Extension Educator, Consumer Economics
Extension Specialist, Consumer Economics
Extension Educator, Consumer Economics
May 27, 2010
Unlikely – for investments today! For the APR on a credit card this is typical but outrageous. Why do we accept paying these high interest rates on credit card bills? Just think about the potential of investing the money spent on interest into a long-term investment.
Every day that you pay on a credit card balance with a high interest rate you are losing the opportunity to invest these dollars somewhere else. You should benefit from the long-term return on your dollar – not the credit card company.
What can you do to change this around? One important step is to avoid the minimum payment trap. When you open your credit card bill do you look at the amount of the minimum payment to decide how much to pay? If so, you're falling into the minimum payment trap.
Why do we call this a minimum payment trap? Research by Dr. Neil Stewart in his article, "The Cost of Anchoring on Credit-Card Minimum Repayments," shows that people tend to pay less when they use the minimum payment as a payment guide.
Research participants were given a mock credit card statement. They were asked to consider how much they could afford to pay, and then to state how much they would pay. Participants saw either a statement that included a minimum repayment amount or an otherwise identical statement without this information.
Those people who saw a statement with a stated minimum payment chose to pay less than those who did not have the suggestion of a payment amount. How does this research help us? Next time your credit card bill arrives, decide how much you can afford to pay BEFORE you look at the minimum payment listed.
Ideally we would pay all of our credit card balance each month to avoid interest charges. Sometimes this is not possible. However, paying even a little more than the minimum required can make a big difference in costs over time.
As a result of the Credit CARD Act, your monthly credit card bill has new information on it. Have you noticed? Take a look – on your bill it states how long it will take to pay off your balance if you only pay the minimum payment. And, there is information about how much you need to pay each month if you want to pay your balance in three years.
For example, Susie has a credit card balance of $3,000 with an interest rate of 14.4%. With a minimum monthly payment of $90, it would take 11 years to pay off the balance. However, if Susie pays just $13 more each month ($103), the balance will be paid off in three years and $1,033 less will be paid in interest charges. This is $1,000 that Susie can invest for her retirement!
For more information about how to manage your credit cards, visit University of Illinois Extension's website, Credit Card Smarts. And, visit the Plan Well, Retire Well website to learn how to invest your money so that compounding returns help you!
May 20, 2010
Occasionally I get asked "how do I decide which investments are best for my retirement savings plan?" In turbulent times like these, that's actually a very important question. Through research and personal experience, I have found that there are several factors that need to be considered when choosing investments. Elements such as time horizon, risk tolerance, and market exposure should be carefully considered before investment choices are made.
Determining how much time you have before your investment will be needed is important in selecting appropriate investment vehicles. The more time you have to invest, the more risk you can take for potentially higher returns. As a general rule, if the money will be needed in the next 5 to 10 years, less volatile investments such as bonds (or bond funds) will likely fund at least 50% of your retirement portfolio. On the other hand, if you have 25 years or more before you retire, your retirement plan is probably 100% invested in equities. The amount of time you have before the money is needed should always be a deciding factor on where your money is invested.
In the world of investing, there are several types of risk. There's market risk, inflation risk, interest rate risk, and most importantly, investor risk tolerance. Risk tolerance addresses the issue of how much risk you are willing to take with any given investment. It is important to evaluate the amount of risk you are willing to take when you decide to invest. If you get really nervous about the ups and downs of the stock market, then you would probably feel uncomfortable investing in individual stocks or sector funds. You would likely feel more at ease in a balanced or income fund that offers a good mix of stocks and bonds. There is a popular saying "the greater the risk, the greater the potential return." However, because taking great risks doesn't automatically guarantee great returns, it is important to know how much risk you are willing to take. To find out the appropriate risk level you are comfortable with take the risk tolerance quiz at MSN Money.
When risk is spread out over several companies or industries, the likelihood of a total crash is lowered significantly. Diversification is an investment strategy in which investor portfolios contain a mixture of various types of stocks, bonds, and other investments in order to reduce the risk of loss. Mutual funds are a popular way for small investors to utilize this strategy for investing. When choosing investments to fund your retirement plan, always look at the top 10 holdings, if you are investing in a mutual fund. Are these holding in different industries? Will the failure of any of these companies indirectly impact the other companies? If the answer to the first question is yes and the second is no, then you may have a diversified investment. There are various types of mutual funds. This month's news release provides an overview of the various types of mutual funds investors have to choose from. Also, check out our Asset Allocation Analyzer to ensure that your portfolio is well diversified.
OTHER FACTORS TO CONSIDER
Performance information is readily available for investors to review. However, the disclaimer that will be printed on any prospectus or investment literature will undoubtedly state "past performance does not guarantee future results." In laymen's terms, you are being told that just because the investment performed well in the past doesn't mean it will do well going forward. Most people choose their investments based on past performance. Although past performance can give investors information about a particular investment, knowing the top ten holdings in your mutual fund, for instance, and what's going on in the world around us in many cases can be a better indicator of future performance.
Companies such as Morningstar provide research-based rating services on stocks, mutual funds and other types of investments. These rating systems can be helpful in identifying which investments you are more comfortable with. Morningstar uses a 5 star rating system to evaluate investments; 5 stars represent the highest rating and 1 represents the worst.
One of the biggest enemies to our savings is inflation. Inflation is the increase in the cost of goods and services over time. This increase can potentially lower your buying power if your investments are not designed to keep pace with inflation. Savings and money market accounts are usually most affected by inflation due to their lower rates of return; investments with higher returns normally fair better.
As the saying goes "the only thing certain in life are death and taxes." Taxation can turn a great investment into an average investment if proper planning is not done. All the gains and increases on your investments can be quickly eaten away by taxes. Higher income tax filers can especially have a difficult time if they don't have credits and deductions to offset their gains. To reduce taxable earnings, some investors are finding IRAs, Keogh plans (for self-employed persons), annuities and municipal bonds viable alternatives. In an effort to keep current with changing times, many companies now are beginning to offer Roth 401(k) and 403(b) plans. These plans allow after-tax contributions into a company retirement plan. The benefit to this type of investment is that tax-free withdrawals are available if you have participated in the plan for 5 years or more and have reached the age of 59 ├??├?┬Ż. An added bonus is that you do not have to make mandatory distributions as is required with traditional plans. Finally, to encourage taxpayers to participate in some type of retirement program, the IRS offers tax credits to tax filers participating in their company's retirement plan, and deductions to those who establish their own traditional IRA, SEP IRA or Keogh plan. For more information on taxes and retirement plans, visit the IRS and Roth 401(k) websites.
As the market continues to go through its ups and downs as markets always do, it is important for you to remember why you are investing. If your investments are for the long term and you believe that over the long term they are solid investments, then you should ride out the wave. As we always remind you, rebalancing your portfolio is always an option. If you need to redistribute current and/or future contributions, then do it with care. Where should you invest? No one has a crystal ball to look into the future. However, watching trends, keeping in mind your time horizon, knowing how much risk you are willing to take, and thinking about your future goals can give you a good idea of which investments will work best for your lifestyle. Until we talk again...
May 7, 2010
Perhaps you were blissfully unaware of yesterday's wild ride on the stock market. But if you were following the news, how did you react? Were you panicked, thinking that you wished you didn't have so much of your portfolio in stocks? Perhaps you intended to rebalance your portfolio after the market gains over the last several months – selling some of your stock investments and boosting bonds or cash to get back to your target asset allocation – but didn't get around to doing it. And now you regret that you procrastinated.
Experiences like this are another wake-up call to make sure that your investments match your goals, and your time horizon, as well as your emotional ability to handle risk and your financial capacity for risk. Here are some thoughts to consider:
Set up an easy way to monitor your asset allocation, so that you'll know when you need to rebalance. (See my earlier post for an explanation of rebalancing.) If you work with an investment adviser, ask if they can generate an alert when your allocation is out of balance by more than, say, 5%. You can also track your own asset allocation if you enter all of your investments into software such as Quicken, websites such as Mint.com or Morningstar.com's Instant X-Ray, or tools offered by your financial institutions. Or, download my Asset Allocation Analyzer in either Word or Excel format. Some retirement plans even offer automatic rebalancing for that portion of your portfolio. One downside: Many of those tools won't generate an automatic alert to rebalance, so you have to remember to check it yourself.
Let dollar-cost-averaging work for you. Don't stop your payroll contributions to your 401(k) or other retirement plan when the market gets crazy. Say you're putting money into Mutual Fund EFG. By contributing the same amount each payday, you force yourself to buy more shares when the price of EFG is down, and fewer when the price goes up. Buying more when it's cheap is smart investing.
If you are five years or less from retirement, calculate how much money you'll need each year in retirement to cover expenses. Subtract income you'll receive from pensions, Social Security, or annuities. The remainder needs to come from your investments, including employer retirement plans and IRAs. To avoid having to sell those investments when markets are down, you may want to shift enough money to cover one year's expenses into a CD maturing in your first year of retirement. Next year, you can sell enough to cover another year's worth of expenses, and put that in a CD maturing in your 2nd year of retirement. Continue each year, building a ladder of CDs to cover up three to five year's worth of expenses. If the market tanks one year, you can skip selling investments that year and live off the reserve you've built. When the market recovers, sell extra to rebuild your cushion.
The stock market might not have another day like May 6, 2010 for years to come. But if you faithfully rebalance and keep money for short-term goals out of the stock market, you'll be prepared when (not if) it happens again.
Click on my name below to tell me how you apply these ideas to your own personal finances.