IF WE HAD TO PAY cash for college costs and for the homes we purchase, many of us couldn’t afford either until our 40s and perhaps later. That’s where borrowing money comes in. It allows us to buy things we can’t currently afford—and, for worthy goals like purchasing a house and getting an education, it can be the prudent thing to do.
The key is to make sure we don’t borrow too much. How much is too much?
YOU MIGHT QUALIFY to fund both a tax-deductible and Roth IRA. Alternatively, perhaps your employer offers the chance to stash money in either a tax-deductible or Roth 401(k). Which should you favor?
It’s a question of whether you want cake today or cake tomorrow. Roth accounts offer tax-free growth but there’s no immediate tax deduction. Traditional retirement accounts usually offer an immediate tax deduction but everything withdrawn in retirement is taxed as ordinary income.
IF YOU ASK FOLKS whether a home is a good investment, you’ll get all kinds of answers—both enthusiastic and downbeat—because you’re now firmly in the land of anecdotal evidence. The fact is, most people own perhaps three or four homes during their lifetime, sometimes with great financial success and sometimes not, and even those who claim their home has been a big moneymaker often don’t have a firm grip on how much they truly made.
WHEN SHOULD YOU CLAIM your Social Security benefit? Ignore all the “wisdom” you’ve heard from family and friends.
Instead, start with this advice: Don’t assume that the best strategy is to claim benefits at the earliest possible age, which is 62, or that the right strategy is to claim as soon as you quit the workforce. Similarly, don’t assume that you should claim benefits early because that’s when you’ll enjoy the money the most or when your retirement spending will be at its highest.
ACADEMICS TALK ABOUT the risk-free rate—the return we can earn while taking virtually no risk. In the academic literature, the yield on Treasury bonds is typically deemed to be the risk-free rate. But for many families, the risk-free rate will be the interest rate on the highest-cost debt they have. After all, by paying down that debt, we effectively earn a rate of return equal to the interest rate that we’re getting charged—and we can do so without taking any risk.
IS A HOME A GOOD investment? We’re talking here about purchasing a place for your own use, rather than as a rental property, though many of the same issues arise.
There are two key factors to consider. First, there’s a question of time horizon. Because of the hefty costs involved in purchasing and especially selling a house, few people would advise buying if you have less than a five-year time horizon—and even that’s arguably too short.
WHEN WE BUY BONDS, we lend money to the government or corporations and, in return, we receive regular interest payments. When we borrow money, the roles are reversed: Instead of receiving interest, we’re paying it to others. On the family balance sheet, any money we borrow is effectively a negative bond.
This is a useful concept for two reasons. First, by viewing our mortgage, student loans, car loans and credit card balances as negative bonds,
IMAGINE YOU’RE a teenager, your older sister is heading off to college and she wants to take the car you share. She offers to buy you out, and says she’ll pay you $5,000 five years from now, after she graduates. But you’d rather be paid today.
What’s a reasonable sum to ask for? The right number might be around $4,500. If you got $4,500 today and invested it, you’d have $5,000 after five years,
SUPPOSE YOU BOUGHT a stock mutual fund five years ago and you still own it today. What return did you earn? If you go to the fund company’s website, it’s easy enough to find out the five-year total return. There’s a chance, however, that your personal performance was quite different from the fund’s published result.
The total return number will be a so-called time-weighted return, meaning it’s the return you would have earned if you bought the fund at the beginning of the period,
ESTATE PLANNING MAY sound like a daunting undertaking—and it can be for some families, such as those with great wealth or who have children with special needs. But for most folks, it isn’t all that complicated.
What’s involved? First, make sure you have the right beneficiaries listed on your retirement accounts and life insurance. For everyday Americans, their retirement accounts are often their most valuable asset, so it’s crucial that they have the correct beneficiaries named.
ANSWERING THIS question is surprisingly easy. Start by figuring out how much pretax income you want each year in retirement. Next, subtract what you expect to receive from Social Security and any employer pension plan. Whatever amount that leaves—let’s say it’s $40,000 a year—will need to come from your savings. You multiply that $40,000 by 25 and you have your answer: $1 million.
Sound like a huge sum? Keep a few things in mind.
WE BUY INSURANCE either to protect the property we own or to protect ourselves and our family. Reflecting this, insurance companies are divvied up into two broad categories. Property-casualty insurers offer auto, homeowner’s, renter’s and umbrella liability coverage. Meanwhile, life companies offer disability, health, life and long-term-care insurance.
Add up these various policies and we’re talking about eight different types of coverage. Which of the eight do you need? Here’s a quick rundown:
MANY OF US GRADUALLY buy into the financial markets over the course of our career. Arguably, that’s ideal, both from an investment and an emotional perspective: We purchase stocks and bonds at all kinds of prices—some high, some low—and the fact that we have future dollars to invest means any market decline has a huge silver lining.
But every so often, we’ll have a larger sum that we want to invest in the stock market.
OUR PORTFOLIO’S BASIC split between stocks and more conservative investments—its asset allocation—is the most important investment decision we make. Too often, folks make this fundamental choice based on some hunch about the stock market’s short-term direction. Alternatively, they back into the decision, buying a hodgepodge of investments and never formally settling on an asset allocation.
Want to do it right? We should think about how much risk we can reasonably take and how much risk we can stomach.
THERE ARE TWO REASONS to hold cash investments: to cover upcoming spending and in case we’re hit with a financial emergency.
Suppose you plan to make a house down payment in the next five years or you’re five years from making your teenager’s first college tuition payment. You don’t want to see this money devoured by a stock or bond market decline, so you probably shouldn’t own anything more adventurous than a high-quality short-term bond fund.