Archives for June 9, 2019

Making smart financial decisions can often seem like a catch-22. You know you should be saving for retirement, but it’s difficult to save when you’re loaded with debt. But put your limited cash toward debt, and you’re missing out on valuable time to save for retirement.

Saving for retirement and paying off debt are both important financial priorities, but there’s no straightforward answer as to which one is more important. As with most financial decisions, it depends on the situation.

Sometimes, it’s best to pay off the more expensive types of debt first, because you may be paying more in interest than you’re earning on your investments. Other times, it’s smarter to put more toward retirement and continue making minimum payments on debt, even if it takes longer to pay it off. The solution that’s right for you will depend on several factors, so it’s important to look at the big picture to determine which option will have the best long-term results.

When to prioritize debt over saving

Not all debt is created equal, and some types are more harmful than others. High-interest debt, such as credit card debt, can be incredibly toxic. Even if you’re consistently making minimum payments, because the interest rates are so high, your balance may simply grow the longer it takes to pay the debt down. Even relatively small balances can take years to pay off (not to mention rack up hundreds or thousands of dollars in interest payments), and taking your time paying off this type of debt can sometimes do more harm than good.

For example, if you have thousands of dollars in credit card debt and you’re paying an interest rate of 18%, putting money into a retirement account earning a 7% rate of return may not be as beneficial as it seems. If you’re paying more in interest than you’re earning on your savings, you’re not actually coming out ahead financially.

That said, if you have a 401(k) that offers employer matching contributions, it’s a good idea to contribute enough to your retirement fund to earn the full match, regardless of how much debt you have. Those matching contributions are essentially free money and can potentially double your savings, so take advantage of them.

Focusing on your higher-interest debt first is also smart if your retirement fund is relatively healthy. While it’s never a bad idea to save consistently, if you have a strong nest egg, you may be able to afford to press pause on saving just long enough to pay off your high-interest debt. 

When to prioritize saving over debt

Lower-interest types of debt such as a mortgage or student loans aren’t as harmful or expensive, so it’s not as critical to pay those off as soon as possible. Although you’ll still need to make the minimum payments on all your debts, aim to save the rest of your money for retirement. 

Saving for retirement sooner rather than later has one key benefit: Your savings grow much faster when you start early, thanks to compound interest. For example, say you have a goal of saving $500,000 by age 65. If you start saving at age 25, you’d need to save just over $200 per month to reach that goal, assuming you’re seeing a 7% annual rate of return on your investments. But if you were to wait until age 35 to start saving, you’d need to save around $450 per month to reach that same goal.

By taking a time-out to focus on debt, you’re missing out on your most valuable asset: time. If you focus on paying off less-expensive debts before saving for retirement, it’s only going to be more difficult to catch up on your savings down the road.

Saving for retirement should typically be your primary financial goal, unless you’re saddled with thousands of dollars in high-interest debt that’s racking up interest by the day. If that’s the case, pay off your most expensive debt as quickly as you can, then devote the rest of your savings toward retirement.

Balancing retirement and debt

Ideally, you should aim to save for retirement and tackle your debt at the same time. It may take a little longer to pay down your debts if you’re devoting some of your savings to retirement, but it will also be easier to establish a strong retirement fund if you’re saving consistently.

If you’re struggling with high-interest credit card debt, one way to ease the burden is to take advantage of balance transfer cards. The best balance transfer cards allow you to shift your credit card balance to a new card with a 0% APR introductory period of up to 21 months. In other words, you can convert your existing debt into interest-free debt for a set period of time. This allows you to chip away at your debt quickly and potentially save thousands of dollars in interest.

At the same time, try to sock away at least a little for retirement. Saving even a small amount each month is better than nothing, and if you can take advantage of employer matching 401(k) contributions, you’ll be in even better shape.

Money management can be challenging sometimes, especially when you have competing financial priorities with only so much cash to go around. By being strategic about which priority you tackle first, though, you can potentially save money and set yourself up for long-term financial success.

The decadelong bull market in stocks has helped increase the number of millionaire households in the U.S. to nearly 7.7 million, or about 6.2 percent of total U.S. households.

That means they hold $1 million or more in investable assets, excluding the value of real estate, employer-sponsored retirement plans and business partnerships.

No doubt some of those millionaires hit the jackpot in a hot stock or two.

But too many investors over the years have learned that you can easily go bust investing in what you think is the “next big thing.”

A more reliable way to amass an investing fortune is to follow a few tried-and-true rules for building a healthy portfolio. Among them:

Start early: Time and compounding interest are an investor’s best friends. Assuming an 8 percent annualized return on his or her portfolio, a 20-year-old could amass $1 million by age 67 by investing a little over $2,000 a year.

A 40-year-old earning the same return could invest $10,000 a year and still wouldn’t crack a million by retirement age.

Cut costs: You can’t control how your investments will perform, but you can control what you pay for them.

Over the course of decades, paying a fraction of a percentage point more in fees can chisel thousands from the value you end up with. Assess your portfolio and jettison expensive mutual funds in favor of cheaper options.

Vanguard Total Stock Market ETF (symbol VTI), a member of the Kiplinger ETF 20, the list of our favorite exchange-traded funds, tracks the performance of the entire U.S. stock market and charges just 0.04 percent of assets.

Diversify: Don’t put all your (nest) eggs in one basket. Spreading your assets among different types of investments increases your portfolio’s chances of withstanding sharp drops in one corner of the market or another.

Owning a mix of stocks, bonds and cash may cause your portfolio to lag when stocks are going gangbusters, but you’ll hold up better when stocks slide.

When Standard & Poor’s 500-stock index plummeted 37 percent in 2008, the average balanced mutual fund with 50 percent to 70 percent of assets in stocks and the rest in bonds and cash surrendered only 27.5 percent. A good choice is Vanguard Wellington (VWELX), one of Kiplinger’s favorite actively managed funds.

Focus on dividends: Those quarterly payouts count. From 1930 through the end of 2017, reinvested dividends contributed 42 percent, on average, to the total return of the S&P 500.

To boost your exposure to dividend-paying stocks, consider Kiplinger ETF 20 member Schwab U.S. Dividend Equity (SCHD), which yields 3.1 percent.

Throughout my career I’ve learned a lot about the financial world. I came to find out that there are many things which are upheld as “sacred cows” of finance, that typically underperform and are overhyped, but at their worst can be detrimental.

And so when compound interest comes up and most people tout its benefits, I’m inclined to disagree. In fact, I’ve become convinced it is slow, dangerous, dogmatic and overall, well- compound interest mostly sucks.

What is this heresy? The financial pundits herald compound interest as this ingeniously wonderful thing, and many of us just accept that it is some sort of money-making miracle. Well, let me kill this sacred cow for you and save you both time and money through a safer and faster alternative way to wealth. 

Let’s identifying 5 problems that illuminate the errors and detriments of compound interest-

It Neglects Cash Flow

Compound interest usually has people over-emphasize net worth. We’re taught “good things come to those who wait”, and so people wait for 30 years. We are trained, taught and educated to dollar cost average by putting money away every month regardless of performance. We are told that in the “long haul” we will buy at an average rate and the market will go up and down, but will ultimately trend upward over time. Are you reading this article to be average or get an average rate? There is a difference between average and actual first of all. If you invest 100,000 and lose 10 percent in the first year, you have 90,000 dollars.  If you gain 10 percent in the second year, you are now back at a 0 percent average return, but you are only at 99,000 dollars before expenses, plus you lost time value of money. When you invest for cash flow, you can measure success month-to-month along the way. No more shirking responsibility in the name of “one day, someday”- but benefitting from it now.

High Risk Doesn’t Equal High Return

Compound interest is fueled by better returns. Wall-street is constantly selling the idea of taking on more risk in hopes of a higher return. But what is the definition of risk? Chance of loss. How by increasing your chance of loss and waiting longer are you assured of more wealth? This faulty notion continually promotes taking more risks than necessary in the name of aggressive, opportunistic returns that invite volatility.

As an entrepreneur you take risk in your business. But you have control to make changes anytime, to stop funding projects or marketing campaigns and learn from your mistakes. Why not consider creating personal wealth with your business by using more risk-free capital. Investing while protecting the downside, creating cash flow along the way, and creating economic independence rather than waiting thirty years for compound interest to do its job.

Fluctuating Tax

We’re actually historically low with taxes right now, but there was a long period- from 1944 to 1981- where the top tax bracket was over 50%. If you are using tax deferred accounts to compound your interest, you may end up paying more tax during the distribution phase. With the government over 23 trillion in debt, what are the chances taxes could go up in the future? This can be especially problematic if you sell you business and lose one of your greatest resources for legally reducing taxes. Plus, when you are on a fixed income in retirement, living off just your interest, especially in a retirement plan that hasn’t been taxed yet, this could really diminish and invade your cash flow.

By maximizing your tax advantages today and building cash flow along the way, you have more control and options in a changing environment. You might pay tax on some of the money along the way now, but at today’s rate instead of a potentially higher rate in the future. Oh, and that myth that you can live off less money in the future, inflation alone is proving that philosophy wrong. One thing I have discovered is that a luxury becomes a necessity. Do you really want to have less money in the future in the name of saving on tax?

Inflation and Changing Interest Rates

Low interest rates are one of the most dangerous components when it comes to compound interest. People that have saved a million dollars or more for retirement are not living the life of luxury. It has been an amazing environment for those business owners that want to secure funding through loans. Interest rates have remained low for a few decades. But for those that have saved for retirement, fixed income interest rates have been astonishingly low. Creating plenty of net worth that hasn’t equated to much cash flow. One million dollars may be providing 40,000 dollars or less, taxable.

And the truth is we have no idea what we’ll actually need to save to provide the income we want. Our money is being devalued through inflation at this very moment. And what we feel might be a good target, we find out years later isn’t going to allow us to live the lifestyle we may have hoped or planned on, because now we have to have more money. And if interest rates are low, it’s harder to have that become cash flow.

The solution? Invest in your business. Turn your non-cash flowing assets into a powerful stream of income. Save on tax, interest, and insurance. Eliminate non-performing investment fees and protect the downside with all your investments. Look to be more efficient with your money and scale your business to create compounding you can count on.

It Takes Time…A Long Time

How long are you willing to wait? Because compound interest doesn’t work well over 10 years, and it isn’t even that good over 20. Where compound interest really gets the kind of exponential growth is around 30 years. Compound interest makes you wait for so long that you don’t even know how if it’s working. Much of that time entrepreneurs are taking money from their business by scrimping, sacrificing, saving, and setting money aside to invest in the stock market that they don’t know or control. This is done with the rationale of once “you get there” and retire, you are supposed to have a “nest egg”. But why not invest that money into your current endeavors and ventures so you don’t have to wait until retirement to build more cash flow and equity in what you know- your business?

Compound Interest Equals Compound Cost

When compound interest does work over long periods of time, it is halted when there are costs that create drag and slow down progress. You may be paying admin and legal fees for a retirement plan or expense ratios and 12B-1 fees to market the funds you bought (yep, you pay those). Small percentages create compound costs.

Those are just a few problems with compound interest that can be solved with an alternative method to investing- your business, cash flow, and not being solely focused on net worth.

Compound interest has masterfully disconnected to the outcome of their income by teaching them to buy, hold and pray it works out 30 years from now.

Scrimping, saving, and just hoping compound interest will do the work has been a failed financial experiment. Think ‘win then play’ by making money on the buy, create cash flow from the very moment you invest, and look for ways to benefit from your wealth today and in the future.

So you’ve decided that consolidation is your best bet for getting a handle on your debt. Consolidating via a personal loan could mean you’ll pay off high-interest debts, simplify your payments and reduce your debt more quickly.

Here are five steps for getting a personal loan for debt consolidation, from checking your credit to closing the loan.

1. Check your credit

A bad credit score (300 to 629 on the FICO scale) may not disqualify you for all loans, but consumers with good to excellent credit scores (690 to 850 FICO) are more likely to win approval and get a low interest rate.

Ideally, the new consolidation loan would have a lower rate than the combined interest rate on your current debts. A lower rate reduces the overall cost of your debt and shortens the repayment period.

If your credit score isn’t at a level to get you a lower rate, take some time to strengthen it. Here’s how:

• Catch up on late payments. Late payments are reported to credit bureaus at 30 days past due and can shave 100 or more points from your credit score. If you’re within the 30-day window, there’s still time to submit your payments.
• Check for errors. Errors on your credit report, such as payments applied to the wrong debts or accounts incorrectly marked as closed, could be hurting your score. Check your credit reports for free once a year at AnnualCreditReport.com, and if you find mistakes, dispute the errors.
• Repay small debts. Debts owed accounts for 30% of your credit score. See if you can pay down any high-interest credit cards before you consolidate. This also improves your debt-to-income ratio, which may help you get a lower rate on the consolidation loan.

2. List your debts and payments

Now make a list of the debts you want to consolidate. This may include credit cards, store cards, payday loans and other high-rate debts. You’ll want your loan proceeds to cover the sum of your debts.

Add up the amount you pay each month toward your debts, and check your budget for any spending adjustments you would need to make to continue debt repayments. The new loan should have a lower rate and a monthly payment that fits within your budget. Commit to a repayment plan with your budget in mind.

3. Compare loan options

It’s time to start shopping for a loan. Online lenders, credit unions and banks all provide personal loans for debt consolidation.

Online lenders cater to borrowers with all ranges of credit, although loans can be costly for those with bad credit. Most let you pre-qualify so you can compare personalized rates and terms, with no impact to your credit score.

Bank loans work best for those with good credit, and customers with an existing banking relationship may qualify for a rate discount.

Credit unions are nonprofit organizations that may offer lower rates to borrowers with bad credit. You must become a member to apply for a loan, and many credit union loans require a hard pull with your application, which can temporarily hurt your credit score.

Shop for lenders that offer direct payment to creditors, which simplifies the consolidation process. After the loan closes, the lender sends your loan proceeds to your creditors at no extra cost.

Other features to consider include: payments reported to credit bureaus (on-time payments can help your credit score); flexible payment options; and financial education and support.

4. Apply for a loan

Lenders will ask for several documents to complete the loan process, including proof of identity, proof of address and verification of income.

Make sure you read and understand the fine print of the loan before signing, including extra fees, prepayment penalties and whether payments are reported to credit bureaus.

If you don’t meet the lender’s requirements, consider adding a co-signer with good credit to your application. This can help you get a loan that you wouldn’t qualify for on your own.

5. Close the loan and make payments

Once you’ve been approved for a loan, the process is almost complete.

If the lender offers direct payment, it will disburse your loan proceeds among your creditors, paying off your old debts. Check your accounts for a zero balance or call each creditor to ensure the accounts are paid off.

If the lender does not pay your creditors, then you’ll repay each debt with the money that’s deposited to your bank account. Do this right away to avoid additional interest on your old debts and to eliminate the temptation to spend the loan money on something else.

Finally, within about 30 days, make your first payment toward your new consolidation loan.