Clone Awareness Month 2014 - Week 4 - Asset Allocation

Clone Awareness Month 2014

Assets allocation is an important topic that only becomes more important as time passes.  To determine your target asset allocation you need to take into account Return and Risk.

Return:

When you are just starting out with investing your overall return makes less of an impact than the amount of money that you are investing.  However, as your account balances grow, your investment return is more consequential than additional investments.  Because of this you want to make sure that you are not investing too conservatively.

Risk:

In general stocks are considered to be more risky than bonds, and bonds more risky than cash.  This generalization can actually be misleading.  Risk is not a single dimensional problem.  Stocks are more volatile in general which gives them there apparent risk.  However, bonds also posses risk.  Specifically, bonds relationship to interest rates.  When interest rates increase bond prices decrease.  So, if we were to transition from a period of low interest rates like we have now to much higher interest rates this will negatively impact bonds.  The main risk with cash is inflation risk.  There are essentially no places to invest cash that will return enough to outpace the rate of inflation.  So, leaving money in cash puts you at risk if inflation picks up much faster than the interest rates that you can get.

Your Allocation:

The factors going into everyone's asset allocation are different.  To begin with you should consider what return you need to get on your money.  There are retirement calculators online that will let you put in how much money you have saved, how much you will invest each year and what percent you expect to get from your investments.  These calculators will then tell you what this will give you at retirement.  The higher the rate of return that you need, the more you need to invest in stocks.

The general rule of thumbs for years to determine you allocation to stocks was to subtract your age from 100.  So, if you are 30, you should have 70% of your investments in stocks.  Over the years since people are living longer in retirement this rule of thumb has been adjusted with some people advocating subtracting your age from 120.  So, if you are 30, you should have 90% of your investments in stocks.

You should expect stocks to return around 6-9% in the long term.  So, if you are 30 and use a retirement calculator that determines you need an average return of 9% you will probably need to be at the high end of the range mentioned earlier.

After you have determined the amount you need in stocks you can then divvy up you other money between bonds, cash and commodities.  Your second largest allocation will be to bonds.  You will want some exposure to commodities, but most likely no more than 5-10%.  You could also have a small allocation to cash.  You cash position should remain small until you are close to retirement.

Your goal for this week:

Your goal this week is to get an idea of what you asset allocation should be and then match it to what your asset allocation actually is.  If your allocation doesn't match what you think it should be, make a plan to get it back to your target and plan to check it every six months to make sure it doesn't get off target by more than a couple of percent.  Remember that each year your allocation in stocks will most likely be decreasing by 1%, so take that into account.

Clone Awareness Month 2014 - Week 3 - Review Tax Return

Clone Awareness Month 2014

As we mentioned previously, the goal of this month is to figure out what your clone has been up to over the past year.  One way to do this is to review your tax return.

The main reason that Clone Awareness Month is in May is because tax day is in April.  Just last month you were thinking about a lot of financial topics as you prepared your taxes.  You most likely had some thoughts of what you could change for the next year.  Well, this week it is time to take action.

Here are some examples.

• Did you notice that you weren't getting the full child tax credit or child care deduction, but were close to the cut off?  If so, you can decide to put a little more money into a pre-tax savings vehicle such as a 401(k) or IRA.

• Did you end up with a large refund or owe a large amount to the IRS.  It is time to adjust your W-4.  You may have heard the questions before "why would you give Uncle Sam a tax free loan?"  With interest rates so low recently it probably doesn't seem as important to minimize your tax return because having money sitting with the IRS isn't much different than earning .1% in your savings account.  However, it makes it easier to plan a monthly budget when you have a better idea of what your tax home pay actually is.  In addition, if you are a more natural spender as opposed to a saver, it is much easier to justify spending a large chunk of your tax return on splurge of some sort than it is pulling that same amount of money out of your savings account, which is where it should have been anyway. 

• Were you close to the cut off between the standard deduction and itemized deductions.  If so, make sure that you are keeping track of all of the items that you can be deducting.  If you are going to be just short of being able to itemize you might want to double up you deductions every other year.  For instance, if you are making sizable charitable donations try to make some or all of next years donations this December if possible.

• Are you managing your taxable investment gains well.  Try to minimize your taxes by offsetting any profits that you take with loses from other positions.

Taking some time now thinking about last year's tax return should give you a head start on next year's tax return and hopefully it will improve the health of you Clone.

Clone Awareness Month 2014 - Week 2 - The B Word

Clone Awareness Month 2014

As we mentioned last week, the goal of this month is to figure out what your clone has been up to over the past year.  There is no better way to see what your money has been up to than to see where the money is going day to day, month to month.

As you guessed this week we are going to discuss budgeting.  What B Word did you think we were going to discuss?

Budgeting is not a very popular or exciting topic.  That is because it can take so long to make a budget and to track your progress and there is very little immediate impact from creating it or monitoring it.  Also, because of basic human psychology the upside of staying on your budget isn't as high as the downside of missing your budget is low.

If you currently have a budget and are successfully implementing it, you get the week off.

If you don't currently have a budget you will be happy to read that the goal for you is not to create a detailed budget.  The goal for this week is to create a savings budget.  So, instead of planning how much you are going to spend in each and every category imaginable, you should instead plan how much you are going to save.  Just complete the three steps below.

1. Determine an amount that you can realistically siphon off of your paycheck.  You want this amount to be somewhat of a stretch, but you don't want to set yourself up for failure.

2. Automate the savings process.

• Clone Level 1 or 4 (Emergency Savings):  See if your employer will direct deposit your paycheck split across two accounts; your main account and your emergency fund account.  If not, set up an automatic transfer from you main account to your emergency fund account scheduled to take place when your paycheck is deposited.

• Clone Level 2, 5 or 7 (Retirement Savings): If you are using a retirement account through work these contributions should already be automated.  If you are using an IRA try automating the amount you want to save each month.

• Clone Level 3 (Credit Card Debt): Instead of just paying extra with your regularly scheduled payment try send additional payments once your paycheck comes in.  Minimize the time that money is in your account.  You have to think of this money as not your money, but the credit card companies money.  The less time it is in your account the less time you get to look at an account balance that is higher than it actually is.

• Clone Level 6 (College Savings): Similar to emergency savings, your goal should be to automate this as much as possible.  Try to set up a transfer from you main (non-emergency) savings account to your child's savings account.

3. Set a reminder for a month or two from now to try to up your savings amount*.

*If you are finding yourself hitting a plateau then you might need to start a standard spending budget to find out where you could squeeze some more money out.

Clone Awareness Month 2014 - Week 1 - Credit Reports

Welcome to Clone Awareness Month 2014

The goal of this month is to figure out what your clone has been up to over the past year.  It is a chance to see how things are going, how they may have changed since last year, and to plan and set in motion actions to improve things for next year.

Your mission for week 1 of clone awareness month is to review one or all of your credit reports.  This is actually a pretty easy process.  The three main credit bureaus have set up a website where you get to request one free copy of each report each year.  The website is www.annualcreditreport.com.  There are other sites that advertise on T.V., radio and the Web that offer free credit reports, but they are doing so by getting you to sign up for a trial of some service.  With www.annualcreditreport.com there is nothing that you need to sign up for.

One thing to note is that these credit reports DON"T contain your credit score.  Unless you are trying to get approved for a loan now your credit score isn't as important as making sure there are no errors in your credit reports.

When you go to request your credit reports on the website you will have the option of selecting which of the three you want.  As the site suggests you will probably want to get all three now if you are planning on applying for a loan soon.  Otherwise, you could decide to space each report out so that you are getting a report from a different agency every 4 months.  This might help you catch issues sooner that waiting to do all three once a year.

If you prefer to request your credit reports over the phone or by mail you can do so.  Check out the "Contact us" section of the web page.

After you receive your report(s) you should either save them as a PDF or print them for future reference.  It will make it much easier to review your report next year if you keep this years.  To review the report you will want to confirm that everything looks correct in general and make sure that accounts that you have closed in the past show that they are closed.

How are you doing financially? - Determining your Clone Level.

If you are just starting out, or just getting serious about managing your money, where should you start?  The following is our general guideline that you can follow.  It is progression of levels that are achieved one after the other.  Start by finding the first category that you don't fulfill and consider your Clone to be at that level.

For example, if you are contributing 10% to your 401(k) at work, but don't have any funds set aside for emergencies, you are at Level 1.

No two situations are the same, so some of these levels may not apply to your situation.  If you don't have access to an employer retirement account with matching funds skip Level 2.  If you don't need to fund a child's education skip Level 6.

It is important to remember that when you are at any given level you need to make sure you are still fulfilling the requirement for all of the levels below.  For instance, if you are at Level 3 but after updating your budget your determine that your monthly expenses are higher than they were before, you need to make sure that you still have one months's worth of expenses saved (Level 1).

[Level 1] - Funding a mini emergency fund.

If you have less than one month's worth of expenses in liquid assets, you should address this first.

Although it is important to pay down any debt that you have already accumulated, establishing at least a small emergency fund first makes sense.  If you put all of your money to paying down your debt and then run into an unforeseen issue you are just going to end up incurring debt again.

This money needs to be readily available, but should be separate from your regular savings/checking accounts so that you are not tempted to pull the money out for non emergencies.

[Level 2] - Getting your employer matched retirement savings.

If you have access to a 401(k) or 403(b) at work that includes an employer match you should make sure you are taking advantage of this.

All plans have the ability to contribute salary on a pre-tax basis and some also offer post-tax or Roth options.  The pre-tax contributions get you a tax benefit now and the Roth get you a benefit when you withdrawal your money in retirement.  The general rule on which type of contribution to make is that if you are relatively young or otherwise expect your income taxes to be higher in retirement you should contribute to Roth.  If both options are available to you and you are not sure which way to go you should be able to split your contribution 50/50.

If you have high interest debt, such as credit cards, or if you haven't fully funded your emergency fund you should limit your contribution to whatever is matched by your employer.  So, if your employer matches 50% of your first 6% of pay, you will remain in this Level until you are investing 6% in your retirement account monthly.

After you have achieved Level 3 and 4 you will contribute more to your retirement account.

[Level 3] - Paying down high interest debt.

As long as you are carrying high interest debt it is acting as an anchor against your financial progress.

The definition of high interest is relative, but most of if not all credit card debt would be included in this.

Sometimes when the stock market is performing very well it is easy to try to justify skipping this step and putting money in the market, but paying off an 18% interest rate credit card is a guaranteed 18% return, while gains in the stock market are not guaranteed and are taxed.

[Level 4] - Completing your emergency fund.

Your emergency fund should be a minimum of 3 months of expenses.  If your job situation is not stable or if your pay is not consistent, maybe because you are on commission, you will want more than 3 months.

[Level 5] - Contributing additional retirement savings.

You will either be adding to your 401(k)/403(b) if Level 2 applied to you or you will be opening an IRA.

IRAs also come in both regular and Roth similar to what was discussed in Level 2 for employer retirement plans.

You will move to Level 6 once you have saved enough to meet your minimum retirement goal which we will be discussing in a future post.  For now move to Level 6 once you are contributing 12% of your pay.

[Level 6] - Saving for College.

It might seem selfish that we aren't addressing college savings until Level 6, but there are important reasons to wait until this point.

• Your child will have most likely will have access to loans may qualify for a scholarship and , no one will be providing you either of these for your retirement.
• If money is tight your child could opt for a cheaper state school instead of private or even attend community college for a couple of years.  Again, this might not be very popular with them, but it most likely won't be any less popular than you living on their couch in retirement because you sent them to a pricey private school and didn't save for you retirement.
• You most likely have more time until retirement than you do until your kid goes to college.  Because of this you will be investing more aggressively in your retirement account than you will in your child's college savings account.  This means that your overall return will be higher investing in just your retirement account as opposed to investing that that same money in a college savings account.

You will want to open a 529 account to save for college.  This is a tax advantaged account specifically for educational expenses.

[Level 7] - Maxing out Retirement Savings and funding other investments.

You will max out this Level once you are saving enough to meet your Maximum Retirment Goal.  We will be discussing this in a future post.  For now try to maximize all available options if you can.  This includes employer retirement plans and IRAs.

The current maximum for 401(k)/403(b) is $17,500 a year.  The current maximum for IRAs is $5,500.  These limits are raised for people over a certain age.

Don't Forget May is clone awareness month.

Monthly Payment thinking (know what you are spending)

When making purchases or saving money it is best to know the true cost or benefit.

When purchasing a car, for instance, the salesperson will often try to discuss the cost of the car in terms of monthly payment.  Such as, "if you add feature x your payment only goes up $10".  Make sure that you are considering the true cost over the length of the loan including interest.  For example if you were planning on paying for the car with a 60 month loan at 2% interest the total cost is about $630.

When purchasing a house, especially when building a new house, it is easy to fall into the same trap.  When something is spread out over 30 years, the monthly payment doesn't seem that large.  Check out the following example.

You are taking out a $150,000 30 year mortgage on a house at an interest rate of 4%.  You decide to add $6,300 to the loan so that you can make some upgrades to the house.  Over the course of the loan the $6,300 is going to cost you about $30 a month or about $10,800 in total over the 30 years.

So, if you decided that you could wait for the upgrades until you saved up enough money you would be paying $6,300 for them instead of $10,800.

If you decide that you can live without the upgrades and instead invest the $30 a month in an investment earning 6% a year you will have a little more than $30,000 dollars at the end of your 30 year mortgage.

So, when buying a large ticket item always be aware of the total price and don't just focus on the monthly payment.  Similarly, when investing, know that even small increases in your savings can provide you will a big payoff down the line.

Let's get started

My goal with this blog is to provide tools and information to help you determine how you are doing financially.  We will be doing this through the use of a financial avatar, your Clone.

No two people will have the same retirement experience, so it makes sense for you to determine not only the type of retirement you want to have, but also the type of retirement that you will be able to have based on your savings.

Some things to consider:

• When do you plan to retire?  Early, Late, Never?
• When you retire will you stop working completely, spending your time on hobbies and/or charitable pursuits, or will you continue to work part-time?
• Do you plan to leave an inheritance, or will you be trying to spend/gift all of your money and assets during your lifetime.

To help you determine what your goals are I have provided a list of Recommended Financial Books.  As you will see they sometimes offer conflicting advice.  I am a firm believer that there is no one right answer when it comes to finances.  So, dive in and get reading.  Don't be intimidated.  If you get in the habit of reading 10-20 pages a day you should be able to finish one book an month.