn before the age of 59.5. All withdrawals are taxed as ordinary income, even after retirement age. 

I think that that is enough for tonight. There are still a lot of savings accounts to discuss! But I will continue tomorrow. If there is something that you do not understand let me know. I thought of an interesting tidbit about compounding interest that I thought you might like: If you invest your money at 10% per year and make no additional contributions, your money will double every 7 years!

Cheers,

Bre

*This blog is strictly informational. The views are my own, and you should contact a financial professional before making any decisions. I am not paid or in anyway endorsed for the content of this blog.

Clarification

Hello Everyone! So I have gotten some great feedback already from all of you and I love it! I realized that some of  the acronyms that I have been using are not clear to everyone. If you do not understand something don't be afraid to say something because I am sure that you are not the only one. Here are 2 points of clarification:

1. CD: CD stands for Certificate of Deposit. They are essentially "Risk-free" investments that earn slightly higher interest rates than a savings account because they are held for a specific time period. Therefore you can earn higher interest because there is less liquidity than a savings account.

2. S&P 500: S&P 500 stands for the Standards and Poors 500 Index. This is one of the most popular US stock markets indices. It is an index of 500 Large-Cap companies. It is a favored index to use when looking at the health of the stock market because of the large number of companies that it represents as opposed to the Dow Jones Industrial Average, which is an index of only 40 companies.

Hope this helps!

Cheers,

B

Interest and Liquidity

Hello everyone! So let's continue our conversation about saving... I realized that there are two basic concepts on interest that I forgot to discuss yesterday. The first being inflation. As you probably know the value of money changes, so a dollar today has a lot less value then it did 50 years ago. In a "normal" economy inflation grows at about 3% per year. We can get into inflation and how the Fed and the Government tries to control it in a later discussion. However it is important to consider this because if your money is sitting in cash or in a very low returning investment you may actually be losing value. If your money is only growing at 25bp (0.25%) and inflation is growing at 3% then you are losing 2.75% every year! 

The second topic that I want to discuss is compounding interest. Einstein once said that positive compounding is the best invention. Let's use a really easy example: if you invest $100 for 1 yr at 10% then at the second year you will have $110 and then at the third year you will have $121... Now add a few zeros after those values and you can see the power of compounding. However, remember that if positive compounding is the greatest invention, then negative compounding is the worst. For example, you have $15,000 and you lose 50% in the stock market, and now you have $7,500. What return do you have to make to get back to $15,000? 100%! and it only gets worse the more you lose. So remember that when you are saving and investing, not losing is winning. 

Ok so now that I have talked about a lot of different scenarios for interest, the next thing that 

we need to consider is liquidity. Liquidity is the ability to access your funds immediately without a significant change in value. Clearly the most liquid type of account is a checking account. You can access your funds anytime you want with no fees (other than ATMs!). Then there are savings accounts, which may have some restrictions on how much you can withdraw but in general they are very liquid as well. Then there are brokerage accounts, which are savings accounts that are invested in stocks, bonds, mutual funds, ETFs, etc. While typically there are no restrictions on how much money you can take out you can be restricted by the what the money is invested in. There are often fees associated with trading and it usually can take a couple of days to actually get your money. Then there are retirement accounts such as IRAs and 401ks. Other than a few exceptions you will get penalized for taking money out of these types of accounts before the age of 59 1/2. Finally, there are investments such as CDs and annuities that will have significant penalties if you try to withdraw the funds before the maturity date. 

My next discussion will take all of these factors about interest and liquidity and discuss what options there are for savings and I will go into specifics about these different types of savings accounts.

Cheers,

B

*This blog is strictly informational. The views are my own, and you should contact a financial professional before making any decisions. I am not paid or in anyway endorsed for the content of this blog.

New Years Resolutions

Hello Everyone! This week I am going to talk about saving. Some of my New Years resolutions for 2011 include personal savings goals. There are a lot of ways to save money and there is a lot to consider when choosing the right way to save. One of the big challenges for me is the mountain of student loans that I have as well as limited cash flow. Therefore I am stuck with the question of whether it is more important to aggressively pay down my loans or to save? While everyone's situation is different, here are some things to consider...

The first two things to consider are interest rates and liquidity. These two factors will help you get the right combinations debt reduction and savings. Today I am going to focus on interest rates.

Interest Rates: Make sure that you consider both the interest rates that you are paying on any debt, as well as the interest rates that you are making, or could be making on your savings. You probably know that interest rates are at extreme lows right now. This can be both good and bad. This is great if you are a home buyer and can secure a mortgage at less than 5%.

On a historical basis, mortgages are extremely cheap.. However if you want a "riskless" investment such as a CD or a savings account your money may only be making 25 basis points (there are 100 basis points in 1%, therefore 25 bp = 0.25%). The low interest rates that are being provided on CDs and savings accounts are definitely something to consider when choosing where you want to save. 

Unfortunately there are no magic answers to the low interest rates on your savings. While there are places that you can earn higher returns, for example the S&P 500 was up over 12% in 2010, there are significantly more risks associated in investments that give higher returns (and potentially large losses, we all remember 2008!). To make the situation even trickier, credit card rates are not nearly as forgiving as mortgage rates, currently averaging right around 15%, and student loan rates averaging around 6%.

Tomorrow I will consider liquidity and then later this week, we will discuss some options for savings solutions based on interest rate, liquidity and cash flow needs.

Cheers,

B

*This blog is strictly informational. The views are my own, and you should contact a financial professional before making any decisions. I am not paid or in anyway endorsed for the content of this blog.

Introduction

Hello everyone. My name is Bre and I am 20 something living in Denver, CO. I work in personal finance and I have a Masters of Science in Finance. Recently I have realized that my friends and family know so little about personal fiance that it could be dangerous. This is no fault of their own, if you were to ask me how to build a desk or how to draw blood that would be dangerous. The difference is that everyone has to deal with their personal finances, while I hope that I never have to draw someone's blood. Additionally, I really enjoy sharing the knowledge of personal finance that I have with people. It is important that young professionals learn about personal finance, you do not have to be rich to make good financial decisions. This is why I am starting this blog. I know about personal finance, I love personal finance, and there are a lot of people out there that need to know more about personal finance.

There are so many things that I can discuss: taxes, saving, retirement, retirement accounts, credit scores... I am going to choose a theme per week and try to come up with as many facets of that topic I can think of to discuss. However, I think that knowing what you want to know about personal finance will make this blog a lot more interesting. So PLEASE ask questions! 

*This blog is strictly informational. The views are my own, and you should contact a financial professional before making any decisions. I am not paid or in anyway endorsed for the content of this blog.