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Finance For Dummies

Finance For Dummies offers personal finance information on investing, retirement investing, finance, insurance, credit cards, loans and more. Personal finance education is our goal.

Monday, July 31, 2006

The Importance of Employer 401k Match

One of the most important benefits of investing in a 401k plan at work is the potential for your employer to match a certain percentage of your contribution. Many 401k allow employers to contribute to the particpant's account, but not all. The amount is usually represented as a specific percentage of the your contribution to the plan. For example, if your employer has a 50% match then for each dollar you contribute your employer would contribute $0.50 to your account.

If you take that example and draw the amount in your account over 20 years with and without a match you will see the huge diiference between the two. If you put in $100 at the end of each month into your 401k and your employer matched 50% the growth over 20 years (1980-2000) would almost be $240,000. Whereas it would be almost $160,000 if there was not employer match.

So take advantage of your employer's match and put in as much as you can because it is free money and the growth of that money will help you towards your retirement.

Sunday, July 30, 2006

Sources of Retirement Income

Do not depend on Social Security as your only retirement income.

  1. You cannot count on that money even being there
  2. Retirement age will be increased
  3. People who depend on it today as their only retirement income are living in near poverty
  4. If you are not in an some sort of qualified retirement plan it will be difficult to meet your retirement income needs
  5. If you have no post-retirement wages the potential for shortfall in your retirement planning may be even greater
To ensure a comfortable lifestyle during retirement, it is necessary to establish and maintain a savings plan that will bridge the gap between the income needed to retire comfortably and the income Social Security provides. Your 401k plan is essential to helping your financial future.

Saturday, July 29, 2006

The Value of Diversification

Diversification might be boring, but it is prudent and profitable in the long term. Diversifying your portfolio holdings is the best way to make money in investing for the long run. By doing what is sometimes ignored because its lack of flash you will be positioned to handle good and bad economic and financial events.

If you want to sleep at night and feel like you are not betting the house you need to diversify. Your retirement money should be diversified; your other investments should be diversified. If you like to gamble for a big pay off keep a mad money fund where you can speculate, but do not speculate with money you will need.

Friday, July 28, 2006

Valuation of Stocks

What you pay for growth in stocks does matter; valuation still remains important. During the late 1990s investors chased high flying tech stocks right off the P/E charts abandoning more reasonably valued stocks in other sectors.You must judge the likely sustainability of earnings and revenue acceleration, potential price appreciation is greatest when a company's stock price does not fully reflect its future earnings power. Therefore, it is best to search for reasonably valued stocks with improving fundamentals.

When you see extremely high P/E ratios it is considered a growth company. You must examine the company closely before investing in P/Es that are out of whack with the overall market.

Thursday, July 27, 2006

Advantages of 401k Investing

Company-sponsored 401k plans can be very beneficial to your retirement. The following are some advantages to participating in your company's 401k plan.

1. Participant Control:

  • You get to decide how much you will invest each pay period up to the IRS's annual limit
  • You get to choose how to invest your money
  • The assets in your 401k plan belong to you, so you take your vested accumulated plan assets with you if you leave the company
2. Pre-tax Investing:
  • The funds you contribute to your 401k plan is deducted from your paycheck before income taxes are considered. This will allow you to reduce the amount of taxes you pay
3. Tax Deferral:
  • You owe no taxes on the 401k investments until you withdrawal it from the plan.
4. Tailored Investment Plan:
  • You can customize your plan to meet your needs according to your age, time horizon, wealth objectives, and risk tolerance

Wednesday, July 26, 2006

1926-2000: Volatility of Returns for Stocks and Bonds

As you can imagine stocks and bonds have had varying return from 1926-2000. Historically, the stock market was very volatile until after the Great Depression and more legislation was passed to protect investors. Since World War II, the stock market has displayed much less volatility because of the economic turn around and regulations.

Bonds have behaved the opposite as the stock market; it has had less volatility in much earlier periods and from 1980-2000 it has experienced a significant raise in volatility. Stocks are still much more volatile than bonds and always will be, however, with that risk has come much better historical performance. So if you mix these two asset classes it proves to be an excellent way to diversify your portfolio.

Tuesday, July 25, 2006

Important Financial and Legal Questions for Kids to Ask Their Parents

We have gone over what you need to prepare in case something goes wrong, but let's also discuss what you need to ask your parents to make sure they have prepared you.

  1. Do you keep a budget? Make sure they know where the money will come from and where it will go.
  2. Do you have a will? If they do, great, but make sure it is up-to-date. If not make sure they prepare one as soon as they can.
  3. Do you have enough money in your retirement accounts? Find out where their retirement money will be coming from and if it will last them 20-30 years of retirement.
  4. Where are all your important documents? If they hide them and you do not know where they hid them prepare to search for a long time.
  5. Are you financially prepared for certain scenarios? Assisted-living, in-home nurse, etc can be costly. Think about long-term care insurance.
  6. Who will make medical and financial decisions if you cannot?

Monday, July 24, 2006

When to Prepay on Your Mortgage

Some people just hate debt. They never had credit card debt and they pay a huge down payment on their car so they do not have to worry about debt. However, sometimes it is good to do this with mortgages and sometimes it is not.

If your mortgage rate is at 6% for 30 years that means when you pay it off earlier you are getting 6% return. If you examine historical stock charts that 6% is not a good long-term bet versus investing in the stock market.

  • So if you have other debt at higher rates it pays to pay those off first and then put more into your mortgage.
  • If you are a conservative investor and do not like to take on a lot of risk then it might be best to get a 15 year mortgage and you will be saving money with a lower interest rate and making that guaranteed return.
  • If you are closer to retirement and your home has greatly appreciated it is ok to take on more debt there because when you retire and sell it you will have more money going towards your retirement.

Sunday, July 23, 2006

Important Financial and Legal Questions

You should always have a plan in case the worst does happen. People do not want to think about it, but that is a selfish point of view. You want to take care of those that love you after you are gone so you need to gather the following:

  1. Estate planning documents: wills and powers of attorneys
  2. Deeds and other property documents
  3. Assests and debts
  4. Account numbers and passwords for investments, banks, etc.
  5. Copy of Social Security and Medicare (or Medicaid) cards
  6. Loan paperwork and statements
  7. Insurance policies and information
  8. Benificiary Designations for assests
  9. Contact information for important people (doctors, advisors, etc)
Get this information ready and prepared and go over with your loved ones so they know what to do if something goes wrong.

Saturday, July 22, 2006

Risk Versus Return: Stocks, Bonds and Bills 1926-2000

Weighing risk and return there is always a trade-off. When you are putting together an investment plan and asset allocation for your portfolio the relationship between risk and return is essential.

When you consider the historical risk and return of small caps, large caps, intermediate government bonds, long-term government bonds and Treasury bills you will again notice that over this 75 year period the more risk you take on the more reward you can expect to receive. Smaller companies carry more risk and typically give higher returns while Treasury bills had little risk, but do not provide much return.

Considering these factors you need to base your portfolio asset allocation according to your ability to handle risk and your performance needs.

Friday, July 21, 2006

Emergency Fund

All people and families need to have an emergency fund even if you think you don't. After you have paid your debt off you need to start an emergency fund in case something happens and you are unable to work for several months. You should not even think of saving for a house until you have at least 6 months worth of living expenses saving in an emergency fund.

Start putting that money in either a high-interest savings account like ING or HSBC. Another good way to put money away for a rainy day is to put it in a money market. Banks and mutual funds both have money market accounts so try to compare what interest rates are available.

Thursday, July 20, 2006

Inflation and Historical Investing: 1926-2000

Often when looking at a certain investments return people ignore inflation. As stated before investing in small cap and large caps bring with it more risk and more potential for reward. During this period inflation averaged 3.2% per year. When you examine closer that would mean the return of Treasury bills at 3.9% per year is barely out-pacing inflation while exposing you to little risk. Government bonds fair a little better with a 5.7% return, but is almost 3 times as risky as T-bills. On the other hand, large and small company stocks have 7 times the volitility of T-bills and 11 times the risk of T-bills. The average return of small caps was 17.3%, but because of the volitility its compound return is only 12.4% because of its peaks and valleys that go along with this type of investment. Large caps have a 13% return average over this period and 11% compound return.

This information is important when deciding what to invest in long-term, mid-term and short-term. Plus it give you an idea how to best allocate your funds while keeping your eye on how inflation will effect your investments.

Wednesday, July 19, 2006

Stock Diversification Through Mutual Funds

Diversification is essential to investing mainly because it lowers your company risk. It does not eliminate risk, but there is a correlation to having more stocks in your portfolio and having lower company risk. When you limit the number of securities you increase your level of risk while not receiving the benefit of higher returns. Investment tools like mutual funds typically have scores of stocks inside their portfolio. Because of this mutual funds are very useful to investors.

Most Americans cannot just go out and buy 100 stocks. Therefore, the use of mutual funds can help the individual investor greatly because these funds have millions and millions of dollars to invest in hundreds of stocks.

Mutual funds also expose your portfolio to more asset classes and this is very important to lowering the company risk and helping the performance of a portfolio (in general). For example, if you have 100 securities in your portfolio your company risk level is negligible whereas if you own one security your company risk is enormous. Market risk is something you can never get rid of in your portfolio, but limiting the company risk by adding more and more securities will lower your company risk.

Tuesday, July 18, 2006

Asset Class Returns: 1926-2000

When looking at annual ranges of returns for asset classes historically you can better understand the risk involved in each investment. Each asset class has some risk; some more than others. If look at the peak and trough of each asset class you will see the inherant risk.

For example, small cap stocks between 1926 and 2000 had a peak of 142% and a trough of -58%. Large caps' best return was 54% and worst was -43.3%. Long-term government bonds high was 40.4% and low was -9.2%. Intermediate-term government bonds highest return was 29.1% and low was -5.1%. Finally, Treasury bills never returned higher than 14.7% and 0% return was its lowest.

From this information you can conclude that small caps have the most amount of risk because they have the largest difference between their peak and trough and so on down the list.

Investing is risk versus return and these statistics bear that out.

Monday, July 17, 2006

Risk Tolerance of Investments

In investing, if you desire high long-term performance you have to be willing to take on high levels of volatility because those are the asset classes that typically produce that type of return.

Risk can vary within asset classes and outside as well. Typically, different asset classes will have differing levels of risk.

Treasury bills and CDs historically have provided low long-term performance, however, that is because they possess very little risk. Small cap companies and international asset classes are higher risk investments so historically they will average higher returns than lower risk investments.

When you are developing a regular investment plan or a retirement investment plan risk tolerance and risk levels are an important place to start. You need to understandtheir correlation to asset classes and then determine if risks are worth it or not for you.

Sunday, July 16, 2006

Money Orders

Money orders are sold in various places across the United States. MoneyGram, Western Union and the U.S. Post Office are the most popular places to go, but often you can acquire them at a local convenience store or grocery. There is often a charge to buy a money order at these places, but if you do have a bank they typically give you one for free.

They are extremely useful if you do not have a checking account. Plus they are safe because only the recipient you name on the money order can cash it--this is much better than sending money through the mail. Even if you do have a checking account it is safer to use money orders than check because you check has your bank account number and routing number.

Remember to keep your receipt in case something happens to the money order so you have proof of your purchase. Also, know that there is limits to the amount of money you can purchase a money order so if your transaction is large be prepared to buy more than one.

Saturday, July 15, 2006

Gas Prices

With oil reaching new heights each day it is quite possible we will have $100 a barrel oil soon. That is no joke and many industry leaders would tell you the same. With the problems in the Lebanon escalating and Iran’s connections to Hezbollah the world is waiting for the other shoe to drop because many say Israel is going to far in their attacks and the U.S. is not stopping Israel.

If Iran gets involved in this conflict their large oil reserves will have an even more important strategic significance and if they chose oil prices could skyrocket. Right now this is speculation, but if this issue is not solved quickly we will be paying $4 for a gallon of gas.

Friday, July 14, 2006

Stock Market Issues

The S&P 500 fell to negative performance YTD after a tough week on Wall Street (June 30th article). Bears are currently dominating trading and it seems like The Herd is almost to a tipping point of negativity. Let’s hope it does not reach that point because that is when millions will follow and make the stock market bump a bruise.

People are particularly nervous because oil has reached a new record high each of the last few days. Oil prices are rising because Israel is taking on Palestine and Lebanon right now and it could make the Middle East even more volatile. The situation in Iraq is no better with an extraordinary amount of sectarian violence this week.

Problems with Iran and North Korea are not helping global stability either. Volitile times like this, as you have seen, negatively affects the stock market. If these problems get worse look for the stock market to reflect that.

Thursday, July 13, 2006

Financial Goals

Have ever sat down and really examined what your financial goals are? Do you know exactly where your money goes? How are you saving for retirement? College funds? Medical costs?

If this scares you—well it should. Because if you are not planning for the future it will be much more difficult to start being disciplined as you grow older. Don’t count on the government solving Social Security’s future or for them to figure out Medicare. You need a plan to take care of yourself and your family.

You need to ask yourself those tough questions. Are you doing everything you should so you and you family’s future is taken care of? It is never too late, but you really need to start now if you have not already.

Start by doing the following:

  • Budget: know where all you money goes
  • Have smart accounts: this means get the best interest rate on checking and savings accounts (
  • Pay your bills online-less paper and more organized way of paying
  • Direct Deposit: most do this already with their paycheck—but start if you have not
  • Direct Debit: investment or Roth IRA funds directly debited from your bank account
  • Refinance your mortgage if it can save you money (rates haven risen, but are still very low historically speaking)
  • Ask your credit card to lower your interest rate

Next you need to set some goals.

For example, let’s say you want to buy a home.
  • Do you have any debt (especially credit card)?
  • Do you have a safety net of at least 6 months of funds to get you by in case of a loss of job, accident, etc.?
You really want a house, but you need to take care of these things first. The average American has $8000 just in credit card debt—that does not even count other types of debt. If you are paying 12% on $10,000 credit card debt you should not be thinking about buying a house yet. You can plan, but you need to focus on reducing high APR debt that you have.

Maybe, you are single, have no debt and little to no savings.
  • How do you plan on getting a down payment for a home?
  • If you do get a down payment what happens if you are hurt and cannot work or lose your job?
Yes, this is difficult but these are only the first couple steps. If you have all of that taken care of you need to try seeing if you can save enough money each month that will be consumed by the mortgage, taxes and insurance.
  • Can you really afford that house?
  • Do you have enough money left to pay the rest of the bills? Save money, save for retirement, etc?
It is something to seriously consider.

Wednesday, July 12, 2006

Investor's Business Daily Investing Classes

A few weeks back we discussed the importance of taking personal finance classes. The face-to-face experience can be more effective for some people in order to learn what they need to know. Others can pick up through reading a blog or website with good content.Investing can be tricky and very scary for beginners and even investors with some experience.

Investors Business Daily has investing classes that they put together in some major U.S. cities. They have four levels of classes and each level gets more expensive. However, the beginning class is $179 and it would be a great primer to start you up on a solid investing path. The information would be some of the best available at a cost of what a community college class might cost. Click here to find out more. So if you live near or can access these cities and can make it to the investing classes it surely would be worth it.

Tuesday, July 11, 2006

The Housing Bubble?

The thrills that lead to an irrational exuberance in the U.S. housing market over the past several years might have come to an end. With the Fed continuing to raise rates mortgage rates have increased as well. This has started the slowdown; but this slowdown might turn in to a bubble.

During this craze of the early 2000s many were talked into mortgages that were not in their best interests. The seeds that were sown during the boom are going to come back and haunt many during the bust. You have already begun to see foreclosure rates skyrocket recently and more are to come.
Many homebuyers thought it was perfectly fine to purchase homes that were beyond their means because ARMs, interest-only loans and piggy-back loans made them affordable. With interest rates increasing and cheap interest rate ARMs coming due some homeowners that used these devices to purchase their home are in trouble. Many were told that it would be easy to flip the property before the ARM came due or interest rates went up. Well, that did not happen for everyone. Some of these loans have gone up 20-75%, maybe more. That has squeezed these homeowners into an impossible position of foreclosure.
A seller's housing market has shifted quickly to a buyer's market. If you are looking for a home the longer you hold out the better the opportunity it will be to get a deal.

Monday, July 10, 2006

Contrarian Investing

Technical analysts used to talk-up the odd lot theory. Basically, what they would do is the opposite of regular smaller investors acted because it is assumed they were less experienced in the market. There has not been found much empirical evidence to back this theory up.

The recent incarnation of this thought process is contrarian investing. Contrarian investors will go against the widely held Herd point of view. They will look for investments that most are bullish on and look for the possibilty that most should be bearish and vice versa. Remember The Herd will build up popular opinion sometimes on investments that are not truly sound. Being at the wrong end of this can hurt your overall performance in your portfolio. There is nothing wrong with following The Herd if you have done your homework and believe the investment will be profitable.

Many mutual funds have popped up investing in the contrarian theory. Just beware of The Herd mentality and placing too much emphasis on it or against it.

Sunday, July 09, 2006

Earnings Season for Wall Street

The 2nd Quarter numbers are ready to come out for many companies this week. This should help the stock market which has lagged for most of the year (S&P 500 YTD: 1.38%). General Electric and Alcoa will lead the charge out of the box this week and many expect great earnings results from both companies. Some insiders believe that with the possibility of a lot of good news this week investors can look for gains in the overall stock market this week. On the other hand there is a camp that think those gains have already been priced into the stock market so they believe the Q2 earnings numbers will just help the market support itself and not so much for gains this week.

Saturday, July 08, 2006

Car Loans

Before you go into the dealership looking for a specific car you need to find out some information on car loan companies. Many people do not even know that there is a car loan option outside of the automaker's loan offer at the dealership. Whether it is a used or new car it does not matter. Do some work first by applying to some car loan companies. A couple that offer good rates and service are E-Loan and Capital One Auto Finance. You can apply online or over the phone and within days you will know the APR rate they offer on the car loan as well as have the paperwork necessary to go forward.

The purpose of applying to several companies for a loan is to get the best deal. You come into the dealership equipped with a couple loan offers and they will know that you know what you are doing. Dealerships will try to get the best loan for them, but if you let them know you have other offers and do not tell them what APR was offered you are in the driver's seat. Another thing most don't know is that you can negotiate a car loan rate. With your other offers you are positioned to get the best rate possible on your car loan. When you purchase the car you will have peace of mind that you were not taken advantage of and that you got the best rate possible.

Friday, July 07, 2006

Russell Indices and Stock Market Benchmarking

Recently Russell reconstituted their indices. Their indices are some of the best benchmarks out there to compare a specific slice of the stock market to. If you have a mutual fund, portfolio of money managers or individual stocks look at their statistics compared to a specific Russell index it is benchmarked against. Is it at the correct risk level compared to its benchmark? Is it providing better performance than the benchmark? These are important ways to evaluate your holdings.

Another benefit is that you can verify what you own is benchmarked correctly. Often times companies will either benchmark themselves against a friendly index or influence decision makers (at a brokerage firm) to benchmark them kindly so their performance looks better than it really is. If a small cap portfolio is benchmarked against the S&P 500 you know there is a problem because the S&P 500 is a measurement of the top 500 companies (according to capitalization) and is the polar opposite of a small cap portfolio.

Click here for a list of indices that reconstituted and what companies make up that index. It is a great learning tool to look up an individual company and learn why Russell lists it as it does. Also, you can learn what criteria Russell requires for a company to be listed in a specific index.

Teaching Your Children about Personal Finance

You might never think about it, but one of the most important lessons of a child's life can be to teach tem about personal finance. Just like any other behavior, if you teach children when they are young about how to handle money they will be ahead of the game when they are on their own. One huge reason credit card companies prey on college students is because their ignorance on credit cards and debt. If you teach your child the importance of saving and even saving for retirement they will lbe better off. It should be a mandatory class taught in school because debt is becoming a worse and worse problem in the United States every year.

The following are great subjects to begin the life-long learn curve on personal finance.
  • Money
  • Savings
  • Investments
  • Retirement
  • Credit
You might think your children are too young, but as long as they can understand the concepts you show have a lesson plan for them to learn about personal finance.

Wednesday, July 05, 2006

The Current Stock Market News

With news of North Korea testing intercontinental missiles and oil reaching a record of $75 a barrel the stock market had a very rough day. Whenever there is global tension like there is right now it can lead to a bear market. We saw an instance of it today, but that does not mean tomorrow this will continue. However, if problems with North Korea escalate further this could have a serious adverse affect on the stock market's behavior.

Personal Finance Magazines

Personal Finance magazines are ubiqitous as are personal finance blogs. Everyone seems to want to offer advice and as always it is smartest to go with the best resources. Here are two that are highly recommended.
Money magazine gives you a little bit of everything while not overwhelming a novice. It touches on everyday realistic topics that we can all relate to. It does have an emphasis on investing help, but that focus does not affect the coverage of the rest. It is easy to read and is good for beginners to experts. You will find Money to be an excellent resource.

SmartMoney magazine gives analysis, investing information and personal finance advice on topics that we all are interested in. Its online companion,, is an excellent resource that gives you the ABCs of how finance works, to much more nuanced and detailed information that focuses on people with more personal finance knowledge.

Try these two personal finance magazines to catch up with your knowledge.

Tuesday, July 04, 2006

Short Term Health Insurance

More and more companies are popping up these days because the industry sector has more importance. With employees switching jobs and COBRA health insurance costs rising more people are looking to short term health insurance. Even at many jobs you have to wait a specific period of time before you are covered. So people need options.

Short-term health insurance plans gives the insured coverage for a limited period of time. Typically, short-term plans offer coverage up to six months and sometimes 12 months. If you will need health insurance for a longer period short term health insurance is probably not best for you.
  • The application process for short-term health insurance is usually simpler than your standard term health insurance.
  • Short term health insurance plans protect you against accidents or illnesses, rather than to provide comprehensive coverage.
  • Typically they do not include coverage for preventive care, physicals, immunizations, dental or vision care.
Purchasing a short-term medical insurance plan will make you ineligible for any guaranteed issue individual health plans commonly referred to as HIPAA Plans. So be aware before purchasing short term health insurance. Also know that short-term health insurance plans typically do not cover pre-existing medical conditions. Pre-existing conditions are usually considered any medical condition you have been treated for in the last 3-5 years. If you have an existing medical condition you will need to look into making sure that you will be covered. If this is the case then COBRA might be the answer.

Otherwise, if you need a stop-gap health insurance policy the short term health insurance are typically a good and inexpensive option.

Monday, July 03, 2006

Investing During Retirement

Investing during retirement is different than investing for retirement. When you retire your investment objectives change to generating income and have enough money to live the rest of your life.

Some things to consider:

· How much can I safely withdraw?

· How can I make my retirement money last until death?

· How do I handle inflation?

· How do I transfer money to my heirs efficiently?

Some potential problem issues to consider:

· Fixed dollar withdrawal programs increase your risk and becomes a serious problem if a market decline.

· You might live until your 90s or older; how can you be ready for that financially?

· Inflation will never completely disappear so expect it.

· Taxes are a retiree's worst problem for returns.

· You have to be prepared to watch your spending carefully.

· At age 70 ½ you must deplete your retirement accounts: how do you handle the influx of money?

If you plan accordingly, you will feel safer about your retirement. With no plan you can lose control of the situation during retirement because there are some many factors that there is no way to control. There is no comprehensive plan to follow; you must assess your situation individually so consider these factors and more when investing during your retirement.

Sunday, July 02, 2006

Capital Gains Tax

Whether you know it or not gains on stocks, mutual funds, and even a house are all subject to capital gains tax.

If your capital makes money between the time you acquired it and when it is sold you will need to pay capital gains tax. The tax depends on several variables and criteria such as: how long you have owned the asset and the type of property you own. You never pay any capital gains taxes on it is actually sold for a profit.

Capital gains tax rates depend on how long you have owned an asset. If you have owned the asset for less than a year, capital gains would be taxed at the same rate as ordinary income. However, tax rates on income obtained from the sale of assets owned for more than a year can be as little as 5%.

In 1997 the federal government passed the "Taxpayers Relief Act" which almost eliminates capital gains taxes on home sales.

Currently, you can make up to $250,000 profit if you are a single owner, $500,000 if you are married, without having to pay capital gains on profits.

Rules for the Capital Gains Tax
  • The house being sold must be your principle residence. You have to have lived in the house for 2 of the last 5 years, but it does not have to be sequential.
  • You can only get free capital gains sale every two years.