Monthly Archives: April 2013

Check your retirement fund costs now!

Fellow Savers, since my financial journey has tackled present, past and future in that order, dealing with my future finances is my newest area and thus the one I feel the least certain about. Plus, you know, it’s the future. I know what happened in the past, I can assess what’s happening in the present. I can only guess at what’s going to happen in the future.

And financial-services companies don’t make it any easier. Why should they? As long as you’re confused and uncertain, you’re at their mercy. Plus, without regulations, no company is going to be transparent about when they’re charging you more than they should.

Luckily for us, new regulations in 2012 make it a requirement that retirement fund choices show the gross operating expense. Unluckily, it’s pretty confusing and intimidating still. That’s why I avoided it for over a year. Until I watched the Frontline documentary “The Retirement Gamble.” (Here’s the transcript if you can’t watch it or would rather read, but I do highly recommend the video.)

I’m still not 100% sure I understand all this, but I’m going to give you my best shot. Please, let me know if you think anything I’m saying is inaccurate.

The gist is, if your retirement provider charges 2% to manage your funds, they will end up eroding 60% of the returns you would have made over the course of your contributing! Now that’s a direct statement made in the documentary. Does that mean, as I immediately thought, that if you made $100,000 in compound gains, you’d only see $40,000 of it? That if you had 10% returns on your investment, you’d only get a 4% return for yourself? If so, you would barely be getting enough return to cover inflation, let alone building wealth.

That’s where I’m not sure if I’m thinking things through completely accurately. But even if it’s not that bad, it’s gotta be pretty bad.

Then the documentary reveals that many funds widely vary in the costs they charge. I knew a bit about that, but not HOW widely. So I looked into the funds my 401(k) was currently invested in. It took a little bit of digging, but under “E-Documents” I found a PDF called “2013 Overview of Plan Investment Options and Fees.” (Yours may be called something else, but hopefully this helps you find it. If not, talk to your HR representative.)

In that document were some columns titled “Fees and Expenses.” Under that the subhead said “Total Annual Operating Expense.” Helpfully, this stat was expressed both “As a Percentage” and “Per $1,000.”

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When I saw how the funds my “target-date” retirement fund had chosen for me, vs. some of the other available options, I started cussing. Check this out (note, my provider did NOT choose either of the Vanguard funds for me; my funds are the others pictured):

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See that column on the far right? That’s the amount per thousand dollars they charge me per year. This particular 401(k) is at about $50,000, and 13% of it was in that top one, the Westfield one. By my calculations, they charged me $84.50 over the past year to hold that fund, when I could have been in the Vanguard one right above it, a better-performing fund by the looks of it, and it would have cost me $15.60.

$70 more doesn’t sound too bad, right? But keep in mind that’s for only 13% of my money; I got charged fees for the other parts too. And I don’t have a huge 401(k). Imagine if it was at $200,000! You can start to see how these fees eat away at your future.

Ordinarily I’d hold off posting until I was better-versed in the subject and could give my own advice with certainty. But this seemed crucial to get out there as soon as possible. So do your own research; watch the documentary, read up on the topic, ask a more math-savvy person than me if my calculations are right. But also, check the costs of your 401(k) options! If there’s a significantly cheaper one that performs just as well and is in the same area of investing, why not go for it?

I changed my holdings in my plan the very next day. I just called the number on the site and a guy did it for me. No matter how much I’m saving myself, I feel good that I’ll be keeping more of what my money earns.

PS: I would love to edit or retract any inaccurate info you see. As I said, I’m no expert and just starting to learn about this myself.

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Stuart Miles / FreeDigitalPhotos.net

Link of the week: “Everything you need to know”?

I’m very drawn to simple, overarching financial strategies that leave lots of room for customization. Of course once you commit to a strategy, you have to dig into each step and figure out exactly how you’re going to accomplish them. But I love a simple blueprint. That’s why I simplified my own overarching philosophy down to just three words: “present, past, future.” It’s also why I love All Your Worth‘s six steps and 50/30/20 budget philosophy.

So I loved this blog post from The Simple Dollar entitled “Is This Everything You Need to Know About Financial Planning?” The author and blog owner Trent Hamm dissects a section of Scott Adams’ 2002 book Dilbert and the Way of the Weasel that purports to sum up financial planning in 9 short instructions, beginning with “Make a will” and ending with “If any of this confuses you, or you have something special going on (retirement, college planning, tax issues) hire a fee-based financial planner, not one who charges a percentage of your portfolio.”

Hamm largely agrees with the summation but highlights a few weaknesses in it. (I was especially interested in how he said money market funds are not a good place to stash short-term savings right now, because that’s one of the options for holding our down-payment fund I was planning to research.)

Here’s how my family’s financial life stacks up against the nine items (though do check out Trent Hamm’s post first, because his responses are as valuable as the original list itself):

Make a will. (Check.)
Pay off your credit cards. (Check.)
Get term life insurance if you have a family to support. (We haven’t done this because we could easily live on two full-time incomes or even one.)
Fund your 401(k) to the maximum. (No, only to the employer match, because we don’t feel our 401(k)s are the best way to invest.)
Fund your IRA to the maximum. (No, because we agree with Hamm’s response to this list item: “If you have non-retirement goals, I’d say it’s a good goal to be saving 10% of your income for retirement and throw everything else you can toward that non-retirement goal.”)
Buy a house if you want to live in a house and you can afford it. (Working on it! We do own a condo and a flat and we can afford them, but working toward the next step of full home ownership.)
Put six months’ expenses in a money market fund. (We only have three months, technically, although it would probably stretch farther than that. I’ll tackle this in a blog post next week!)
Take whatever money is left over and invest 70% in a stock index fund and 30% in a bond fund through any discount broker and never touch it until retirement. (No, because again, we’re saving for a short-term goal and don’t want the money in a high-risk account.)
If any of this confuses you, or you have something special going on (retirement, college planning, tax issues) hire a fee-based financial planner, not one who charges a percentage of your portfolio. (We’ve sought advice from various sources but haven’t yet hired a planner. So far we seem to be working things out on our own pretty well, even though our financial life is quite unusual.)

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digitalart / FreeDigitalPhotos.net

Beyond the piggy bank: Where should we stash savings?

So, Savers, say the time for saving has come. Your budget is on track with a monthly surplus. Your debt is paid off (or you have a good plan for paying the rest off). Your retirement contributions are taken care of with automatic withholding or transfers. Now you want to save every extra penny toward a different goal: a replacement car. A tour of Europe. A house down payment. An adoption.

Where do you put the money? There are so many options. You can leave it in your checking account if you have the discipline to not spend it. You can put it in a savings account. You can withdraw it in cash and stash it in your sock drawer. There are CDs, mutual funds, gold bars … so many places to stash your savings. So which do you choose?

That’s an issue my family is facing — or will pretty soon. We’re saving for a house down payment and a potential international move. We have a little money set aside, but I decided we needed to get at least one more student loan out of the way before we really started saving. But that loan should be gone by the end of this year, and then our budget surplus will start going toward our down payment fund again.

This is a short-term goal, meaning we’ll be spending this money soon. We hope to have determined where we’re going to live by the end of 2016. So the risk vs. return question seems especially difficult. When it’s my retirement money, which I know I won’t need for 30-odd years (and I know will be losing value if I don’t give it a chance to grow), I have no problem opting for the aggressive (i.e., stock-heavy, higher-risk) option. Over the years, chances are good that money will grow despite fluctuations. But I don’t want to save diligently for three years only to find myself in a dip when the time comes to buy a house, so we have to either wait to move or take a loss on our investment.

However, savings rates are just miserable. Absolutely safe places to stash money (savings, CDs) are paying 1% at best in savings accounts, maybe 2% if you’re willing to tie it up in a 3-year CD. What money we have right now is sitting in an online savings account with a 1% interest rate.

And that was going to be my plan, until a blogger friend of mine (who recently started a new, more public blog) facing the same problem got a bit of advice: put the money in a blue-chip dividend stock fund. From what I understand, companies such as Vanguard have funds that invest in the types of big companies that pay out quarterly dividends. You reinvest the dividends in the same fund, so theoretically the stocks grow in value AND you get dividends.

So it sounds pretty interesting. My blogger friend did some calculations of what would have happened if she’d invested the money at various times, and in some cases she would have lost some money, but in other scenarios she would have made quite a profit. It’s a risk, but maybe not as big of a risk as, say, playing the stock market yourself. It’s a fund, so they pick the stocks for you.

I’m tempted. I’m also thinking, though, that even if we do this, we’ll keep at least some of the money in our piddly savings account. Maybe 50/50?

As you can see, this is one area where I don’t feel strongly and don’t have a firm recommendation for myself, let alone anyone else. So what would you do? If you’re saving for a goal, where are you stashing your savings?

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Grant Cochrane / FreeDigitalPhotos.net

Link of the week: a new Friday feature?

I thought it would be fun to connect to other interesting financial news stories and sources out there, so I may make this a regular weekly thing. If you run across stories you’d like to share, let me know in comments, or join the forum page and share them there.

Anitra came across this news story about how people are paying their credit card debt with more success than just a few years ago. Apparently there are fewer delinquent accounts, and the average percentage of the debt that gets paid each month is greater.

The article does note that this is probably due in large part to banks cutting off bad credit risks, not just to people acting smarter on their own. But isn’t that what banks should have done in the first place, to be responsible? So I think, either way, it’s a very positive bit of news.

Discuss: Do you think it’s unequivocal good news? Have your own credit card behaviors changed over the years? Did the Great Recession have any impact on how you view debt?

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Image courtesy of Naypong / FreeDigitalPhotos.net

Second meeting wrap-up

For the second League of Ordinary Savers in-person meeting, we discussed All Your Worth by Elizabeth Warren and Amelia Warren Tyagi. It’s a great primer for getting finances in balance, and I realized while re-reading it that it follows the same basic present-past-future philosophy I have. I read the book only after I was well on my way to financial freedom, so it must be a natural way to handle things: Get your current budget in order, clean up past mistakes, then plan for the future. (It also says to pay off the debt that bugs you the most, which is one of my other big beliefs, as expressed in my previous post!)

If you’ve never read the book, here’s an excellent (and enjoyably brief) summary of the main points. Even more briefly, the book is about how to get your money to the point where you’re putting 50% to must-haves (or needs), 30% to fun (or wants), and 20% to savings (for retirement, an emergency fund or bigger purchases such as a house) and extra debt repayment. It also gives very basic (but very sound) advice on mortgage shopping, bankruptcy and investing.

We spent a good part of the meeting just talking about the three categories and what should go into them. It’s seemingly simple but deceptively so. For instance, I myself agonized over where to put diaper-cleaning service; our kids need diapers, but I’m quite aware we could get generic-brand disposables for less than we pay for cloth upkeep. Also, if we were REALLY strapped and still wanted to do cloths, we could (shudder) try to clean them ourselves. So I finally put diaper service under “wants” (which is why I don’t call that category “fun” ;)).

One confusing aspect is whether to count parts of your money that are automatically withheld from your paycheck, or just your net pay. It seems easier to just count the net money and not worry about the other parts, but then many of us (including myself) would struggle to get the savings part of the formula up to 20%.

The Warrens recommend calculating everything except tax withholdings. So when you’re making your lists of needs, wants and savings, you would look at your paystub and enter health insurance and related expenses into the “needs” category, and 401(k) contributions into “savings.” (I go a step further; I look at my employer’s matching amount, and I add that to both my gross income and my “savings” category. After all, it is part of your income, albeit a part you don’t see or think about much, and it is part of your savings percentage too.) Remember to multiply by 2 if you get paid twice a month and are calculating your expenses by the month!

It’s pretty simple to make a spreadsheet to do this, and I have one (of course) that I update whenever there’s a change to our income or fixed expenses. (I don’t record every little windfall or unexpected expense, but if there’s a more permanent change such as a raise, or a regular bill changing because the interest rate is variable, I’ll update it in my spreadsheet.) That way I always have a good idea of how balanced our money is.

So, how balanced IS our money? Well, excluding tax (federal, state, Social Security and Medicare), my family’s spending is at 45% needs/24% wants/31% savings (including extra debt repayment). The Warrens might say we should let loose and spend a bit more on wants. But I figure, two of my biggest “wants” are to get out of student-loan debt and save for a bigger home, so in a way, you could put part of that savings/debt repayment ratio into our wants category. See what I mean? It’s a lot more complicated than it seems at first!

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The age-old question with many right answers: which debt to pay first?

“Here’s a question for your budgeting conference. I owe on my house, my car, and 2 credit cards. Is it better to pay them off by balance or by interest rate? I’m paying a little bit extra on everything, but feel like I’m getting nowhere. Thoughts or suggestions?”

When she heard I was forming the League of Ordinary Savers discussion group, one of my out-of-town friends gave me the question above to ponder.

It’s been covered by many experts and wondered by anyone who’s ever had lingering debt hanging over their heads. So I’m not sure if my opinion sheds any new light, but since she asked, here goes.

She encapsulated the two main schools of thought in her question.

One: Tackle your debts in order of smallest to largest balance. Pay the minimums on all your debts but throw everything extra at the smallest debt. When it’s gone, roll what you were paying toward the next-smallest debt, and when that’s paid off, put all the money that was going toward those two into paying off the next-smallest. Some call this a “debt snowball”; you can imagine the ball of money getting larger and larger as it absorbs smaller debt payments. When you get to your largest balance, you can pay as much as you were for all the smaller debts, so it goes away relatively fast. Seeing debts get eliminated quickly earlier in the process gives an emotional satisfaction that keeps you motivated to continue paying off debt at an accelerated pace.

Two: Aim for your highest-interest debt first, and go from there. That way, you’re eliminating the debt that’s costing you the most cents on the dollar, and by the time you get to the end of your debt journey, your last one will be lowest-interest and so most of the money you put toward it will go to principal rather than interest.

With either method, most people agree you should pay off everything else before you start paying your mortgage. For the small-balance-first camp, this makes sense because your mortgage is probably your highest balance. For the lower-interest camp, even if your mortgage isn’t your absolute lowest-interest debt, the tax break you get for itemizing interest typically offsets that and makes it your least onerous debt.

Me, if I have a school of thought, it’s that there are good debts and bad debts. Or at least, debts that can bother a person more than others.

Confession time: When my family started our journey out of debt, we had 5 credit card balances, 2 overdraft balances on checking accounts, 1 unsecured loan of consolidated credit card debt, 3 student loans (with another college education spelling even more loans), 2 mortgages, 2 home-equity loans, and 1 interest-free loan from a parent. Whew!

My “method” has been a combination of tactics. I first focused on the overdraft balances. They were some of the higher-interest debts, and they were easy to pay (we just had to transfer any leftover money into the overdraft account). But more important, they were the most demoralizing debts. Seeing our checking accounts in the red signaled to me that we were not successfully living within our means, that we weren’t even holding steady, let alone getting ahead.

Once the overdrafts were gone, I focused on the credit cards and the unsecured loan. I went by interest rate and paid off the higher-interest ones first, regardless of balance. Pretty practical, although the last credit card we paid off had a lower interest rate than one of our mortgages and a couple of our student loans! But I just really wanted to say I was credit-card-debt-free. It was a huge motivation for me.

But once we were free of that consumer debt, I went for the least-expensive loan: the one to my dad. There were no minimum payments and no interest. He’d told me to take my time and pay him whenever, and he never complained, even when I went more than a year between payments. But the debt felt personal. There was a face on the other side, a beloved one, not just a giant corporation making money off my financial instability. I just couldn’t think of anything else; I threw myself into paying my dad back.

That felt pretty good; we had no credit card debt and didn’t owe any family members! So we slacked off a bit while we focused on other goals: building an emergency fund and financing an elaborate estate-planning and adoption process. We even started spending more on our “wants,” such as travel.

Student loan debt didn’t make me feel quite as ashamed as consumer debt or family debt; I felt there was something valuable to show for it, however intangible. But recently I’ve felt we needed to eliminate them so we could focus on moving and purchasing a bigger home for our growing family. So we’ve been hitting those loans hard, and we’ll be free of them in less than three years (maybe closer to two!).

The mortgages will still be there, and I’m not sure if I’ll put more money into them or just keep paying the minimum until we sell the homes. With more money in the bank vs. equity in the homes, we’ll have more flexibility with how we can use the money when it’s time to move.

When we’ve resettled, I imagine I’ll put a bit extra toward the new mortgage each month; after all, the debt-repayment habit is a hard one to break once it’s there! And I do want to be mortgage-free before we retire, which may be sooner than 30 years once we take out our new mortgage. But like many people, I don’t see a mortgage as a terrible debt. As long as it’s not causing other budget problems, I don’t view it as a failure or a flaw.

So, to sum up, what debt do I think you should pay first? Well, I do think you should focus on one debt at a time, so they don’t get ignored and so you see real progress to keep you motivated. But in the end, I don’t think it matters whether you conquer your debts in order of interest rate, balance, or whether they’re “good” or “bad.”

What matters is that you conquer them in the order that keeps you fired up. The order that makes debt payoff a triumphant game rather than just a grim death-march. Go after the ones you just feel  are worse, whether you view higher interest as the worst villain, or nagging little small-balance debts, or debts that represent a past mistake or a family obligation unfulfilled.

Focus on the debts in the order of how much they bother you. That’s what matters to you, so that’s what will work best for you.

The many-headed debt monster! Photo by Wolfgang Sauber.

The many-headed debt monster! Photo by Wolfgang Sauber.