As you know, we constantly monitor our marketplace to provide better rates to borrowers and great returns to investors. We keep an eye on our own market dynamics as well as the overall economy trends.

This time, we observed that defaults continue to trend lower, which gave us the opportunity to decrease rates to borrowers while preserving investors’ net returns (rate minus defaults & fees). Also, lower interest rates help attract higher quality borrowers, leading to less defaults, so it is a virtuous circle.

So there you have it… Lending Club has been able to drop their rates because borrowers have been behaving themselves. It’ll be interesting to see how the “virtuous circle” plays out in the coming months.

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Mortgage payments

For example, our first mortgage payment is due in March. Along with our mortgage payment, we’re also putting money into an escrow account to cover our property tax bill and home insurance premiums. While we budgeted for it and anticipated paying these costs, it still feels odd to have our housing bills mapped out for the next 30 years.

The mortgage payment itself (considering principle and interest) is much lower than the rent we were paying for our two bedroom apartments. The discrepancy between the cost to own and rent in our city is one of the big reasons we considered buying a house. If it was much cheaper to rent, we would’ve continue renting, either saving for a huge down payment (making the mortgage much smaller) or investing the difference for other goals.

Our goal is to pay an extra $150/month starting with our first payment for 2010 payments to help pay off our mortgage early and greatly reduce the amount of interest we pay over the life of the loan. If and when we can afford more, we’ll add to this amount accordingly, but we want to make sure we build up our emergency fund first.

Homeowners’ association fees

This is a new bill that I’m not too crazy about, but membership is mandatory with in our development. Our HOA fees covers water and sewage, pool and clubhouse access, lawn maintenance, and condo area upkeep. When we were looking at some older homes in the area, we found that the HOA dues were often higher and sometimes came with fewer amenities.

After reading some horror stories on HOAs, we asked some friends who live in a development by the same builder and with the same company running the HOA for their opinion. It turns out that they’ve been happy with their experience thus far, and the fees have remained consistent so far.

Property taxes

As I noted above, we’re paying into an escrow account every month to cover our property taxes (as well as our homeowner’s insurance). Property taxes are an unavoidable expense of being a home owner.

My best advice is to look at your city or county’s tax records online to get an idea of what you might expect to pay in taxes before you buy. While we were shopping around, I looked at different neighborhoods and researched the property taxes. As a result of this additional information, we actually ended up reducing the amount we were willing to spend on a new home just so we could stay within our budget.

Once you’ve bought your home, don’t let your guard down. Keep an eye on your property tax assessment, and don’t be afraid to appeal your home’s assessed value.

Your take

I’m curious to hear how you guys made the transition when you went from being renters to owners. What was the biggest financial adjustment you had to make as a home owner? If renting is a better option for you, I’d like to hear about that, too.

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As an investor, I’m not crazy about this change, as I’ll earn a bit less while shouldering the same risk that I’ve always faced. Prospective Lending Club borrowers, on the other hand, should be thrilled with this move. If you’re looking to refinance your high interest debt, now appears to be a good time to do so.

I’m still looking for an announcement to provide some context for this change, but haven’t found anything yet. I’ll update if/when I know more.

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If you’re like most people, you may think that retirement is so far away that it can be dealt with later. The reality is that it is never too early to begin planning for retirement, and there is no better day than today. But some of you out there may be wondering, “How can we adequately save for retirement when my spouse and I only have one income?” Well, you’re in luck, as there are some options available to help you meet your goals.

Spousal IRAs

Whether you are a stay at home parent or simply taking time off work, you should still be taking the appropriate measures to save for retirement. Most individuals who work for a company have the option to save for retirement via a 401(k) or other savings plan.

Even if they don’t have a retirement plan at work, working individuals can save money in an Individual Retirement Account (IRA) because they have qualifying income. But what about those who do not have an income of their own, such as a non-working spouse? This is where the “spousal IRA” comes to the rescue.

A spousal IRA is a special type of account that is funded with the working spouse’s income. Technically, there really is no such thing as a spousal IRA. It just means that a non-working spouse can rely on a working spouse’s income to contribute to fund an IRA. In order to qualify, you must file a joint tax return, and the working spouse must make enough income to fund the account.

Based on current IRA contribution limits, you can contribute up to $5,000 ($6,000 if you are over 50) per year in either a traditional (deductible) IRA or a Roth IRA.

Traditional Spousal IRA

The non-working spouse can contribute up to $5,000 ($6,000 if over 50) to a traditional IRA as long as the working spouse has enough income to justify the contribution. These contributions can be deducted on the joint tax return up to a certain adjusted gross income (AGI) limit. Depending on your income tax bracket, this deduction can result in significant upfront savings.

The deductibility of the spousal IRA begins to be phased out when your joint modified AGI reaches $166,000 and is completely phased out at a modified AGI of $176,000. However, if the working spouse does not have a retirement plan at work, the full deduction can be claimed regardless of income. These contributions grow tax-deferred until retirement. Once withdrawn in retirement, the earnings are taxed at your ordinary income rate.

Roth Spousal IRA

If tax-free growth is more desirable, the non-working spouse can contribute to a Roth IRA. The Roth IRA allows you to contribute up to $5,000 ($6,000 if over 50). Just keep in mind that your contributions will become limited once your joint AGI reaches $166,000 and will be completely phased out once it reaches $176,000 (meaning you cannot contribute to a Roth IRA).

The big advantage of the Roth IRA is that, since you are placing after-tax dollars into the account, they will grow completely tax-free. That means that there will be no income taxes due when you take the money out in retirement.

Taxable Accounts

Although taxable accounts are not the preferred option for retirement saving, they may be advantageous for one income households. Since retirement options are limited for the non-working spouse (i.e., they have no workplace savings plans), a taxable account can be used to supplement retirement savings.

Because investments in this type of account will be typically be held for a long time horizon, they will be taxed at the favorable long-term capital gain tax rates when you liquidate them. Currently, the long-term capital gain tax rate is 5% or 15% depending on your marginal tax rate.

So there you have it. No more excuses. Start saving for retirement today! And remember… You have until April 15th to fund an IRA for last year, so you can still make up for lost time.

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» links for 2007-01-09

• Interest earned (1099-INT)
• Dividends received (1099-DIV)
• Cancellation of debt (1099-C)
• Government payments (1099-G)
• Proceeds from broker transactions (1099-B)
• Retirement distributions (1099-R)
• Miscellaneous income (1099-MISC)

There are more, but I’ve hit the big ones above. When these forms are issued to you, the issuer is also supposed to send a copy to the IRS. This allows the IRS to keep closer track of how much money you’ve earned.

There are a couple of things to keep in mind when it comes to Form 1099, however. First, a 1099 is generally not required unless you earned more than $600 from that source during the year. This doesn’t mean the income isn’t taxable, just that they payer doesn’t have to issue a 1099. Second, payments to a corporation don’t require a 1099. Thus, if you’re self-employed and have incorporated your business, you might not receive any 1099s.

What if you didn’t get a 1099 form?

Assuming that you’re truly due one or more 1099s, you should have received them by now, as the deadline is January 31st. If you are expecting one and it hasn’t shown up, your best bet is to contact the payer. If it still hasn’t shown up by February 15th, you can call the IRS at 800-829-1040.

Note that you don’t really have to have all of your 1099s to file your taxes, as you don’t usually need to attach them to your return. As long as you can accurately piece together your income (as well as any income taxes withheld) from other sources, you can just go ahead and report it without documentation.

If you file your taxes and later receive a 1099 that you had forgotten about, you’ll have to amend your return using IRS Form 1040X.

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I’m at the “now what” stage. We have paid the car off, and a fat savings account. We do not plan to pay off the house because we want to move soon. Not sure that the house will sell for the amount we paid. 401(k) is funded.

This is a great question. We spend a ton of time and energy focusing on getting out of debt, building an emergency fund, funding our retirement accounts, saving for college, paying off our mortgage, etc. But once we get a handle on these things, what’s next?

It’s not uncommon for people to be so focused on their daily lives that they don’t give any serious thought to what the future holds. In fact, if you ask around, you’ll find that a lot of people will flatly state that they’re pursuing “financial independence” without really knowing what they mean.

This is actually an issue that fellow blogger JD Roth tackled about a year ago when he wrote the following about the so-called “third stage” of personal finance:

I’ve reached a place of financial security. My income is good. I save and invest. I don’t spend frivolously. Now I find myself in the enviable position of having to decide: Should I decrease my workload, or should I use some of my income to invest in the things that make me happy?

Unfortunately, JD didn’t have the answer, and neither do I. In fact, I’ve struggled mightily with this issue. Should we charge ahead toward the finish line (retirement) trying to get there as quickly as possible? Or should we slow down and enjoy the ride?

There are no easy answers. Moreover, just as Matt pointed out when he wrote about financial priorities, the “right” answer will vary from person to person. With that in mind, I’d like to hear your thoughts…

Stepping back and taking a look at the big picture, what are your long-term goals?

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A healthy challenge for each of us

In response to my recent article on when you should start investing, FCN reader John laid out his financial “order of priority.” John’s rundown moved me to prioritize my own specific plan, publish it here on FCN, and challenge you to do the same.

We all have unique circumstances, but because financial fundamentals remain consistent, we’ll likely see a lot of similarities sprinkled amongst the difference between our individual plans.

In writing this article, I have two specific goals. First, I want to challenge everyone reading it to prioritize their financial plan. Second, I want to highlight the fact that unique circumstances sometimes call for deviations from well accepted “best practices” such as Dave Ramsey’s baby steps.

My financial order of priority

Before giving you my ordered list, I should briefly touch on our giving strategy, and also outline our 75/25 method of debt reduction and savings contributions we adhere to throughout most every step.

• We always give away at least 10% of our pretax income.
• 75% of our discretionary income (i.e., after living expenses, etc.) is applied to high interest debt reduction (post tax.)
• 25% of discretionary income gets evenly distributed among our liquid and retirement savings accounts (post tax.)

Once we have given, paid the bills, and divvied up our cash into our budgetary envelopes, all remaining money goes toward savings, debt, or interest on debt. Below is our current road map of financial priority.

1. High interest debt repaid. For us this means around $4,200 in a Lending Club debt consolidation loan that was used to pay off credit card and auto loan debt.
2. Finish building emergency fund to one month of expenses. (if not already achieved via our 75/25 method)
3. Repay 2nd mortgage. This is not our next smallest debt, but rather the one with the next highest interest rate.
4. Repay my student loans. Again, this loan carries our 3rd highest interest rate.
5. Repay my wife’s student loans. Here I deviate from the highest interest plan adhered to earlier and opt to pay this lower rate loan off prior to repaying our 1st mortgage.
6. Finish building emergency fund to six months expenses. (if not already reached via our 75/25 method)
7. Max out tax sheltered retirement savings. This includes a 401(k) and 403(b) (mine and my wife’s, respectively), both of our IRA accounts, and possibly other tax sheltered accounts we may have in the future (like a SEP-IRA.)
8. Repay first mortgage. If all goes according to plan, this will be our last debt and will work to pay it off early using all discretionary money remaining after step 7.
9. Savings for children. At this point, we have no children (yet), and see our freedom from debt as being more beneficial than worrying about contributing to their education. As time goes by, however, we will start saving thinking about branching out into things like a 529 college savings plan.

What about you?

Now that you know our plan, please share yours. While certain details of your approach might clash with ours, that’s okay. It’s not imperative we agree on every little detail and, in fact, what’s right for me might not be right for you. The important thing is for each of us to have a written plan in place that is tailored to our specific needs.

So… What is your financial order of priority?

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As of February 1, I’m rocking a 10.23% net annualized return on a portfolio that is currently composed of 233 notes. You can see from the graph below that my performance is currently right around average. I’d be thrilled if this keeps up.

Regular readers know that I’ve had one default thus far, which was a byproduct of my initial “high risk,” auto-selected portfolio. I’ve had one other loan in that portfolio go late, though that borrower is not on a payment plan and has been meeting their obligations.

In contrast, all of the loans in my “low risk,” auto-selected portfolio are current. The same can be said of my hand-selected portfolio, which is how we’ve invested the bulk of our funds. If you’re curious about how I select notes, check out my Lending Club loan selection criteria.

If you’ve been investing with Lending Club, I’d love to hear the details. How long have you been doing it? How many notes do you have? How do you select them? And how has your performance been?

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Are you at all concerned about where mortgage rates are headed as we roll into 2010? If so, it’s understandable since many analysts have predicted rates to rise as the year goes on.

While there’s still some uncertainty surrounding the future direction of mortgage rates, it’s safe to assume that rates will rise in the absence of the Fed’s mortgage-backed securities (MBS) purchase program. As evidenced by the statement from the very latest Federal Open Market Committee Meeting (FOMC), the Federal Reserve maintains that their purchase program will expire at the end of the first quarter.

A quick history lesson

As a strategy to lower conforming fixed rate mortgages and to promote stability in the housing market, the Fed announced a program on November 25, 2008 that was designed to purchase $500 billion in Fannie Mae and Freddie Mac MBS. By early 2009, the Federal Reserve decided to purchase an additional $750 billion in MBS in order to keep mortgage rates low.

The Fed’s influence on rates

By March 31, 2010, the Fed will have spent $1.25 trillion to keep conforming rates at or near historic lows. By our reckoning, the Fed’s involvement in the mortgage market brought conforming fixed-rates down perhaps 0.75% below where they would be absent the program. This means that we expect interest rates to rise somewhat when the program concludes.

By how much rates will actually rise will depend on whether or not private investors will be in a position to buy these investments. How strong that private demand will be is still uncertain at this time. It’s best to plan for at least some increases in interest rates as the end of the Fed’s program approaches, and for some period after the March 31 deadline.

While some analysts expect an immediate increase of up to a full percentage point in rates when the Fed decides to stop buying agency MBS, we’re not among them. We think that any rise in rates would be accompanied by a reduced demand for mortgages, which in turn would serve to somewhat temper any upward rise in rates.

Here’s why: The Fed’s purchases are serving to help keep rates low by absorbing MBS supply that the private market cannot or will not buy. When the Fed exits, the additional supply might overwhelm remaining demand, causing a rise in interest rates. That rise in rates would strongly curtail refinancing (and possibly some homebuying) activity, limiting the amount of new MBS supply the private market will need to absorb. This falloff in new MBS supply means that rates might not rise as much as some fear, since the private market may be able to more easily digest it.

Back to “Normal”

During 2010, the mortgage market will transition from almost-fully-government-supported to one once again driven by the private market to a much greater degree. As markets return to “normal,” so too will mortgage rates, which, for the early portion of 2010, should still remain among the best seen during the past 50 years. However, barring a double dip to the recession, borrowers should have no expectations that rates will remain at multi-generation lows throughout the year.

Broadly, we expect 30-year fixed-rate mortgages to hang around the 5% mark during the first quarter of 2010, as support programs (MBS purchases and the homebuyer tax credit) remain fully in force. After that we’ll start the transitional period described above and, for planning purposes, borrowers should expect rates to rise one-half to even a full percentage point higher than where they are now.

Rates for the rest of the year are likely to be more economy- and inflation-dependent. With continued economic healing expected, pressure will build for the Fed to raise their Federal Funds rate and remove certain supports like the TALF and the TSLF. Absent any resumption of these programs, rates will nudge closer to 6% than 5% for the final two quarters of 2010.

Will yesterday’s failed loans continue to distort the market? Will Fannie Mae and Freddie Mac’s evolution cause rates to rise or fall? Will lending standards ever ease? You can get the answers to these questions and more by consulting HSH.com’s “2010 Outlook for Mortgage Rates and the Mortgage Market.”

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Aside from carpooling, there are a number to reduce our automotive expenses. Today I’m going to highlight some suggestions that will hopefully save you some money.

Saving money on gasoline

Saving money on gas is a big concern for us. My husband is in the habit of saving gas receipts and dumping the information into a spreadsheet. He’s therefore able to track and see his gas mileage and spot trouble. For example, we noticed that I needed a tuneup when my car’s mileage dipped lower than normal.

Your behavior behind the wheel can also help improve your mileage and thus save money. “Hypermiling” was a popular term when gas was $4/gallon and everyone was trying to cut down on fill ups. The term basically refers to driving in a more fuel efficient way, though some practitioners take it to the extreme. For most drivers it boiled down to a few simple changes when they’re on the road.

• Track your mileage. Take a page from my husband’s book and record your miles driven and gallons burned after every fill up in a mileage spreadsheet.
• Drive the speed limit. Life in the fast lane isn’t always better, as your mileage drops dramatically at high speeds.
• Reduce fast acceleration and braking. By maintaining a relatively steady speed, you can waste less gas. Anticipate the traffic and lights ahead and coast if possible. If you’re driving a distance on a relatively flat highway, consider using cruise control to help you maintain a fuel efficient pace.
• Turn off your car to reduce idling. I was surprised to learn that if you’re going to be idle for more than 10 seconds, it pays to turn off the car and restart it later. While I’m not comfortable doing this at a red light, it might be useful for those waiting to pick up their kids from school.

Saving on car insurance

Another big expense with owning a car is having enough insurance to cover it. Over the years, we have found ways to save money on car insurance.

Shop around for the best deal. It’s amazing to me how effective shopping around can be. There can be a huge difference between insurance companies for the same coverage on the same car. When I shopped around for car insurance, I discovered that by switching companies I could save $40/month — a huge savings for a college student.

See if your memberships can get your a good deal. We really saved money with this tip. After doing our regular, semi-annual price shop, we checked our Costco membership and found a policy for about half of what we were paying. We’ve also taken advantage of the free towing and roadside assistance that they offer.

Maintaining your car

My husband and I are thrilled that we don’t have any car payments. We’d like to make this situation last as long as possible, so we’re doing our best to keep our cars in good condition. The good news is that it’s possible to do some minor checkups and car maintenance yourself. Not only will you save some money, you’ll also learn quite a bit about your vehicle.

• Air filters: A clogged air filter can decrease your fuel efficiency, so check it out whenever you get a tune up.
• Clean the car inside and out: Not only does this improve the appearance of the vehicle, but you can use it as a chance to see if there is any rust or other maintenance problems developing. Having a clean car may also help reduce your urge for a new car that you can’t afford.
• Fluids: Checking and filling your fluids yourself is a great way to keep your car running smooth while saving money.
• Tire pressure: This is a common tip for saving gasoline, but it’s not a big win according to Edmunds’ tests. Regardless, underinflation can wear out tires quicker and become a serious safety issue.

If you’re not a handy person, then by all means spend some money on a trustworthy mechanic. Either way, having regular check ups on your car can improve the life of your vehicle and save you money at the pump.

Replacing your car

Eventually, even a well maintained car will break down and you’ll have to find a replacement. Having a car replacement fund allows you to get a car without having expensive financing.

Open a high interest savings account specifically for your car replacement fund. We’ve used ING Direct for our savings for the last couple of years. If you already have an account with them, setting up a sub-account takes less than 5 minutes. Having a separate account reduces the chances of you dipping into it before your next car purchase.

It’s also a good idea to automate a deposit into your car savings account every time you get paid. Have the transfer go from your checking account into your savings account immediately after getting paid. If you don’t, you might spend the money instead of saving it. If you can, aim for saving a car payment ($250-$350) into your fund each month.

Any other suggestions?

I’ve shared some of my favorite tips, and I hope that they help you reduce your car expenses. If you have any tips, please share them as I’m hoping to stretch our transportation dollars even further.

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New customers are eligible for this special offer after opening a new OptionsHouse account with a minimum of $3,000. You must apply for the commission-free trade offer by inputting promotion code FREE100 when opening the account. New accounts receive 100 commission-free trades for each stock or option trade executed within 60 days of funding the new account.

The short version: new customers only, $3000 minimum, promo code = FREE100

After you use up your free trades (or after they expire in 60 days), you can make stock trades for $2.95/each and options trades for $9.95/each. I’ve never used OptionsHouse, so if you have an opinion, I’d love to hear it.

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Getting started

For those that aren’t familiar with Lending Club, I thought I should start from the beginning… Not surprisingly, you get started by logging in. From there, simply click the “Invest” tab along the top.

This will pull up a screen that offers you three different “auto-invest” scenarios: More Conservative, Moderate, or More Aggressive. There are a couple of things to note from this screen…

For starters, you can click on the “More Options” tab to get a slider that gives you access to a continuum of strategies. Next to that is a button labeled “filters.” Click this button gives you access to a wide variety of filters that allow you to set specific investment criteria.

Those options are all well and good if you’re comfortable with auto-investing, but I’m not. If you’re looking for more control, look no further than the “Build a Portfolio from 117 Notes” link over to the left.

Selecting your filters

Once you decide to build your own portfolio, you’ll want to develop a set of custom filters to rule out loans that you deem unacceptable. The good news is that you really only have to do this once, as you can save your filters.

Filters can be accessed over in the sidebar of the “Browse Notes” screen. Though they’re all collapsed, you can see the primary filters that I use in the picture below.

Setting up your filters

If you’re intent on selecting your loans by hand, you’ll need to learn how to effectively filter out the loans that don’t interest you. The following is a rundown of how I set up my filters.

• Inquiries in the last 6 months. This filter can be set from 0-10. I limit it to 3, as I’m not interested in lending money to people who appear desperate to borrow.
• Delinquencies (Last 2 yrs). I set this one to zero. In reality, I won’t lend money to anyone that has a delinquency on their credit report (ever), but Lending Club doesn’t have a “no delinquencies, ever” filter. Thus, I use this one to pre-filter and then I double check by hand.
• Min length of Employment. This can be set between 0-5 years. I’m looking for stability, so I require 3 or more years in their current job.
• Max Debt-to-Income Ratio. Note that this is not a typical DTI calculation in that it doesn’t take housing expenses into account. On the first pass, I typically limit this to 10%, though I’ll sometimes relax it to 15%.
• Exclude loans already invested in. Lending Club loans sometimes take awhile to get completely funded, and I don’t want to accidentally invest in the same one more than once, so I check this box.
• Public Records. I exclude all borrowers with a public record on their credit report. Fortunately, Lending Club has an absolute filter for this one, so I don’t have to review them by hand.
• Month since last Delinquency. As noted above, I don’t want to lend to someone with a delinquency on their record, so I set this to the most stringent setting (60 months or more) to get rid of as many as possible.

Once you have your filters set up, click the “Save” link near the top. You’ll now be able to quickly and easily filter the current crop of loans whenever you come back (by clicking the “Open” link).

Manual review

While the filters above do a good job of filtering out the least attractive loan requests, I next do a quick manual review before investing. Here, I’m looking for two main things…

As noted above, I’m not willing to invest in anyone with a delinquency on their record, no matter how long ago. Thus, I quickly scan through the loan requests and rule out anyone with a delinquency. The good news is that only a few such loans are left after running the filters outlined above.

Next, I compare the monthly payment on the requested loan to the borrowers gross monthly income. If it’s more than 10%, I pass. There’s nothing magic about 10%. It’s just an arbitrary threshold that I’ve selected to make sure the loan payments won’t be a huge burden to the borrower.

While this sounds like a lot of work, it’s really not. If you click on the title of the loan (after filtering), it will expand to reveal more information. In order to efficiently review the loans, I click on each title (one-by-one), eyeball the delinquencies and payment-to-income ratio, and then collapse anything that isn’t acceptable. That leaves me with a slate of expanded, candidate loans from which to select.

Other considerations

In my experience, the above process knocks out the around 75% of the listed loan requests and it only takes a few minutes. From here, I follow my gut. One big thing that I do is to avoid business loans. In general, small businesses have a high rate of failure, and I don’t the added risk.

Other than that, I take look at what the loan is for and ask myself if the details add up. Borrowers are asked to include a loan description. Some do, and some don’t. If they can’t be troubled to explain why they need the money, I pass. If their reasoning doesn’t make sense, I pass. If a lender has asked them a question and the answer doesn’t make sense, or if the borrower has evaded part of the question, I pass.

Another common sense test is whether or not the request is consistent with the available information about the borrower. For example, many people request money to refinance credit card debt. In such cases, I compare that amount to the revolving debt on their credit card. If they’re requesting a bunch of money and don’t have much in the way of revolving debt, I steer clear.

Closing thoughts

While I haven’t been at this for a long time (less than a year), I’ve had a fairly good experience thus far. I’ve had one loan (from my auto-selected, high risk portfolio) go into default. That being said, all of my “low risk” loans are being paid on time, as are all of my manually selected loans.

Could I get away with using the auto-selected portfolios? Quite possibly, but I like having a bit more control, and I’ve managed to streamline my loan selection process to the point that it doesn’t take too much time. If Lending Club added a bit more flexibility to their filters, I could do it in even less time.

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Related Articles at fivecentnickel.com:

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» Lending Club Update – November 2009 Performance
» Lending Club – August 2009 Performance
» Lending Club Update – October 2009 Performance
» Lending Club – July 2009 Performance
» Lending Club: Invest in Your Friends
» Lending Club $64.62 Signup Bonus
» Lending Club Reduces Interest Rates for Borrowers

We continue to rely on methods of identity verification used by traditional lenders, but in an era of online identity theft, Lending Club is continually redefining industry best practices.

We cannot disclose our exact methodology, practices, or sources of information, as this could simply empower the fraudsters we are trying to disarm. But what we can say is that we use information gathered from social networks to help give us more confidence that a member is in fact who they say they are.

While it makes sense for them not to disclose detail of their approach, it would be fascinating (at least to me) to know how they’re implementing this. Any guesses?

Regardless of how they detect it, when they do find a case of ID theft, they say that they work with the true owner of the identity to track down and prosecute the fraudster, and they also reimburse lenders the unpaid principal balance of loans that involve identity theft.

Have any of you had any experience with a fraudulent Lending Club loan? I’ve had one default thus far, but I’m not aware of any instances of outright fraud.

Source: Lending Club Blog

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» Lending Club Update – December/January Performance
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I work 33 hours/week at $11.40/hour. My boss wants to give me a lead position and a raise of $0.20/hour. However, he then told me he was doing some figuring, and found that the raise would put in in a new tax bracket, and would thus not be worth it. I am single, no dependents. What do you think?

The short answer is that I don’t think Frank’s boss understands how income tax brackets work. Either that, or he’s trying to pull the wool over Frank’s eyes.

Here’s the deal: Income tax brackets reflect your so-called marginal income tax rate. It might help to picture your income falling into separate buckets.

At the low end, you have a 10% bucket. In 2010, the first $8375 of a single individual’s income would fall in that bucket. Next, we have the 15% bucket. The next $25,625 would fall in that bucket (for a total of $34,000). After that, we have 25% bucket, the 28% bucket, the 33% bucket, and the 35% bucket.

(Click through for a full rundown of the 2010 Federal income tax brackets.)

This is, of course, a bit of an oversimplification, as you also need to adjust the numbers for whatever income tax deductions, tax credits, etc. for which you might qualify.

Setting aside that fact that Frank doesn’t actually appear to be near the boundary of any of the current tax brackets, let’s work through a quick example…

Income tax bracket example

Consider a single individual earning $50,000. This puts him in the 25% tax bracket. That does not, however, mean that he pays 25% taxes on his full taxable income. Rather, he pays 10% on the first $8375 (bucket #1), 15% on the next $25,625 (bucket #2) and 25% on the remainder of his income (a partially filled bucket #3). In total, this works out to $8681.25 in taxes, or a “real” rate of roughly 17.4% (ignoring deductions, credits, and other adjustments).

If this individual got a big raise that pushed him into the 28% tax bracket, he wouldn’t lose anything. He’d pay 25% on the balance of bucket #3 (up to $82,400) and then 28% thereafter (until he hit the 33% bracket). As you can see, you have nothing to fear from moving up a tax bracket, and anyone who tells you different is either uninformed or trying to take advantage of you.

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Related Articles at fivecentnickel.com:

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» How to Calculate Tax Equivalent Yield
» Commonly Overlooked Income Tax Deductions
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» Making Sense of Tax Efficient Money Funds
» Roth IRA Conversion in a Down Market
» Tax Diversification When Investing

SPECIAL SAVINGS + LIMITED TIME OFFER: You can continue to monitor important changes to your Equifax credit file and FICO score at a special rate. To SAVE 15% on Score Watch (monthly or annual version), re-subscribe using this promotional code: RENEW

They then provided a link to go back in and reactivate my account. I bring this up not because I’m thinking about reactivating my subscription, but because people who are interested in subscribing can easily get this 15% discount by simply signing up for the free 30 day trial, canceling online, and then reactivating with the discount code.

If you don’t want to jump through these hoops, you might also be able to use the RENEW promo code straightaway when signing up. The e-mail wasn’t entirely clear about this, so you’ll just have to test it out if you’re interested.

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Perhaps you’ve been asking yourself this question but have been unable to settle on an answer that you’re comfortable with. If so, you’re not alone… Many people push investing to the back burner because they’re unsure where, when, or how to begin building their nestegg.

In fact, it seems that many people want to start investing, but simply aren’t ready to take the plunge. And even if they are ready, they have no idea where to start. In this article, I’ll be focusing on the issue of readiness.

The obvious answers

Many people aren’t comfortable tying up their money in long term investments until they’ve met a couple of key milestones.

1. Consumer debt is paid off. Getting rid of your high interest consumer debt should be high priority. It’s probably best for you to forget about investing until your most burdensome debt obligations are met.
2. Liquid savings buffer built. Having ready access to money when you need it is always important. Make sure you have a comfortable amount of money set aside in a high interest savings account before you begin investing.

While debt reduction and emergency savings are certainly important considerations, there are other important factors to consider.

Other factors to consider

• Age. While there is no ‘one size fits all’ age to begin investing, the sooner you start, the sooner compound interest can begin working for you. Optimal investment vehicles and portfolio allocations will differ depending on age, so be mindful to choose age appropriate solutions.
• Matching funds. Does your employer match your 401(k) contributions? Are you fully vested in their contributions right away, or on a graduated scaled based on years of service? If they do offer a match, this should only speed your decision to contribute.
• Children. If you have kids, you might be tempted to begin saving for their education, but you shouldn’t put this ahead of retirement savings. Instead, you should consider consistently putting 15% of your income toward retirement investments prior to saving for education.
• Job status. How stable is your current source of income? If you have a stable job and solid savings, you might feel more comfortable locking up a portion of your income in retirement accounts. If your situation is more tenuous and you may be let go tomorrow, you should build a larger emergency fund.
• Marital status. If you’re considering a move into investing and have a significant other, be sure to include them in the decision making process! When married, these long-term decisions affect both spouses equally, so be sure to communicate and decide accordingly. The best decisions are usually made together.
• Insurance policies. It is important to carry the proper types of insurance at each point in our lives. A decision to invest should not be made without balancing our investment strategy with situation appropriate insurance coverage. Health insurance, disability insurance, long-term care coverage, and life insurance coverage are all important and need to be considered alongside any decision to invest.

In closing

While there are certainly other factors to consider before making the decision to invest, this list should provide a good foundation and get you started in the right direction.

When making important financial decisions, always move slowly, ask question, and consider as many contributing factors as possible. You might even consider consulting with a professional advisor for feedback.

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» About FiveCentNickel

American Express recently announced that it was teaming up with two independent payment agencies to allow its cardholders to pay their federal, state or local taxes with Amex Membership Rewards points. On the surface, this sounds like a good use of points that might otherwise sit in your account for months or years before you get around to redeeming them. However, there is a potential downside to consider if you’re thinking of using this service.

I’ll explain the process in greater detail, but here’s the crux of the issue: If you pay your taxes with Membership Rewards points, you won’t only be paying your taxes, you’ll also be paying an extra 2.35% fee to cover what are essentially credit card processing costs. In other words, if you owe $1,000, you can pay with points, but you will be paying a bill that in actuality is now $1023.50.

To further complicate matters, you should understand that the redemption rate for Membership Rewards points on tax payments is 200 points per dollar — in general, the industry standard for points redemption is 100 points per dollar. For example…

You can redeem 2,500 Membership Rewards points for a $25 Home Depot gift card, but that same 2,500 points would only offset $12.50 in taxes. So you’re getting half the value from those points if you use them for tax payments compared to their value when used for other rewards.

Confused?

If you don’t understand why your tax bill goes up by 2.35% when you pay with points, a quick primer on the system American Express is using to offer the points-for-taxes deal will make it more clear. For a number of years, the Internal Revenue Service has allowed you to pay your taxes via credit card. However, by law, the IRS can not pay the processing fees that banks would charge if the government accepted your credit card directly.

Instead, the IRS outsources the credit card collection to authorized partner companies who can accept your credit card payment — for an additional fee to cover the credit card processing fees. In order to get the convenience of paying by credit card, you agree to pay a fee that is a percentage of the taxes you owe (see also You Can Pay Taxes By Credit Card; Here’s Why You Shouldn’t).

What American Express has done is to team up with two of these authorized government partners — Pay1040.com and OfficialPayments.com — in order to make Membership Rewards points one of the payment options when you use these services. In essence, you are paying your taxes by credit card — with the additional 2.35% fee — but you can offset or completely cover your taxes due with the points in your Membership Rewards account.

Deal or no deal?

You may see the reduced value of your points as a perfectly fine trade-off for the opportunity to use points instead of “real” money for tax payments. Or, you may choose to pay in a traditional way and get full value for your Membership Rewards points via gift cards or other rewards. Whatever you choose, it is worth knowing the pros and cons beforehand so you can make a sound decision.

Related: 0% Balance Transfer Credit Cards

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Related Articles at fivecentnickel.com:

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» Another Reward Credit Card Change?
» Citi Thank You Redemptions? No Thanks
» AmEx Credit Card Signup Bonus Disappearing Soon

From their FAQs:

Thank you for trying Score Watch Free Trial, we hope you found our product informative, helpful and of value. To cancel or convert your Free Trial, please contact myFICO Customer Care:

Email:
Click here to send an email.

We will respond to your inquiry within two business days.

Phone:
1-800-319-4433
Mon-Fri 6am to 6pm Pacific Time
Sat 7am to 4pm Pacific Time

Since I had a few days to spare before the cancellation deadline and I didn’t want to deal with talking to a live CSR on the phone, I clicked the link to send them an e-mail. When you do that, you’re taken to a form where you can click a radio button for “Cancellation,” and another one for the product you are canceling (the “Score Watch Free Trial“).

You’ll then be taken to a form where they ask you to enter some personally-identifying information to complete the request. Note that they did ask for my Order #, though it wasn’t required. I went ahead and dug up my confirmation e-mail just to be safe, but you should be fine without it.

That’s it. I received confirmation that they had cancelled my trial the next morning. Very, very easy.

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» Credit Score – Good? or Good Enough?
» Effect of Foreclosure, Short Sale, and Bankruptcy on Your Credit Score

In the end, we did manage to get a better deal, and I wanted to share the process from start to finish.

Last minute delay

We were less than 48 hours away from our closing date and had just came out of the walk through of the condo. It looked great overall, and we wrote down a few things that needed to be fixed before closing. We were nervous and excited about the place as we headed towards Lowe’s to get some painting supplies for the big move. We received a call from the building company and were told that our closing date was delayed.

Since we were getting an FHA loan and it was a condominium, the builder was supposed to notify HUD when it was complete, and then HUD had to have some paperwork approved before the bank would be willing to the loan us the money. Unfortunately, HUD was backed up, and the earliest we could close would be sometime in the New Year.

Working with the builder

Our main worry was about our housing situation until we could get the financing worked out. We were supposed to close Wednesday and be out of our apartment the following Monday. To make matters worse, it was a holiday week so we needed come up with somethings ASAP. The builder acknowledged the hardship they caused us and said they’d help us out.

We called the leasing office at the apartment to extend our month-to-month lease until we could get this sorted out. They said they’d be happy to help us, but we’d have to pay $300/month more than market price! We were already paying an extra $150 since our lease expired, and $300 was too much.

We then contacted our real estate agent to negotiate something with the builder, and gave them several options hoping to get an answer right away.

Switching lenders – worth the incentive?

Unfortunately we had to wait to hear from the builder. Their first offer was a little more than $500 off at closing, but in order to talk further we’d have to call a lender they recommended so they could get the paperwork in sooner. We were skeptical about talking to another lender, but we called just to see what they had to offer.

The guy who answered explained that they could give us a better rate (by about 1/4%) than what our current lender was offering. In addition, they could close in about two weeks instead of another month or so. I asked how could they close quicker than big bank we were dealing with. He responded that they were a “correspondent lender” (i.e., they lend money and then immediately sell off the loan) and wouldn’t have to wait for the sign off on the condominium before proceeding.

Since they were sort of a mix between a mortgage broker and lender they had some leeway with things. The catch was we had to completely re-do our paperwork (which they claimed they could expedite) to get the house through them. He was pushing how some other buyers were switching to their company from other lenders because of the better rate, and he insisted we’d have a great deal. I told him we needed to think about it before we’d commit to anything.

I had a bad feeling about this last minute change in lenders, so I started to gather more information. Since I had some friends that used this particular lender, I called them to see what they thought. As it turns out, they didn’t like the lender at all. In fact, when they called to lock their interest rate, the lender had already locked it without their permission which at a rate that was 1/2% higher. They worked it out, but it was a pain to get the paperwork changed.

I told our real estate agent that we didn’t want to go with the correspondent lender, and to instead see if the builder could offer something more suitable. If not, we wanted to just end the deal. Meanwhile I went to check with the Department of Housing and Urban Development.

Calling HUD for information

Since we’re first-time home buyers, we wanted to get more information about how this process worked. I went to HUD’s website and found the HUD office in our state. From there, I was directed to an office in my city and was connected to the finance help department.

I explained our situation to the rep and asked if this was a typical occurrence. The woman said things weren’t typically that messy, and that it was wise we didn’t jump to a different lender. We ultimately received a lawyer referral hotline number and contacted a real estate attorney. Under the program, you can get a 30 minute legal consultation for $30. We came away with more information of what to expect, and what would be reasonable to request.

More Closing Costs Covered

Through emails and phone calls, we relayed the information we were given and told them we had contacted HUD and a local lawyer to get everything squared away. It helped that we kept all of our documentation and organized our notes to be clear and concise.

We finally heard back from the builder that they would increase their offer. By being persistent and informed, we were about to save an additional $1,400. That worked for us, as we found a cheaper housing solution in the mean time.

While we would’ve preferred to avoid this trouble altogether, I’m glad we took some time to negotiate and get ourselves a better deal. We were able to get a good mortgage rate, the lender we wanted, and a better deal on our closing costs. We’re now in the process of painting, moving, and unpacking from our apartment to the house.

Your take

How did your home buying process go? Did you ever hit any speed bumps? And were you able to get any additional concessions from the builder/seller to make up for the trouble?

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While we could’ve (arguably) saved some money by opting for adjustable rate mortgages, we already have enough unknowns in our life. Thus, we quickly narrowed our options to fixed rate products. While there are some 20 (and even 40!) year fixed rate mortgages out there, 15 and 30 year mortgages are far more common.

So… Which to choose?

Advantages of a 15 year mortgage

Aside from being amortized over half the total time (15 vs. 30 years), mortgage rates are usually significantly lower for 15 vs. 30 year terms. This combination of a shorter term and lower interest rate means that, while your monthly payments will be higher, you’ll pay far less interest over the life of the loan.

Advantages of a 30 year mortgage

The primary advantage of a 30 year fixed rate mortgage is that it will have a lower monthly payments. As noted above, 15 year mortgages typically have significantly lower rates, but 30 year mortgages have much lower monthly payments. Thus, many people opt for them, as they make home ownership more afforfable on a month-to-month basis.

A subtle difference here is that a far greater proportion of your monthly payment (especially at first) will go toward mortgage interest with a 30 year mortgage. Thus, you’ll have more mortgage interest to deduct with a 30 year vs. 15 year mortgage. Of course, that also means you’ll be paying far more in interest over the life of the loan, so be careful.

15 vs. 30 year mortgages by the numbers

Consider the following scenario… You’re in the market for a $200k mortgage, and you learn that you can get a 15 year fixed rate mortgage at 5% or a 30 year fixed rate mortgage at 5.5%. Which should you choose?

Running the numbers

For a $200k, 15 year mortgage at 5%…

Your monthly payment will be: $1581.55 (principal + interest)
Your total cost over the life of the mortgage will be: $284,685
Your total interest paid will be: $84,865

For a $200k, 30 year mortgage at 5.5%…

Your monthly payment will be: $1135.58 (principal + interest)
Your total cost over the life of the mortgage will be: $408,807
Your total interest paid will be: $208,807

As you can see, the 30 year mortgage is significantly more costly, but it frees up an additional $446/month that can be used for other things (living expenses, investing, additional principal payments, and so on).

The best of both worlds

What if you’ve decided that you want to be mortgage free as soon as possible? A 15 year mortgage is a no-brainer, right? Maybe, but maybe not.

Depending on a number of factors, such as your income, job stability, and level of self-discipline, you might be better off taking out a 30 year mortgage and then simply over-paying it every month.

The advantage of this approach is that you you get the best of both worlds… You can pay your mortgage of in 15 years (give or take) while still having the flexibility to fall back to the lower payment level if you ever run into financial problems.

Another look at the numbers

Let’s say you went ahead and took out the 30 year mortgage detailed above with one exception… You dedicded to send an extra principal payment of $446/month, making your monthly payment equal to the 15 year mortgage.

If you did that, you’d end up paying off your mortgage in 15 years and 10 months at a total cost of $299,698. That’s an extra 10 months and $15,013 as compare to the 15 year mortgage, but it’s a savings of roughly $109k vs. following the 30 schedule, and it also comes with significantly more flexibility than a 15 year mortgage.

If you wanted to achieve the same 15 year payoff period with the 30 year mortgage, you’d need to send roughly $500/month in additional principal payments ($1635/month), making your monthly obligation $54 higher than with the 15 year mortgage.

Once again, however, you’d have the freedom to fall back to that $1135.58 base payment if you really needed to. Of course, this flexibility is a double-edged sword. It could be a blessing to those who wind up needing it, or a curse to those who lack the self-discipline to send extra principal payments.

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» links for 2007-08-19

In the absence of this bill, you would’ve had to wait until you file your 2010 taxes to claim the deduction. Instead, any donations made between January 12th and February 28th can be included in your 2009 filing. A similar piece of legislation was passed in the aftermath of the 2004 Indian Ocean tsunami that devastated parts of Thailand and Indonesia.

If you’re curious as to what sort of donation qualifies, here’s what the House version of the bill says:

A contribution is described in this subsection if such contribution is a cash contribution made for the relief of victims in areas affected by the January 12, 2010, earthquake in Haiti for which a charitable contribution deduction is allowable under section 170 of the Internal Revenue Code of 1986.

So… It has to be a cash contribution, and you’ll presumably have to prove that it was for relief efforts in Haiti if you’re ever audited. This shouldn’t be hard as long as you have a receipt from a relief organization that’s helping with the recovery efforts. If you’re looking for ways to donate, check out my list of organizations from last week.

Tax implications

Keep in mind that just because you can claim the donation for 2009 doesn’t mean that you have to. In some cases, it might actually be beneficial to wait and claim it in 2010. For example, if you’re not itemzing for 2009 but will be for 2010, then wait. Also, if you expect to be in a higher tax bracket for 2010, it might make sense to wait.

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Well… I now have my “before” and “after” credit score, and guess what? It went down! At the time we paid off our mortgage, I had a FICO credit score of 781. Fast forward a few weeks and I got a ScoreWatch e-mail alert. Bingo. Just what I had been waiting for.

When I logged in, I saw the following…

Which was followed by this little gem…

Just to be sure that the mortgage was to blame, I poked around a bit more. And… Boom goes the dynamite:

The only change they were showing was our lump sum mortgage payoff off which resulted in a zero balance. Interestingly, when I read on about how this change might impact my credit score, I learned that:

“Generally, less debt is better for your FICO score.”

(in case you can’t read it, that’s the bit underlined in red)

Hmmm. It’s generally better, but clearly not always.

I’m no FICO credit score expert, but my understanding is that the decrease occurred because I no longer have any installment loans. Apparently their algorithms aren’t smart enough to distinguish between people who’ve never had an installment loan and people who’ve had one, never made a late payment, and paid it off within the past month.

Anyway, I’m not sweating it, but I thought it would be worth tracking to see what would happen. I also thought some of you might be interested in the outcome. Thoughts?

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For starters, be sure to use your gift cards. According to an article in the WSJ, Americans spend $65B per year on gift cards (no including bank issued, pre-paid cards), with $6.8B going unredeemed. In some cases, that money becomes “abandoned property” that is collected by the state. In other cases, the retailers absorb the unused balances as pure profit.

Second, I recently read a statistic that people who use gift cards typically spend 1.4x the value of the gift card. If you use a gift card to defray the cost of a more expensive purchase that you might have otherwise made, that’s great. But if a gift card prompts you to spend more than you otherwise would have just to be sure you get that balance down to zero, then you should explore your options.

For example, while out in California over the Holidays, I discovered that you can get cash back at Target if you make a purchase and wind up with a gift card balance of less than $10. The ability to do this likely depends on both state laws and retailer policies (e.g., Target back home doesn’t allow this) but it’s worth checking out.

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Sacrifice yields success

Simply put… Debt reduction takes sacrifice. It requires us to set aside immediate desires in favor of long-term piece of mind. It’s not easy, and we’re not robots. We run the risk of burn out, failure, tension with loved ones, embarrassment, and exclusion, but… The victory, and even the thought of victory, is just so damn sweet!

Even as I write this, I can already faintly taste it. It seems so far off, but I know that it’s within reach. I know that our plan, though not easy, will allow us to feast on our sweet victory over debt. I simply cannot wait.

From start to finish, the process of debt reduction is peppered with milestones. One of the ways to stay motivated is to appreciate and recognize each and every victory… No matter how large or small.

Celebrate your milestones

“…a milestone is the end of a stage that marks the completion of a work package or phase…”

Wikipedia

In order to avoid burnout, it’s important to allow ourselves rewards for our accomplishments. This reward need not be lavish. Rather, it can be something as simple as a piece of your favorite pie (a la mode!) at the local diner, or that new video game your friends have been raving about.

Regardless of how you do it, celebrating each milestone gives you that small break you need to reflect upon your accomplishment, tease yourself with a taste of success, and then turn your attention and focus once again to the task at hand… Finishing the goal through completion.

Mrs. Jabs and I will most likely be paying off our Lending Club loan by the end of February. Once we do that, we’ll be left with two mortgages and two student loans.

How do we plan to celebrate the milestone? We’re not sure yet… But you better believe we’ll be living it up one way or another — without spending too much, of course!

Here are a few debt milestones reached from friends on Twitter:

• @MoneyEnergy tweeted: “I just finished paying off 2 credit cards for good, with 1 left to go next month + 1 student loan. Celebrating with a budget!”
• @TTaxChels tweeted: “Paid off all credit card debt. Celebrated with a woohoo!”
• @RJWeiss tweeted: “Paid off our student loans recently. Celebrated by deciding to pay off our mortgage by the time we’re 30.”
• @nomorespending tweeted: “We became debt free just b4 Christmas (£45k) no celebration just a feeling of a weight being lifted, this still with me now )“

As you can see… Money is rarely a prerequisite for celebration! Especially among those dead set on paying off debt. Budgeting and paying off even more debt may not sound like a celebration to some… But this just goes to show what a great feeling one gets from destroying their debt!

A debt free goal and another huge milestone reached:

Nickel just paid off his mortgage. How did he celebrate?

“I kissed my wife and breathed a sigh of relief. Honestly, it hasn’t entirely sunk in yet, but hey… We’re done, so we don’t need motivation anymore! Truth be told, we’re going on a nice vacation this spring, and we’ll be basking in that fact that it’s being paid for by our lack of a mortgage payment.”

And guess what? Nickel isn’t the only one who’s hit a milestone recently.

Paul of FiscalGeek.com recently paid off an astounding $63,535.65 worth of non-mortgage debt in just 11 short months! Paul and his wife decided to celebrate the same way they paid off their debt… Without spending any money! Here is what Paul had to say:

“We’re celebrating, but not in your typical fashion. Frankly, we don’t have two nickels to rub together right now because we really busted it at the end, so it just so happens that we’re celebrating via social media. Between Facebook, my blog, and Twitter we’re having a great time sharing our experience and celebrating with others.

The same day we paid off our debt also happened to be my son’s 9th birthday party, so we dovetailed with that celebration. We haven’t felt the need to spend any more money, as we’ve done plenty of spending over the years. Our reward is really knowing that all the extra money I find next month is truly mine! I’m so stoked about that.”

Immediately redirect cash flow

While your debt milestones should be celebrated, don’t screw around… As soon as you’ve blown off some steam, get immediately back into your plan.

If you still have debt, you may want to redirect all available resources toward the next debt of choice. If you’ve finally achieved debt freedom, you could redirect all your newfound resources into retirement savings, college savings for your kids, or giving it away!

Do whatever makes sense for you situation… Just be sure to keep your eye on the ball until you’ve met your goals.

What about you?

What was the most recent debt reduction (or other financial) milestone that you reached? And how did you celebrate?

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Related Articles at fivecentnickel.com:

» Weekly Roundup – 07/28/06
» Use Weight Loss Strategies to Get Out of Debt
» Carnivals – Week of 10/01/07
» Debt Reduction: Share Your Story
» MightyBargainHunter Joins the MoneyBlogNetwork
» Carnivals – Week of 09/23/07
» Reducing Your Debt With Micropayments
» Q&A: Dave Ramsey and Debt Reduction

While you think about that, here are some links to interesting articles that I’ve recently run across. And guess what? They’re all free!

• How to Report Tax Frauds and Tax Cheats
• IRA Conversions: What’s Special About 2010?
• Knowing When to Outsource Your Taxes
• The Need to Re-Think Retirement
• Best Credit Cards of 2009 (part 2)
• How to Choose ETFs for Your Portfolio
• Even a Small Emergency Fund Can Bail You Out
• When Not to Save Money

That’s it… Have a great night (or day, depending on when you read this).

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» Weekly Roundup – First Day of Summer Edition
» Weekly Roundup – 03/09/07

One of the ways 2009 made history was by having the most sustained episode of deflation since the 1950s. As the year progressed, however, it was clear that inflation was making a comeback. This emerging trend should be a reminder that planning for inflation is critical to your retirement savings plan.

How inflation affects retirement savings

You still see articles wondering if a million dollars will be enough for retirement. Increasingly, though, new generations should regard the premise that a million dollars is adequate for retirement as a quaint notion.

Given the historical average inflation rate of 3.75% a year, by the time a 25-year old today reaches 70 years of age, he would see inflation turn that million dollars into the equivalent of $190,781 in today’s dollars. All of a sudden, that doesn’t sound like such a lavish retirement nest egg, does it? Clearly, any retirement savings target has to factor in the effects of inflation over time.

Factoring inflation into a retirement savings plan

Here are some tips for factoring inflation into your retirement savings plan:

• At an average annual rate of 3.75%, inflation will double approximately every 19 years. Use this as a rule of thumb to figure out how many times your cost of living will double by the time you need the money.
• Don’t use your retirement date as the endpoint for your retirement planning. Remember, you could easily live another 20 years or more in retirement — time enough for your cost of living to double yet again.
• Inflation may vary greatly from year to year, but keep that 3.75% average in the back of your mind before locking in any certificates of deposit (CDs) or any other long-term investments. Also be sure to consider the impact of taxes. If you’re looking for a “safe” investment, it’s currently better to keep your bank deposits short and flexible — e.g., in a high-interest savings account or money market account — until bank rates recover.
• In the long run, you’ll need to consider investing more aggressively to protect your nest egg against the devastating effects of inflation. Without the higher returns offered by stocks and bonds, it will be virtually impossible to outpace inflation.

Because of the compounding effect of inflation over time, failing to account for inflation in your retirement savings plan can be as devastating as losing more than half of your money. However, if you get an early start and make sensible investments, you can get the power of compound interest rates working for you rather than against you.

Sources: US Bureau of Labor Statistics, BLS Data

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» Can You Retire With a Million Dollars?
» Series I Savings Bonds Now Paying 3.36%
» Money Poll #9: Retirement Savings Rate

If you have one of these plans and want to take advantage of the lower rates, you have to contact them to switch plans. The good news is that you can do this without renewing or extending your contract.

AT&T is encouraging customers to make their changes online, though I’m sure you can call or visit an AT&T store if you prefer. Verizon is encouraging people to make their changes online or by calling 1-800-922-0204. Here again, I’m betting that you could visit a Verizon store if you prefer.

The AT&T press release can be found here.

The Verizon press release can be found here.

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Our plan for 2010 is getting serious with about saving for retirement, especially now that we’ve reduced our monthly expenses and automated our bill payments. I’m mailing in my paperwork to consolidate my student loans tomorrow and, if all goes well, my interest rate will drop to 2.5%. That’s low enough that we’re comfortable increasing our retirement contributions while paying down our debt.

Setting contribution amounts for his 401(k)

My husband’s job offers a 401(k) with a match of up to 5%. The matching funds are immediately vested which means that even if he left for another company, he can take all of the money in his 401(k) with him. We’re already contributing enough to get the entire company match, but we’re looking to do more.

My husband wants to keep his investments simple and just focus on a few funds. The problem for us is finding the right mix of funds to invest in. In the end, we went with a couple of growth funds for the majority of his holding. We would have preferred to put his contributions into low cost index funds, but there aren’t any offered in his plan.

While a 1% or so difference in expense ratios between a typical index fund and the funds offered in my husband’s 401(k) might not seem like much, it adds up to some significant money down the line. I ran the numbers, and if you invest $100,000 over 20 years in an index fund with a 0.75% expense ratio vs. a fund with a 1.9% expense ratio, there’s a difference of $216,700!

Thus, we’re going to focus on funding his Roth IRA instead of putting extra money (beyond the company match) into his 401(k).

Setting contributions amounts for our IRAs

My husband now has to decide how he wants to invest his Roth IRA contributions. When he started a new job here in North Carolina, he started investing with Vanguard because of their low fees and the fact that he had enough money stashed away to meet their minimum investment requirements.

I have my retirement funds with Sharebuilder, and I’ve set up an automatic monthly deduction for my Roth IRA for 2010. Back in 2009, I decreased, and then paused, my Roth IRA contributions so I could devote more money to paying off my car loan and building up our house down payment.

In terms of investments, I’ve been focusing on mutual funds instead of individual stocks since I don’t have a lot of money, and I want good diversification. I actually started setting aside money for retirement through an employer plan when I was 21. I wish I could say that I continued my contributions uninterrupted, but I ended up cashing it out when I left that job.

Not only did I have to pay taxes on the distribution, but there was a penalty on top of that, decimating what little savings I had. I learned my lesson and now I don’t touch my accounts unless I’m contributing more money or rebalancing my portfolio.

Focusing on the future

Since we’re now making regular contributions, and we’re still quite young, we have the powerful effects of compounding on our side. We’ve also learned a valuable lesson about cashing in our retirement accounts, and won’t be taking any early withdrawals. Instead, we’ll be focusing on increasing our contributions each and every year.

I know people who think you need to have a huge amount of money to invest effectively, but that’s simply not true. Even small amount add up — at least you’re doing something. You can always increase your contributions as your earning power increases.

As things stand, we intend to adjust our contributions every January and then automate things for the rest of the year. That way our investment program will be both convenient and sustainable.

Your thoughts

So… What do you have planned for this year? Are you increasing, decreasing, or holding steady with your retirement contributions for 2010?

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» Traditional and Roth IRA Contribution Limits for 2010
» Look Before You Leap: Roth IRA Conversions in 2010
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No more escrow

As most anyone with a mortgage is aware, your mortgage is made up of four primary components: principal, interest, taxes, and insurance. The principal and interest payments are kept by the lender, whereas the taxes and insurance typically go into an escrow account that the lender maintains on your behalf.

The reason that it works this way is that your lender wants to be 100% sure that your property taxes and insurance premium get paid. Once you pay of your mortgage, however, you’re on your own. Thus, you’ll need to contact your insurer and ask them to begin billing you directly for your insurance, and you’ll also need to stay on top of your property tax bills.

Increased cash flow

Several readers have asked what we intend to do with the increased cash flow that accompanies a paid off mortgage. In the short run, we’ll likely focus on investing what we would’ve otherwise been sending to our mortgage lender. In the long run, the lack of a mortgage payment provides us with significant flexibility when it comes to lifestyle decisions.

Of course, as noted above, we’ll no longer be paying into an escrow account. Thus, it will be important to consistently set a bit aside to cover our homeowners insurance and property tax bills.

Tax planning

Of the tax advantages associated with home ownership, the mortgage tax deduction ranks near the top. For those that are unaware, you get to reduce your taxable income (with some limitations) to the extent that your mortgage interest and other deductions exceed the standard deduction.

Beyond effectively reducing the interest rate on your mortgage, the mortgage interest rate deduction helps you get over the standard deduction hump, which has an impact on the tax treatment of other financial decisions — such as charitable contributions.

In fact, the loss of the mortgage tax deduction is the main reason that I recently started investigating donor-advised funds. Instead of donating a set amount each year, we may begin donating twice that amount in alternate years.

This strategy will maximize the tax benefits of our charitable donations, and the use of a DAF will remove the urgency associated with making those donations.

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» 40 Year Mortgages Going Mainstream
» Carnivals – Week of 07/31/06
» An End to Rising Rates?

Yes, we’re well aware of the mathematical advantages of keeping your mortgage and investing our extra cash, but we decided to pay off the mortgage for a variety of non-mathematical reasons.

Our mortgage story – in the beginning

We got our first mortgage back in June of 2002. Actually, we got two mortgages back in June of 2002. We didn’t have enough cash on hand to put 20% down, and we wanted to avoid PMI, so we went with an 80/10/10 when we bought our first house.

Our primary mortgage was a 30 year fixed rate around 6.5%, whereas our second had a rate around 8% and was amortized over 30 years, but there was a balloon payment due after 10 years if we still had it.

Anyway, not long after closing on our house, we ended up killing off the second mortgage in favor of a HELOC with a significantly lower rate. Over time, we rebuilt our savings and eventually plugged it into our HELOC to kill of the balance.

Nowadays, I probably wouldn’t recommend this strategy… We essentially rolled our emergency fund into the HELOC to save on interest. It worked well, but the credit markets are now much dicier than they used to be, and there’s always the risk that your HELOC might get shut down.

Anyway, we ultimately rebuilt our savings without ever having to tap the HELOC, and thus all that was left was our primary mortgage. Throughout this time, we were also consistently paying at least a little extra toward principal.

At the same time, mortgage rates had been falling and we decided to refinance to a lower rate. Once again, we opted for a 30 year loan, but our rate dropped into the mid 5% range. The breakeven period was about a year, so it seemed like a no-brainer at the time. We ended up keeping that mortgage for around two years, so we ultimately came out ahead.

Our mortgage story – movin’ on up

In 2006, we ended up moving to another state. We made a tidy profit on our first house when we sold and… Though we ended up moving to a larger, more expensive home, we were able to put down 50% this time around. Unfortunately, rates had drifted back up at this point, so we wound up with a rate a bit over 6%.

As before, we continued making extra principal payments every month, so the balance was spiraling downward. About 18 months later, rates dropped dramatically and we decided to refinance once again. This time, however, we went with a 15 year fixed rate mortgage at a bit under 5%.

This time around, we had minimal closing costs. Thus, even though we ended up paying the whole thing off about 18 months later, we still came out ahead.

Our mortgage story – paying it off

Okay, as I noted above, we’d been consistently making extra principal payments. Over time, these prepayments got more and more aggressive, so our balance was dropping fast. At the same time, we had also been saving and investing aggressively, fueled not only by my day job, but also by my online endeavors.

Fast forward to this past December. After giving it a lot of thought, my wife and I decided to request a payoff statement from our lender and to make a lump sum payment to payoff our mortgage early. After transferring some money around, I headed over to the bank to wire the funds to our lender.

And that’s all she wrote… The funds arrived later in the day, and our mortgage account was updated the next day to reflect our zero balance. From start to finish, this entire process took just about 7.5 years. This isn’t to say that you should pay off your mortgage early, but rather to provide evidence that it can be done if you decide that it’s the right course of action for you.

P.S. Hey Matt, our debt-to-income ratio is zero.

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Related Articles at fivecentnickel.com:

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» Reaching the Mortgage Crossover Point
» How to Decide When to Refinance Your Mortgage
» 15 vs. 30 Year Mortgages: Which is Right for You?
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This an interesting problem…

On the one hand, it doesn’t seem fair to hit someone with a higher fine just because they have more money in the bank. On the other hand, while a “typical” speeding fine might really strain a poor person’s budget, it wouldn’t even register for a wealthy person. Thus, as long as you have enough money, you can essentially ignore things like speed limits, at least from a financial perspective.

Of course, there are other types of punishment available, such as suspending a driver’s license. But this still begs the question… Is it fair to index punitive measures such as speeding fines to an offender’s ability to pay? Is it fair not to do this? What do you think? Please share your thoughts in the comments.

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» From the Archives – (March 16th – March 22nd)

• The American Red Cross has pledged an initial $1M in support. You can help support their efforts by donating online, or you can donate $10 by texting HAITI to 90999. Receipts for your text donation are available through mGive.
• UNICEF has set up a dedicated site for their relief efforts.
• Doctors Without Borders has also created a dedicated website for their efforts.
• You can support the Yele Haiti Earthquake Fund (started by Haiti’s own Wyclef Jean) by donating online, or you can send $5 by texting Yele to 501501.

For a more complete list of options, check out The Daily Beast.

As always, if you smell a scam, beware. You can (and should) check out charitable organizations using sites such as Charity Navigator, Charity Watch, BBB.org, or The Foundation Center.

Hat tip to Lifehacker.

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What is your debt-to-income ratio?

Commonly referred to as your “DTI,” your debt-to-income ratio is a personal finance benchmark that relates your monthly debt payments to your monthly gross income.

As an example… Let’s say that your gross monthly salary is $5,000 and you are spending $2,800 of it toward monthly debt payments. In that case, your DTI would be an unhealthy 56%.

This version of your DTI is sometimes referred to as your “back-end” DTI. This is often broken down further to give a front-end debt-to-income ratio, which is a component of your back-end DTI.

How to calculate your front-end DTI

Your front-end DTI is calculated by dividing your monthly housing costs by your monthly gross income. Front-end DTI for renters is simply the amount paid in rent, whereas for homeowners it is the sum of mortgage principal, interest, property taxes, and home insurance (i.e., your PITI) divided by gross monthly income.

From above, if that $2,800 in debt payments is attributable to $1,500 in housing costs and $1,300 in non-housing costs, then your front-end DTI is $1,500/$5,000 = 30% (and your back-end ratio is still 56%, as calculated above).

How lenders use your DTI

Mortgage lenders typically use DTI (along with other variables) to determine whether or not you qualify for a loan, and to help determine your mortgage rate. A high front-end DTI raises red flags with lenders because it is commonly associated with borrower default. In fact, reducing front-end DTI to reduce the risk of homeowner default was one of the main objectives of the loan modification programs introduced by the government in 2009.

There are specific limits for DTI that are used as cut-off points when evaluating borrowers. Current DTI limits for conventional conforming mortgage loans are typically 28% on the front end and 36% on the back end, though these limits are slightly higher for government subsidized FHA loans.

While there are certainly other factors to consider when determining our eligibility for financing (e.g., credit score, etc.), your DTI is an important determinant that you should be aware of. By working to improve it, you can make yourself a better credit risk, and thus get more favorable treatment from lenders.

Two obvious ways to improve DTI are to increase your income and/or decrease your debt. Both are solid goals.

What is your DTI?

I just figured our current household DTI. Our front-end ratio is 15%, and our back-end ratio is 24%. What is yours?

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This (potentially) valuable tax credit is known as the “Retirement Savings Contribution Credit,” and it’s available to anyone who meets the income requirements and makes a qualifying retirement contribution.

For tax year 2009, you can claim this credit if you AGI is no more than:

• $55,500 (married filing jointly),
• $41,625 (head of household), or
• $27,750 (single, married filing separately, or qualifying widow[er])

The credit ranges from 10% to 50% of your contribution amount, and the maximum contribution on which the credit is calculated is $2000. In other words, you can get a credit of up to $1000. The actual rate can be determined by completing IRS Form 8880.

Eligible retirement plans/accounts include a traditional or Roth IRA, or elective deferrals to a 401(k), 403(b), 457(b), SIMPLE IRA, or a salary reduction SEP-IRA. Contribution to a 501(c)(18) plan are also eligible.

And guess what? It’s still not too late to take advantage of this tax credit for 2009. Even if you haven’t made any retirement contributions, you can still fund a traditional or Roth IRA up through the day your taxes are due. So what are you waiting for? Get cracking!

See Chapter 5 of IRS Publication 590 for complete details.

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I’m talking here about are deductions on your 1040 that you can claim whether or not you itemize. Tax adjustments can lower your adjusted gross income, which in turn can put you in a lower tax bracket, and might help you qualify for some other tax benefits.

Moving expenses

Taking a new job can benefit you come tax time. If you move for the sake of a new job or business, or due to a new job/business location, then you may be able to deduct a portion of your moving expenses. You have to move within 12 months of the job change, and your move also has to pass these two tests from the IRS:

• Distance test: You have to prove that you decrease your commute by at least 50 miles with your move.
• Time test: If you are an employee, you must work full-time for 39 weeks during the first 12 months following your move. You do not, however, have to work for the same company.

When claiming your moving expenses, keep in mind that you can only include reasonable expenses, such as packing and shipping your household items to the new location, storage for the move, switching utilities, and gasoline for your cars during the drive. Meals are not included, nor are reimbursed expenses.

Tax breaks for the self-employed

There are some special tax breaks specifically geared for the self-employed. Did you know that you can deduct half of your self-employment taxes, and that there is no maximum you can deduct? This can be a significant amount, so be sure to take advantage.

If you have a retirement plan such as a SEP-IRA, SIMPLE IRA, or Keogh Plan, you will have also gain some tax benefits when you make contributions, though each plan has specific rules. If you are looking for more information on these retirement plans, as well as other tax breaks for the self-employed, then be sure to check out IRS Publication 560.

Student loan interest

Being a college student can have some perks come tax time. You may be able to use some of the student loan interest you paid as an adjustment, and also reduce your taxable income. You don’t have to itemize your deductions to include this adjustment on your 1040. Be aware that you should receive a 1098-E form if you’ve paid more than $600 in student loan interest.

The maximum you can deduct for student loan interest payments on your taxes is $2,500. If you have a filing status of Single, Head of Household, or Qualifying Widow(er), you will see their deductions reduced if your modified adjusted gross income is more than $55,000 with a complete phase out at $70,000. Married (Filing Jointly) couples will see their deductions reduced if their modified adjusted gross income is more than $115,000 with a complete phase out at $145,000. Note: You can not take this adjustment if you’re married filing separately.

For your student loan to qualify for this adjustment, you must have taken it out for educational expenses (tuition, room and board, and textbooks) for a qualified student at an accredited educational institution.

IRA deductions

Another way you can reduce your taxes is to make a deductible IRA contribution. We’ve previously talked about IRA contribution limits. In short, you can deduct a contribution of $5,000 ($6,000 if you’re 50 or over) to your traditional IRA, though this deduction is subject to income limits if your or your spouse is an active participant in an employer-sponsored retirement plan.

Keep in mind that you can make this contribution up until you file your taxes, so there’s still time to make your 2009 contributions if you haven’t done so yet.

Alimony and other adjustments

If you paid alimony during the past year, you’ll can get a tax break. You need to have your ex-spouse’s social security number, and they need to report their alimony as income for you to claim this deduction.

If you’re a teacher or educator, you can deduct up to $250 (per spouse if both are qualified educators) of qualified expenses on your 2009 tax return as an adjustment. Anything above that amount could be deductible but you’d need to put it on Schedule A.

Any other favorites?

The tax code is a complex beast, and there are tons of other ways to reduce your tax burden. What are your biggest tax breaks in a typical year? Please share so we don’t miss out on any good ones.

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While Schwab still trails some discount brokers (e.g., TradeKing @ $4.95/trade), they’re well ahead of others (e.g., E*Trade @ $12.99/trade). When combined with their very low mutual fund investment thresholds, this change makes Schwab a fairly attractive option for people who are just starting out.

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Some accounts were meant to be separate. Retirement accounts are an excellent example. Others are probably better off being joint. Joint access to an emergency fund means that either partner can act in case of an emergency, and having two sets of eyes on the account can put a stop to frivolous withdrawals.

But checking accounts are practically their own animal, and there are pros and cons on both forms of ownership, separate and joint. I have a bias toward separate accounts. My wife and I have been married for 16 years and the separate arrangement has worked so well that we’ve never even entertained the idea of a joint account.

Separate checking accounts

There may be more advantages here, but below are five compelling reasons favoring separate accounts:

1. Each person has a sense of control over some piece of the household budget. Call it “mad money,” or whatever you will, but just as each of us needs our own small space in the home, and our own separate collection of personal stuff, we also need our own financial “space.”
2. It eliminates the possibility of two people drawing from the same account and the overdraft fees that can result. Debit cards compound the potential for this.
3. It avoids the prospect of trying to keep track of each spouses expenditures in one account.
4. It creates diversification. If a problem, like identity theft, causes one account to be closed or suspended, the couple can continue operating out of the other’s checking account.
5. It can avoid a lot of fights related to money. Each spouse is responsible for their own account and can’t blame the other for messing it up.
6. It splits responsibility for household finances between both spouses.

Another thing that we don’t like to think about is the ability of each spouse to handle their finances in the event of divorce or the death of the other spouse. How often do you hear of situations in which the financially-minded spouse dies, and the surviving spouse is clueless about handling the checkbook?

In many respects, managing a checkbook — and the bill paying that’s attached to it — is the single most important component of money management. If one spouse is shielded from that function, the shock of losing a spouse will be that much greater.

Joint checking account

I’m able to come up with just as many reasons why a joint account would be preferable, and you might be able to come up with a few more:

1. No need for two separate household budgets, which may not be the most effective way to minimize expenses.
2. It eliminates the yours vs. mine conflict, and creates a sense of “we.”
3. It can neutralize a spouse who is weak on finances and budgeting, but only if the “stronger” spouse controls the checkbook.
4. It can maximize the accumulation of savings by centralizing bill paying and allocation for savings.
5. It creates a division of labor, or specialization of functions within a marriage. One spouse may handle the finances, while the other takes charge of kids’ schoolwork. Each function is important, each makes a contribution to the household, but in different ways.
6. A joint account results in half as many bank fees as compared to separate accounts.

In addition, as Nickel has pointed out, a joint account makes complete sense for a single income couple.

Separate accounts have worked beautifully in our marriage, but different arrangements work for different couples. Which do you prefer, joint or separate? What are the advantages and disadvantages that you’ve discovered?

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» How to Create ING Direct Subaccounts
» ING Direct $25 Electric Orange Account Signup Bonus
» Establishing Credit With a New Taxpayer Identification Number
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“If bank A offers me a certain APR with roughly $3,000 in closing costs, while bank B offers me a lower APR with roughly $3,000 in closing costs, but bank B is a no name bank, which do I pick? In the end, a contract is a contract, right? If I sign with ‘Joe Blow Bank’ and they loan me X dollars at the lower APR, should I go with them? Or should I remember what my mom told me? If it sounds too good to be true, then it probably is.”

Personally, the only factors that I really pay attention to are the mortgage interest rate, lender’s fees, and closing costs. We’ve generally worked through a mortgage broker, and haven’t ever thought about who would ultimately wind up underwriting our loan.

In fact, it’s very common for mortgages to change hands within a few months of origination. As such, it’s not like you really get to choose who will end up servicing your loan, anyway.

Just be 100% sure that you’re comparing apples with apples… For example, adjustable rate mortgages (ARMs) typically have low initial rates that will move upward after three, five, or seven years. In the case of fixed rate mortgages, shorter term loans typically have lower rates than longer term loans (e.g., 15 year rates = 30 year rates).

Assuming that you’re being offered truly equivalent products, I’d focus on the financial details rather than sweating the name of the bank. Of course, you’ll want to be sure that your prospective lenders are legitimate outfits, so go ahead an check them out with the Better Business Bureau, but… Don’t let name recognition (or lack thereof) push you into a more costly mortgage.

If you have anything to add, please share your thoughts in the comments.

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Related Articles at fivecentnickel.com:

» What is a Mortgage Escrow Account?
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» Are Biweekly Mortgage Payment Plans Worthwhile?
» Our Mortgage was Sold
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Just be aware that you have to visit their site and opt-in to these promotions.

Here’s the scoop:

• March 2010 (signup starts Feb 1st): 5% cash back on purchases at grocery stores and drug stores.
• April-June 2010 (signup starts March 1st): 5% cash back on home and fashion. This includes home improvement stores, department stores, and clothing stores.
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If you already have a card, be sure to sign up to get the bonuses. If you’re interested but don’t yet have a card, you can click through and apply now.

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So why is this so hard for us to grasp, adopt, and live by? It’s not complicated, it’s not unreasonable, and it makes perfect sense. So what’s the deal? Why do most Americans spend money that they don’t have?

Well, I don’t have the answer for that, so… Rather than opening that can of worms, I will present sound information that will help us grasp the Save Then Buy concept, adopt this commonsense philosophy, and live by the wisdom of it’s simplicity.

Save money, then buy – grasp the concept

If people would simply take a step back and rationally analyze the Save Then Buy mindset, there’s little chance that they could come up with a valid argument against it. Moreover, if one were to make an equitable comparison between the Save Then Buy mindset and the modern American cultural norm of Buy Now Pay Later, there’s little doubt that they would deem the former as the best financial choice.

If we can see the wisdom of the concept, but have not yet adopted it… What is holding us back?

An example

Let’s take a look at a simple example of Save Then Buy versus Buy Now Pay Later in the context of a college education…

Save Then Buy: A prospective college student might seek a low level job in an industry of interest, then either attend classes while earning enough to fund them, or save for a few years and begin schooling once they have enough saved, gathering no debt along the way.

Buy Now Pay Later: With this mindset, a prospective student would first seek financial aid (most often in the form of loans), amass a mountain of debt throughout their college years, and graduate with tens of thousands of dollars of student loan debt.

While some might argue about the value of getting that college education as quickly as possible, my view is that the Save Then Buy student will come out on top across the board. They will have gained work experience prior to and during their education which will help them refine their field of study, and will provide them with necessary experience for launching their new career.

In fact, they will often already have a job with a company in their field of expertise, and can start climbing up the ladder with their new degree. They’ll also start their professional life with no student loan debt, and can begin saving and investing out of the gate.

The Buy Now Pay Later student will graduate with no relevant job experience, no job, and a mountain of debt. They will have to go into the world and compete against better equipped Save Then Buy candidates.

Save money, then buy – adopt the philosophy

I’m guessing that many people reading this article currently have a Buy Now Pay Later mindset. That’s okay… I used to be hold that view myself.

The good news is that you can change your behavior today. You no longer have to be a slave to a poor economic mindset just because “everybody else is doing it.” Break free from a culture of temptation and start living by a new personal economic mindset that is based on wisdom and sound financial principles.

Will it be hard?

Sure… It might be. Was it hard for me? Not really. All I had to do was calculate how much our debt was costing us. Once I had the numbers in front of me, the reality of $1,300+ of my hard earned money going toward interest on my debt was all the motivation I needed.

Get mad at your debt

Using the spreadsheet that I developed, you should sit down and take a long hard look at how much your debt costs. I can virtually guarantee that you will wind up with some good healthy anger toward your debt, which should help motivate you to adopt the Save Then Buy philosophy.

Save money, then buy – live by simple wisdom

Now that we’ve fully explored the concept, analyzed the numbers, and gotten mad about our current situation, all that remains to be done is to adopt the concept. Don’t buy stuff you can’t afford. Instead, save your money money until you can comfortably afford the expenditure.

From laborer to capitalist

In making this transition, you should also stop thinking like someone who trades their time for money, and instead start thinking like someone whose goal is to live off the proceeds of their money. If we want to win with money, we have to start considering our future every time we open our wallets. With each decision we make, we should be moving ourselves closer to the wise goal of living off the proceeds of our assets.

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Related Articles at fivecentnickel.com:

» Save Money by Questioning Your Purchases
» Saving for Retirement at the Last Minute
» Weekly Roundup – Massive Failure Edition
» How to Save Money on Health Insurance
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» Save on Medical Care – Part III
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» Credit Card Receipt Poll Results

What is a donor-advised fund?

A donor advised fund is essentially an umbrella charity run by an investment company. You can make donations into an account over which you serve as an “advisor” and take an immediate tax deduction. You can then advise the company on how to invest the money, as well as when and where to direct the funds in the form of a charitable grant.

Advantages of donor-advised funds

The primary advantage of a donor-advised fund is that you can use it to aggregate charitable contributions in a specific year even if you want to spread the donations themselves out over time. This can help maximize your tax savings while giving you time to make prudent decisions about who gets what (and when).

Beyond the above, you can also directly donate appreciated stocks, mutual funds, etc., which saves you from paying capital gains taxes on them prior to the donation. While some charities are set up to take such donations, others aren’t. A donor-advised fund makes this strategy available to all.

Finally, if you make lots of charitable contributions, a donor-advised fund can simplify your paperwork. Instead of getting receipts from many individual charities, you get a single tax receipt. This is especially helpful if you want to donate securities, as outlined above.

Disadvantages of donor-advised funds

The biggest disadvantage of a donor-advised fund is that you technically lose control over the money. According to IRS guidelines, your contribution must both irrevocable and unconditional. While you are allowed to advise the fund on how to invest and when/where to donate funds in your account, all such moves must be approved by the fund.

In reality, this is less scary than it sounds, as the approval of grant recommendations is typically automatic as long as the recipient is a bona fide charity. In fact, I’ve never heard of a case where a legitimate grant request has been turned down. The restrictions come because the fund itself is technically the charity to which you’re donating.

Other downsides to donor-advised funds are management fees and minimum investment requirement. While the fees aren’t huge (typically less than 1% plus whatever expenses are associated with the underlying investments), they are definitely something to consider. As for minimum investments, the lowest values I’ve been able to find are in the $5k range for the initial contribution with subsequent contributions starting at $500.

What about taking credit vs. remaining anonymous?

If it’s important to you to receive credit for your donation (i.e., for the recipient to know who you are), then you’re in luck. Donor-advised funds allow you to name your fund (e.g., The Smith Family Charitable Fund) and will provide the recipient with contact details when they disburse the funds.

Conversely, if you’d prefer to remain completely anonymous, a donor-advised fund can provide an additional layer of isolation between you and the ultimate recipient. Thus, you can make truly anonymous donations

Who offers donor-advised funds?

Donor-advised funds are available through a number of mutual funds families, including Vanguard, Fidelity, Schwab, and T. Rowe Price.

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» How to Write a Mortgage Gift Letter
» John Bogle’s Favorite Mutual Fund Companies
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» How Large is Your Emergency Fund?
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Here’s the rundown:

1. New York, NY
2. Los Angeles, CA
3. White Plains, NY
4. San Francisco, CA
5. Honolulu, HI
6. Miami, FL
7. Chicago, IL
8. Boston, MA
9. Houston, TX
10. Washington, DC

While American cities haven’t traditionally ranked amongst the most expensive worldwide, New York moved from #22 in the world in 2008 to #8 in the world in 2009. If you’re interested in looking more broadly, you can find the complete, worldwide dataset from which the above list was generated by visiting this link.

Not surprisingly, the main reason that New York sits atop the US leaderboard is the high cost of housing. In fact, housing costs (as measured in terms of 2 bedroom luxury apartment rents) in New York are nearly double those of #2 Los Angeles. Of course, many Los Angeles residents also have to deal with long, costly commutes.

A couple of other interesting tidbits:

The city on this list with the most expensive cup of coffee (on average) was San Francisco at $4.50.

As for fast food hamburger meals, the highest cost was in White Plains, NY at an average of $6.29.

Where does your hometown rank?

I’m just thankful that we live in a place where I can earn a good income without facing an astronomical cost-of-living. According to an online cost-of-living calculator that I just dug up, New York is nearly twice as expensive as our hometown. Once again, housing makes up a disproportionate amount of that difference.

What about you? How does your hometown stack up?

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Related Articles at fivecentnickel.com:

» One Year Ago This Week (June 18th – June 24th)
» America’s Cleanest (and Dirtiest) Cities
» The World’s Most Costly Cities
» From the Archives (June 17th – June 23rd)
» From the Archives (June 8th – July 5th)
» Daytime Population Fluctuations
» Americans Moving Back Into the City
» Florida Travel Recommendations?

Cash flow

I start with cash flow because you need to make sure that you’re not spending more than you earn. finances are not sinking you more and more into debt. Grab a budget spreadsheet and input all your income and expense numbers. If your expenses are higher than expected, looks for areas where you can cut back.

For example, instead of going out to see a movie every weekend, try visiting museums and art galleries on free nights, visiting local and national parks, or seeing if there are any free concerts and festivals. If you’re still intent on seeing movies, consider signing up for Netflix or Blockbuster.

If you’re looking for ways to increase your income, consider starting a second job or building an alternative income stream based on a hobby or other passion. It doesn’t have to make you full time money in order to improve your bottom line.

Emergency savings

I’ve learned from personal experience that the only way to lessen the pain of an emergency is to prepare for it. Cars break down, jobs get lost, and appliances stop working at the absolute most inconvenient time.

Make sure you’re comfortable with amount of emergency savings that you have. If not, then start building it up. By putting it in a high yield savings account, you’ll have easy access to it and earn a bit of interest at the same time.

Outstanding debts

It might help to separate this category into high interest consumer debt such as credit cards and low interest and/or tax advantaged debt like student loans or your home mortgage. Attack the high interest debts first, as they can get out of control if put them off too long.

The easiest way for me to pay off my credit cards has been automating my credit card payments. Try to pay the minimum on all but one of your debts. Put the rest of your debt reduction money into either your debt with the highest interest rate. If you’re not comfortable with that approach, try attacking the lowest balance first.

Retirement accounts

If you have retirement accounts, make sure that your asset allocation isn’t out of whack. If they are, then you should rebalance them. You may also want to review your fees and expenses to see if you can save some money.

If your job offers a 401(k) retirement plan and you haven’t already joined, you should enroll. Many companies offer a match on a percentage of your contribution, and failing to take advantage of this free money can be a costly mistake.

You can also get started by opening a Traditional or Roth IRA through your favorite brokerage or mutual fund family.

Your thoughts

How does your financial snapshot look? Is it better or worse than a year ago? What are you planning on doing in 2010 to improve things?

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Related Articles at fivecentnickel.com:

» The Financial Snapshot
» What Would You Do With $1000?
» Our Investment Portfolio: Asset Allocation and Location
» Creating a Home Inventory for Insurance Purposes
» Our Home Renovations: The Beginning
» Money Poll #7: Online Banking
» Thinking About a Housing Addition
» Avoiding Do-It-Yourself Disasters

January

• Calculating Your Mortgage Refinance Payback Period
• Should You Pay Your Kids for Good Grades?
• Commonly Overlooked Income Tax Deductions

February

• Ten Common Income Tax Credits
• How to Choose an Online Savings Account
• Alternatives to High Yield Online Savings Accounts

March

• How to Save Money on Health Insurance
• Debt Reduction vs. Retirement Savings
• How to Save Money on Life Insurance

April

• The Downside of Target Date Mutual Funds
• How to Get Out of Debt
• How to Fix Errors on Your Credit Report

May

• Do You Care About Your Credit Score?
• How to Save Money on Car Insurance
• Pay Off Mortgage Early? Or Invest?

June

• How to Pay Off Your Mortgage Early
• Joint or Separate Finances?
• Index Mutual Funds vs. Exchange Traded Funds (ETFs)

July

• Breaking Free From a Culture of Temptation
• Save Money by Questioning Your Purchases
• Buy vs. Rent: The Real Estate Dilemma

August

• Calculating Your Real Hourly Wage
• Investment Performance: It’s a Matter of Perspective
• Avoid Lifestyle Inflation: Create an Artificial Sense of Scarcity

September

• How to Get a Raise (or at Least Keep Your Job)
• The Pareto Principle and Building a Better You
• Create Your Own “Extended Warranty Fund”

October

• Clean and Maintain Your Windows Computer for Free
• Salary Negotiation – How to Win
• Should We Get Rid of 401(k) Plans?

November

• Use Weight Loss Strategies to Get Out of Debt
• How Much Does Your Debt Cost?
• Considering a High Deductible Health Plan

December

• How to Get a Good Deal on an Apartment
• How to Ask for Discounts
• Can You Retire With a Million Dollars?

Honorable mention

While making the above list, I came across numerous instances where I wanted to highlight more than three articles in a month. Because of this, I’ve put together a list of twenty more articles that are deserving of an “honorable mention.”

• Refundable vs. Non-Refundable Income Tax Credits
• Turning Money Into Time
• CD Ladders in a Low Interest Rate Environment
• Visualize Your Savings Goals
• How to Save Money on Groceries – 45 Ways to Reduce Your Grocery Bill
• Lending Money to Family and Friends
• How to Prepare for a Power Outage – Without a Generator
• Risk Tolerance vs. Risk Capacity
• How Much Life Insurance Do You Need?
• How to Find the Best Mortgage Rates
• Strategies to Curb Lifestyle Inflation
• How to Get Off Junk Mail and Telemarketing Lists
• How to Save Money on Homeowners Insurance
• Historical FDIC Insurance Limits
• How to Get Out of Your Cell Phone Contract
• Is it Possible to Live Without Credit Cards?
• How to Find a Good Deal
• What is Debt Settlement?
• Who and How Much to Tip During the Holidays
• Your 401(k) Match: Don’t Miss Out on Free Money

Thanks again for a great 2009, and best wishes for 2010.

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Related Articles at fivecentnickel.com:

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Those of you that have been following along know that I’ve been investing in Lending Club notes for awhile now. What I haven’t spend much time talking about is the other side of the coin — borrowing money from Lending Club.

While I’ve written a lot in the past about using 0% balance transfers to consolidate your debt, such offers have gotten a lot harder to find and considerably more restrictive.

Why use Lending Club?

Aside from providing investors like me with more loans to invest in, one of the biggest reasons to use Lending Club to consolidate your debt is that you’ll get a relatively low, fixed rate. For those that are unaware, Lending Club loans have a 36 month repayment period, and their rates start at 7.89%.

In other words, if you consolidate with a Lending Club loan and then stick to the plan, you’ll have your debt paid off in no more than three years. It’s also worth noting that there’s no prepayment penalty, so you – even less if you make extra payments.

Who can borrow via Lending Club?

Pretty much anyone can apply for a loan through Lending Club, but fewer than 10% of all applications get approved and funded. Just to be sure you’re not wasting your time, here’s a rundown of their general requirements:

• Minimum FICO credit score of 660
• Debt-to-income (DTI) ratio of <25% (excluding mortgage payments)
• Credit history of at least three years
• No current delinquencies
• No bankruptcies within the past seven years
• No more than ten recent credit inquiries

How much does Lending Club cost?

As I noted above, Lending Club offers fixed rates as low as 7.89%. Beyond this, the primary cost is a borrower processing fee, which starts at 1.25% for the highest quality borrowers, and goes up to 4.5% for the lowest credit grades. This processing fee is deducted from your loan amount, and is only assessed if your loan is funded.

There’s also a small service charge on the investor side whenever a payment is credited. That’s really a non-issue from the borrower’s perspective, though, as it’s built into the stated interest rate.

What’s the risk?

While Lending Club investors run the risk that borrowers might default (in fact, one of my high risk loans has defaulted), there’s no real risk from the borrower’s perspective. Assuming that your loan is approved and funded, the money is transferred into your linked bank account (minus the processing fee). If your loan isn’t funded, you pay nothing.

Of course, all the usual debt reduction caveats apply. For example, if you consolidate your debt and then keep using your credit cards, you’ll wind up in an even deeper hole. But if you’re committed to getting out of debt, consolidating and refinancing via Lending Club could be a great tool.

Don’t believe me? Just ask FCN staff writer Matt Jabs, who consolidated about $11k worth of debt and is currently saving a ton on interest.

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Related Articles at fivecentnickel.com:

» Lending Club Reduces Interest Rates for Borrowers
» Lending Club: Invest in Your Friends
» Lending Club – August 2009 Performance
» Lending Club Update – October 2009 Performance
» Lending Club – July 2009 Performance
» Lending Club Update – December/January Performance
» Our Lending Club Investments, One Week Later
» My Lending Club Loan Selection Criteria

Matt has already opened up a discussion of financial goals for 2010, so I invite you to chime in over there about what you have planned for the coming year.

And now… I’m off to spend time with family, watch some football, and relax. I hope you’re doing the same. Happy New Year!

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» Happy New Year!
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» Happy New Year!
» Happy Fourth of July! (Changes are Afoot)
» Happy Tax Freedom Day!
» A Few Things for Which I’m Thankful

Reduce your debt

Debt reduction should, in my opinion, always be numero uno. This is especially true if you’re dealing with high interest consumer debt. But even if your debt has a low interest rate, you might still want to make debt reduction a high priority. Whether or not you should pay off your mortgage early is a hotly debated topic, but even that is worth considering.

Build your savings

Your first line of defense when it comes to your finances is your emergency fund. Open a high yield savings account and work to build it up as a hedge against job loss or other unexpected curveballs that you might come your way.

A lot of people say to maintain a minimal emergency fund until you are out of debt, but I disagree. I think you should always pay yourself at least a small amount. That’s why I stick to a 75/25 savings plan.

There are, of course, other savings priorities that you might need to consider. For example, if you have a high-deductible health plan, you should be funding a Health Savings Account (HSA) so you can pay for health expenses with pre-tax dollars. Unlike a Flexible Spending Account (FSA), you can modify your HSA contribution levels throughout the year.

Fund your retirement

When it comes to funding your retirement, you have several options.

Individual Retirements Accounts – These come in two main flavors: Roth and Traditional. I personally prefer Roth IRAs over Traditional IRAs, but your needs may be different. Regardless of the type you choose, funding your retirement is an important priority. If you are under 50 years old, the 2010 IRA contribution limits are $5,000 or 100% of your taxable compensation, whichever is less.

If you are 50 or older and have sufficient taxable compensation, you can contribute $6,000 in 2010. The extra $1000 is referred to as a “catchup” contribution. Either way, getting started in January is your best bet for fully funding your IRAs. In fact, you still have time to make your 2009 contributions if you haven’t done so yet — the deadline is April 15, 2010.

Employer plans – Depending on where you work, you might have access to a 401(k), 403(b), and/or 457(b) retirement plan. We’ve previously outlined the contribution limits for these plans. In short, you can make elective deferrals of $16,500 to these plans in 2010 with an additional $5500 in “catchup” contributions if you’re 50 or older. If your employer matches your contributions, you should at least take advantage of the match so you’re not leaving money on the table.

Taxable investments – If you’re doing all of the above and still have money to spare, you should consider investing in a taxable account. You can do this either through a major mutual fund family, or through a discount broker. Either way, you’ll want to pay attention to tax efficiency when deciding what to hold where.

Save for college

Once you have everything else under control, you might be interested in funding your child’s education. Here are some of the best ways to do so…

529 Plans – When it comes to 529 plans, you have your choice between prepaid tuition plans and college savings plans. The former is a hedge against tuition inflation, while the latter depends on the performance of the underlying funds.

Regardless of which route you choose, make sure you do your homework. The good news is that qualified distributions are state an federal tax free (at least for now), and you might also get a state income tax deduction on your contributions.

Education Savings Accounts – The “Education Savings Account” (ESA) is a less-utilized college savings vehicle that has undergone some attractive changes since its inception as the “Education IRA.” Like a 529 plan, qualified distributions from an ESA are tax free.

ESAs can be used not only for qualified college expenses, but for certain K-12 expenses, as well. The contribution limits were raised from $500 to $2,000 in 2002 and remain there today. If you’re in a position to fund your child’s education accounts, make sure you look into this as an option.

What are your financial goals for 2010?

As I noted above, everyone’s financial priorities are likely to differ at least a little bit. While the above outline is a good place to start, you’ll want to tailor things for your own needs. You might even have things on your radar that I haven’t touched on.

What are your financial goals for the coming year?

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Related Articles at fivecentnickel.com:

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» Top Financial Goals for 2008
» Traditional and Roth IRA Contribution Limits for 2010
» Pursuing Financial Independence: Now What?
» Ratcheting Up Our 403(b) Contributions
» Get Focused on Your Finances
» Most Common Financial Resolutions
» 401(k), 403(b), and 457(b) Contribution Limits for 2010

Because inflation has been so low, however, there’s not much new under the sun. The IRA contribution limits will be staying the same in 2010 as they were in 2008/2009. What follows is a table of contributions limits dating back to 2002, and running through next year.

Remember, you can make your 2009 contributions all the way up until April 15th 2010. As for your 2010 contributions, you can start immediately on January 1st, with a deadline of April 15, 2011.

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» 2007 IRA Contribution Limits
» Roth IRA Conversion Limits Going Away
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Aside from learning that I currently have a 781 FICO credit score, I ran across some interesting numbers about the effect of your credit score on interest rates. What follows is a breakdown of the numbers for three different loan types.

30 year fixed rate mortgage

These are the numbers for a 30 year fixed rate mortgage. As you can see, the numbers increase by about an eighth of a point at each level while you’re still in “prime” territory.

If you want the best mortgage rates, you’ll need a credit score of more than 760. The other thing you’ll notice is that the rates skyrocket once you drop below 660, which pushes you into subprime territory.

15 year home equity loan

If you’re already in a house and are looking to borrow against your equity for home improvements, you might be interested in home equity loan rates. In this case, there’s a big jump once you dip below 720, and it only gets worse from there.

48 month auto loan

Finally, we have the 48 month auto loan. While I wouldn’t generally recommend borrowing money to buy a car, many people do this, so I thought it would be worth covering. In the case of car loans, the uptick in rates is significantly more pronounced as your credit score drops.

Keep in mind that the above rates are just a snapshot from one point in time. While the overall rates will change, the numbers above will give you an idea of things will vary across.

It’s also worth noting that the credit score ranges differ for the three different types of loans. For example, the top range for a 30 year mortgage is 760-850 whereas the top range for a 15 home equity loan is 740-850. This is how the data were presented, so that’s how I’m giving them to you.

If you’re curious about where you stand in terms of you credit score, you might consider signing up for the MyFICO 30 day trial. Just be sure to cancel before your thirty days are up if you’re not interested in continuing (and paying for) the service.

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Related Articles at fivecentnickel.com:

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» How is Your FICO Credit Score Determined?
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» Experian to Discontinue Consumer Credit Score Access
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In life, we’re routinely faced with situations that require an immediate reaction. Consider the need to pay monthly bills and keep your head above water. Beyond these short-term reactions lie proactive decisions that provide longer-term benefits.

For example, paying yourself first with just $50 extra per month to go directly into an IRA, 401(k), or other account is a proactive step that will lead to a better retirement. While such thinking results in obvious benefits, however, it typically requires delayed gratification.

With budgets becoming increasingly tight for Americans, being proactive in just a few facets of your financial decision-making can provide you with enormous benefits and set yourself up for long-term financial success.

I’ve highlighted below a few situations in which it pays to be proactive rather than reactive. If you find yourself constantly reacting to financial situations, you may want to ask yourself why, and whether it’s time to get a little more proactive.

Emergency savings

Having an emergency fund prevents painful emergency fees, payday loans, credit card interest payments, and other non-essential payments that you wouldn’t otherwise incur. Nobody sets out in life saying, “I’m looking to pay exorbitant fees on debt for the rest of my life,” but that’s the situation many people find themselves in without proper planning.

Life happens, and the repercussions of living without a safety net can last for years. You risk bankruptcy or foreclosure, or at least being forced to sell off personal assets at a loss to make ends meet.

If nothing else, having cash to fall back on will help you sleep better at night and should outweigh the perceived benefits of owning a high-end car or the latest HDTV technology. If you don’t have an emergency fund, think about what it would take to build one. The near-term sacrifices will be worth it in the long-term.

Budgeting

Living paycheck-to-paycheck carries thousands of dollars per year in hidden costs. Without sufficient cash on hand, you lose out on things like early payment discounts on taxes, insurance, etc. You’ll also wind up facing unnecessary overdraft fees when your accounting is off by as little as $1. Beyond this, you’ll be unable to take advantage of one-time opportunities where having cash on hand can save you money (see below). If you can’t stand budgeting, at least consider implementing a reverse budget to avoid these problems.

One-time events

Americans have been presented with numerous one-time opportunities to exploit situations created by the financial crisis, but only those with liquid cash and/or good credit have been able to take advantage of them. Examples abound, including the homebuyer tax credit, cash for clunkers, and the opportunity to buy into the stock market when investor capitulation sent shares down by as much as 50% (70% for Emerging Markets).

An upcoming opportunity is the cash for appliances program, which is being rolled out state-by-state. This program will allow you to replace your aging appliances with a more energy efficient model at a substantial discount. You will also realized the long-term benefit of decreased energy costs.

Perhaps your existing appliance are already reaching the end of their useful life. If you combine the government’s incentive program with adequate cash on hand and a bit of research, you can realize a very strong return on your investment in 2010.

Paying for convenience

People sometimes take the easy route instead of the smart route at the expense of a few dollars here, a few dollars there. This translates into hundreds, if not thousands of dollars per year in leakage from your after-tax budget. A simple example involves buying food and drinks at the movie theater instead of taking them with you.

Here’s another example: I went to a Borders and browsed the store for books for my wife last week. I found several that I knew she’d love, but instead of just buying the books on the spot, I whipped out my iPhone and checked out the prices at Amazon. Even with the in-store “discounts” and club card, the savings at Amazon were over 30%. By planning ahead and allowing time for shipping, I saved a quick $30 on Christmas and personal book purchases.

Finally, we shop at Costco several times per year and buy in bulk instead of paying significantly more per unit at a grocery store. While shopping at Costco takes a bit more planning, and the up-front costs are higher, we save a ton of money. Surely, you encounter these sorts of situations daily. Each time you’re making a purchase, think about whether you could’ve done better with a bit of advance planning.

High ROI expenditures

Seeking out a high return-on-investment (ROI) is a smart way to improve your bottom line. There are some very simple and inexpensive ways to reduce utility expenses at home that many people don’t consider. For example, while buying conventional light bulbs is cheaper than CFL bulbs, there’s no question that you save money with CFL bulbs over the long term. Other examples include reducing your utility costs by switching to a low-flow shower head, planting shade trees around your house, and investing in an energy audit for your home.

Investment strategies

Reacting to market news by altering your investment strategies has wreaked havoc on retirement funds of millions of Americans. While Western society has hundreds of years of historical market data indicating that over long periods of time, equities outperform bonds and cash, millions of investors sold out of stocks last winter/spring, effectively locking in their losses.

They just couldn’t take the continued declines and bad news. Unfortunately, those individuals that reacted to recent market performance and deviated from a long-term investment strategy missed out on a huge rally. In contrast, investors that stayed the course are now seeing their 401(k) balances at or above the pre-crash levels (Vanguard notes that 60% of 401(k) accounts now have more money in their accounts than prior to the start of the crash).

While cynics will point out that monthly investments and company matches continued along the way, the point is that by sticking to the same long term strategy, these 60% are in pretty good shape compared to those who panicked and reacted to poor market performance by jumping ship.

No responsible investment adviser would advocate 0% equities in a retirement account with a 20+ year time horizon, but I have colleagues and friends in their 30s who completely sold out of stocks earlier this year and said they’re never coming back. Their investment portfolios will almost certainly lag behind inflation, meaning their money will be shrinking.

Closing thoughts

As you can see, there are many situations in which we’ll be forced to react if we haven’t gone to the trouble of planning for the future. Yes, being proactive and planning ahead requires short-term sacrifices, but the long-term benefits make it all worthwhile.

Do you have additional examples of being proactive vs. reactive in your financial life? If so, please share them in the comments.

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