For readers in the Philadelphia area: I will be teaching a class on personal finance at Tenth Presbyterian Church starting Sunday, June 9, 9:00 – 10:15 AM. Location is in the 1710 Spruce Street Boardroom. There will be 6 sessions running through July 14.
The class will be interactive and tailored to the financial questions, needs challenges and goals of the individuals attending. Bring your questions!
Here are some of the topics to be covered:
A Biblical perspective on money, wealth, stewardship and contentment
Practical suggestions on becoming savvy consumers, cutting costs, stretching dollars and living below your means.
Getting out of debt, staying out if debt. Good debt vs. bad debt
Saving and investing: the power of compounding, the importance of an
emergency fund, long term investment for college and retirement. Saving
for a house.
Legal essentials, particularly for families with young children.
Please join us. Directions and parking can be found on Tenth’s website. Regards, Paul
Sadly, times have changed; a million dollars isn’t what it was.
Photo credit: voxeros via Foter.com / CC BY-NC
Once upon a time, one million dollars represented the hallmark of rarified wealth. But due to inflation, the value of a million dollars has been greatly diminished. Today, one million dollars might provide a comfortable, middle class retirement, assuming it’s supplemented by Social Security and one does not retire in a high-cost region of the country. Indeed, a million-dollar fortune 100 years ago would amount to $21 million dollars today!
Facts about Inflation
Inflation is a reality that must be factored into your long-term financial planning
Excessive inflation can be devastating but moderate inflation is a sign of a healthy economy. And inflation is definitely better than its alternative: deflation. Why? Think Great Depression.
Over the past 60 years, inflation has averaged 3.80% annually. At that rate, prices double (and the value of a dollar is cut in half) every 19 years. (Here is a link to an Inflation Calculator. Also, recall the Rule of 72 for estimating when money doubles.)
The effects of inflation are quite uneven. For example: healthcare and college education have far outpaced the general rate of inflation. (see chart below)
On the other hand, prices for many items, particularly electronics, have sharply declined. In 1965, RCA announced the first color television set for under $400 ($399.95); that would be the equivalent of 3,100 dollars today. The IBM PC introduced in 1981 sold for $1565; this would be roughly $4400 now. Today a vastly more powerful desktop computer – or a flat screen high definition TV — can be had for under $500.
Here is a chart that tracks inflation on various goods over a twenty year period. The average or composite rate of inflation 1996-2016 is 55%
Take Aways and Recommendations
Be warned: just as investments can grow exponentially, thanks to the power of compounding, the impact of inflation also grows. Over time, the buying power of a dollar willerode. (For the power of compounding, refer back to Pennies a Day)
Inflation is a major threat to retirement – particularly for those depending upon fixed-dollar payouts such as pensions and annuities. One advantage of Social Security is that its payments are indexed for inflation. However Social Security income by itself is not sufficient for most folks in retirement.
Plan for inflation in retirement by keeping a portion of your retirement funds in investments that potentially outpace inflation, such as stocks.
The Frugal and Wise are not early adopters of new technologies. They are cheapadopters of technology. There is a huge premium to be paid for being the first with the latest gee-whiz gizmo. Wait a couple of years and watch prices plummet. (Being a cheap adoptor of technology will be the topic of a future FW&W posting.)
Don’t despair that a million bucks ain’t what it used to be. Or that you are nowhere near accumulating such a sum of money. No matter what your income or stage of life, beginning today, diligently save, invest and patiently watch your nest egg grow over time.
Photo credit: Howard County Library System via Foter.com / CC BY-NC-ND
The April 2017 issue of Kiplinger’s Personal Finance magazine recently arrived. It is a special one indeed: celebrating the 70th anniversary of a venerable publication. To commemorate this occasion, the lead article is 70 Ways to Build Wealth. Definitely a worthwhile read for the Frugal and Wise. (Check for the issue at your local library.)
I certainly cannot claim such ideas as original but neither did I merely copy them from other sources. Any number of fundamental, financial actions can lead to building wealth and living better on less. But there is the satisfaction in knowing what I mention on Frugal, Wealthy and Wise is also being espoused by such a prominent source as Kiplinger’s.
I have been reading Kiplinger’s Personal Finance for at least two decades. It has been influential in my journey towards being a savvy consumer, a shrewd manager of family finances and a builder of wealth. (Kiplinger’s Personal Finance and The Economist are the only two magazines I read.) The introductory rate for a year’s subscription is $15 or less – worth checking out; see if it earns its keep for you.
Words from the Chief
The 70 Ways to Build Wealth article contains 10 saying from Knight Kiplinger, Editor in Chief (page 28). These sayings are comparable to words of wisdom from Warren Buffet, Jack Bogel – or even King Solomon in Proverbs.
1) Wealth creation isn’t a matter of what you earn. It’s how much you save.
2) Your biggest barrier to becoming rich is living like you’re rich before you are.
3) Pay yourself first.
4) No one ever got into trouble by borrowing too little.
5) Conspicuous consumption will make you inconspicuously poor.
6) The key to stock market success isn’t your timing in the market. It’s your time in the market – the longer the better.
7) Diversify, because every asset has its day in the sun – and its day in the doghouse.
8) Keep a cool head when others are losing theirs.
9) Money can’t buy happiness but it can make unhappiness easier to bear.
10) Sharing your wealth with others is more fun than spending it on yourself.
A simple portfolio of Vanguard Index Funds performs amazingly well compared to college endowments.
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Photo credit: altopower via Foter.com / CC BY-NC-ND
I recently encountered a fascinating article on the site: A Wealth of Common Sense. It’s a blog maintained by Ben Carlson that focuses wealth management and investments.
This particular article: How the Bogle Model Beats the Yale Model compares the performance of college endowment funds to portfolio comprised of only three Vanguard Index Funds. (You may recall that Jack Bogle founded Vanguard, thus the name. It should also be duly noted that Mr. Bogle is a Princeton grad.)
College endowments are a huge business. The largest endowments (primarily Ivy League schools) run into the tens of billions of dollars. Nationwide, college endowments total more than half a trillion dollars!
With such huge sums of money involved, colleges can afford to hire the best and brightest money managers. Furthermore, significant funds provide access to private placements and other exotic, ‘alternative’ investments.
But guess what? The Vanguard portfolio of three mutual funds (aka the Bogle Model) more than holds its own in this comparison. Indeed, its returns rank in the top quartile (top 25%) of best-performing endowments! And this is not just a one-year aberration – the Bogle Model stands the test of time for three, five and ten year intervals. I encourage you to read the article for yourself (click here or the link above).
Thoughts and Takeaways:
This analysis should be a tremendous encouragement to us all. It gives great hope to the common man and woman that they, too, can attain financial independence.
The Vanguard portfolio averaged a 6% annual return over the last ten years. If you were to invest $500 per month for 30 years with a 6% annual return, you will have accumulated over a half million dollars! (Disclaimer: no one can predict future returns but historical returns do provide a small sense of confidence. Very small.)
It’s rare and very difficult for actively managed mutual funds to consistently beat their corresponding index funds. (But not impossible)
It’s perfectly OK (and even desirable) to grow rich the slow, boring way.
Don’t be continually chasing the highest returns. Merely average or even mediocre returns can still make you quite wealthy.
When it comes to investing, simple is good.
It seems crazy to be comparing billion-dollar college endowments to a Vanguard portfolio that you could easily recreate in your IRA. But there you have it.
At this point, you are probably screaming at the top of your lungs, “SO WHAT IS THIS BOGEL MODEL????” Well, it’s:
40% Total U.S. Stock Market Index Fund (VTSMX)
20% Total International Stock Market Index Fund (VGTSX)
40% Total Bond Market Index Fund (VBMFX)
The annual expenses for these funds are a minuscule 0.16%, 0.19%, and 0.16% respectively. With more than $10,000 in any of theses funds, you can upgrade to the ‘Admiral’ version where the annual expenses drop even further to 0.05%, 0.12%, and 0.06%.
Disclaimer: please don’t blindly transfer all your investments into this portfolio without further study and analysis. Investing is not a ‘one size fits all’. You may want to seek advice. If so, find a fee-only consultant with CFP (Certified Financial Planner) credentials. Avoid ‘financial planners’ that work on commission for financial products they sell.
That being said, the Bogle Model might be a good place to start. You could possibly do better. But you could also do a whole lot worse.
Open a Flexible Spending Account (FSA)– wouldn’t you like to save thousands of dollars annually by paying for everyday expenses pretax rather than post-tax? (For a review of the value of money pretax vs. post-tax, re-read A Penny Saved is NOT a Penny Earned.) To refresh your memory: a dollar post-tax (the net proceeds of your paycheck) could be worth a $1.50 or more pretax (depending upon your tax bracket, state and local taxes). Here’s the skinny on FSAs:
FSAs are only offered through employers. If your employer doesn’t have an FSA program, lobby the HR department to set one up. Signing up for an FSA may only be allowed during the benefits open enrollment period. Ask. If you missed getting in on an FSA for 2017, make sure you get signed up in time for 2018!
Your FSA is funded through payroll deductions. This lowers your income used to calculate Federal, Social Security, Medicare, and (in some cases) state/local taxes. It’s a wonderful thing!
There are actually 3 separate FSA programs: (1) Out-of-pocket healthcare expenses – for 2017, up to $2600 annually per household (2) Dependent Care/Child Care – $5000 annually per household (3) Parking and public transportation commuting costs – ($255/month) Note: not all employers offer all three.
As you incur healthcare, dependent care or commuting expenses, submit documentation to be reimbursed from your FSA. Some programs even provide a debit card for convenience.
What if you took advantage of all 3 programs to the max? That would be a total of $10,600 paid pretax. Let’s say that your take-home pay after taxes is only 70 cents on a dollar pretax (pretty common). You would have saved approximately $3200 in taxes!
Use it or lose it! The one downside to FSAs. If you don’t spend all the money in your FSA by year end, you lose it! But even if you have to walk away with some money remaining in the FSA, you may still come out ahead on tax savings. In recent years, the Use It or Lose It rules have been relaxed somewhat. Some plans allow you to claim expenses into the first few months of the following year. Others plans allow carrying up to $500 over to the next year.
Open a Health Savings Account (HSA) – FSAs and HSAs easily confused but are actually two completely different programs. But in some respects, an HSA is an FSA on steroids. Here’s the scoop on the differences and HSA advantages:
A Health Saving Account can only be used in conjunction with a “high-deductible” health insurance plan. For 2017, a high-deductible policy means a minimum deductible (that you pay) of $1300 per person or $2,600 per family.
It’s an either/or choice for an FSA or HSA. They are mutually exclusive. However, you could have an HAS for healthcare and FSAs for dependent care and commuting costs.
HSAs do not have a Use It or Lose It provision. You can accumulate funds in an HAS and use them years or even decades later in retirement.
HSA contributions may be invested or kept in an interest-bearing account, so the balance grows over time.
HSAs can be offered by employers or opened by individuals (provided the high-deductible policy requirement is met).
HSAs offer these tax advantages: (1) contributions up to the annual limits are tax deductible (2) earning and appreciation are tax free. (3) withdrawals for medical expenses are tax-free.
HSAs have much higher annual contribution limits compared to FSAs. As of 2017: $3,400 per person or $6,750 per family. If you are over 55, add in an additional $1,000 as a ‘catch-up’ contribution. For couples with no dependents on their health coverage, I recommend maximizing contributions by setting up two individual accounts rather than a single, family account.
Contributions can only be made until age 65 (when you become eligible for Medicare.)
Increase 401K/403B contributions – at a minimum, you should be contributing enough to your 401K or 403B to get the full employer match (typically 6% of your salary for a 3% employer match) failure to do so means losing out on a huge sum of money over a lifetime. This year, try to ratchet up your contribution another 1 or 2 percent. Such a small reduction in take-home pay likely will not be missed but could significantly accelerate your retirement savings. (go back and read You can’t spend what you ain’t got: Why You Need to Automate Your Savings.)
Open a Roth IRA – a Roth IRA is beautiful thing indeed! While contributions are made with after-tax dollars, Roth IRA appreciation and retirement withdrawals are tax-free. There is also some flexibility for withdrawing contributions penalty-free prior to retirement (although I wouldn’t recommend it.) Unlike conventional IRAs, there are no minimum withdrawal requirements in retirement. Contribution limits are $5,500 or $6,500 if you are over 50. Be aware: eligibility to contribute to a Roth is phased out or eliminated at higher income levels ($117,000 for singles or $184,000 for couples as of 2017). And how would you contribute to your Roth? With an automatic deduction, of course! (Note, some employer 401K and 403B plans also offer a Roth option.)
Start saving for the children’s college education; open a 529 Plan(s) – money contributed to a 529 grows tax-free. Many states also permit 529 contribution to be deducted from state income tax (but no such luck on federal tax). Generally, as much as $14,000 per child can be contributed each year (limited by federal gift tax exemptions). 529 Plans are administered on a state-by-state basis. However, you are not confined to your state’s plan; you can chose to go ‘out-of-state’ Here’s one article about the Best 529 Plans (Forbes, March 2016)
Set up automatic transfers to a savings account – there are many reasons for bulking up your savings: establishing an emergency fund in case of layoffs or unexpected expenses, saving for a house down payment, saving for a replacement auto or a major appliance, even a vacation. The list goes on. Set up an automatic transfer to the savings account. Better yet, divert part of your paycheck directly to a saving account. A great place to keep said savings account: the Capital One 360 Money Market account. It’s pays 0.60% interest for balances under $10,000 and 1% for balances over $10,000. And it’s FDIC insured.
Review last year’s expenditures – when it comes to managing your finances, it’s difficult to know where you’re going, when you don’t know where you’ve been. Tally up your spending activities from last year using records and statements. Which categories of spending ‘jump out’ at you? Where are opportunities to cut back? How much were you able to save? Don’t have any idea where your money went last year? Skip Immediately to #13 and get this year off to a good start!
Track expenses –tracking expenses is essential for taking control of your finances and planning for future. Do you need to keep such meticulous records that you know where every penny went? Well, no. But the more accuracy, the better. Recording expenses can take many forms: a notepad or journal, a spreadsheet, online (mint.com, budgetpulse.com), a PC program (Quicken, Microsoft Money) or any number of smartphone apps (Mint, GoodBudget, Mvelopes). Personally, I’m old school and use Microsoft Money. It was discontinued years ago but copies are still available on ebay and, it works fine installed on modern PCs. It fits my needs. I am also a little bit leery about keeping financial records in the cloud, or apps such as Mint that directly access accounts,. However, Mint is well regarded.
Set a budget – not to worry. Establishing a budget does not have to be as tedious and painful as you fear. Step one: begin by recording on-going, necessary monthly expenses: mortgages, loans, tuition, phone and internet. Step two: estimate variable expenses based on last year: auto repairs, gas, utilities, house maintenance. Step three: estimate necessities where there is leeway for spending, such as clothing and food – these are areas where spending can range from basic to lavish, from Mac’n’cheese to Porterhouse steaks. Step four: estimate spending for purely discretionary items: vacations, dining out, entertainment, hobbies. Add it all up and adjust the items in steps 3 and 4 to fit your income. Allow (plenty of) room for saving and giving.
Set goals for big-ticket items – some goals may have a timeline of decades (saving for retirement, attaining financial independence). Some last a decade or so (kids’ college education). Others are a few years or even months (replacing a car or appliance, home renovation, down payment on a house, a vacation.) Dream a little, but then prioritize. Evaluate the viability of your goals and what it takes to achieve them.
Set up automatic bill payment to save time and postage, avoid late fees – this action is as much about quality of life as it is about saving money. Life is simply too short to spend it writing checks and stuffing envelopes. Moreover, the cost of postage and stamps can really add up. Say you write 10 – 15 checks a month for recurring bills and donations. A first-class stamp is currently 47 cents. An individual check may cost 10 cents, or more. Altogether, you could needlessly be spending $60 – $100 on stamps and checks every year! Worse yet, what if you overlook or forget a payment and get socked with a late fee? Late payments can also adversely impact your credit score. Set up as many automatic payments as you can for (1) charitable donations, (2) utilities (3) internet and phone (4) credit cards (5) mortgages and loans (6) insurance (7) rent, (8) IRA and HSA contributions, and more.
All for now. Look for Actions 17 – 21 early next week. Cheers, Paul
Photo credit: Universal Pops (David) via Foter.com / CC BY-NC-SA
The April 2017 issue of Kiplinger’s Personal Finance magazine recently arrived. It is a special one indeed: celebrating the 70th anniversary of a venerable publication. To commemorate this occasion, the lead article is 70 Ways to Build Wealth. Definitely a worthwhile read for the Frugal and Wise. (Check for the issue at your local library.)
vs.
