Notes on Suze Orman's Money Book for the YF&B

Visit Orman's Web site (www.suzeorman.com) for a number of supplementary resources and references. Click on the YF&B link and enter the code: YF&B. To register, you will need to enter your information, along with the number: 98635472; then you will create your password to use whenever you sign back on.

1: FICO

Your FICO Score Make-up

The FICO Ranges

Credit Bureaus

Experian

Equifax

TransUnion

Strategies

• Focus on what matter to the FICO folks:
  1. Pay (at least minimum balance) on time
  2. Manage debt-to-credit-limit ratio
  3. Protect credit history (i.e. don't arbitrarily close out accounts)
  4. Create the right credit mix
• Keep credit card bills super-low in the months before applying for a mortgage
• Keep mortgage shopping to under a two-week period, so your FICO score will not be negatively affected
• Strive for a FICO above 719
• Check credit report at least once a year: www.annualcreditreport.com; (877) 322-8228
• File a fraud alert with a credit bureau if you think you are a victim of identity theft; also, complete an ID fraud affidavit

3: Credit

• Evaluate each purchase before you "charge it." Is the purchase a good or bad use of credit?
• Keep up with your rates: strive to lower them
• Keep up with your grace period
• Know your billing cycle:
  • average daily balance (yes)
  • two-cycle average daily balance (no-no)
• Minimize your minimum amount due (if you are cashed strapped): different card companies compute minimum amount due using different percentages of the balance
• Look out for mistakes on your statement
• Pay off credit cards using your savings; but don't touch the 401(K)
• As much as possible, refrain from using an HELOC to pay off credit card debt

4: Student Loans

If you don't know where your paper work is, head over to the National Clearinghouse loan locator at www.studentclearinghouse.org. Click on the Students & Alumni tab. You can also track your loans through the National Student Loan Data System maintained by the US Department of Education (http://www.nslds.ed.gov).

Strategies

• Forgiveness (i.e. cancellation): Volunteer work in the peace corps, military service, career in law enforcement, teaching in underserved areas, etc.
• Deferment: an entitlement: you will be granted a deferment if you meet the qualifications; interests do not accrue on subsidized loans (but do on unsubsidized loans) during the deferment period;
• Forebearance: at lender's discretion; interests accrue whether the loan in subsidized or not
• Consolidation: Student loan interest rates change every July 1, based on the going rate for a Treasury bill index... you can get around the variable rate stress by consolidating your loans (and, in effect, locking in the current rate). If you consolidate within the 6-month grace period (post-graduation), you get an even lower rate. Some Caveats: if you consolidate, you are no longer eligible for deferment or forbearance. You might also become ineligible for forgiveness even if you take up one of the careers that qualify you for loan forgiveness.
• If all your loans are from the same lender, you must consolidate with that lender; if you have loans from a variety of lenders, you can shop around at banks, credit unions, and other loan sources, such as Sallie Mae (http://www.salliemae.com, (800) 448-3533), to consolidate. Also, the Department of Education's loan consolidation program is at (800) 557-7392 and http://loanconsolidation.ed.gov.
• Lower your rates: promise to be punctual with your consolidated Stafford loans, agree to have your loan payments automatically deducted from your account, be on time for 36 straight months, and watch your rate do down.
• Tax break: Get a tax deduction up to $2500 a year on interest on student loans.

5: Saving

• Stop getting a tax refund: you are simply getting paid money you should never have paid in the first place; and, worse, you didn't get to earn interest on the money—Uncle Sam did.
• Steer clear of life insurance (you're young, single, ...)
• Raise your insurance deductible
• Scrutinize your bank/credit card statements; balance your checkbook
• Take small, everyday steps to "create" savings: who needs a land line? or cable? space-out hair cuts more... wash more, dry clean less... club less... brown-bag it... go public (transportation)... find less expensive recreational outlets (movie rentals rather than the movies)... get a roommate... drive your car longer...
• Savings for an Emergency Fund: Setup a certificate of deposit (CD), money-market deposit account (MMDA) with a bank or credit union (See: http://creditunion.coop for list of Credit Unions; or a money-market mutual fund (MMMF) with a discount brokerage.
  • CDs: require you to leave your money untouched for a predetermined period of time; you will have to forfeit a portion of the interest earned if you wish to withdraw your money before the CD matures; FDIC Insured.
  • MMDAs: like a CD, unless you earn less interest and your money is never tied up (you can even write checks on your account--though with restrictions); FDIC Insured. Shop for the best CDs and MMDAs at www.bankrate.com. You do not have to use a bank in your state; and you should check with the bank where you have a checking account; sometimes if your combined balances are above a certain level, you can qualify for a higher interest rate.
  • MMMFs: mutual funds that invest in low-risk short-term securities like CDs and MMDAs. Drawback: Not FDIC insured. Benefit: Will generally allow you to open an MMF with as little as $50 (as opposed to the $500-$1000 that CDs and MMDAs might require), if you sign up for their Automatic Investing Plan (AIP), where you agree to have a certain amount directly invested in the account each month. Key: Since MMMFs are not FDIC insured, stick with reputable companies like:
    • TIAA-CREF: (800) 223-1200
    • T. Rowe Price: (800) 638-5660
  • Series EE bonds: See www.treasurydirect.gov. See also: http://www.publicdebt.treas.gov/sav/savcalc.htm

6: Retirement

401(k)

• Contributions are taken out of earnings, pretax
• Many companies add money to your 401(k) account—the employer match or company match—typically a percentage of your contribution up to a specific dollar limit
• Strategy: Enroll in your company's 401(k) plan and invest enough to get the maximum company match (which, in effect, is free money)
• Vested Interest: In most cases, you really don't own the employer match until a few years have passed; this is known as vesting
• Tip: If you anticipate changing jobs or returning to school in the next year or so, you might want to skip the 401(k), since you won't be around long enough to "collect" the vested employer match. Instead focus on funding a Roth IRA.
• Tax Policy: While your money is invested in a 401(k) you pay no tax on your earnings; the taxes are deferred until you take the money out. That is, during all the years that the money stays invested, no taxes are due (think: compounding). When it comes time to take money out of your 401(k)—between ages 59½ and 70½—you will be required to pay taxes on the money that you take out at whatever your income tax bracket is at that time
• Restriction: Once you invest in a 401(k), the penalty for attempting to withdraw before 59½ is the income tax on the amount withdrawn + a 10% early-withdrawal penalty. You can however take a loan from your 401(k) without the early-withdrawal penalty. While it is important to be aware of this option, take a loan from your 401(k) should be a well-reasoned decision (i.e. weight the costs and the benefits... e.g. is it worth it to take a loan from your 401(k) for a downpayment?)

Roth IRA

• Unlike a 401(k), a Roth offers no up-front tax break: your contribution comes from after-tax dollars
• However, Roth offers a better tax deal on the back end: money that is contributed is not going to be taxed (it has already been taxed, remember); further, investment gain is not going to be taxed either, as long as you have owned the Roth for a minimum of five years and you are at least 59½ at the time you make the withdrawal.

Roth vs. Traditional IRA

• The maximum contribution in a Traditional IRA was the same for a Roth in 2004: $4000
• Just like a 401(k), with a Traditional IRA, the money grows tax-deferred, but you must pay income tax on your withdrawals
• [If you don't have a 401(k) at work, you can invest in a traditional IRA, no matter what your income is, and your contribution is tax-deductible. However, if you have a 401(k), you are eligible for the full tax break on the Traditional IRA if you are single and your modified adjusted gross income (MAGI) is below $50,000 or married filing a joint return, $70,000--in 2005... Between 50K-60K and 70K-80K for single and married couples filing a joint return, respectively, filers get partial deductions, and no deductions thereafter... (i.e. you can still contribute to a Traditional IRA, but it must be with after tax money).]
• Even if you get the full tax break on a Traditional IRA, the Roth is still a smarter move... Why? Because the (tax) rates are so low now, and can only be expected to rise (with the looming budget deficits, and social security crisis)... Also, your tax bracket will rise over time, thus increasing your tax liability down the road... It makes more sense to invest in a Roth today (again, with after-tax dollars) and never have to worry about a tax bill down the line. If you can manage it, definitely contribute to the annual maximum allowed.
• Rules: It is important to know that there are income eligibility requirements for contributing to a Roth IRA...
• Roth Advantage: Few strings attached: you can withdraw the money that you contributed at any time without paying tax or penalty; it's only the earnings on those contributions that you can't take out without penalty and tax. While you shouldn't raid your Roth IRA for "any old indulgence," it does serve a double duty as a great retirement investment and an emergency cash fund.

"Where to Roth"

• Discount brokerages: Muriel Siebert: (800) 872-0444, www.msiebert.com; Scottrade: (800) 619-7283, www.scottrade.com; Fidelity Brokerage: (800) 343-3548, www.fidelity.com.
• No-load mutual fund company: Vanguard: (800) 662-7447, www.vanguard.com; T. Rowe Price: (800) 225-5132, www.troweprice.com.

In Summary

1. If your 401(k) offers a company match (and you plan to stay at the company long enough for your match to vest), invest in it to get the maximum company match;
2. After you max out on your company match (or if you don't get a company match in the first place), stop your 401(k) contribution for the rest of the year. But make it clear that you want to start the contribution on time for next year, when you once again want to invest enough to get the maximum company match.
3. Once you suspend your 401(k) contribution, decide what to do with the money that would normally go into your 401(k):
   • Pay down credit card balances (ask your credit card company for interest rate reductions as your FICO score improves; do balance transfers if necessary);
   • When interest rates on debts are less than 8%, start saving for a home downpayment using a MMDA or MMMF;
   • After buying a home, open a savings account to build an 8-month emergency fund;
   • Fund a Roth IRA to the annual maximum;
   • Go back and fund your 401(k) to the annual max.

Finally...

• Taking a 401(k) loan is a downright dangerous proposition. Work on boosting your FICO score so that you can transfer to a low-rate card, before you consider a 401(k) loan;
• When you leave a job in which you have contributed to a 401(k), your options (with respect your contributions, from least to most appealing) are to:
  • Cash out (a "collosal mistake"; think: income tax, early-withdrawal penalty, loss of retirement investment and interest that would have compounded thereon...)
  • Leave it at your old employer (assuming it is at least $5000): (you are restricted to the investment options offered by your old employer, unless you absolutely love those options)
  • Move it to your new employer's 401(k) plan: (you are restricted to the investment options offered by your new employer, unless you absolutely love those options)
  • Do an IRA rollover (best move; you simply transfer your 401(k) balance out of your old employer's plan and into an IRA account at a discount brokerage or no-load mutual-fund company that has low expenses... You literally "roll" the money "over" into a Traditional IRA.) As far as the IRS is concerned, you are simply moving your money from one tax-deferred retirment plan to another: you owe no taxes or penalties until withdrawal. And, you now have maximum flexibility in how you can invest your retirement money.
  • If you meet the income rules, you can convert your rollover account into a Roth IRA. However, you can't move your money directly from a 401(k) to a Roth... But you can move it to a rollover IRA, and then convert that into a Roth. (Notice that you will have to pay income tax on the amount that you convert). IMPORTANT: Always choose a direct rollover where the money is transfered without you touching a penny of it... If you cash out your 401(k), the IRS gives you 60 days to fund a rollover account, otherwise you get hit with income tax + the 10% penalty. A direct rollover ensures that you do not go through this: your existing 401(k) sends the money directly to the firm where you are going to set up your new IRA. ALSO: You may want to convert only a portion of your total IRA every year so that you aren't hit with one huge tax bill...
• Don't forget about "taxable" accounts (like ING Direct's Orange Saving)
• If you absolutely must withdraw money from your retirement fund for a downpayment (which, again, is not recommended), here are your best options from best to worst (each one has limitations and qualifications):
  1. Take a withdrawal from a Roth IRA
  • You are free to withdraw the money you put into your Roth at any time for any use whatsoever
  • You can also withdraw up to $10K in earnings, penalty-fee if the money is used for a downpayment. The only catch: if the Roth is less than 5 years old, you will be hit with income tax on the earnings withdrawal. (This is a great reason to open a Roth today, even if its a small amount... It will start your 5-year clock ticking immediately).
  2. Take a loan from your 401(k)
  • Normally, you have just 5 years to repay a 401(k) loan, but when the money is used for a home downpayment, you may be able to pay back the loan over the entire lenght of the mortgage. Risk: If you leave your job--voluntarily or involuntarily--you will need to repay the loan typically within 60 days. If you can't repay the loan within that time frame, it is treated as a withdrawal and you get hit with income tax + the 10% penalty. Risk Mitigation: Take out a Home Equity Line of Credit (HELOC) immediately you have enough equity in your home. Don't use the HELOC; just keep it handy for an emergency--i.e. if you have to leave you job, and have to repay the 401(k) loan immediately.
  3. Take a hardship withdrawal from your 401(k)
     • The IRS does consider a home downpayment a "hardship," so you will not have to pay the 10% penalty... but you are required to pay income tax on the amount you withdraw. [The difference between the 401(k) loan and the hardship withdrawal is that you have to repay the former...)

7: Investing

Fee-based vs. Commission-based Brokers & Financial Advisers

In general, opt for fee-based financial professionals over commission-based ones (if you must make the decision), because they charge you a flat fee for basic services or to manage your assets, make no money off commissions, and thus have no incentive to suggest that you buy a product that isn't really in your best interest.

Saving vs. Investing

• Investing: intended to meet long-term goals (such as retirement); usually comprise stocks, bonds, & mutual funds;
• Saving: intended to meet short-term (such as paying a downpayment for a home); [see 5: Saving, above]

The objective in 7: Investing is two fold: (1) what to invest in your 401(k), and (2) what to invest in a Roth IRA or an IRA rollover of an old 401(k).

Mutual Funds

Styles

The stocks in a mutual fund generally break down into 3 broad styles: growth, value, and blend.

• Growth stocks are shares of companies whose earnings (profits) and revenues are growing fast.
• Value stocks' share prices are believed to be lower than the true value of the company. Value investors use patience to their advantage; they look at the underlying fundamentals of the company. If they feel the stock is wrongly undervalued, they will buy and hold on to it until others in the market take notice that the stock is undervalued and start to buy in.
• Blend funds are mutual funds that own stocks that share both growth and value characteristics. [Note that the 'blend' refers to that fact that each individual stock in the fund share both growth and value characteristics; we are not saying that blend funds diversify by combining growth and value stocks...].

Size

• Small-cap funds own stock of smaller companies. Often, there are newer, faster growing firms... and thus offer a great chance of big gains if the company continues to grow; but there are also the risks that it will hit turbulence as it continues to grow into a more mature firm.
• Mid-cap funds own stock in companies that are still in their faster-growth stage, but have more stability than small-cap companies... Many people believe that mid-cap stocks offer the best of both worlds
• Large-cap funds own stock in companies that are consider the least risky in that they are big, established, multinational companies that are entrenched in their industries.

Level of Management

• Actively managed funds come equipped with a professional money manager whose full-time job it is to figure out the best investments for the fund.
• Unmanaged, or Index, funds do not have a manager that makes ongoing buy and sell decisions. An index fund simply tracks an existing market index... A market index is made up a number of stocks that represent a slice of the market. There is no human judgement at play with an index fund. [The most well-known index is the Dow Jones Industrial Average, which is composed of just 30 stocks. When those 30 stocks move up or down, the Dow Jones Index moves up or down accordingly. Another popular market index is the Standard & Poor's 500 stock index, which comprises of 500 stocks of big established companies. The NASDAQ Composite tracks all the stocks traded on the NASDAQ exchange--typically smaller, new companies and stocks in fast-growing industries such as technology.]

It is important to note that over the years, index funds have outperformed the majority of actively managed mutual funds. (1) Index funds charge less fees, which boost their net return; and [here's my own two cents:] (2) it reflects the collective intelligence of the market...

Expenses Ratios

All funds charge annual fees (known as the expense ratio) to cover their operating costs. The average expense ratio of an actively managed stock fund is 1.5%. That is, the fund deducts 1.5% off its performance each year to pay the manager and various fees.

Index funds, like the Vanguard 500 index at 0.18% per year, have very low expenses.

Long-term Performance

Funds are long-term investments. It is important to evaluate the funds performance over the past 3, 5, and 10 years, rather than the past month, quarter, or year.

If you are evaluating an actively managed fund, you also want to check out how long the manager has been on the fund (did a fund with a terrific 10-year performance just hire a new manager?). How does the fund compare to its peers in its fund category? [See: finance.yahoo.com; input a funds ticker symbol (5 letters than end in X); click over to the performance information on a fund, to see its performance relative to both its category and a pertinent index fund.]

Loaded—or Not

A load is a sales commission that is used to pay the adviser who sold you the fund. It is different from the expense ratio; all funds have expense ratios, but not all funds have a load. You should never buy a mutual fund that has a load, says Orman, and here's why:

There are basically 3 main fee structures for mutual funds that you can invest in: A-share funds, B-share funds, and no-load funds.

• Funds with A at the end of their name charge a load or sales commission (which can be as much as 5%) when you invest;
• Funds with B at the end of their name are sold to you under the guise that if you just stay in the fund for a certain period—typically 5 years—you will not pay a load. There are 2 catches with B-share funds: (1) Even though you aren't paying a load when you invest, the fund company will still pay the adviser who sold you the fund. Naturally, the fund company will now find a way to get you to pay, in hopes that you won't understand what is happening... The way the mutual fund company gets paid back for fronting the commission to the adviser is to charge you a super-fat expense rate that includes a 12b-1 fee... and you pay that higher expense ratio every year. AND (2), if you try to leave the fund before they get all their money (usually, 5 years), you get hit with a back-end load, or what is also called a deferred-sale load or surrender charge. A surrender charge can start at 5% or higher the first year, and then decline one percentage point a year until it disappears. Worse scenario: you buy B shares in a 401(k), but no adviser "helped" you out: you're still stuck with the high fees. Moral: Avoid both A and B shares.
• Funds that are true no-loads are the only kinds of funds that you should consider buying. A true no-load fund never charges a fee to buy--or sell, no matter when you want to exit. And, of course, you want your no-load to have a low annual expense ratio. It is important to understand, at this juncture, that commission-based financial advisers [will not] sell you a no-load fund, because they make no money that way. So if you go to a full-service brokerage and an adviser suggests a fund, you can be pretty sure it is a load fund. [If you want to find out if a fund has any kind of load on it, just call customer service--every fund has an 800 number--and ask. The Question: If I invest $5000 this morning, and the market didn't change during the day..., if I were to sell tonight, would I get my entire $5000 back?]

A Little Goes A Long Way

As a YF&Ber, steady is the way to go. Investing in a broad market index fund, or top-notch actively managed fund will give you a smart diversified approach to investing. And by investing small amounts every few weeks or monthly, you are going to latch on to one of the most amazing investing tricks: dollar cost averaging, DCA.

The Process of Dollar Cost Averaging: When you make periodic investments (such as having money deducted from your paycheck every two weeks and deposited in your 401(k) account, or making periodic investments into a Roth account), the amount you invest probably doesn't change. But the price of the funds will change... When the fund share price is lower, your dollars buy more shares. If you commit to your steady periodic investment, the idea is that over time, you will buy more shares at a lower cost that if you simply invested in a one-time lump-sum investment. [It is important to note that DCA will not necessarily work in this direction every year; indeed, there will be years when the price will rise throughout the year, so that you will be buying fewer shares... The larger point is that over many years, you will eventually end up making a nice return on your investment, as long as you are in good stocks or mutual funds.

DCA is a built-in feature of 401(k) investing (your contributions are taken out periodically), but it behooves you to consider it for all your other investments, such as Roths, rollovers, and even regular taxable accounts (like INGDirect's Orange accounts). A handful of mutual funds encourage DCA by offering special deals of you agree to make a direct deposit from your bank account every 2 weeks, or monthly, or even quarterly.

• T. Rowe Price mutual funds: (800) 638-5660, www.troweprice.com (Start for $50...)
• TIAA-CREF funds: (800) 223-1200, www.tiaa-cref.org (Start for $50...)
• The Oakmark funds: (800) 625-6275, www.oakmark.com (Start for $100, with $100 in each subsequent investment)

Action Plan

The easiest one-stop-shopping move is to put your money in a total stock market index fund. This index mimics the Wilshire 5000, which includes large-cap, mid-cap, growth, value, and blend stocks—all in one investment.

Notes

• These are just baseline recommendations--feel free to branch out from here. Nonetheless, diversification is key.
• If you love researching funds, or think you can find the managers who beat the indexes, then by all means reduce your index allocation and add some actively managed funds to your mix.
• Be sure that you know when to sell a fund
• Importantly, these allocation recommendations are targeted to your YF&B years. As you reach your 40s and 50s, you are going to want to tweak your portfolio, typically by adding a portion of bonds to help provide stability as you get nearer to retirement.

Bonds

A quick review: when a company needs to raise money to fund its growth, or to pay expenses, it has two ways to do it: (a) sell shares of the company, which are known as stock, and (2) raise funds by simply borrowing money and issuing bonds.

A bond is a debt that a company or government takes on to finance its operations. When a company or government borrows money, it issues a bond. When you buy a bond, the money you pay is your principal investment. The bond issuer (the company or government) agrees to pay interest on that principal (usually semi-annually). And they also agree that on a certain date, known as the maturity date, you will get your principal returned. The further the maturity date, the higher the interest rate you will be paid.

Risk: The only risk with a direct investment in bonds is that the bond issuer will go into default (i.e. it goes belly-up and cannot make interest payments or return your principal). However, every bonds comes with a "credit quality" rating. For example, a US Treasury bond virtually "guarantees" that you will be repaid.

Bond Funds

Bond funds own a bunch of individual bonds. The problem with bond funds is that there isn't a set maturity date when you are "guaranteed" to get your principal investment back. Also, in a bond fund, you have to pay expense ratios, which cut into your already slim returns.

The only time that investing in bond funds might be recommended for those in 401(k) plans where your choices are limited is when interest rates are very high and are expected to start falling: when interest rates fall, the value (or price) of bonds rises. ?

Stock Options

Stock options give you the right to purchase company stock at a future date, once your shares have vested. When you purchase the stock, the technical term is that you are exercising your options. The price you will pay for the stock is determined on the day you are given your option; this is known as the excercise price. And there is usually a pre-set date as to when you are legally allowed to exercise those options.

The whole allure of option is that by the time you are allowed to exercise them, the current stock price will be higher than your exercise price (hopefully). The difference between the exercise price and the market price on the day you will sell is your realized profit.

There are two basic types of options: the most popular type are known as non-qualified stock options (NQSOs). [The name refers to how you get taxed on your options.]

The recommendation: If you're vested and have a nice gain, you should exercise the option, get the cash, and reinvest the profit in another investment. The idea is that if you are doing well at the company, you will probably get additional options periodically, so it makes sense not to have all your "paper" money tied in this one stock. It is better to take some of the profits off the table from time to time and move them into other investments.

So, when you exercise NQSOs, sell the shares immediately and diversify into other investments.

Index Funds vs. Exchange Traded Funds: Liquidity

Mutual funds (index or actively managed) do not trade during the day. When the stock market opens at 9:30AM (Eastern time), the prices of stocks within a fund start to go up and down... so the fund simply has to wait until the end of the day to price all their holdings, based on the closing price of stocks for that day. The implication is that if you called your fund at 10:08AM to buy/sell, the order will not go through until the close of market, when the fund is priced.

This is where exchange-traded funds (ETFs)trump index funds. ETFs are index funds with one added benefit: they trade like a stock not a fund in that they can be traded during the day: ETFs are more liquid than index funds; and they can have even lower expenses. A popular ETF that tracks the S&P 500 is the iShares 500 index, which has an expense ratio of 0.09. You can research ETFs at the American Stock Exchange website, www.amex.com, as well as Yahoo! Finance.

But remember: investing for retirement is a long-term goal, so the fact that ETFs are more liquid than index-funds should cause a big headache. Also, ETFs do not make sense if you use the dollar cost averaging method of investing. ETFs are sold through brokerages, so you will need to pay a commission. Imagine having to pay $10 commission on a $50 investment, every two weeks.

See Orman's site for a listing of recommended ETFs.

Variable Annuities

Two words: avoid them.

VAs are basically mutual funds with tax breaks... However, they are very, very expensive... In addition to the regular expense ratio of the fund, you'll also have some insurance-type charges than can run more than 1.3% a year!

...

Advice & Strategies in Summary

• Don't fret when the markets go down, you benefit from DCA (i.e. accumulate more shares of the stocks in your fund), so that when the prices rebound, you are much better off...
• Beware of the Disposition Effect which causes people to hold on to their losers (in hopes that the prices will rise at least to enable them break even before they sell) and sell their winners. If you won't buy a stock today, you should not continue to own it; your propensity should be towards ridding yourself of your losers and letting your winners run... (This is not to imply that any investment that is down should be sold, but to recommend a general perspective...)
• Twice a year, give your fund a checkup... if it is actively managed.
  • Check the funds performance relative to its category peers and the index fund that it most closely resembles. [Don't fret over the month or quarterly performance... You are looking to see that your fund is keeping ahead of its peers over periods of three years or more (i.e. consistently above average)]
  • Check for "musical chairs." If a new manager has taken over, go to the firms website and see what the new manager's background is. You should also check some investing websites such as www.morningstar.com which will give an analysis of whether the change is something to worry about.
  • Keep an eye on the news. If you ever hear that your fund company is accused of improper activity, you are to move your money immediately--especially if your investment is in a Roth or a 401(k); you can sell you shares and invest in a new fund without triggering a tax bill.
• On lifestage funds: they are okay if you want a quick and easy solution. However, you can do a lot better without too much extra effort. (See action plan above)
• Aim for funds with low annual expense ratios--below 1%--and never pay a front-end or back-end load.
• Remember that low-cost index funds often outperform actively managed funds.

8: Big-ticket Purchase: Car

• Buy, not lease
• There's typically a trade-off between 0% deal and getting the dealer to offer you a cash rebate. As alluring as the 0% deal might sound, it actually might make more sense to take the cash back on a lower-priced car and finance the rest of the purchase with a regular loan.
• Shop around for the best loan terms. Banks and credit unions might (and usually do) have a better offer than the dealership. Also check out websites like www.lendingtree.com and www.eloan.com. Know what your options are before you walk into the dealership.
• Go for a "new used" car (1-2 years old, <10,000 miles), rather than brand new car; Look at so-called Certified Pre-Owned (CPO) cars... make sure the "certified" part comes from the manufacturer, not the dealer. And, nonetheless:
  • Spend $100 or so for an independent mechanic to inspect the car.
  • Ask the dealer for the car's inspection history... If they won't give it to you, consider that a red flag
  • Run the car's VIN through a national database to check for records of accidents. At www.carfax.com, for about $20, you can get a report on the car's background.
  • Read the warranty carefully so you understand what is, and what is not covered.
• The manufacturer's warranty on a CPO makes this option more expensive, but it can be worth it for peace of mind alone. You can shop for CPO cars at websites like www.carmax.com and www.autotrader.com, or check out a car manufacturer's website for information about their CPO offerings.
• If you must go for a brand spanking new car, use the invoice price rather then the manufacturer suggested retail price (MSRP) as your baseline for negotiating.
• Be aware of manufacturer incentives (like cash-back deals, or holdbacks) that might lower the invoice price even lower. Visit www.carsdirect.com or www.edmunds.com to learn about dealer incentives.
• Don't talk about financing options with the car sales person until after you have agreed on the price. When you are negotiating prices, keeping for the out-the-door (cash-down) price. Once the price is set, you can discuss financing options; compare that to what you have already researched on your own, and decide how you want to proceed.

Car Insurance

• You want to make sure you have ample coverage to protect you in case of an accident: you must have bodily injury liability to provide coverage if you or anyone else is injured, as well as property liability coverage if you damage another car or piece of property. Collision insurance is an important option for more expensive cars, since it provides coverage no matter who is at fault. Comprehensive coverage covers repairs--and replacement--if your car gets damaged in a non-car-related mishap, such as a collision with a deer.
  • A typical miminum amount of mandatory coverage is often expressed as 30/50/20, which means you have $30K worth of bodily liability coverage for each person, with a $50K limit per accident, and then $20K in coverage for property damage. You are however advised to go for 100/300/50 if you own your home or have started building some investment assets.
• Other tips:
  • Get your FICO score as high as possible to put yourself in line for the best auto insurance rates.
  • Double-check that your rectods at the DMV is in good shape. Contact the DMV to make sure that you don't have any erroneous entries in your records. Also, make sure that any points that should have expired are in fact wiped off your record.
  • If you own your own home, check with your insurer about coupling that policy with an auto policy; using one comapny for both policies can cut your premiums by 10% or more. If you don't have an agent, the Internet can be a great place to shop for insurance: www.insure.com gets you premium quotes from multiple lenders; www.geico.com and www.21stcentury.com are two low-cost auto insurers.
  • Go for a high deductible. Insurance is meant to protect you against "big-ticket accidents--not little dings." You'll want to raise your deductible to $1000. It will reduce your premium by 15 to 30% and keep you from annoying your insurer (with small claims). Ideally you will have an emergency cash fund that will cover having to pay a $1000 deductible. Also, it is worth it to finance paying a deduction on a low-rate card.
  • Reduce premium further by dropping collision coverage on an old car. (You can check the book value of your car based on its make, model, mileage, and condition on The Kelley Blue Book, www.kbb.com)

Strategies

• As a rule-of-thumb: take the cash back option if you're buying a car that costs less than $20K, and opt for the 0% financing if the car price is above $20K. [However, you might need to pull out good ol' Excel to double-check this heuristic.]
• Keep the car for as long as possible.

9: Big-ticket Purchase: Home

• Mortgage
• Downpayment (Typically 20%)
• PMI
• Closing Costs (Varies; typically about 2-3% of Mortgage)
  • Origination points (1 point = 1% of your mortgage amount)
  • Good faith estimate
• Mortgage Options:
  • FIRM
  • ARM
  • Hybrid

Here are some national averages for typical closing costs on a $180,000 home:

• You can pay discount points to get an even lower interest rate. A point equals 1% of your mortgage amount. If you have some extra cash handy, each discount point that you pay the lender when you are taking out the loan will reduce your interest rate by 1/8 to 1/4 of a percent. As a YF&Ber though, you might want to use that extra cash towards your downpayment or as part of your emergency cash fund (which you will especially need now that you're a homeowner). The biggest factor is how long you intend to stay in the house; if you are paying cash to get the lower rate, you want to stay in the house long enough that you will recoup the points with your lower mortgage payments. If you plan to move in 5 years or so, you probably don't want to pay any discount points.
• Eschew escrow accounts as much as possible. Shop around for a mortgage where you can hangle your tax and insurance payments yourself. The money you are paying into escrow should stay in your savings account where you can earn interest on it until those bills are due.
• When you are comparing mortgages, look for two numbers: the interest rate and the APR. APR is a calculation that includes the cost of any points and many of your closing costs, and then average those over the term of your loan. You are to use the interest rates, rather than the APR in your comparison of different mortgage options.

Assembling Your Team

1. A qualified mortgage broker: who will shop around at different lenders for your best deal, and quite often, will get a lower interest rate than you would get from the loan officer at your bank. If you feel confident that you know the ins and outs of mortgages, you can instead look into using online lender services such as www.lendingtree.com or www.eloan.com.
• Once you have found a qualified broker, ask for a prequalification; however, the prequalification is not a guarantee that the lender will give you the exact same deal when you come back in a few weeks or months and apply for a mortgage... To get that rate guaranteed, you need a "lock-in" rate; that is your lender's guarantee of the mortgage rate you'll get--typically within 60 days.
• Again, you want your FICO score to be at least 720
• As a rule, the mortgage you are hoping to get should not equal more than 28% of your gross monthly income, and
• All your debt shouldn't equal more than 36% of your gross monthly income
2. A qualified real estate agent:
3. An inspector
4. An attorney

Budget

1. Base monthly mortgage payment
2. Monthly property tax (from <1% to >3% of home's value)
3. Monthly homeowner's insurance
4. Monthly PMI
5. Unexpected repairs
6. Utilities & maintenance
   1. electricity
   2. heat
   3. water
   4. garbage collection
   5. maintenance (landscaping, snow removal, etc.)
   6. monthly assessment (if applicable)

Tax Break

You get a tax break when you own, which will reduce your real housing costs. The interest you pay on your mortgage is tax-deductible.

Tips

To make an informed offer, you need to start keeping track of what real estate is doing in your area long before you are ready to house shop. Become an avid reader of the real estate section in your local newspaper. Check out the list of homes that have sold recently, and start your own housing spreadsheet. Here's what you want to track:

• How many weeks are homes in your area on the market before they sell?
• If homes are selling above or below their asking price, then by how much above or below?

Here's the key: If homes are selling faster and faster, and are selling for more and more above the asking price in your area, then you are still in a seller's market and you may have to pay full price or even above the asking price... However, if homes are staying on the market for longer before they sell, and if they are also selling below their asking price, you are in a buyer's market. Therefore, you most likely will not have to pay full asking price...

More tips...

• When you find a home you like, get at least two "comps" from your agent.
• Every bid that you make should include a contingency cluase that the property must pass a structureal inspection. (Ask friends rather than the real estate agent for referrals). If you find any major problems, you can either walk away from or negotiate with the seller; get an estimate of the cost of repairs and have it deducted from the sale price. You are also advised to go along on the home inspection... Among other things, you should:
  • Run the bath and shower to make sure the water pressure is good
  • Check how long it takes for the water to run hot in bathrooms and kitchen
  • Run the heating and air conditioner
  • If there's a fire place, light some paper to make sure the smoke runs up the flue not into the house
  • Flush all toilets
  • Check behind pictures for any cracks or water damage
  • Check condition of storm screens or regular screens
  • Turn light switches on and off
  • Do final walk-through of the house before the closing... If the seller scraped the walls while moving out, get them to cover the cost of the repair. If they agreed to include the dishwasher, washing machine, dryer, etc. in the purchase price, make sure those appliances are still there...
  • Decide on how you are going to take title to the house, if you aren't a single homeowner... Your options, simply, are joint tenancy with right of survivorship (JTWROS) and tenancy in common (TIC).
    • See www.realestate.com for useful information and resource for smart homebuying.
  • For insurance, go for a policy that provides replacement cost coverage rather than one that provides actual cash value coverage. Further, make sure that your coverage stays up-to-date with rising construction costs and home values, and make sure you and your insurer review the policy annually. You can comparison shop for home insurance coverage at www.insure.com and www.insweb.com.

10: Life & Money

For a joint living arrangement, devise a plan that is based on equal shares, not equal dollar amounts:

1. Figure out your combined monthly living cost. Everything from rent/mortgage to utilities, groceries, a few dinners out, insurance, etc. Add 10% to that amount;
2. Add up your monthly take-home pay;
3. Divide your total expenses by your total take-home pay to figure out the percentage of those expenses that each of you are to pay.

Protecting Your Family: Insurance

Once someone (a spouse, kids, aging parents) become dependent on you, you will do well to buy term life insurance. There are a slew of other types of life insurance, such as whole life, universal life, and variable life, which are typically known as cash-value policies. Ignore them. Don't listen to anyone, especially an insurance agent who tells you that cash-value is better than term.

Rationale: Unlike a term policy, the insurance in cash-value policy is in place for the rest of your life. If you keep up with the premium payments while you are alive, your beneficiaries are guaranteed a payout, no matter when you die. In real terms, A $500K universal life policy on a healthy 30-year old could have an annual premium of $1850. A $500K term policy that lasts for 20 years for the same 30-year old could run about $360 per year!

Term insurance provides coverage for 5, 15, 20, or 30 years. You choose the "term," based on how long you think you dependents will rely on you. You want to get a guaranteed level premium, which means that your annual cost will not change for the entire policy term. If you die during the term, your beneficiaries get the payout of the death benefit. If you die after the term is up, they get nothing. [Example: if you are buying the policy to protect your kids, you will usually want a policy that provides coverage until the youngest child is 23 years old--or until you feel they would have enough to live on if you were to die prematurely.]

There's a new type of term called "return of premium." You should avoid this is a much as cash value policies.

How big a life insurance policy do you need? If you don't yet have any other big assets you can rely on, your death benefits should be 20 times what your loved ones need to live on each year. Some pertinent sites: www.selectquote.com, www.accuquote.com, and www.term4sale.com.

Will vs. Trust

A living revocable trust is the way to go over a will. The word "trust" refers to the document itself. "Living" refers to the fact that it kicks into effect while you are still living... That's the big difference between a will and a trust: the will comes into play when you pass. "Revocable" means you can make changes to the trust at any time.

Example: Dave creates a trust; he is the trustor. He is also the trustee--the person in control of the trust. As long as Dave is alive, he is also the beneficiary of the trust. Furthermore, Dave names a "successor trustee" who can take over if he dies or becomes too ill to take care of himself. Further, Dave names his son Mike as a beneficiary for when he dies.

Once the trust is set up, Dave "funds" the trust by transfering the title of all his assets to the name of the trust, so it becomes the Dave trust, with Dave as trustee. In reality, nothing changes, Dave still owns every asset in the trust, because he is in charge of the trust. But when he dies, rather than having to transfer the title of his assets to Mike, it's already taken care of. The assets are in the "name" of the trust, and Mike takes possession of the assets because he is named as the beneficiary who succeeds his father, Dave. There would be no need to hire a lawyer and go through the often-costly probate process.

Again, a will only kicks in when you die. But what if you fall into a coma or become too ill at some juncture to take care of your financial assets? A trust that includes [a durable power of attorney with] an incapacity clause will provide protection in these scenarios: the person designated as your successor trustee (your partner, parent, sibling, child, or even friend) can take over and handle the assets in the trust; just make sure it is someone you trust to make the best decisions for your family.

Durable Power of Attorney (DPOA)

In a durable power of attorney (DPOA) for health care, you spell out what your wishes are in regard to life support and other medical issues if you are not able to make those decisions for yourself. You do this by appointing an agent to represent your wishes if you are unable to express them yourself.

Misc.

Federal Trade Commission. www.ftc.gov or (877) 382-4357.