How the CFPB Serves YOU

Jul 21 2014

Published by under Military Benefits

EHAS_hero_landing_pageWhen it comes to making financial decisions, knowing where to get help and who to trust isn’t always easy. The Consumer Financial Protection Bureau is there for you, and they want to hear your story. Your feedback will help the CFPB protect consumers and create a fairer marketplace.

You can even check out stories from other people looking for help along their financial journey.

Watch Captain Jamison share a story about a servicemember having trouble with mortgage lenders:

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Millennial? – 4 Steps Into Simple Financial Planning

Jul 14 2014

Published by under Investments

Who likes budgeting? Who am I kidding, no one does!

Who likes living for today? Yeah!

Who wants to work the rest of your life? Buzzkill man…

Budgeting and financial planning is unfortunately a necessary evil in our lives if we ever want to get ahead of the grind at some point. However, there is a bright spot because the process doesn’t have to be a pain in your tookus.

Regardless of the amount of income you earn (everything’s relative ya know), we can all get control of our financial situations and start winning at the money game.

This is your starting point. Use this foundation to build upon. Every journey begins with the first step so put those noses to the grind stone…buck it up…rub some dirt on it…and let’s get started. You can do this.

1. Determine Where You Are Now.

If you don’t measure, you don’t know where you are and whether you are making any headway. Don’t make this difficult on yourself. These can be ballpark. You don’t have to count to the penny.

  • First, write down your income.
  • Second, identify your fixed expenses. These are things you can’t control. The costs are fixed like rent, mortgage, insurances, and utilities—all payments where you know you owe X-amount every month whether you like it or not. Not credit or loan payments, yet.
  • Third, identify your variable expenses. These are items where amounts fluctuate from month to month or they’re amounts you can control. Examples are food, clothes, your vehicle, home improvement, entertainment. Not credit or loan payments, yet.
  • Fourth, now credit and loans. We want these separate from the other expenses because we want to call these out for special attention. You want to see these amounts hitting you in the face and focus your efforts to annihilate these entries.
  • Finally, your savings and investments. This is an area that may not exist now or is in short supply but over time it will assume the space left vacant by credit and loans.

Here’s an illustration of what living paycheck to paycheck may look like for you:

paychecktopaycheck

Everything coming in goes out. There is nothing left for savings or investments. You don’t have the flexibility to help your primary causes. Note how the variable expenses are squeezed to make room for the expenses you have to pay and your debts.

If you are living on credit cards, the outflow may be more than your inflows and the green part of this pie chart is smaller than the other parts combined. Stop spending and living off credit. You cannot live on credit without making big trouble for yourself.

Paycheck to paycheck is not a fun life because you are under the thumb of others. Think of the debt as a huge hole that you have to fill up with your income. As long as that hole exists, your income does not belong to you. You can’t use your income for your higher purposes like your major causes or for building your assets that create wealth. Vow to take back control over your life!

If your financial life isn’t to your liking, put yourself on a track to change it. Realize you hold the power to control both income and expenses.

For better income you can:

  • market yourself better and get a new job
  • do the things necessary to make you more marketable to get a better paying job
  • create your own job

For most of us, doing the things necessary to be more valuable to employers meant that we gave up other expenses to afford more education or training—you live cheaper now to have a better life later. You can take a class or two at a time while you work.

If you are short of money, there are financial aid programs to help with education costs or ask your employer about training assistance or pick a less expensive school. Your main commodity is time. Fill up your waking hours with activities that help you increase your value or teach you the skills to start your own business. Try to minimize education debt, but if managed well, education debt is actually an investment in your future and higher lifelong income.

We all make choices about our living expenses. Find places in your budget to cut the fat. Prioritize your spending. What are spending requirements and what are the nice to haves?

We have one life to get this right. The price to pay for not getting this budget thing right is a life of work or a retirement of just getting by on Social Security.

Start visualizing what you want your pie chart to look like in the near future then plan and work to make it happen.

2. Where You Should Be Now—Or In The Near Future.

If things are going well, your income covers all your expenses, allows you to have a life, and you are saving for the future. How does this happen?

whereyouwanttobePeople on the right track live within their means. They pay themselves first (savings and investments) and live off the rest. If you don’t pay yourself first, there is never enough money left over for savings after all the “necessary” spending. You can’t use credit as a substitute for an income.

It’s about making the right choices when faced with a financial decision and not defaulting to the easiest or pleasurable choice. You have to be disciplined in controlling your outflows. It’s hard; we’ve all been there.

Outflows come in two forms, liabilities and assets. Liabilities are expenses where you never see your money again. You own your assets and they grow over time to create wealth. You have to minimize the liabilities and maximize your assets. That’s how the money game is played successfully. Assets allow you choices and freedom.

3. Where You Should Be In The Future.

People who think about and plan their future financial situations tend to be successful. They envision a future like this:

whatsyourvisionTo achieve this pie chart requires a plan. The sooner you plan, the better your chance of success. This plan would require actions to:

  • Reduce your fixed expenses over time
  • Increase your savings and investment amounts
  • Eliminate your loans and credit
  • Keep your variable expenses under control
  • Increase your income over the years to help accomplish the above points

You have to start paying yourself first and living off the remainder. Constantly increase your savings and investments as you change jobs, get promoted, and get pay raises.

Have a plan to decrease your “financial footprint” over time. Your financial footprint is how much you owe anyone and everyone. Going into retirement you want the smallest financial footprint possible. Having a small financial footprint means you either require a lot less income to live comfortably or you will have more income to live a fun life. Win-win!

4. Mission Accomplished.

allittakesisplanning

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Wealth Creation and Real Estate Investment

Jul 10 2014

There are three ways to build wealth:

  1. Investing in the markets
  2. Starting a business
  3. Owning real estate

For many of us, numbers 1 & 3 are the most likely ways for us to achieve our financial dreams of freedom. For military personnel, we can invest in TSP (which is a good, tax deferred way to save or post-tax way to save). Personally, I recommend any investment portfolio include the use of a financial professional to ensure proper diversification.

Owning real estate is a good option, especially to those who move frequently (as military do). Take this scenario, if a military member moves on average every 3 years (as was the case, when I was in and when my father was in), one could accumulate 5 houses in 15 years (assuming that for the first 5 years, the military member does not purchase a home). If the average home costs $150,000 (around $100,000 in the beginning and up to $300,000 in the end of a career), it is possible to control $750,000 of real estate after a 20 year career in the military.

Why is property ownership such a good thing? First of all, there is the tax advantage. There are ways to pay capital tax rates (0-15%)[1], whereas TSP earnings are subject to ordinary income upon withdrawal from the TSP account (with a tax deferred account) or taxed at ordinary rates (10-39.6%) upon contribution to a Roth-style TSP account. The second advantage, regardless of the crashes which have taken place (2008 and late 1980s for example), the real estate market has grown over the long run.[2] While there are many short term loss possibilities, over the long term, real estate tends to hold its value, in the aggregate. Third, real estate taxes are deductible, whereas only certain taxes are deductible on investments. Fourth, it is easier to obtain financing for real estate vice investments. Have you ever gone to the bank and said that you wanted to borrow money to buy stock on the open market. Give it a try and let me know how it goes!

HouseForRentOwning property is good, but what about renting property out? The first thing on your mind is likely “I don’t want to deal with the hassle!” Setting this aside for a moment, let’s look at the benefits of renting out real estate.

  • When renting out property, you move the property from an investment property to a “production of income” property. What is “production of income?” It is like running a business, but is treated under the IRS codes differently. For the sake of simplicity, treat it as running a business (unless I state otherwise). In this case, you can take deductions against your rental income, which you receive, which are “ordinary and necessary.”[3] Permitted expenses include:

* Real estate taxes
* Interest payments (on the home loan or equity loan)
* Management fees[4]
* Other ordinary and necessary expenses (cleaning, repairs, advertisement, etc).[5]
* Depreciation[6]

  • Someone else is paying off your mortgage in your other home, while you still retain ownership! This is provided you can rent out the home for at or more than the interest and escrow costs of your home. Why interest and escrow costs? Principal is more about paying yourself (which acts like a savings account over time). This is why even if you are not able to rent out for more than your payment, you might still make out profitable because of the amount of principal and the tax advantage of owning the home.
  • If you own a vacation home and use it for less than 14 days[7] out of the year (or 10% of the days rented out if rented out for less than 140 days[8]), it still counts as 100% rented out for the year. Imagine owning a nice home in North Carolina (or Oregon for those on the West Coast) near the beach and vacationing there for a week each year. If it is rented out for more than 140 days, you can treat it as 100% rented out for the year (but personal expenses directly attributable to the time you use it are not deductible, for example cleaning or food expenses)
  • Home values (generally) go up over time.[9] While the increase is not equal to that of the stock market, real estate is an investment, which tends to hold its value. When including the amount of rent received, minus the cost of maintenance and adding the tax advantage, if can be a good investment.

This is something to consider along with a balanced portfolio. In order to achieve the balanced portfolio, it is recommended you discuss your financial plans with a certified financial planner (CFP®), CPA or EA. In future blogs, I will discuss in further detail how this works with dealing with the IRS and state tax agencies.

[1] §1221 of the IRC
[2] http://www.census.gov/hhes/www/housing/census/historic/values.html
[3] §212
[4] §212-1(h)
[5] IRS Schedule E
[6] §167(a)(2)
[7] §280A(d)(1)(A)
[8] §280A(d)(1)(B)
[9] http://www.census.gov/hhes/www/housing/census/historic/values.html

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Don’t be a Scaredy Cat; 4 Ways to Manage Your Stock Market Risk

Jun 30 2014

moneyfrustration_WEBI don’t like putting my money in the stock market; it’s too risky.

Stupid stock market! My retirement account goes up and down but generally goes nowhere.

These statements indicate a problem but it’s not with the stock market. The problem has to do with your risk management. We all have to be invested in the stock market; we have no choice. “What!? I have no choice?” That’s right. Here’s why.

Look at the typical retirement prospects awaiting average hard-working people.

  1. Your only source of retirement income is government, family or charitable help.
  2. You work your whole life.
  3. You create enough wealth and/or income to allow a higher standard of living in retirement— including other sources of income like a pension.

 

chart

Okay, so you do have choice if working your whole life or choosing a standard of living supportable by Social Security is on your radar. However, if you want more for your retirement, you have to create wealth that will sustain you for decades of retired life.

To create wealth requires ownership—lots of ownership. Ownership is stocks (ownership in companies through the stock funds in your TSP, 401k, etc.), properties, or building your own successful business. Only ownership provides investment returns large enough to offset the negative effects of taxes and inflation and allow us to build enough wealth from our limited incomes. Ownership provides the necessary returns because ownership involves risks and risk pays. Safe and conservative savings plans do not provide returns high enough to offset taxes and inflation and build wealth.

That’s the problem. Ownership involves risk and I hate risk.” Yeah, but risks are manageable. You manage risks every day: driving, exercising, walking across a street, your health, you name it. Life is a risk. Investing is no different; risks can be managed to your benefit. Here are four of the easier ways to manage stock market risks.

Take a long-term view. The shorter your investment horizon, the greater your risks. The longer your view, the lesser your risks. That’s why you have to attack stock investing as a long-term game plan. Hey, you’ll be a stock investor until you die so what’s the hurry? When measured in 10-year chunks, the worse U.S. stock market 10-year period was 1999-2008 when it was down 1.4% (SP500 index). “Seriously, only a whopping 1.4%!” Yep. Considering periods 15 years and greater, there has not been a negative stock market period.

Voila! Stock market risk eliminated by having a long-term game plan. But you can do better.

Average down. This is also known as dollar-cost-averaging. It’s a dirt-simple investment strategy. All you do is contribute to your stock fund investments (401k, TSP, IRAs, etc.) on a regular basis for a long time. Why? Because the stock market goes up and down by its nature over shorter periods (remember over long periods 15+ years it’s always up). As the stock market drops and your contributions continue religiously, you buy more shares (shares = ownership) of stock funds in your accounts.

Eventually the stock market will bounce off the bottom and go on to higher levels while you picked up beau-coup shares at bargain basement prices. Under this strategy, a down stock market is your friend—you’ll actually want the stock market to drop.

The name of the game is lots of ownership; not watching your account value. The person who retires with the most ownership shares wins! Your account value will take care of its self as a by-product.

Wasn’t the stock market dropping a fear for you earlier? A falling market was the risky part of investing. Now you’ll love falling markets and they can make you wealthy over time. In fact, the stock market has to drop for average investors to build wealth.

Kiss the fear of this risk good-bye.

Allocation. This is the percentages of your portfolio’s mix of stocks, bonds and cash…for the most part. As an illustration, 80% stock funds, 15% bond funds, 5% cash funds. All markets (stocks, bonds, cash) go up and down over the short term. Stocks are the most volatile (up and down by greater degrees), bonds next and cash last. Therefore, the more stocks you own, the more your portfolio value swings up and down. The more bonds and cash you have, the less your portfolio swings up or down.

Use allocation like a regulator to control the up and down movements in your portfolio values—in other words controlling your risk. Most times stocks, bonds and cash move in opposite directions from each other so bonds and cash act to tap down the volatility in a stock portfolio.

If you have a long time horizon before retirement, you want your account to have wide swings in value to take advantage of the principals discussed above.

If retirement is within 10 years, you start adjusting your portfolio allocation to reduce the chance your account value will drop too much as you get ready to use your wealth for retirement.

You now have a safety valve to control risk. Now don’t you feel powerful?

Rebalance. After discussing averaging down and allocation above, you now realize you structure your portfolio allocation to achieve an objective. Generally, your objective is either wide swings in your account value to maximize the effects of the averaging down strategy or preventing wide swings to protect your account value as your close in on your retirement years.

Whatever your chosen objective and allocation, it will get out of whack as markets move up and down over time. Be sure to re-balance your allocation every year to ensure your allocation maintains the objective you intended. Just the act of re-balancing to your original allocation forces you to sell the shares that are high so you can bulk-up the shares that are low. Buy-low, sell high. Bet you heard that before. Another risk lessened.

Add these all up and you have your risks understood and managed. Now, what are you scared of?

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Just What is a Retirement Account?

Jun 30 2014

iStock_000004276434XSmallWhen is a retirement account not a retirement account?  No…this is not a question like “Who is buried in Grant’s tomb?”.  A retirement account is not a retirement account when it is an inherited Individual Retirement Account (actually an IRA is technically called an Individual Retirement Arrangement).

This was recently determined in a Supreme Court ruling.  In a unanimous decision the Supreme Court ruled that while inherited IRAs maintain the word retirement in their name, they are not retirement accounts.

So what? Well, one of the advantages of an IRA is since it is a retirement account it is generally protected from bankruptcy.  There are limits at the federal level of how much money is protected, but for most of us the money is protected.  Since an inherited IRA is not a retirement account it is not protected from bankruptcy.

OK…so what?  You may want to re-think your estate plan.  If your spouse is the beneficiary of the IRA your spouse has the right to roll your IRA balance into his/her IRA and maintain the retirement characteristic of the account.  However…If your children (or anyone else for that matter) are contingent beneficiaries or are your primary beneficiaries to your IRA, you might to play out some “worst-case” scenarios.  If your child has some problems managing money and could be subject to bankruptcy designating a trust as the contingent or primary beneficiary may make sense.  This will protect your assets from bankruptcy if the trust is structured properly.

You’ll also want to make sure the trust is set-up correctly to give the trustee the option of spreading the pay-outs over the life of the beneficiary.  If you don’t set the trust up correctly the funds will have to be paid out in 5 years.

As I always say, don’t do estate planning without a net.  But even if you’ve done your estate plan with a competent Financial or Estate Planner, if you’re concerned about Junior’s exposure to bankruptcy it might be time to revisit your estate plan.

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