15-year fixed-rate mortgages. These
are fast-payoff mortgages so each monthly payment is higher than the payment under a
30-year mortgage. However, you'll avoid 15 years of interest payments while you pay a
lower rate: currently, around 8%.
Insight: You can take out a
30-year mortgage and pay it off at the same rate as a 15-year mortgage. That way, you can
cut back to the 30-year payment, if you have cash flow problems, and not jeopardize your
credit rating or your home ownership.
Adjustable-rate
mortgages (ARMs). Such mortgages have
a low initial rate but they adjust each year, to reflect the current mortgage environment.
Currently, the national average is under 7%. The low initial rate may enable you to
qualify for a larger loan. With a good ARM, the interest rate can go up no more than 1%
per year and 5% over the life of the loan. If you think you'll be moving in a few years,
take an ARM. Why lock yourself into an 8% rate for 15 or 30 years if you can pay 7%
initially and then move to another house?
Hybrid mortgages. They offer a fixed rate for three, five, seven, or
10 years, after which the rate adjusts every year. Thus, you have some security, knowing
that your monthly payment won't increase for a certain number of years, as well as a
somewhat lower rate. Choosing a three- or a five-year hybrid mortgage (the most popular
forms) probably will shave 0.5% to 0.65% from the 30-year fixed mortgage rate.
No matter which type of
mortgage you prefer, approach a lender about pre-qualification or pre-approval. When you
have such a certificate you'll know how much you can afford to pay for a house-and sellers
will know that you're good for the purchase price. Your chances of getting the house you
want will be greatly enhanced.
Once you have your mortgage,
don't forget about it. If rates drop, you can refinance and take out a new loan at a lower
rate. Insight: When you get a mortgage, insist that the loan be structured so that you can
refinance easily. That means no credit check will be necessary; all that will need to be
done is to re-confirm the value of the house.
If you want to refinance a
loan, spend some time on the Internet. Many financial sites will help you get an idea of
the lowest interest rate. For starters, visit www.hsh.com.
3. Investing
Without Saving
The returns produced by the stock market in the 1980s and 1990s have led many people to
invest heavily. That's fine, but most financial professionals advise individuals to keep a
cash reserve of at least three months' worth of living expenses. With a reserve, you won't
have to sell stocks in case an emergency arises and you need cash.
Fortunately, recent Federal
Reserve efforts to cool the economy have boosted the yields on cash equivalents.
Three-month Treasury bill yield around 5.75%, money market funds average nearly 5.5%, and
three-month bank CDs pay an average of 4.65%; all of these yields are the highest in
several years.
Money market funds. They
offer decent yields, penalty-free access to your money, and safety. Only one small money
fund has ever stuck investors with a loss of principal, back in 1994, and investors still
wound up with 96 cents on the dollar. For current data on money market funds you can visit
www.ibcdata.com. If you do most of your investing with one broker or mutual fund company,
you might as well use that company's money fund, for convenient investing. Another option
is to ask your bank if it offers a money market fund, because keeping your money there may
lower fees on your other accounts or allow you to build a valuable relationship.
Bank certificates of deposit
(CDs). These are easy to acquire and virtually risk-free, with the Federal Deposit
Insurance Corp. (FDIC) covering bank accounts up to $100,000. If you have bank accounts
over$100,000 you might want to spread your money among two or more banks because that's
the upper limit for Federal Deposit Insurance. However, if you're going to place a sizable
amount of money in CDs, you should put some into one-year certificates, some into two-year
certificates, etc.
That way, you'll have CDs
maturing each year in case you need cash; when a CD matures you can put cash in your
pocket without paying an early-withdrawal penalty, which can be substantial. If you don't
need the cash you'll have the opportunity to reinvest at the highest rates available then.
Treasury bills. In addition
to relatively high yields, T-bills are backed by the federal government so they're
extremely safe. The market is liquid so you can sell your T-bills at any time, without an
early-withdrawal penalty. (You may take a slight loss of principal if you sell before
maturity, though, if interest rates have risen since your purchase.) As an added bonus,
the interest you earn is exempt from state and local income tax.
Under a "Buy
Direct" program, you can purchase Treasury securities with a toll-free phone call
(800-943-6864) or at the Bureau of Public Debt Web site (www.publicdebt.treas.gov). Your
investment will be deducted from a designated bank account so you don't have to bother
mailing in forms or checks.
With the Buy Direct program
you pay no fees, other than a $25 annual charge if your account exceeds $100,000. The
minimum purchase is$1,000; until recently, minimums were $10,000 for short-term Treasury
bills.
4. Saving
for College in the Wrong Name
A college education is just as expensive as it is essential so saving for college is a
prime financial goal for most parents. However, problems arise when deciding whether
college savings should be done in the child's or a parent's name. Here are some of the
issues:
Tax savings. Putting the
money in a child's name seems to make sense because investment income may be taxed to the
low-bracket student rather than the high-bracket parent. If you keep money in the name of
a child under age 14, there will be no tax due on up to $700 in investment income, in
2000, and only 15% due on the next $700. After age 14 the "kiddie tax" no longer
applies so the child can have over $25,000 in taxable income yet still be in the 15% tax
bracket.
Control. Investing in a
child's name means that money will belong to the child, perhaps as early as age 18. Today,
a family with young children will have to put away a huge amount in order to send those
children to big-name schools 10 or 15 years from now. Many people don't want to turn over
that much money to their kids.
Rather than turn over money
to children, parents can invest in their own name, giving up some tax savings but
retaining control over the funds.
Financial aid. Investing
college money in a parent's name may have another advantage: the way college financial aid
forms are set up, money in a child's name counts more than money in a parent's name when
it comes to calculating the "expected family contribution." Thus, saving in the
parent's name may result in more financial aid.
Discipline. The benefits of
saving in a child's name are psychological as well as financial; putting money into a
child's account is very satisfying to a parent. The parent thinks, "That money is for
college." Money that's saved in the parent's own name is more likely to be used for
other purposes.
If you prefer to invest for
college in your children's name, for tax savings and emotional satisfaction, how can you
keep your children from buying a Harley and "doing the Grand Canyon," when they
come into their money? Some parents don't tell their kids how much is in those accounts.
When the time comes to pay for college a letter can be typed, saying something like,
"Please take $10,000 from my account to pay for my college bills." The parent
might indicate that the child could sign the letter, in order to get money for college.
5. Being
Too Aggressive in Stocks
The stock market's advance to lofty levels raises inevitable comparisons with the early
1970s, when the "Nifty Fifty" (including Avon, Kodak, and Xerox) dominated the
market and eventually fell from favor, causing a 45% drop in the Dow during 1973 and 1974.
Will we see a similar stock market swoon? No one can say for sure but prudent investors
may want to rein in their exuberance and cut their exposure to future stock shocks.
Monitor the market. Wary
investors need to go beyond the usual indicators such as inflation, interest rates, and
price-to-earnings ratios. In addition, study technical as well as fundamental indicators.
For example, when the daily newspapers report that the number of stocks reaching their
lowest price for the previous 12 months far outnumbers the stocks reaching their highest
price, investors should turn cautious.
Cash in. If the signs point
to a correction, one basic move you can make is to sell stocks and park the proceeds in
cash equivalents such as bank accounts, money market funds and Treasury bills. You'll
receive a positive return, albeit a modest one, and you'll reduce stock market risks.
Boost your bond holdings.
You also can seek a balance between bonds and stocks. The bonds could be weighted towards
short-term, high-quality issues (such as Treasuries and investment-grade corporate bonds),
which have less risk of losing value due to increasing inflation or economic weakness.
Select safe stocks. If you
decide to trim your equity stake, to protect against a slump in stocks, you still have to
decide which stocks to retain and which ones to buy with any new money you're committing
to the market. Generally, you should emphasize domestic large-capitalization issues, which
are more liquid and thus easier to sell in times of market distress.
Walk, don't run. One risk reduction strategy that
should not be overlooked is an old favorite: dollar-cost averaging. That is, if you get
$100,000 from an inheritance or the sale of your home you should not commit the entire
amount to the stock market immediately. You could invest when the Dow is at 11,000 only to
find the Dow at 10,000 or even 9,000 a month later.
Instead, park the cash in a
money market fund and invest gradually, perhaps each month or each quarter. You might give
up some gains if the market keeps rising but you'll be able to buy in at lower prices if
the market falls. Thus, dollar-cost averaging sacrifices possible upside in return for
downside protection. Playing some defense today may help you survive any near-term stock
market losses and increase your score when the market resumes its winning ways.
6. Paying
Too Much for Insurance
You definitely need insurance to protect yourself and your family. However, if you buy all
the coverage that agents try to sell you, you may see a huge chunk of your disposable
income going for insurance premiums. Here's how to cut back on costs while maintaining
necessary protection:
Self-insure to the greatest
degree possible. Bear everyday risks yourself, in order to lower insurance premiums. By
raising deductibles and extending waiting periods, you can lower your costs yet still have
coverage for true catastrophes. Instead of a $100 or $250 deductible on your auto and your
homeowner's insurance, specify a $1,000 deductible. Yes, you'll pay out-of-pocket for
broken widows and minor dents but you'll also save 30%-40% every year on your premiums.
Moreover, you'll be covered in case of a disaster, which is the real reason for buying
insurance. (Don't forget to ask your agent about any discounts available on auto and
homeowner's insurance.) Similarly, you might buy a disability insurance policy with a
90-day waiting period instead of a 30-day period. Here, you'll assume responsibility for
an extra 60 days of lost income but you'll still be protected in case you're out of work
for years. Again, you might save 30% or more in premiums, year after year.
Think term. When it comes to
life insurance, the way to cut costs is to buy term insurance, which is pure insurance
protection. For the vast majority of people, term insurance is the best choice. Today,
because of competition in the market, you can buy 10-, 15- and 20-year term policies at
reasonable prices, especially if you're in good health.
Take care early. At that
point in your life, start to consider long-term care (LTC) insurance. The younger you are
when you buy this insurance, the lower the premiums--the late 50s are a good age to buy
this coverage. Married couples may want two policies, so some insurers will offer a
marital discount of around 10%.
Even if you buy while in
your late 50s, LTC insurance can be pricey, especially for a couple buying two policies.
One way to reduce your premiums is through "cost sharing." Suppose a nursing
home costs $150 per day in your area. You might decide to buy a policy that pays $120 per
day; if you need care you'll pay the balance from other funds. Again, you can save money
on LTC insurance by extending the waiting period from 30 days to 90 days, for example, and
thus agreeing to cover an additional 60 days of care out of your own pocket.
7.
Overpaying Your Taxes
A few basic tax planning pointers can yield sizable savings, year after year: Make your
investments less taxing. Rearrange your portfolio to emphasize potential capital gains
(which will be untaxed until you take your profits) rather than interest and dividends
(which will be taxed immediately.) If you've been paying substantial taxes because of
large capital gains distributions from mutual funds, consider switching funds. Many funds
with good records also boast of tax-efficiency, meaning that they seldom make sizable
capital gains distributions to shareholders.
"Roth-ify" your
IRA. Contribute to a Roth IRA rather than a regular IRA. You and your spouse can each have
a Roth IRA if your AGI is below $160,000. If it's below $150,000, you can each contribute
the maximum $2,000. Children can contribute as much as they earn to a Roth IRA, up to
$2,000 per year. Generally, Roth IRAs are better than deductible IRAs. With a Roth IRA,
you may be able to receive tax-free payouts. With a deductible IRA you'll save a modest
amount of tax upfront and owe income tax on every penny withdrawn in the future.
Beat the deadline. Checks
that you write in December (or items that you charge on a credit card) may be deductible
on the return you file the following April.
Mortgage payments. Get your
January check in the mail before Christmas so that it will arrive in time for you to get
credit for the interest payment this year.
Property taxes. Finish
paying off any taxes due for the first half of the next calendar year.
Charitable contributions.
You can be especially generous knowing that Uncle Sam is picking up part of the tab. Give
away appreciated securities rather than cash in order to escape paying tax on capital
gains.
State and local income
taxes. If you must pay these taxes by January 15 you might as well pay three weeks early
and get a deduction for the prior year. Check with your tax pro first, though, to see if
you are at risk of owing the alternative minimum tax.
Earn tax-free rental income.
The "Masters" tax break, supposedly passed to benefit homeowners in Augusta,
Georgia, allows you to rent a home for up to 14 days per year without having to declare
any taxable income. This chance for tax-free income may be especially appealing if you own
a primary residence or a vacation home in a resort area, near a major sporting event, or
in a city where college graduation attracts many celebrants.
Another option: if you run a
sideline business (or if your spouse is a business owner) your home can be rented to the
company for a retreat or a management meeting. The company can deduct the payment, as long
as it's reasonable for the length of the meeting and the time of the year, while you pick
up no taxable income.
8.
Neglecting to Anticipate Retirement
Many people are eager to retire but there's a flip side: when you're no longer working
you're no longer earning a living. Nevertheless, you probably intend to maintain a
comfortable lifestyle in retirement, so the money has to come from somewhere.
Indeed, one of the main
reasons for hiring a financial planner is to find out when it's prudent to retire and how
much you should save during your working career. If you plan to spend $40,000 per year,
for example, you might be told that a retirement fund of $800,000 will be necessary. Once the target has been set, the question is how
do you get there from here. That is, if you have $150,000 saved up at age 40 and you want
to retire with $800,000 at age 58, how much should you invest each year and how do you
allocate your investments?
Avoid a "siege
mentality" as you approach retirement age. Some people develop a short-term outlook
so they want to convert everything to cash or "safe" investments.
In truth, few young retirees
will live for a short time. According to the IRS, a 60-year-old couple has a joint life
expectancy of nearly 30 years-you could be retired longer than you worked.
Think long term. With a
paid-off mortgage, the kids out of college, a retirement plan, Medicare, and Social
Security, you may have less need for liquidity during retirement than during your working
years. After you stop working your investments will have to work even harder, and that
means maintaining a strong commitment to stocks in your portfolio.
Include inflation in your
projections. Savvy pros use a 2.5%-3% inflation rate for forecasting future spending
because that's the rate prices climbed during the 990s. In other words, a retiree who
spends $40,000 in 2000 will be spending $80,000 in 2025, to maintain the same lifestyle.
Plan for windfalls. If you
expect to sell a big house in the Northeast and retire to a smaller place in Arizona, you
may free up a considerable amount of capital that can be used for retirement expenses. You
or your spouse may expect an inheritance, which also should be factored into your
retirement plans.
Project a possible need for
long-term care. This can be a real wild card: you or your spouse may suffer a stroke and
have to spend years in a nursing home.
Therefore, you should plan
to pay premiums for long-term care insurance or to pay for care out of the money you've
accumulated.
Work with a competent
advisor so that you truly understand your options. Such an advisor will develop a plan
that's calculated to meet your goals, then revise that plan periodically to reflect the
results you've achieved in the intervening years.
9.
Ignoring the Threat of Incapacity
Death and taxes may be life's only certainties but gradual deterioration rates a high
probability. At some stage in your life you might lose the ability to manage your own
affairs. Some bills won't get paid while others get paid twice; you may make unnecessary
purchases or fall victim to shady schemes. (Even if you're a long way from such actions,
your elderly parents may be susceptible.) Taken to extremes, incapacity could leave you or
your parents without heat, light, phone service, or money in the bank. Fortunately, there
are steps you can—and should--take now, to help protect against competency.
Execute a durable power of
attorney, empowering a loved one to sign legal documents on your behalf. The power of
attorney should be "durable," meaning that it will remain in force even if you
become incompetent. In case you're reluctant to give someone else such authority, the
power of attorney can be a "springing" power, meaning it will take effect only
if you are unable to act on your own behalf.
Create a revocable trust as
a further protection against possible incapacity. Generally, the creator of such a trust
(you) acts as trustee, remaining in control of the assets that have been placed in the
trust. In case you lose competency, a backup trustee can take over, with no need for a
court hearing to appoint a guardian.
You should name several
backup trustees, in case someone can't serve.
Arrange for most of your
income to be deposited directly into a bank account. In addition, you can arrange for
recurring bills to be paid automatically. Such steps can reduce the risk of the
electricity being turned off for nonpayment, for example. However, it's not possible for
every bill to be paid automatically, so other measures may be necessary, such as arranging
for some bills to come to a younger relative.
Move assets into joint
ownership. Put your name onto a joint bank account with a grown son or daughter; he or she
can write checks if you become incapacitated. Such a tactic is common because it's
inexpensive and easy to implement but there also may be negative aspects to joint
ownership. In such arrangements, the surviving co-owner always inherits. That is, if you
change your brokerage account to joint name, with your son as co-owner, he'll inherit all
the securities in that account at your death. Your daughter and other loved ones will be
excluded, no matter what it says in your will.
Thus, joint ownership
reduces estate planning flexibility and may create gift tax problems. If you are going to
use joint ownership, you may want to restrict it to a checking account that holds a
relatively small amount of money.
10.
Leaving Your Heirs Unprepared to Inherit
Chances are, you expect to leave a legacy of peace and prosperity. Unfortunately, the
reality may be much different. Stories abound of siblings fighting over a parent's
possessions, from great works of art to a few wooden spoons.
Other problems may arise
after your death. Your heirs may fall victim to predators or spend their inheritance
foolishly. Valued property, such as real estate, may be mismanaged. In remarriage
situations, there may be ill feeling between your surviving spouse and your own children.
Such problems probably can't be avoided altogether but they can be alleviated, especially
if you anticipate them. The time you take to help your heirs prepare for the future can
pay off in a legacy of relative harmony.
Give your children a
reasonable idea of what they can expect to inherit. Go over the numbers with them. Let
them know they'll have to build up their own retirement fund rather than rely upon a huge
inheritance.
Name an independent party as
the estate's executor. A bank trust department or an independent trust company might be
appropriate. Your heirs may not appreciate paying for an executor but if you name a
surviving relative as executor the family pressure on that individual may be enormous.
What's more, an executor assumes a fiduciary responsibility that may be better left to an
institution. One of an executor's roles is to file an estate tax return, pay any estate
tax due, and eventually distribute the estate's assets. What happens if the return is
later audited and more estate tax is due? The executor is legally responsible and the
other heirs may not be willing to give some of their money back to pay the tax. When you
name an institution you shift that liability away from a family member.
Prepare your heirs to handle
the assets they'll inherit. Have them meet with your attorney and accountant for an
explanation of the tax planning strategies that you're developing, so they can be carried
on after your death. If you have a broker or financial planner, your heirs should all meet
with this investment advisor for some educational sessions. Otherwise, a carefully
constructed portfolio might be sold after your death, then reinvested in a few highly
speculative issues or even a fraudulent scheme.
Create a family limited
partnership (FLP), then call a meeting of the partners. Such a meeting likely will be
serious and businesslike because it serves the purpose of managing valuable assets held by
various family members.
Draw up a trust to
hold your assets after your death. You can place whatever restrictions you think are
appropriate on the trust funds. Some of the principal might be distributed when the
beneficiaries reach a certain age, some more of the principal five or 10 years later, and
so on, in hopes that the trust beneficiaries will become more capable of handling money as
they grow older.
