Joe's Money

It’s odd.  Every financial adviser I’ve ever encountered swears up and down that their actively managed fund will out perform index funds hands down.  However, statistics show otherwise.  Statistics show that index funds out perform managed funds 80% of the time.  On top of that, of the 20% of managed funds that do out perform the index funds, how is one supposed to know which managed funds, or more importantly, WHEN the managed funds will be in that top 20%.

Lets take a quick look at the differences between actively managed funds and index funds.

Actively Managed Funds

The name is pretty obvious with actively managed funds.  It simply means that there is an individual or group of individuals that watch your funds.  They buy and sell based on their professional expertise.  Expenses are typically much higher than index funds because someone is actually “watching” your money.  Fees can be 1.5% or even higher.

Index Funds

Index funds are simple.  Index funds have literally a spread of all stocks on the market.  A little of this, a little of that.  Index funds do not have anyone watching your money.  As the market fluctuates as a whole, so do these funds.  They are bench marked against some of the biggest indexes like the DOW, S&P 500, Nasdaq, and many more.  Fees for these funds can be as low as .02%.

After reading the difference of the two types of funds, you’re probably thinking you’ve got to be kidding me!  I can let this run on auto-pilot and do better than the professionals?  The short answer is yes, or at least 80% of the time.  Remember that even though 20% do out perform the index funds, it is nearly impossible to tell which funds will, and even more difficult, when they will.  Heck, even if you do win, the margin of difference is usually so low the fees eat up the rest of superior gains.

In a nutshell, stick to index funds for the long term.  These funds are available in any style, conservative, moderate, aggressive, you name it.  Keep in mind, you will be investing for 20, 30, or more years.  Stick with your plan.

Stocks are simply a piece of ownership in a company.  While usually not a very big chunk of ownership, you can own a piece of any publicly traded company for a small price.

Companies generally start out as private companies, mom and pop if you will, but on a larger scale of course.  At this phase, most investors (Average Joe’s) cannot buy into the company via a stock.  When the mom and pop company starts to grow and needs more capital (Cash!) to increase production or open more stores, they offer an IPO.  An IPO is an “Initial Public Offering.”  This is the first time a stock will be available for the company in question.

So why buy a stock?  Stocks, in general, are the fastest way to grow your investment.  In simple terms, if the company you own the stock in is doing well, the price of the stock goes up.  Of course there are many factors that go into the price being driven up or down.  The current state of the economy, expected future growth or shrinkage, industry trends, etc.  Over the stock market’s history, the average return is 11%.  Keep in mind that is over a very long period of time.  The last year or so has shown us that this is not constant and you should be prepared at any time for extreme losses if you are in higher risk stocks/mutual funds.

Ok, ok.  So this is probably the most worn out topic ever.  However, based on recent survey data, only about a third of the workforce that is offered a 401k, are enrolled and contributing to it.  This is a ridiculous statistic considering the average company match is 4%.  Think of it this way, if your boss asked you if you would like a 4% raise, would you take it?  I sure hope so.  If not close this web page, there is no hope for you.  All kidding aside, take a look at the numbers below to see how much FREE money you are missing.

The calculation is easy.  Take your earnings, before tax (Gross) and multiply it by the employer match.

Ex.  Current salary is $36,000 per year with a 5% employer match.

$36,000 * .05 (The employer 5% match) = $1800.  The total contribution is simply the employer match * 2.  The other half is what you need to contribute.  Hence the employer “match.”  So for this example, the total is $3600 per year total contribution.  Remember, this is FREE money.  All you have to do is contribute your portion first.

What investments does my 401k use?

Most 401k plans consist of mutual funds that target different objectives.  Most plans offer a little something for everyone.  Some funds are more conservative while others are much more aggressive.  The mutual funds offered are typically stock funds, bond funds, target funds, index funds, real estate funds, and more.

Stay tuned for more on how you can determine your risk tolerance and other factors on determining what funds you should invest in.

Another piece of recommended reading.  Rich Dad Poor Dad is a book about about the upbringing of a child with two father figures.  One, a well educated man, the other, uneducated.

The book compares the teachings of both men.  The book demonstrates how they both attempted to climb the financial latter and how they succeeded.

Definitely a good read, the book can be purchased for only $9.90 new on Amazon.  Otherwise, used copies start at $.01 + shipping.

The financial crisis hit individuals at all career levels.  The average 401k balance fell 30% to $45,500 from about $65,000.

The good news is, the recent rally has driven account balances back up to near pre-crisis balances.

The 401k hits affected everyone differently.  A 20 something that just started his of her career isn’t going ot be affected as much as someone nearing the retirement age.  Many people nearing retirement age didn’t have much focus on their retirement savings and never realocated to lower rusk securities.  This lack of action likely prevented many people from retiring as it was too late to correct the damage.

It also affected people in the middle age group.  Most of this group was also weighted heavily in stocks within their 401ks.

Unfortunately, many 401k contributors either lowered or stopped contributing all together when the markets started to drop.  While this seems like a good plan, generally 401k participants who continue to contribute at the same levels through down turns, make out better in the long run.  This is because you are able to but at a lower cost.  You get more shares for your money.  Over the last 100+ years, the market has made an average 11% return.  Based on statics, you can bet your accounts will grow again.  When you continue to contribute through a recession, your cost average per share goes down.  Example below.

You buy 100 shares of a stock or mutual fund for $10 each for a total of $1000.

You then buy another 100 shares or the same stock or mutual fund when the market is down.  Say the price is now $5 per share, or $500 total.

Your cost average is is now $7.50 per share.

Assuming the stock or mutual fund price continues to rise to say, $20 per share, you would have actually made more money on your investment by sticking in through the down trend.

Keep in mind that accounts like 401k are long term investment vehicles, usually 30 years or more.  Don’t let emotions drive your long term investment goals.  Stick with the facts.  The market on average, returns 11% per year.

Roth IRAs are great ways to save for retirement.  While your contributions are after tax money, they grow tax free, even when you withdrawal during retirement.

This the 2009 tax year, you can contribute up to $5,000 in your Roth IRA.  The greatest advantage of the Roth IRA is all gains are tax free.  You have complete tax free growth.  The only downside is, again, you contributions are your money after it has been taxed.  The contributions are not tax exempt like your 401k.

Since the Roth uses after tax dollars for contributions, this helps you diversify your portfolio since your 401k will be taxed upon withdrawal.  Since there is no way to tell what tax rates will be like when you retire, having both a 401k and a Roth IRA gives you the best of both worlds.

One of the other benefits of a Roth IRA is you do not need to distribute your account once you reach 70 1/2 years old.  The account can continue to grow if you don’t have a need to withdrawal the funds.  So in a nut shell, you can keep your money in the tax free growth account as long as you like.

With Roth IRAs, you can also withdrawal funds without penalty, but only your contributions apply.  Only gains are penalized for early withdrawal.  Also, the funds must be held for 5 years to be eligible for withdrawal.  Example:  You contribute $3,000 to your Roth IRA that grows to $3,500.  You can withdrawal up to $3,000 (You contribution) without penalty at any time, after 5 years have past.

Roth IRAs do have some eligibility requirements though.  In order to be eligible, your adjusted gross income must not exceed $105,000 and for married couples $166,000.

For 2009, the maximum IRA contribution is $5,000 unless you are over age 50.  If you are over age 50, you qualify for contributions of up to $6,000.

Well, it turns out no matter what income bracket you’re in, you probably still broke with negative net worth.

This book was a real eye opener for me.  It describes the perception and the reality of millionaires and how they got their millionaire status.  The truth is, the average millionaire is not driving a $100,000 sports car, or even a new car for that matter.  The folks driving the $100,0000 sports cars are usually just as worse off financially as the person making $8/hour if not worse.  They make more they spend more.  The doctors and lawyers may be book smart, but according to the author, they are decades behind on financial literacy.

Check it out, this is a good, inexpensive read!  Enjoy!

Link to purchase book – Used copies starting at only $.50

Certificates of deposit are sold by banks.  They are more widely known as CDs.  Typically, CDs are low risk but generally low returns.  CDs are great for keeping cash in a safe place where you won’t need it for months or years.  CDs carry a commitment.  You cannot withdraw the funs for a predetermined amount of time.  The duration varies quite a bit, anywhere from short term one month CDs up to 5 years is common.  Usually the longer the time frame required, the higher the interest is.  Unfortunately, if early withdraw is required, a penalty will likely be assessed.  All gains from CD accounts (unless in a IRA) are taxable.

CDs are very safe investments, about as safe as they get, in fact.  CDs are FDIC insured providing your bank is FDIC insured.  The predetermined rate the bank gives you is guaranteed.  If rates slide while you are in the CD, you are locked in at the original rate.  On the contrary, the same is true if rates rise.

Some common CD types are:

Traditional CD:  A predetermined interest rate is paid over the predetermined term, or length of time.  When the term is up, you can remove all funds plus interest or renew the CD at most current rate.

Bump Up CD:  Basically, these are the same as traditional CDs.  The only difference is you are allowed to contribute additional funds usually once, in addition to the opening amount.

Liquid CD:  This type of CD account allows you to withdraw funds before the maturity date.  Since you have more freedom, it comes with a cost, a lower interest rate.  The rate will still be higher than a typical money market account though.

In addition, most of the above accounts are available at your local branch or online.  I have found that online accounts usually have much better rates than local banks.

CDs are great investments.  For people nearing retirement, they are ideal due to their security.  CDs are guaranteed and will never lose money.  CDs can also be used for your emergency funds as well.  Simply pick a shorter term.  If needed, you can withdraw funds early, but the penalty will be assessed.  The penalty is usually a few months interest.  However, since this is your emergency fund and it should only be used for true emergencies, hopefully the interest has paid you far more than you will lose for early withdraw.

I hear a case of living beyond your means just about daily.  The entitlement factor in this country is unreal.  You need to get realistic and buckle down your finances.

Unfortunately, most people in our society have been brought up to live beyond their means.  We are surrounded by images and videos of people living extra large lifestyles that are simply out of reason for most.  Growing up with the constant barrage of the rich and famous, has created a society that not only thinks they need this lifestyle, but think they are entitled to it.

When growing up, most teenagers spend their parents money.  Unless they are working, they are likely spending their money on frivolous things like fancy clothes and electronics.  According to statistics, only about 42% of high schoolers find paid employment.  According to the statistics, less than 50% of teens are working, so their parents are funding their popularity contest.  They are simply keeping up with the teenage Jones’s.

Unfortunately, this upbringing sets the teenagers up for failure later in life.  They are taught that at no matter what expense, they must appear to be keeping up.  This is proven by their average credit card debt of over $5,000 for age groups 25-34 year olds.  Had they been taught the value of the dollar at a younger age, perhaps the frivolous spending would have stopped.

The worst part of this ridiculous spending spree is, that age is not a factor.  The statistics are similar for just about all ages.  Many books state the same.  The more you make, the more you simply spend.  Doctors, lawyers, and the like are all chasing their tails with the fast food burger flippers just on a different scale.  If you earn $20,000 per year, maybe you spend $10,000 on keeping up with the Jones items.  If you’re making $100,000 per year, your simply spending $50,000 on most expensive Jones items.

I don’t know the Jones’.

Many people have the ability to carry the perception of being well off for long periods of time.  However, eventually, the jokes on them.  The charade is over and all that is left is the consequences of leading this type of lifestyle.  The result is usually a lifetime of debt.  I like to refer to this as chasing your tail.  You can chase it all you want, but your never going to catch it.

What you need to realize is, you need to stop buying items you don’t need on credit.  If you don’t have the cash, DON’T BUY IT.  Its that simple.  You need to learn to sacrifice for the better long term goals.  Take a serious look at your spending. Tell yourself, you don’t know the Jones’.

Here are a couple of quick tips

1.  Learn to budget and search for bargains.  If you can’t pay cash, don’t buy it.
2.  Do not give children credit cards.  They do not have the financial foundation to handle them.
3.  If you have credit card debt, call your provider to negotiate a lower rate.
4.  Pay off small balances first, then tackle the larger ones.  Remember, always pay at least the minimum though.
5.  Once you’re out of debt, don’t go chasing your tail again, stay out of debt!

I am confident that we can agree that simply put, you must spend less than you make to build wealth.  Whether rich, poor, or somewhere in between, if you often spend more than you make, you will never accumulate wealth.  Although this concept may be equally as important as some of the things listed below, it is not the number one reason people fail to build wealth over their lifetimes.

Reason No. 9:  Procrastination

Many people fail to invest in their own financial future until it’s too late.  While you are young, you have a excellent opportunity and a definite advantage over the older folks because you have time.  The reasons behind not starting young vary quite a bit and are wide ranging.  Also, age seems to have an effect on why you fail to save.  While young, people in their twenties are just entering the workforce and tend to indulge themselves with the hottest trends, electronics, cars, etc.  Once you hit your thirties, maybe a young family is preventing you from putting away as much money as you would like.  At this point you may be living check to check and this is where debt problems stem.  Forties hit and you may have children in college or unforeseen medical expenses.  By the time you hit your late fifties, it is already probably too late.  Compound interest no longer has time to grow as much as it would have had you saved earlier.

Reason No. 8: Lack of Discipline

Most people find it difficult to save because they constantly buy, and very seldom, save.  It is much easier to say yes to your impulses.  Those who are able to say no, are going to have a much easier time building wealth.  Most are lead by advertising and the ease of being able to swipe a credit card.  The “I don’t need to pay for it now” ideas kick in.  Worry about it now, not later.  Until you find the power to say no, you will never get ahead.  Stop trying to keep up with the Jones’.

Reason No. 7:  Inadequate Protection Against Unexpected Expenses

Life unfortunately throws a lot of curve balls at us throughout the years.  May it be a water heater, car repair, or medical expense, these can all put a damper on your financial well being, and quickly.  Implement an emergency fund to cover these unexpected expenses so you don’t fall back on using credit.

Reason No. 6:  Poor Debt Management – Borrowing too Much

Lack of patience can cause you to turn to credit to get what you want NOW.  Again, learning to say no now, will save you tons of money in interest payments as well as buying items you may not have really wanted to begin with.  When using credit, unless you can afford to pay the item off in full at the end of the month, the item can end up costing much more than the original sticker price.

Reason No. 5:  Failing to Adjust How You Live

When people are used to a certain lifestyle or are used to spending, it is very hard to break the trend.  Try to find a way to break the routine. Otherwise, you will never change, and never seek the financial freedom you were looking for.  Don’t be afraid to try something new.

Reason No. 4:  Lack of Foresight

Winners have the ability to look beyond the immediate and into the future.  Although some may see your visions as dreams, don’t forget you need to have a vision to make your dreams come true.  You are not going to win the lottery.  Set a goal and create a path to help you get there.  Look into the future, find what you want, and plan how you will get there.

Reason No. 3:  Using Time Poorly

You’ve heard it a million times, time is money.  You have a choice to spend your time on watching TV all day or taking a look at how you will finance your future.  No one is going to knock on your door and give you the magic formula needed to plan for yourself.  Once time has been wasted, it’s gone.  Use it to your advantage.  Plan what you desire.

Reason No. 2:  Failure to Plan

My old man said it best, if you fail to plan, you plan to fail.  It couldn’t hold more true.  If you don’t plan what you want, you have essentially removed all hope of ever getting where you want to be.  According to polls, only 5% of people plan and only 2$ have their plans written down. Planning and writing your goals down can be a great motivator.  Everyday when you get up and look at your goals, you are setting the mindset that the reward is later and you can and will stick to the plan.  If you don’t have a plan or goals, how can you succeed?

Reason No. 1:  Lack of Knowledge

This should actually read lack of willingness to gain knowledge.  Most people give up after reading one thing they don’t quite understand.  Make an effort to read more about financial literacy.  This subject can be found in countless books and online websites.  The knowledge is there for the taking.  It is up to YOU to take in and process it.  This will help you find what is best for you.  No one, including financial advisors, have a better picture of your financial future than you.  Turn off the tube and read a book.

Stop living paycheck to paycheck.
Stop blaming your financial problems on anyone and everything besides you.
You are the only one that can control your future.
Find motivation to plan the rest of your life and stop living like a sucker!