Posts Tagged ‘Money’

The Best Way to Invest your Money - Part 7

Personal Finance | Posted by C.C.Mitchell
Mar 01 2009
Wall Street Investments

Wall Street Investments

So now that you’ve learned about Compound Interest and rates of return here. I bet your wondering how to go about it. There are thousands of funds to invest money in. But how to choose? First off if your employer offers a 401(k) retirement plan take it. Most 401(k)s offer a match where if you contribute a set percentage of your salary or wage to your plan your employer will match it with a set percent per dollar. 401(k) plans are also tax deferred savings investments. This means that this contribution is taken from your pay check before the government takes out taxes. Since the money is contributed on a pre-tax basis. You get more bang for your buck. The government collects between 25% and 33% on the dollar for most income earners. By contributing pre-tax dollars it equals what would cost $1.25 to $1.33 of after tax dollars.

Multiply that by Thousands of dollars a year and it adds up to a significant amount of money. $1000 would become $1250 dollars. This money also grows tax free, you do not pay taxes on its earnings unlike the Mutual Funds I discussed in Part 6. That’s what tax deferred means, you defer tax payments until a later date. In the case of a 401(k) that date would be when you reach retirement age and begin withdrawals from your 401(k) retirement plan. Imagine how much faster that same $1000 grows with out paying taxes on the earnings reinvested each year. If it earned $500 in a year it grows by $500 not by the $375 that would be left after Uncle Sam got his share.

Most 401(k) plans are made up of several Mutual Funds to choose from, usually 8 to 12 different funds that cover all the bases. Diversity is a key factor when it comes to investing, you don’t want to put all your eggs in one basket because if that basket falls you don’t break all of your eggs.

Investment Choices

There are a number of key areas most plans will offer several choices to choose from to better diversify your holdings, they are:

  • Bonds, and Money Market Funds
  • Small- Cap Funds
  • Mid-Cap Funds
  • Large-Cap Funds
  • International Funds

Bond and Money Market Funds are the safest way to invest but don’t provide the returns that other funds produce. Bonds will for all intents and purposes pay a set interest rate. Its a little more complicated than that but that’s something to ask your Fund managers about.This is where those who are approaching retirement want to put that nest egg they have grown for so many years. It won’t grow very much but the safety of your retirement funds are almost guaranteed.

Small-Cap, Mid-Cap, and Large-Cap Funds are Mutual Funds that hold assets in companies with varying amounts of Capital respectively; small, mid, and large. So whats the difference? And which one are best?

Large-Cap Funds are more stable they hold the bulk of their assets in large corporations like Microsoft, or GE. They tend to be more stable and their stock values fluctuate at a minimal level. Many of these stocks pay dividends to share holders (The Fund in question in this case). Since their values don’t change dramatically in short time spans your money is generally safer in Large-Cap Funds. They may not grow in leaps and bounds but they don’t plummet suddenly either. Large-Cap Funds are a place to invest safely over long periods of time.

Small-Cap Funds are just the opposite of Large-Caps in just about every respect. These Fund investments are made in companies with smaller amounts of capital. This could be exemplified by that locally owned foundry at the end of town . They are much more volatile, and their value tends to fluctuate wildly. This instability is a double edged sword you live or die by. These funds can made huge gains in short periods of time or they suffer huge loses just as quickly. This is a popular investment strategy for those who are younger and have more time to invest and ride out the lows that come with the highs. If you are close to retirement avoid Small-Cap Funds, they are not a safe place to put money you intend on needing in a few short years.

Mid-Cap Funds are a little more enigmatic so lets just say they fall in between Large and Small Cap funds, for the most part in all respects.

International Funds are funds that invest assets in companies outside our borders. Companies such as Mercedes-Benz, and Novo Nordisk (A global leader in drugs to treat diabetes located in Denmark.) The idea is to diversify by putting money in companies that may not be suffering from what ever is dragging down the U.S. markets.

Other Retirement Investments

Stock Market Bull

Stock Market Bull

If you do not have the benefit of a 401(k) plan with a match, or if you merely want to further invest for your future look no further than the  Roth IRA (Individual Retirement Account). Differing from a standard IRA, the Roth, formed in 1997 and named after its creator William Roth (a republican from Delaware), holds special advantages when it comes to tax implications.

Benefits such as:

  1. Tax-free withdrawals.
  2. Distributions are not required based on age.
  3. Larger contribution limits.

1. Tax-free withdrawals, unlike the traditional IRA your contributions can be withdrawn tax-free as long as the account is at least 5 years old and your withdrawals don’t exceed your principal contributions. For withdrawals with out penalty on amounts beyond the principal contributions the account holder must be 59 1/2 years of age.

2. The Roth IRA does not require distributions at the age of 70. Therefore you can choose not to draw it when other IRAs require you too, so you can leave it to your heirs or your favorite charity.

3. The Roth IRA has built in provisions for annual contributions limits larger than other traditional IRAs. For 2008 the annual contribution limit is $5,000,for a Roth, since your income has already been taxed before contributions you can pay over and above the $5,000 limit to the equivalent of your tax bracket (i.e. if you are in a 25% tax bracket you would be able to contribute $6,250 or $5000 X 25%). This is to offset the loss of pre-tax contributions gained by IRAs and 401(k)s.

Of course with a Roth IRA you have to make the contributions the old fashioned way you cannot do a pre-tax payroll deduction. You can however have a funds withdrawal directly from your bank account if you like. This is still the best way to invest in retirement outside of a 401(k) plan. Many people use it to supplement their 401(k)s and to further diversify by choosing funds groups that they don’t already have access to through other retirement plans.

Its also prudent to state that time may be running out for the chance to set up a Roth IRA, 2008 may be the last year because the powers that be in Washington may end the Roth IRA program to new comers. It has never been a popular thing with democrat politicians and they now have the power to change the tax code.

Only in a Cracked World would anyone want to recall such a great retirement plan.

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Mortgage Rescue or Ruin?

Economics, Politics | Posted by C.C.Mitchell
Feb 21 2009

On of the hottest issues in Politics today is, what should be done about the ever declining housing market if anything. The White House currently has a plan, but the skeptics ponder its effectiveness. Some believe it will do more harm than good; while The White House contends that it is our best bet. I see it as a bet; a gamble for our futures.

Its a PITI

PITI in mortgage lingo means (Principal, Interest, Taxes, and Insurance), these are the components of a mortgage. Hmm, PITI! Ironic isn’t it?

Property Taxes and Insurance alone often account for close to 35% of a mortgage payment; usually paid out in the form of an escrow account. Escrow accounts are a way of making sure that your state and local governments get their taxes owed out of you, and  your lenders’ investment (your home), is protected. Your home is their collateral they need to make sure its protected, so if something bad happens and your home is destroyed they get their money out of it. Isn’t it nice that they let you pay a premium that they benefit from?

Mortgage ApplicationIn the Obama Administrations’ plan to make bad mortgages affordable PITI is a key factor. It constitutes the percentage that must be met to achieve the Homeowners Affordability and Stability Plan or HASP. The percentage put forth by The Treasury Department is 31% of the borrowers gross income, thats pre-tax income.

To make a mortgage affordable and stable one of more of three factors: The interest rate, the principal balance, and the duration of the loan, must be altered.

Here is one problem with the plan: HASP does not account for Home Equity Loans, and Equity lines of credit that lender have to consider when issuing loans. This is a knot that must be untied before much good can be done.

In regard to the altering of mortgage loans in an attempt to make them HASP worthy. Foxbusiness.com put forth an example which examines the guts of the HASP plan far better than I could as I am not a big numbers guy. Their example reads as follows:

“For a sample household with payments adding up to 43% of his monthly income, the lender would first be responsible for bringing down interest rates so that the borrower’s monthly mortgage payment is no more than 38% of his or her income. Next, the initiative would match further reductions in interest payments dollar-for-dollar with the lender to bring that ratio down to 31%. If that borrower had a $220,000 mortgage, that could mean a reduction in monthly payments by over $400. That lower interest rate must be kept in place for five years, after which it could gradually be stepped up to the conforming loan rate in place at the time of the modification. Lenders will also be able to bring down monthly payments by reducing the principal owed on the mortgage, with Treasury sharing in the costs.”

The monthly payment on a $220,000, 30-year mortgage, assuming an interest rate of 6%, would be $1,319. On top of that, the typical borrower would have to pay about $660 for taxes and insurance each month for a total payment of $1,979. If that were 43% of income, it would mean income of about $4,600 a month or $55,200 a year (which is higher than the $50,200 median household income).

Could this mean back to the drawing board for The Obama team? If Foxbusiness is correct I hope so.

Economic pundits of the plan say the math doesn’t work with the numbers put forth by the Obabma Administration because the Tax and Insurance portions of the payments are fixed leaving all the altering to the Principal balance and the Interest rates. Coupled with the fact that the $75 billion pledged to bail out the housing market won’t be nearly enough to cover all loans in need of assistance. Many on Wall Street say it will cost closer to $275 billion to fund such an ambitious plan.

Here’s an idea, why doesn’t the government simply wave all property taxes for five years instead of forcing lenders to take less for contracts signed in good faith by mortgage holders?

Would that be more cost effective than doling out what many authorities on this stuff say will cost upwords of $275 billion?

Would this not help out the banks with all their bad paper too?

Wouldn’t they get the money the lended with at least most of the interest they’ve been counting on to stay afloat?

These are my thoughts. I’m just trying to make sense of a Cracked World.

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New Found Wealth - Part 6

Personal Finance | Posted by C.C.Mitchell
Feb 18 2009

First of all Congratulations on your New Found Wealth! Now that we have worked on preventing your money from working against you we’ll look at how to make it work for you. When I say work for you I mean lets make your money make more money for you. Your money used to make more debt it can also make you more money. I’m talking about compound interest.

Compound Interest can be your worst enemy or your best friend. If you carry a balance on your credit cards, it’ll be your worst enemy. That 15% interest rate on your Credit Card means that 15% of your card accounts balance will grow by 15% annually. At this rate a $1000 balance with a 15% interest rate will grow to $1150 in a year. That amounts to an additional $12 a month; that doesn’t seem like much but when you consider the amount of debt the average consumer takes on it can be a formidable foe. A $6000

Compound Interest

Compound Interest

balance would grow to $6900! A $900 dollar increase, that breaks down to $75 a month. THAT SUCKS! What sucks even more is that growth is added to the balance and the next month the 15% interest rate is figured based on the new higher balance. For instance that $6000 that grew to $6900 now will grow another $1035 to total $7135 the next year. OUCH!

But we have dealt with debt earlier in this series. Now we are going to see the alter ego of compound interest.

When it comes to compound interest the same rules apply to you that apply to the average credit card. meaning that you can be the recipient of that compounding cycle. The way this is done for the average Joe, or Joann, is through investment in mutual funds usually through an IRA or 401(k).

Mutual Funds don’t earn an interest rate. They do however earn a rate of return based on how profitable your mutual fund or funds are. This rate of return is presented in the form of a percentage score. A 15% rate of return produces the same effect as a 15% interest rate. Remember the $6000 dollar credit card balance we just discussed?

Now imagine having $6000 in a mutual fund(we’ll call it Fund X). Fund X earns 15% in one year, you just made $900! Now the idea is that you reinvest your returns right back into Fund X and if it were to make 15% in the following year, it earned $1035 and is now worth $7135 that’s a $1935 profit for doing NOTHING! Nothing but waiting. Keep in mind these rates of return are averages they won’t earn the same amount every year some years Fund X may earn 20% and other years only10%. It takes a lot of years, but in the grand scheme of a lifetime its worth the wait.

TIP! - Time is Money

The sooner you start the better. The more years you spend harnessing the power of compound interest the more money you will finish with. Therefore you have to put it in and leave it in, (don’t pull out all of your money because of one or two down years). This builds momentum like the locomotive in Dumping Debt. The compound rate grows exponentially over time.

I started investing at age 20, I bought stock in a mutual fund and built up my contributions to $1000 by age 22. From there I have never added another nickel to that fund, if this fund continues its historical average return of 12% over the remaining 43 years until retirement it will have grown to $130,729.91. That’s the power of compound interest working for you.

Here’s the great part, what if I start contributing to the fund again? Or I start contributions to a new fund?

On both counts I grow even more wealth over the years. I am now 38 years old. Opening another $1000 fund account now would grow to $21,324.88 in the remaining 27 years until I turn 65. If I never added another penny to it.

Contributing another $1000 to my existing fund now would grow it to $152,054.72 an increase of $21,324.80! For $1000!? That’s impressive. I guess I need to come up with another $1000. If I wait just one more year to make that new contribution, it would grow to $135,763.14, so one year makes a difference of 16,291.58.

There are no guarantees in life, the numbers in these scenarios are not carved in stone. But in the history of mutual funds, no fund has ever lost money over a ten year period of time. That is a pretty good track record since mutual fund became a legal financial entity in 1934 — that’s in the middle of The Great Depression! I’ll cover how to investing more thoroughly in a later installment in the series.

Now you know what to do with your money in a Cracked World.

Any questions?

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Dumping Debt - Part 5

Personal Finance | Posted by C.C.Mitchell
Feb 12 2009

Now that your living on a budget and training your money, saving for the important things, and keeping ahead of the game its time to learn a key mechanic to winning the game.

Budgeting and saving becomes easier when the debt is gone. Imagine a locomotive, it starts out slowly and gradually gathers speed until its own momentum carries it at great speeds. It possesses the might to smash through barriers, and is virtually unstoppable. This is how your debt reduction should be, like a locomotive.

Be the Locomotive!

Your debt reduction plan, like the locomotive we discussed starts out slowly and gathers momentum. Budget to pay the minimum payments on all of your bills and debts except for the smallest balance of all your debts and put all of your extra funds on that debt.

Here is an example: After paying all of your utilities, and your Rent/House payment and all of your groceries. You use the money you have left over to pay on your debts. So lets say you have a Visa balance of $150, a Master card balance of $225, an auto loan for $5,500, and a student loan for $25,000. They all require minimum payments of $20, $25, $250, and $400 respectively. After you account for all of these payments lets say you have $45 left over.

Take the $45 left over and use it to pay an extra large payment on the Visa balance because its the smallest. So instead of paying $20 to Visa leaving a balance of $130 for them to charge you interest on you’ll pay them $65 (the $20 minimum + the $45 extra) and have a much smaller balance of $85. The following month in our example you would do the same thing again. Paying another $65 on the remainder of the Visa account would leave a balance of around $20 give or take a buck or two from interest. The following month after that you will be able to pay off your Visa account and have extra left over for the new smallest debt.

See how the momentum builds? Once the first smallest debt is gone you now have that much more to put on the nest one. In our example you were paying an extra $45 dollars a month on your smallest debt for a total of $65 a month. Now you will apply that $65 a month you were paying Visa to the Master card balance because it is the next smallest debt. Your payment will be the $25 minimum + the $65 extra for a total of $90 a month. On a $225 balance you will have that one gone in a little more than two months (Don’t forget you have been paying minimums all along on this balance already so that balance is far less than $225).

So the basic concept is to build momentum with your debts by prioritizing them from smallest to largest and taking them out in order one at a time.

!Remember!

You MUST make minimum payments on all other debts!

Imagine the force at which your locomotive will hit your next debt.

Always prioritize  smallest to largest  by the size of the balance. Do not take in to account interest rates. Interest is irrelevant to momentum.

In the days to come we will look at what to do with this new found wealth you had buried under debts. Look for New Found Wealth - Part 6. Its a solid solution for a  Cracked World!


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