Three Ways To Give Yourself A Break In 2106


'Tis the season to start with all of those self-improving resolutions. Aargh. If you're like me, you are still fighting off the sugar crash from an overdose of green and red frosted products and wondering if your house will ever look the same again after a trail of visiting family. So, I'm scrapping the financial resolutions and focusing on finding the easy path. Here are a few ways to put in less effort around your finances.

Open a spending account

That's right, a spending account. For years (generations?) wise people have been hammering away at us to have a savings account in which we diligently put 10% of our pay every week or two so that we can (somewhat magically) become tycoons in our old age. In actuality, it's pretty good advice. But there are two problems. For one, most of us would be hard pressed to reach tycoon status on our annual pay. And that fabulous .06% interest rate the banks are paying these days can make the savings process can be a little demoralizing in the short-term. Worse yet, it is really, really hard for a lot of us to find an "extra" 10% of our income.

If this sounds familiar, flip the advice on its head. Have your paychecks deposited into your regular account as usual. If you don't already, use online bill pay to have all of you fixed expenses paid automatically (that's your rent/mortgage, monthly subscriptions, health insurance premiums, car or transport payments, memberships and monthly credit card payments). Then put in one more automatic payment—a monthly amount that goes every pay period from your regular account to your new spending account. The spending account will be for anything you want to buy until the next pay check. Some of these are necessary expenses, like groceries. But all of the rest should be for fun stuff—entertainment, nights out, new clothes, gifts for friends, comic books, flowers—whatever makes your day better. And better yet, you can spend every dime of the money in that account. Because the amount you put in for auto-transfer to your spending account left a little extra that wasn't needed for the fixed expenses I mentioned earlier. That little extra just accumulates as savings in your account, growing a little more every week while you aren't looking.

The great thing about this system is that the savings happens without you paying any attention to it. And the spending account is just that—a license to buy whatever the heck you want to get between paychecks—guilt and mathematics-free.

It does happen, though, that we hit times when saving is just not possible. And that brings me to point #2...

The experts are a bunch of jerks

In the enthusiastic crusade to get us all to save for retirement, financial experts, banks, employers and nosy family members have bombarded us with frantic messages about how our failure to be "responsible" with our money will end in cat food and a home under a bridge. Unfortunately, all this advice tends to overlook the fact that in real life, people have good years and bad years. In good years, you really should be putting aside some money, whether it's for retirement, a new house, a new business or just a rainy day. But unless you are very fortunate (and probably had a little parental help with stuff early on), you are going to have some bad years, too. These are the years when medical crises hit, when you or another family finds yourselves between jobs, or maybe just when you are starting out and your paycheck is too crappy to cover much more than ramen noodles and bed in your parents' basement. That doesn't make you financially irresponsible. It just makes you busy with life.

So, ignore the stories about people who socked aways thousands of dollars by eating from trash bins after closing time. If you are that person, you don't need financial advice anyway, but you might look into a good health plan. Recognize that some years are savings years and some are spending years. If you are in one of those years, decrease the amount you are putting aside or eliminate the savings altogether. Measure your financial progress instead in terms of career growth, or personal growth, or just getting back on your feet. After all, those things are all just as important, if not more so, than building your retirement account. Now mark your calendar to check every 6 months to review your situation. When things are looking up financially, it's time to start the savings again, but feel free to start small. And until it is that time, give yourself a break.

Stop expecting to know everything

The whole point of this blog is to help people understand and feel more comfortable with financial issues. As a former professor, I love it when people decide to really dig in and teach themselves more about the financial world and their own investments. But it does take a lot of work and time. Financial questions involve rapidly changing tax regulations, new investment types, new investing laws and constantly renamed and re-jiggered products. That means that unless you are dedicating regular time to reading and research, it's going to be hard to keep up. And that's true even for people who are in related fields like law and banking. If you are interested in the field or just committed to doing it yourself, that's great. But if don't want to spend your evenings learning about index funds, who can blame you?

For those of you who don't want to put in the time, stop feeling guilty and hire an expert. As self-serving as it might sound coming from a financial advisor, the cost of having someone qualified go over your financial situation and goals with you is almost always a tiny fraction of the extra money you can earn, save, or make by following professional advice. This is just as true for those of us in who work for a living as it is for the mega-rich we usually think of as having financial advisors. And let's face it, there's a lot more at stake for us.

Skip the stock brokers and the insurance agents and look for an RIA rep, or at least a CFP, who is focused on planning, as opposed to focused on selling you a particular investment or account. Ask how much a plan costs and what that process involves. A good plan will finish with something in writing you can take away, but should also involve more than one conversation with you to really understand your resources, your debts, your concerns and you goals. All good planners offer a free initial consult—use it, and don't be afraid to keep shopping until you find someone with whom you feel good about working.

And once you've got the pieces of your plan set up for the year, your savings or non-savings strategy in place, and your spending account on auto-pay, treat yourself to one more sugar cookie before you embark on any of those fitness resolutions.


High Stakes Learning: why figuring out your investments is so hard


Last week we kicked off the Women & Finance series with a "Stocks & Sushi" stock trading game night in Cambridge. As you might have guessed, the emphasis was on having a good time. Our 15th Floor event room above Kendall Square gave us panoramic views across to Boston, and trays of sushi, cakes and a case of wine meant no one was feeling particularly stressed out about learning anything. But the learning—along with a healthy dose of competition (and a little buttercream frosting)—happened all the same.

Since Thursday, I've had a slew of comments and emails from attendees about how much better they understand their own investments since participating in the game. The game itself is a version of something I used to do with an auditorium full of undergrads when I taught the origins of the modern stock exchange. You can't, in my opinion, really understand how and why stock prices fluctuate (and how bonds work at all!) until you are in the middle of the psychological cauldron that is a marketplace. When the dice send the market into a meteoric rise, you can actually feel the tempting pull of the next big bet or the cautionary tug of anxiety, even though those make-believe shares of "Doctor & Gamble" in your hand are, literally, not worth the paper they are printed on.

So why, if this all quickly becomes clear in the game, do the real investments in our 401k account remain so murky to us? I think the answer has something to do with the stakes of the game.

I once had a conversation with a client about why her teenage daughter seems to magically understand all the bizarre features on her smart phone while my client still struggles with turning the camera on and off. "Think about when you use the phone," I said, "you've got a grocery bag in one hand, your half-drunk coffee in the other and you realize you have to make a quick work call in the two minutes before a meeting starts." On the other hand, her teen is using her phone while waiting in the car with a bag of chips and her feet on the dash. While my adult client has precisely three seconds to get the phone to do exactly what she needs before everything starts to come unglued, her teen can play with every button, slide and touch without worrying about it. She's literally just playing around (and she's not paying for that phone). We don't say this often, but the teenager with the smart phone is in a much better state for learning.

If you really want to learn something, it has to be ok to try stuff out, to take risks, to push random buttons and see what happens. But unless someone's already covering retirement for you (wouldn't that be lovely), you aren't going to feel that relaxed about your actual investments. Which means we need to find ways to make learning about finances a more playful experience. It can be events like stock trading night (no one cried or lost their homes when American Textiles went bankrupt following an embezzlement scandal). Or we could be using all of those apps and game software to make the foundations of our financial system accessible to anyone who wants to understand them. And sometimes the answer is just in the way we present investment choices to people. Frankly, those of us in the financial industry—from actual financial advisors to the agents and brokers handling most of the country's retirement plans—have kept the tension high and the chance for learning pretty low. We are going to need to do better.

In the meantime, we will get going on another Stocks & Sushi night. I'm feeling like "Donut Barn" has some real earnings potential.

What the Heck is an ETF? More on Understanding Funds


When I first started this blog several months ago, I added a snappy little glossary definition of ETF's, figuring that I would not be able to get many of you excited about them as a topic. But the other night I got a question from a reader about these increasingly popular investment vehicles, so I have decided it's time to give you the fully story (or at least the slightly-longer-but-not-too-tedious story)—

Let's start with my original glossary definition:

An investment fund that tracks a list of stocks, bonds, commodities or other investments. Investors own shares of the fund, rather than directly owning the investments within it. Unlike mutual funds, ETF's trade like a stock such that the price changes throughout the day.

The best known ETF's are index funds and are popular for their low costs.

If you really want to wrap your head around ETF's, you need to understand how funds in general work. A fund is a like a shared pot for which the fund manager buys a selection of investments. Those investments are usually stocks or bonds, but there are other investments they can choose from as well. Once the fund manager has created that "pot", she will buy and sell investments according to whatever strategy she has laid out at the beginning—think of that strategy as the fund's "recipe." The recipe can be pretty precise: "I'll only buy stock from companies that make things out of timber." It can be broader: "I'll look for the most undervalued stocks in the U.S. market." Or it can be blended: "I'll always keep 70% U.S. stocks and 30% U.S. bonds."

Regardless of the fund manager's strategy, all of the money for these purchases comes from people like you who buy shares in the fund. And this raises the question of how you buy "into" the fund...and how you get your money out. This is where the type of fund you buy—ETF or mutual fund—makes a difference. If you want to purchase or sell one share of a mutual fund, you will always find the price of a share from the fund's Net Asset Value (NAV for short). That number is a simple calculation of how much the fund's current investments are worth, and it's only calculated once a day—at the end of the trading day. Simple!

An Exchange Traded Fund (or ETF) doesn't make things so easy. Just as stock prices slide up and down over the course of a trading day as people bid and sell them, an ETF price slides around constantly depending on how much traders in the market are willing to pay for a share in it at that moment. If everyone is betting that the fund manager is doing well, the price of a share in the ETF will go up (and vice versa).

Should you buy ETF's?

As you can see from my glossary entry, ETF's have been a particularly popular form of "pot" for a fund manager wanting to create an index fund, where the "recipe" is to have a little bit of everything on a given list (say, all companies on the S&P 500, or all U.S. oil companies). With index funds, a computer does most of the work calculating buys and sells, and the fund manager generally can charge you, the fund owner, a little less as a result. Lower fund management fees is always a good thing.

And there is one other thing you should know about ETF's vs. Mutual Funds—the taxes are different. If you own a share of a mutual fund, you and the rest of the fund's owners will share the fund's tax bill at the end of the year. These are called contribution taxes, and they come from the capital gains taxes created when the manager sells an investment in the fund for more than she paid for it. As with any investment, you will also pay a capital gains tax on your shares when and if you sell them for more than you originally paid.

On the hand, the IRS treats ETF's like a big, funny looking stock. As with the mutual fund (and other investments) you pay capital gains taxes when you sell your shares. But the IRS ignores the fact that the ETF has all of that other buying and selling going on inside it, which means no contribution taxes for you. A lot of investors and fund managers choose ETF's over mutual funds for this tax efficiency.

Have more questions about ETF's or other investments? Post something to me in the comments box below!


Who Needs an Annuity and Why?


My clients might well be surprised to see this post—I spend a lot of time railing about the over-selling of annuities and the hefty commissions that go to the advisors who sell them. But the annuity has a long, respectable history and can actually be a good financial tool for the right situation. So what is that situation?

First, it helps to know how annuities work. They aren't quite as dreary as they sound. Way back in the 17th and 18th centuries, annuities were a great way for a very wealthy person to fund the retirement of a widow, an artist or a beloved servant. For that matter, they were one of the original prizes in government lotteries. Essentially, an annuity is a contract that gives the beneficiary the right to receive a certain sum of money every month or every year for the remainder of his or her life. Sounds great, right?

There is a little more to it, though. These days, annuities are insurance products. Like any insurance policy, the insurance company has used statistics about people's life spans to predict how much they need to charge you (and how much they could pay to the beneficiary) in order for the insurer to make a profit on the deal. So, for instance, Wholesome Life Insurers, Inc. are happy to sell you an annuity that costs $100,000 up front and pays $20,000 per year to your Aunt Betty for $100,000 if they think she'll drop dead after the second year of payouts.

And there are necessary costs. In addition to paying the people who sell you the annuities, the insurance company needs to pay people to file the required reports, process the applications, run the office, etc... That isn't all, though. In point of fact, your insurance company is hoping to make most of their profit by investing your initial $100,000 until it needs to be paid out. For that, of course, they need to pay investment managers. All of these costs are built into how much the annuity costs you.

So why not just invest the $100,000 yourself and skip the other costs? This is the question at the heart of the matter when it comes to annuities. In most cases, it is cheaper to fund your own (or your Aunt Betty's) annuity. But relying on your $100,000 investment to grown enough that it can pay you back the money you need in retirement is a gamble—a gamble on the investments and a gamble on your lifespan not going longer than planned.

In the Bloomberg article with which I started this series, David Little, Director of the Retirement Income Planning Program at the American College of Financial Services, chose to take care of most of his own investing, trusting that he would do better than the relatively high fees and low returns that an insurer would get. But he also purchased an annuity as a supplement to the investments. The annuity offers him a baseline amount that he will get every month during retirement to prop up his social security benefits in case the investments disappoint or in case he lives to, well, 103.

As Little's plan suggests, annuities make sense in those instances when security matters to you much more than cost. Whether it's being able to insure a comfortable living for your Aunt Betty, or locking in a baseline for yourself, annuities are about covering a basic need—often psychologically as much as financially.

Just one last note on annuities—there is no such thing as a "guaranteed" investment. Make sure you feel as confident about the insurance company you buy from as you do about your choice to buy. If you want to learn more about the types of annuities out there, check out the SEC's online guide to annuities.

Making Sense of Your Company's Retirement Plan

Retirement PlanI meant for this post to be part of the week's series on starting a new job, but I get questions about retirement plans all of the time from people who have had accounts for years. The truth is that most employees feel a little vague at best about the details of their retirement plans. This post will try to break down the basics to help you fit your employer's retirement plan into your planning and, in some cases, raise the questions that might lead your employer to improving the plan itself. So what do you need to know about your retirement account? Read the key points I've given you below and then find whatever qualified plan your employer is offering on the chart at the bottom to gather specific questions you should be asking your employer.

Tax Deferrals

Whatever plan you have, you should know what the big deal is about retirement accounts—it's all in the tax breaks. The majority of "qualified" retirement accounts allow you to put part of your paycheck into the account and deduct that money from the income you list on your tax filing for the year. This is great for two reasons: 1. you pay fewer taxes that year; and 2. the money you were going to put toward taxes can start earning money itself through investments.

You do eventually pay those taxes. When you start taking money out of the account (hopefully in retirement), you will pay a tax on both the money you put in and the extra earnings you take out. In the meantime, though, you should have been able to make a lot more in investment returns thanks to this "loan" of your tax dollars from the government.

More Tax Deferrals

In the case of Roth IRA's, the government offers you a slightly different deal on your taxes. With these accounts you do pay your taxes this year on the money you put in but don't have to pay any taxes while you investment account is earning. Why does this work? As with tax-deductible plans, you can keep reinvesting the money your investments earn year after year without paying the taxes until you take money out. But you also have the benefit of being able to take out that original contribution tax-free (because, of course, you paid the taxes before putting the money in). This works well if you think your income tax rate in retirement will be lower than it is right now. People often use the Roth as a second retirement account to save more than they can under an employer's plan.

Fancy Terms You Should Know

There are a few key words and terms that make all of the difference in understanding retirement plans. Here are some:

Vesting: With some plans the money is yours as soon as it hits your retirement account. You may have to pay a penalty to the IRS for taking it out early, but your employer has no more claim on the money. With other plans, the "ownership" of some or all of the retirement account money does not pass to you until it vests, usually after you've worked a specific number of years for the company.

Qualified Contributions: These are the contributions you and/or your employer make that are tax deferred. All retirement plans have limits on these—often you can add more to your account, but you don't get that tax break after you hit the qualified contribution limit.

Matching: In many plans, your employer has agreed to contribute its own money to your retirement account whenever you do. How much the employer adds depends on the terms of the account, but we usually talk in terms of percentages (does your employer match 100% of your contribution or 50%?) and limits (the employer will stop matching when it reaches a certain amount or percentage of your salary).

Contribution Limits: Every year the IRS announces what the limits will be on how much you can put into retirement accounts and still get those great tax breaks. Here they are for 2015.

The Risks

In the rush to get you to invest in your retirement plan, we in the financial industry often forget to tell you something really important—there is a good reason NOT to contribute. Specifically, it can be extremely expensive to get that money out of your plan if you need it before retirement. You are always going to pay any taxes you did not pay when you contributed, of course. But unless you fall under one of the special exceptions, taking money out of your qualified retirement account early (usually before the age of 59 1/2) will mean paying a 10% penalty to the government. Ouch. Make sure you have some other funds or go-to plan for emergencies before you put yourself in the position of paying extra to get to your own money.

Which Qualified Plan Does Your Employer Offer? (click to enlarge)

Your Employer's Retirement Plan