This is a great starting point for understanding and being in control of your personal finances. Summarize what you own and owe to see your net worth. The USAA Educational Foundation has a simple form to fill out to get you started.
When it comes to investing, dollar cost averaging refers to investing an amount of money in a stock or mutual fund at regular time intervals. The idea behind this investment strategy is that you are getting a lower price when the market is down even though you are paying a higher price when the market is up and, overall, the average price you pay is lower than what get from investing a lump sum. At first, this may not look consistent with my previous post on The Golden Rule... of Investing: Buy Low, Sell High, but let's take a look at an example to see how you can benefit from this strategy.
Assume you invest $100 every month for five months into a given stock. The stock price at each of these purchase dates is as follows (with the number of shares purchased):
Jan.: $20 (5 shares purchased)
Feb.: $14 (7.1 shares)
Mar.: $13 (7.7 shares)
Apr.: $15 (6.7 shares)
May: $23 (4.3 shares)
Total: $85 (30.8 shares)
The $500 invested purchased 30.8 shares, resulting in a cost per share of about $16.23. This means that when the stock price is above $16.23, there is a gain on the investments.
But what if the May stock price was still down around $15 as it was in April; what are the results then?
Total: $77 (33.2 shares purchased)
The $500 invested purchased 33.2 shares, resulting in a cost per share of about $15.06. A gain would exist when the stock price is above $15.06. The May price is not above that price so there is no gain until the stock increases.
So what do we learn from these examples? That Dollar Cost Averaging is not necessarily going to give you better returns; it completely depends on the stock performance over the given period. So does that mean I should just invest the $500 all at once? Well, if you did that in Jan. in the example, you would be even worse off since your cost per share would be $20 instead of $16.23 or $15.06. If you invested the $500 in Feb. you would be better off with only a $14 cost per share. Since we don't know how a stock or mutual fund will perform, investing continuously over a period diversifies away much of the market risk (the risk of market fluctuations). Also, most individuals do not have enough money to make a single investment now to carry them through to retirement, but rather have smaller amounts set aside each month as income is received. Another way to take advantage of continuous investing is by reinvesting dividends rather than having them paid out. This can be done automatically by your financial institution or brokerage.
Beginning in 2010, the IRS is allowing everyone to convert a traditional IRA to a Roth IRA. (Refer to previous post to learn more about the IRA Basics.) Prior to 2010, only taxpayers with a modified adjusted gross income (MAGI) that was not more than $100K could make the conversion. The main reason to make the conversion is to gain the tax advantages of a Roth IRA, which is tax-free growth and tax-free distributions. The catch to making the conversion is that the IRS requires you to pay tax on the amount you pull out of the traditional IRA that would have been taxed had it been taken out as a normal distribution from the IRA account. That means that the growth or earnings in your traditional IRA account is included in gross income for the year in which you convert it to a Roth IRA. For 2010 only, the IRS is allowing that amount to be split evenly and included in your 2011and 2012 gross income. The benefit here is that you can spread out the taxes you have to pay for the conversion over 2 years rather than only in the year of the conversion. Even with the IRS allowing you to soften the tax blow when converting to a Roth IRA this year, make sure that you have the money to be able to pay these taxes before deciding to make the conversion. The bottom line is that you pay the taxes now rather than later.
There are also estate tax impacts to converting a traditional IRA to a Roth IRA. If your estate is large enough to incur estate taxes, both traditional IRA and Roth IRA assets will be taxed at the estate tax rate. Once the beneficiary has received the assets, distributions from IRA accounts are still taxed according to their taxable nature. In other words, distributions from a traditional IRA are taxed and distributions from a Roth IRA are tax-free. This results in double-taxation of the traditional IRA. Yet another benefit to a Roth IRA. If you have the cash to pay the tax on the IRA conversion, your beneficiaries may thank you for making that conversion. The bottom line here is that you pay the taxes now rather than your beneficiaries paying the tax later.
It sounds intuitive if you want to make money in the stock market, or anywhere else for that matter: buy low and sell high. The difference is your gain (or loss) on that investment. Even though it sounds intuitive, people often do not take advantage of the opportunity. The typical reaction to a slower economy is to sell stocks before the losses get any worse. This may be a good rule of thumb to avoid further losses if you are nearing retirement or are depending on that money in the near future, but what about long-term investors? This presents a great buying opportunity. The recent recession is obvious when looking at the Dow Jones Industrial Average over the past five years. Investing at the market low in March of 2009, would have resulted in some pretty hefty gains as of today. People often choose to stay away from riskier stock investments during a slow economy due to their volatility, but for the long-term investor, that can be the opportune moment to invest.
Most employers offer a matching contribution to a 401(k) account up to a certain percentage of your gross salary. Whether it is a dollar for dollar match or a 50% match (i.e. $0.50 contributed for each $1.00 you contribute), that is money ready to be handed out to you simply for setting aside money for retirement. And that is something that you should be doing anyway. Bloomberg reports that 91% of 401(k) participants belong to a plan that offers a match. Make sure you are enrolled in your employer's 401(k) matching program and increase your contribution percentage to the maximum matched by your employer. The earlier you start saving, the more you will have for retirement.
A few tips to keep in mind if you're trying to improve your credit score.
An IRA is an Individual Retirement Account. An IRA can be referred to as an investment vehicle. If you think of an individual stock, bond, or mutual fund as a passenger, an IRA is the automobile that the passenger rides in. You can choose from a wide variety of investments to ride in an IRA vehicle. The primary advantage of IRAs is the tax savings typically associated with them. Different IRAs have different tax advantages and are often used as the primary vehicle for investing for retirement.There are four different types of IRAs:
Distributions are also governed by rules and exceptions to those rules. Distributions are subject to your current income tax rate and are also subject to a 10% penalty if withdrawn before reaching the age of 59 1/2.
A 401(k) account can also be rolled over into a traditional IRA because the tax treatment is the same (tax deducted at the time of contribution and paid at the time of distribution).
2. Roth IRA: A Roth IRA is a similar vehicle to a traditional IRA with the same combined contribution limit of $5,000, as noted above, or $6,000 if you are 50 years of age or older. Contributions are also subject to the same AGI limitations. The primary difference is the tax treatment as contributions are not tax deductible. The tax advantage, though, is that the distributions received from a Roth IRA, as well as any gains those contributions earn, are not taxable. The taxes are paid in the year of the contribution (because it is not tax deductible) rather than in the year of the distribution, as is the case with a traditional IRA. Even though you miss out on the tax deduction, you may pay less tax on the contribution than you would on the distribution if you are in a higher tax bracket at the time of the distribution. I personally like the tax advantages of a Roth IRA and knowing that the earnings growth and distributions are tax-free.
Distributions are also subject to a penalty of 10% if taken before reaching age 59 1/2 or if withdrawn within five years of opening the Roth IRA.
3. SEP IRA: A Simplified Employee Pension (SEP) IRA is an employer established and funded SIMPLE IRA and is often used by small business employers in place of a 401(k). Employers can contribute directly to employees’ traditional IRA accounts, or sole proprietors can contribute for their own benefit. The tax advantages and early distribution penalties are the same as a traditional IRA.
4. SIMPLE IRA: Savings Incentive Match Plan for Employees (SIMPLE) IRAs are retirement plans sponsored and administered by employers, which allow employers to contribute up to $11,500 (limit for 2010). These can also be used for sole proprietor's benefit. The tax advantages and early distribution penalties are the same as a traditional IRA. The penalty becomes 25% if the distribution is within two years of first participating in the SIMPLE IRA plan.
As noted, these are the basics for understanding IRAs as an investment vehicle for retirement. The IRS regulations regarding IRAs are considerably more extensive but mostly apply to special circumstances and exceptions to the general rules. These basics can assist in finding the right retirement account for you.
Avoiding debt is possible but not always realistic when it comes to purchasing a house. The key then becomes ensuring that the debt you do incur is manageable based on your income. In order to keep any debt incurred as low as possible, you need the interest rate as low as possible. That is where your credit comes into play: the better the credit, the lower the interest rate you can get.
The first step in keeping your credit clean is knowing what your credit looks like. Everyone is entitled to a free credit report each year. Visit AnnualCreditReport.com or Credit.com to sign up for a free credit report. You will not receive your actual FICO score, but you will receive a comprehensive look at your credit history. To find out your FICO score, you can pay for that at MyFICO.com for about $15. Some of these sites also provide some advice on how to improve your credit from where it currently stands.
The primary way to ensure you have good credit is to pay off your debt on time. If you use a credit card, pay the full monthly balance before the due date each month. If you have a mortgage, make sure your monthly payments are made on time for the full amount. If you have a large purchase or payout to make coming up, use a budgeting strategy to save for it rather than borrowing more money for it. Excessive debt will hurt your credit rating as well as your financial foundation. The same strategies that can be used to pay down your debt will also help you increase your credit rating and, in turn, strengthen your financial foundation.
The key to building a reserve is obviously not to spend it. There are many reasons to build a reserve including emergencies, education for you and/or your children, retirement, or other large purchases. The bigger the reserve for each of these purposes, the more likely you'll be able to avoid debt when they come around. Although, you can't exactly go into debt to build your retirement fund as you may be able to with other situations.
The most important reserve to start is a cash reserve. Your reserve for unexpected emergencies requiring cash payout needs to be in liquid investments. That means it could be in the form of cash itself, a checking or savings account where it can be withdrawn quickly, or even a money market account. With each of these, the interest earned increases ever so slightly. Cash in your house will earn nothing, while cash invested in a money market account may earn dividends slightly larger than what you may get from a savings account at a bank or credit union. All of these locations are liquid and allow you to access the cash when it is needed. My rule of thumb is to keep enough cash in these locations to live off of for at least 3 to 6 months if you were to have no income. The amount will differ for everyone based on their spending habits. This will allow 3 to 6 months to find another source of income, most commonly to replace a lost job, or provide for a large unexpected payout without other consequences.
Having enough cash on hand will bring greater peace of mind, knowing that when the unexpected comes along you will have enough cash to get by without falling into a more difficult situation.
Struggling financially can be very painful whether you are a child wishing for enough money to purchase a new toy or an adult with greater financial responsibility. Understanding the basic principles of family finances can help overcome such pain and frustration, so it is key to teach others the primary principles laid out in #1-4.
Children can especially be taught at a young age how to be responsible for their own money. As they grow and gain more responsibility, they will also gain more money and need to know how to handle it in a way that they don't regret. As children learn to work, they will also learn the value of the rewards that come from the effort put forth. An incentive for children to save their money rather than spending it all is found in helping them understand how their money grows by earning interest. Parents may even consider an additional incentive by matching a percentage of what the child sets aside for savings similar to an employer 401(k) match. This requires some sacrifice by the child (saving money rather than spending it) for a greater good (to build greater wealth in the future). This way, parents have something to reward the child for (setting aside savings) rather than giving out an allowance for nothing.
As you help your children and others around you become more financially responsible, you may actually find it easier to be more financially responsible yourself. That, in the end, will lead to a strong financial foundation.