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GUIDE to PERSONAL FINANCE Provides Clear Explanations of the Sometimes Complex Issues, Questions, and Decisions That Are Part of Everyday Finances

GUIDE to PERSONAL FINANCE Provides Clear Explanations of the Sometimes Complex Issues, Questions, and Decisions That Are Part of Everyday Finances

GUIDE TO PERSONAL provides clear explanations of the sometimes complex issues, questions, and decisions that are part of everyday . This essential guidebook contains the information you’ll need to make smart decisions about every- thing from banking and using wisely, to home finance, financial planning, investing, and taxes. The Guide is the perfect resource for becoming your own personal finance expert.

• Banking • Mortgages $ $ $ $ $ $ • Financial Planning

• Credit • Taxes $0.00 • Investing ISBN 978-1-933569-09-3 MORRIS 90000>

& • Paying for Tuition MORRIS 9 781933 569093

Lightbulb Press, Inc. lightbulbpress.com Phone: 212-485-8800 VIRGINIA B. MORRIS AND KENNETH M. MORRIS GUIDE TO UNDERSTANDING PERSONAL FINANC E

205 East 42nd Street, 20th Floor New York, NY 10017 (800) 99-HERON www.heronwealth.com

NAV3/12 ill-uncle'sam's hat VIRGINIA B. MORRIS KENNETH M. MORRIS In the earlier editions of the Guide to Personal Finance, we explained the principles of making sound banking, credit, and mortgage decisions, as well as the basics of investing, financial planning, and taxes. Our goal was to be comprehensive without being exhaustive, informative without being over- whelming. Our focus was on what you should know, what you can expect to pay—and earn—and the pitfalls you should be aware of as you make financial decisions.

Those goals haven’t altered, and neither has our approach. Since the last edition, however, there have been significant changes in the world of personal finance, giving people more choices but requiring more decision making. and investing have grown by leaps and bounds. Tax-free Roth IRAs and higher contribution limits for deductible traditional IRAs provide greater flexibility in planning. Larger estates can be left to beneficiaries tax-free. To benefit from these changes, people have to know what they are and how to take advantage of them. That was one of our goals in bringing the Guide up to date.

This revised edition blends clear and concise information with visually appealing design—a style that’s the trademark of Lightbulb Press. LIGHTBULB PRESS Project Team We hope you enjoy the Guide and find it helpful and Design Director Kara W. Wilson Editor Mavis Wright informative in exploring the often perplexing and ever-changing Production Thomas F. Trojan world of personal finance. ©1993-2014, 2016, 2017 BY LIGHTBULB PRESS, INC. ALL RIGHTS RESERVED. www.lightbulbpress.com Tel. 212-485-8800 Virginia B. Morris ISBN: 978-1-933569-09-3 No part of this book may be reproduced, stored, or transmitted by any means, including electronic, Kenneth M. Morris mechanical, photocopying, recording, or otherwise, without written permission from the publisher, except for brief quotes used in a review. While great care was taken in the preparation of this book, the author and publisher disclaim any legal responsibility for any errors or omissions, and they disclaim any liability for losses or damages incurred through the use of the information in the book. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that neither the author nor the publisher is engaged in rendering financial, legal, accounting, or other professional service. If legal advice, financial advice, or other expert assistance is required, the services of a competent professional person should be sought. CONTENTS CONTENTS

GUIDE TO FINANCIAL PLANNING 58 Financial Planning 76 Annuities PERSONAL FINANCE 60 Making a 78 Social 62 Managing Your Flow 80 Life 64 Your Net Worth 82 Types of 66 Paying for College 84 -Term Care 68 529 Plans 86 Estate Planning BANKING 70 Planning for Retirement 88 Making a Will 6 Basics of Banking 14 Payment Systems 72 Employer Plans 90 Trusts 8 Checking Accounts 16 Tracking Your Balance 74 IRAs: What They Are 92 10 Opening an Account 18 Savings 12 Banking by Card 20 CD: INVESTING 94 Investing 110 Investing in Bonds 96 Risk 112 The Value of Bonds CREDIT 98 Figuring Your Return 114 Special Types of Bonds 22 Using Credit 32 The Substance of a 100 Allocation 116 Investing in Mutual Funds 24 Credit Cards 34 On Track With Credit 102 Diversification 118 It’s a Fund-Filled World 26 Using Cards 36 Coping With Credit 104 Investing in 120 Anatomy of a Prospectus 28 Card Rights Problems 106 Taking of Your 122 Options and Futures 30 124 Investing in Real Estate 108 Other Ways to Trade

HOME FINANCE TAXES 38 Buying a Home 48 Mortgage Rates 126 Paying Taxes 132 Prepaying Taxes 40 Making an Offer 50 The Closing 128 Completing a Return 134 Tax Planning 42 Signing a Sales Contract 52 Owning a Home 130 Tax Status and Brackets 136 Keeping Records 44 Qualifying for a Mortgage 54 Home Equity Borrowing 46 The Cost of a Mortgage 56 Insuring Your Home

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ELECTRONIC BANKING LIKE MONEY IN THE Even if your bank or was Are the safest place to keep your Basics of Banking built with traditional brick and mortar, money? The answer is an unequivocal yes. employs tellers, and contains a vault The reason is theFederal Deposit The breathtaking pace of the banking evolution shows full of safe-deposit boxes, most of the Insurance Corporation (FDIC). This no sign of slowing down. you do there is handled federal agency guarantees depositors’ electronically. So is everything that balances up to $250,000 for each goes on behind the scenes, from eligible account, including individual, Managing your personal finances is a And, if you’re looking for help with direct deposits to your accounts to joint, retirement, trust, and business continual balancing act—keeping track financial planning or making invest- bill payments from them. accounts, in each participating bank. of your earnings, paying your bills, and ments, most banks and credit unions Even the paper checks you write are Accounts with different banks are accumulating savings to pay for the offer these services too. scanned to create digital images when insured separately, and there’s no cap things you need and want. For most The reasons for working with a bank or they’re deposited. The details are verified on the total amount that qualifies for people, it also involves having access to credit union haven’t changed very much in real time and sent electronically to FDIC insurance provided that no one credit, including a and loans since automatic teller machines (ATMs) your bank through a Federal Reserve account holds more than $250,000. But, to buy a home or a car. were introduced in the 1970s. But over Bank or local clearinghouse. Then the if you open similarly registered accounts Banks and credit unions can help time the way you bank, and the way a amount is debited electronically from in different branches of the same bank, you handle these tasks efficiently using bank delivers its services, have undergone your account and credited to your they’re considered one account for insured checking and savings accounts. a radical and largely digital transformation. payee’s account—typically within a insurance purposes. The National Credit single business day. Union Administration (NCUA) provides Some elements of traditional banking identical insurance for accounts held in do survive: You still have the of participating credit unions. THE MAJOR PLAYERS making a deposit or withdrawal at a Remember, though, that FDIC teller’s window and talking to a bank or NCUA insurance applies only to One of the primary officer in person about a specific request deposits in checking or savings accounts, challenges of banking or problem. But that requires a trip to not to investments you buy through the is deciding where to Commercial Banks the bank and sometimes a wait in line. bank or credit union. open your accounts. In most parts of the country you have a large and varied Virtual Banks choice. What you’re WHEN A looking for is the best BANK ISN’T combination of cost, convenience, and A BANK service that you Nonbank banks are can find, whether or not that means financial institutions working with a single institution. that offer some but Local Banks not all of the services banks offer. Most Large commercial banks that operate uniformly less expensive than for-profit Credit Unions offer credit, but not either nationwide or in relatively large banks. Each credit union sets its own checking or deposit geographic regions typically have the membership requirements, and some are accounts. They aren’t most branches, the widest range of more restrictive than others. For example, licensed or regulated accounts and services, and the most you may have to work for a company THE SERVICES BANKS PROVIDE by federal or state sophisticated technology. Most operate to be eligible for its credit union. Large banking authorities. under a charter and are credit unions serve a national client Here’s a quick summary of primary Participants in this regulated by the Federal Reserve and base and offer the same services as large banking services: shadow banking the Office of the Comptroller of the commercial banks, though some small system range from Currency (OCC). credit unions may offer limited electronic • Checking and savings accounts investment banks, Local banks serve a more limited banking, a list of services, and few Certificates of deposits and money funds, and community but offer many of the branches or ATM locations. •  firms same services that larger banks do while Virtual banks offer the same services accounts to mortgage lenders charging lower fees and setting lower as brick and mortar banks but exist only Direct deposit and check cashing and check-cashing minimum balances. However, there online. There are no branches and no •  operations. Using may also be limitations, including fewer proprietary ATMs. You transact all your Online bill payment their services is often ATMs, less sophisticated electronic business with them electronically, by •  convenient but not banking options, and fewer options for computer or other digital device, though • Account-linked debit cards always cost-effective. international money transfers. Most you can call to resolve questions or prob- Credit cards and other lines of credit What’s more, lack have the same federal oversight as larger lems. A major advantage of virtual banks •  of regulation may banks, although some operate under is that many provide low-cost or no-fee Mortgages and personal loans limit consumer state charters. services, including rebates for ATM fees, •  protections. Credit unions are not-for-profit insti- as well as higher rates on savings accounts • Money transfers tutions owned by their depositors and are than more traditional banks offer. 6 7 banking banking Checking Accounts You pay your bills with a checking account even if you rarely write a check.

When you pay a bill from your bank or longer if your bank is sending a paper account, you’re using what’s known check because the payee doesn’t accept as a or transaction electronic payments. account. Demand means that your money is available when you want it, ACH WHO? without giving the bank prior notice. Most electronic payments you autho- Transaction means that you can tell rize from your checking account move the bank to transfer money from your to your payee’s account through an account to another account. You’re the automated clearinghouse (ACH), or elec- NONSUFFICIENT a new account, but you should ask how payer in this situation and the person or tronic network operated by the Federal FUNDS ACCOUNT to qualify. Some basic accounts don’t institution you’re paying is the payee. Reserve Banks. That’s the case whether Banks follow your offer it at all, but many accounts do. So Whether you use a paper check, you authorize payments as they are due payment instruc- BALANCE its availability may be a factor in deciding computer, tablet, or mobile phone, you or schedule payments on a regular basis, tions, whether they’re where to open your checking account. must provide the same information: such as installments on a mortgage or given in writing or car loan or your monthly electric bill. electronically, provided STOP THAT PAYMENT The name of the payee •  Deposits into your account, includ- there is money avail- When you send a paper check, you can The amount you want transferred •  ing your paycheck and payments from able in your account to ask the bank to stop payment, which Your authorization, using either a •  government programs such as Social cover the amount. But means it should refuse to honor the handwritten or electronic signature Security, are also handled though the if you’re short, even check when it is deposited. If you make Most of the other information that’s ACH network. if you’ve deposited your request in writing before the check imprinted on a paper check—the bank ACH deposits are available either on money that hasn’t yet has been cashed, your bank will usually routing number, your account number, the day they are paid to your account been fully credited do as you ask although it may charge a and the number of the check—is built or the next business day. The same tim- to your account, $0 substantial fee. A stop payment order into the bank’s bill-pay program. ing applies to cash deposits but often you’ll face a poten- remains in effect for 60 days. Timing checks to make sure your not to paper checks you deposit. The tial problem Electronic payments generally payments arrive on time requires some bank may make a portion of the check variously can’t be stopped once you have planning whichever way you pay. With amount available the day of deposit but known as authorized them. But if you have a paper check, unless you pay in person, hold the full amount for several days, an , OVE AFT authorized a recurring debit from you have to allow time for mail delivery, depending on the source of the check. nonsufficient RDR your account, you can generally end which can vary by region and distance. National banks are required to credit funds (NSF), the arrangement by notifying the bank If you pay electronically, you can sched- your account with the full amount in no insufficient funds, or in in writing three days before the next ule the date the payment is made, but longer than five business days—though some cases unavailable funds. Informally debit is scheduled to occur. you may still have to allow two or three there are some exceptions, including it’s called bouncing a check. If debits that have revoked continue days for the electronic funds to transfer, new accounts and deposits over $5,000. If the bank refuses to pay your debit, to be honored, notify the bank in as it could, you’ll owe an overdraft fee writing within 60 days from the time and the payee’s bank will almost cer- you get your bank statement that reports when you can withdraw tainly charge a similar fee. What’s more, the debit. The bank must investigate Funds may be available on a slightly different schedule at each bank. Here’s one example of when you if a payment is returned for insufficient within ten days. might be able to withdraw after depositing different types of checks, each for $1,000. Your bank should funds, you may face a late-payment fee You can also file a complaint with the display the schedule it uses or make a copy available. and an interest charge from the payee. Consumer Financial Protection Bureau In addition to keeping careful track (www.consumerfinance.gov) if it’s a 1 day later 2 days later 5 days later of your available balance so you don’t national bank, with the National Credit encounter this situation, you can often Union Administration (www.ncua.gov), A federal, state, or local arrange overdraft protection linked or your state banking department. government check* $1,000 to your account. In most cases this is a special from which the bank CHECK SHORTCUTS A bank, certified, or travelers check $1,000 automatically transfers money to your Instead of returning cancelledOVERDRAFT paper checks, account to cover . You must pay most banks provide electronic reproductions, A check from your own bank $1,000 interest on the amount that’s transferred reduced-size images, or simply a list of items as well as repay the balance, and there that were paid in your monthly statement. If you A local check $100 $400 $500 may also be a penalty fee each time you need a copy of a check as legal proof of payment, access the credit. In the long run, though, you should request a substitute check, which has A non-local check $100 $900 overdraft protection can save time, money, the words “This is a legal copy…” printed on it. and major inconvenience. But be prepared to pay a fee. Most, though not *Special deposit ticket may be required. Your bank may not automatically all, banks charge for this service. offer overdraft protection when you open 8 9 banking banking

MINIMUM BALANCES Opening an Account A minimum balance is the least amount TAKE A TIP of money you must keep on deposit Here are some things to think about before Costs and features vary enormously, so it pays to in your account to satisfy a bank’s you choose a new checking account: check around. requirement, and can range from $500 • The number of transactions, including to $15,000. ATM withdrawals, you have each month. Some banks figure your average The more there are, the more flexible an Most banks offer several types of checking arrangement, often part of a free monthly minimum balance, which account you’ll need. accounts to meet the needs—and attract checking account, allows unlimited means you can meet the minimum even the business—of potential customers. use of a bank’s own terminals as well as if your balance dips below that required • The way you pay most bills. If you prefer In most cases, the best account for those within a regional, national, or even level at some point during the month. electronic banking, be sure the bank’s you is the one that will cost you the international network, such as NYCE, Other banks charge the fee if your programs are state-of-the-art. least to manage your finances efficiently. Cirrus, STAR, and Plus. balance drops below the minimum at • The special services you may need, such But that’s not always the cheapest Other fees may apply as well, to cover: any point. You should always know as bank checks or signature guarantees. account—or the one with the most which method your bank uses so you Overdrafts, also known as non- In this case you may need a local bank benefits. To choose wisely, you need to •  can avoid low balance fees. sufficient funds (NSF) in addition to a virtual one. be clear about the services you need. Often, though not always, you can Money orders and bank checks Many banks have an account •  meet the minimum using the combined How much you travel, domestically and Stop payment orders •  designed specifically for students and •  average of all your accounts: checking, internationally. You may be better off Check printing another for seniors. These tend to cost •  savings, certificates of deposit (CDs), using a major bank with lots of ATMs. less than regular accounts, though they Some banks have experimented with and sometimes even outstanding loans. may have some limitations. In addition, fees for talking to a teller or using your There are two cautions: Meeting SHOP AROUND some states require banks to offer a and may revisit them again. minimum balance requirements can The best place to start your search for lower-cost but barebones account to The bank must explain its fee struc- save you money on bank fees. But you’ll checking accounts is online, focusing help make banking available to everyone. ture in writing and notify you whenever want to compare what you would save on banks and credit unions near your there are changes, but the details are on fees with what you could earn by home or office as well as those of virtual THE PRICE OF BANKING often imbedded in the fine print of the investing the money you’re using to banks. Then follow up on the ones that Cost is a major factor in choosing one client account materials you receive. meet the minimum elsewhere. And seem most promising. bank over another, assuming both offer That’s why it is important to keep up you’ll want to be careful not to choose One caution: be sure the sources comparable services. Cost may also be to date on the costs and to question an account with a minimum you’ll have you’re using to conduct your search are the driving force in switching banks. any charges that seem wrong to you. to struggle to meet. The penalty charges current and impartial, not promotions In most cases, the key is a The real catch is that checking fees you’re likely to incur could cost you a lot. from a specific institution. And check checking account, including access to vary not only from bank to bank but with family, friends, and others you traditional and electronic bill payments, among account types at the same bank. respect to find out what their banking unlimited ATM use, and a debit card. A So you may have to investigate carefully experiences have been. If you’re having monthly fee may cover all those features, to find the least expensive option that trouble finding credit unions, contact but there may be a combination of meets your needs. the Credit Union National Association monthly fee plus additional charges for (CUNA) at www.cuna.org. transactions over a limited number. The good news is that it’s possible to find a bank that includes these services without charge in exchange for keeping at least a minimum balance in your account and having your paycheck direct deposited. The bank may describe this arrangement as free checking, but, given the minimum balance requirement, that’s not exactly the case. You’ll also discover that virtual banks generally offer free checking without minimum deposits.

CHECK THE FEES You’ll probably want to pay particular attention to ATM charges if you use cash machines regularly. Some banks charge a fee—often $1 or $2, but sometimes more—every time you withdraw or check your balance, and most banks charge a fee when you use a terminal it doesn’t own. A better

10 11 BANKING BANKING

But if you miss the deadline, Banking by Card you could be out up to $500 of any amounts withdrawn during ATM withdrawals were those 60 days plus anything and everything that’s withdrawn only the start of beginning on the 61st day. electronic banking. Your bank initially has ten days to investigate your report and refund any money it agrees When you go to the bank, you’re was withdrawn without your likely to use the ATM to make a permission. If it wishes, the bank withdrawal, deposit, or electronic can extend the investigation for payment on your credit card or up to 45 days. But if you’ve filed bank loan. Or you might simply a written report, it must put the check your account balance. disputed amount back into your And when you pay for a purchase, account within ten business days chances are you swipe, dip, or wave a so you won’t be out the money. plastic card or use an app on your smart- The bank has more flexibility with phone. In many cases, the card is linked Debit Card accounts open less than 30 days. It can directly to your and take 20 days to finish the initial inquiry transfers the amount you spend from • Access to ATM Access to ATM  •  and refund your money, and up to your account to the payee’s account. 90 days for an extended investigation. One reason that paying this way is so POS purchase POS purchase •  •  If the bank believes the evidence doesn’t attractive is that if you’re careful to keep using PIN using PIN support your claims, getting a loss your spending in line with your account resolved can be time-consuming, balance—and don’t overdraw—you don’t • POS purchase potentially costly, and maybe futile. have to worry about accumulating , WHICH CARD FOR YOU? using signature, which is always a risk with a credit card. Bank cards may be less vulnerable to abuse, since the card is worthless to a thief phone, and online NON-IDENTICAL TWINS or fraudster without your PIN. But many The card that gives you direct access to banks are phasing them out in favor of your checking account may be a bank debit cards, so you may not have a choice. card or a debit card. They’re not identi- cal. The bank card gives you access to But the law is on your side, spe- ATMs and allows you to make point-of- won’t be inconvenienced or embarrassed cifically the Federal Reserve Board’s sale (POS) purchases using your personal by having a transaction rejected. But the Regulation E (Reg E), which governs identification number (PIN). A debit reason to decline is that you limit the all electronic fund transfers (EFTs). card can be used this way but addition- risk of overspending or incurring over- The bottom line is that if you notify ally to make purchases by signing your draft fees and interest payments, which your bank that your card is missing name or providing the number online can be substantial. or that money has been fraudulently or by phone, with no PIN required. withdrawn from your account within How can you tell the difference PROTECTING YOUR MONEY two business days of making the CREDIT OR DEBIT between the two? A debit card, some- The real danger is that someone using discovery, the most you can lose is Debit card users may sometimes be times called a check card, has a VISA your bank or debit card without your $50. In fact, many banks will refund confused when they use the signature or MasterCard logo as well as the bank permission could potentially withdraw the entire amount, including the $50. rather than the PIN option to authorize name and logo. A bank card, sometimes the entire balance in your account, plus Of course, if you have made a a retail transaction. Because a signature called an ATM card, has just the bank the full amount of your overdraft line number of payments against what purchase goes through a credit card net- identification. of credit, if you have one. you thought was an adequate balance, work, users must select the credit rather those payments may be returned for than the debit button when they swipe HOW THE CARDS WORK insufficient funds. That’s a separate or insert their card. But it’s still a debit. There are generally no limits on the problem you’ll have to resolve. number of transactions you can autho- A WORD OF WARNING rize in a day, though banks may set a Reg E THE TICKING CLOCK A potential problem may occur if daily dollar limit on ATM withdrawals Reg E is flexible on the two-day rule. you use a debit card to charge certain and card purchases. At some banks the You don’t have to report the card , such as gas or hotel rooms, amount you can spend is equal to the missing within 48 hours of the actual where the cost is not fixed. In that case, amount you can withdraw as cash, for loss, since it’s entirely possible you may the retailer debits your account twice, example, $500 in each category. Other not discover that it’s gone right away. first to hold the amount that you might banks set a single daily limit. In fact, you have 60 days from the spend and a second time for the actual If you want overdraft protection postmark on the bank statement that amount you spent. It can take several with your bank or debit card, you must reports the loss or misuse. days for the first charge to be credited agree, or opt-in, to allow the bank to As long as you’re within the time back to your account, potentially provide it. The advantage is that you limit, you still won’t lose more than $50. putting you in an overdraft situation.

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Payment Systems A WARNING Preauthorized can be a bad idea Finding a convenient way to pay is rarely a problem. in cases when a payee is not scrupulously honest and continues to debit your account You may be satisfied with the bill pay- widely available, just as you would with against your wishes. While it is ment options your bank offers. But if sharing your Social Security number. legally possible to terminate you’re looking for other ways to pay— You may also want to be careful such an arrangement, it may and be paid—you shouldn’t have any before you schedule recurring payments, $100 not be as easy as it should trouble finding an alternative. In fact, especially those where the amount varies be. In some cases, banks you may want to investigate several. from month to month. Preauthorizing a have been faulted for Prepaid Debitard profiting from abusive debit of an unexpectedly large payment C could risk overdrawing your account. debit payments. In addition, if you authorize each pay- ment separately, especially in the case of credit cards, you can decide how much PayPal describes itself as a digital to pay each month. With a prescheduled wallet where you can link your various debit, the only options may be paying financial accounts, including banking, only the full balance or the minimum debit, and credit arrangements, to a amount due. PayPal account and choose the one you’ll use to make a payment. The POP GOES THE MONEY PREPAID DEBIT CARDS privacy feature, which means, among Popmoney, which describes itself as a You can use a prepaid debit card any other things, that you never have to personal payment service, lets you make place you can use a regular debit card. share your credit card or bank account or receive person-to-person payments, The difference between the two is that number, is a major attraction. pay bills, or make gifts electronically, the amount you can spend is loaded PayPal isn’t a bank, does not insure using your existing checking, savings, onto the prepaid card rather than the money in your PayPal account, and or account. debited directly from a linked account. isn’t regulated by any federal or state Payers must provide an email address, The advantage of using a prepaid card authority. And not everyone is happy mobile phone number, or bank infor- is that it’s much harder to overspend. with its service. There have been glitches mation for the payee so the transfer That’s because you have no overdraft over the years, and banks provide some can be made. There is a mechanism for option. But the potential risk is that services that PayPal doesn’t. But there’s refunding transactions that can’t be com- some cards carry fees that consume no question that PayPal is a major force pleted—for example if the payee doesn’t a substantial portion of the amounts in the world of electronic money. PAYEE REQUESTS respond—but payers are responsible for loaded on them. So investigate fees care- Rather than using your bank’s bill-pay providing correct contact information. fully before you choose a prepaid card BITCOIN software, you can authorize your payees The service is free for recipients, and confirm that your balance will be Bitcoin is one of the most controversial to debit your checking account when while senders may or may not pay a refunded if your card is lost or stolen. payment options in the still-evolving world a payment is due. Direct debit assures fee, depending on where they bank. of digital currency. This software enables that your payment is made on time even But there are limitations. There are daily PAYPAL person-to-person transactions worldwide though the amount may not be trans- and monthly dollar transfer limits, the You can use PayPal to pay for purchases, using metaphorical electronic wallets. ferred from your account immediately. service works only within the United be paid for something you sell, or send Bitcoin payments you receive can be Just be sure, when you authorize a States, and up to three days may elapse money to another person, all while converted to local currency. But because debit in this way, to record the con- between authorizing a payment and guarding the privacy of your personal bitcoin is not a fiat currency whose value firmation number that appears on the completing a transaction—though financial information. Buying is free, and is established by an issuing government, payee’s website and hold onto it until real-time payments may be available so is transferring money, provided you it doesn’t have a fixed value and can be the statement reflecting payment arrives. through banks that offer the option. send it from a linked bank account or a volatile. And as the website www.bitcoin. Authorizing debits requires you For more information, or if your PayPal account. If you transfer money org warns, it’s a high-risk asset that’s to share your bank account number, bank doesn’t participate, you can contact using a debit or credit card, you pay the not suitable for savings. You may not something that may make you uneasy. www.popmoney.com. There’s also a same fee that you do when you sell. Fees be ready to use it right now, but it’s When payees are reputable institutions, Popmoney service for small . on international transactions are higher. probably worth learning more about. such as the banks that issue the credit cards you use, your wireless tele- phone provider, or the company that financed the purchase of your car, there’s virtually no chance that your account will be at risk. But you want to exercise caution in making your bank- ing account information more

14 15 banking banking

If you chronically after the first or Tracking Your Balance overestimate your second one in a balance, however, month, and for each You need to stay current on what’s in your checking account. chances are you need purchase you make. to pay more atten- If your only option tion to what you’re is a payroll card, and It’s easier than ever to keep track of the of the checks you write. None of these is spending, especially the fees are eating up activity in your checking account. The especially useful for keeping a running if you pay for most too much of your pay, details of each credit and debit transac- tally of your account if you also make purchases, even you should complain tion, the type of transaction it was, and electronic payments. But they can be small ones, with to the Consumer the current balance are available online helpful in confirming that you have, in plastic and don’t keep the receipts. Financial Protection all the time. Regularly scheduled debits fact, written checks to specific payees Bureau at www.consumerfinance.gov that are due but have not yet been paid and that the amount of each check is PAYROLL CARDS and your elected representatives. The may be listed as pending. accurately reflected in your statement Some employers use payroll cards to pay purpose of payroll cards is not to create Once a month, though not always at or online account details. or , either instead of, or in a financial drain on employees. the end of the month, activity in your addition to, direct deposits to your bank account is compiled in a statement GETTING IT WRONG account or paper paychecks. Some payroll that may be mailed to you, can be You’re not likely to find many mistakes CASH ALMOST INSTANTLY cards provide monthly statements that: downloaded as a PDF file, or both. in bank statements. But you should regu- You can use authorized Statements going back several months larly compare your own records—such as • Allow you to track your spending non-bank institutions, or longer are also available, but you may ATM and debit card receipts and regular • Limit the number of fees such as MoneyGram have to request that they be retrieved direct deposits of your paycheck or other • Provide FDIC insurance and reim- and Western Union, from the archives. —to what your account details bursement of remaining balances if to transfer money While there is sometimes a fee for or monthly statement show, since mistakes the card is lost or stolen, though you in as little as ten checking your account balance at an can happen. Generally you have 60 days may have to pay for a replacement card minutes or up to ATM, it’s easy—and free—to access to report problems with electronic fund three days for a fee But all cards are not created equal. your account balance online or from transfers (EFTs), but only 14 days for that’s determined by the Some have fewer consumer protections your mobile phone. That means you other types of errors. The sooner you notify speed of delivery, amount of the transfer, and higher fees. And some seem down- should never tap your overdraft line of the bank, the better. And always follow up and the destination, which may be domestic right predatory: They may include charges credit accidently or have a withdrawal a verbal report with a written one. or international. for inactivity fees, for all ATM withdrawals refused for insufficient funds. But you What’s more likely to happen is that do have to make the effort to check on your sense of what’s in your account a regular basis. is different from what the bank detail shows. If you’ve underestimated your CHECKBOOK RECORDS account balance, which probably If you still use paper checks, your check- doesn’t happen very often, it may be book will have a recordkeeping system, that you’ve forgotten about deposits whether as a separate ledger, stubs you’ve made, especially as deposit slips attached to the checks, or a carbon-copy have become extinct.

mybank contact us help security Log Out Bank: Chat 1-800-111-222 SPECIAL Home PAYMENTS Accounts My Accounts 6:50 PM Sometimes a payee Transfers i You have a new message. View message I want to... mb Carol’s Checking Log Out Pay Bills Open a new account will require a check that Summary Report theft or stolen card Account Type Number of Accounts Total Balance Communications View pending activityAccount balance Daily interest guarantees payment will Deposit Accounts 4 $120,664.80 Transfer funds My Profile CDs 10 $56,241.26 $4,014.79 $1.28 be made. That generally Total 14 $176,906.06 Download statements Reward activity means having a personal check certified The check, which comes with a carbon Deposit Accounts Account # Account Name Interest YTD Balance Availability or using a bank check or money order. copy for your records, is machine XXXXXXXX0324 Checking Account $1,343.24 $9,400.29 $8,655.04 XXXXXXXX6550 $53.30 $10,005.84 $10,005.84 Get upPiper to Realty -$1,200.00 When you write a certified check, printed and signed by a bank officer. XXXXXXXX2999 My Money Market $69.55 $30,432.07 $26,506.70 $40010/25 XXXXXXXX7881 External Money Market $300.33 $49,454.19 $49,454.19 your bank puts a hold on the amount of The same is true of a money order, XXXXXXXX7889 External Money Market $121.33 $21,372.11 $20,377.06 in Gift Cards with a MyBankCheck #1501 certified Checking Account +$1,200.00 the check, and stamps on the which you can purchase from a bank 10/26 Learn more > face. There’s no limit on the amount of or a post office. The fee is often higher Certi cates of Deposit Transfer - MyBank -$200.00 Account # Account Name Interest YTD Balance Availability 10/27 the check, provided you have enough at a bank, but the limits on the amount XXXXXXXX00043 CD $208.24 $5,673.09 $3.200.56 money in your account to cover it. of the money order are also higher. Anna Tylor -$89.98 10/29 When it’s cashed, the amount is debited With all these guaranteed payments, and shows up in your bank statement. once the document has been sent or Korner Kafe -$6.59 10/30 To arrange for a bank check, you given to the payee, you can’t stop City of Spring eld -$60.00 tell the bank teller how much the check payment. And with bank checks and 10/31 should be for and who the payee is. You money orders, there is no confirmation then either write a check to the bank in your bank statement or elsewhere or debit the amount from your account. that payment has been made. 16 17 banking banking

Figuring Interest Savings Some savings accounts, including money market accounts, may pay different rates of interest on different balances or different segments of your total balance. If the rate istiered , you earn Putting money away for a rainy day is the basic idea the highest rate on your entire balance once you meet the minimum. If it is blended, you behind savings accounts. earn different rates. Compare Tiered means you earn Blended means you earn Bank deposit accounts, better known Among their primary benefits accounts offering the highest rate the bank offers one rate on the first $1,000, a better as savings accounts, pay interest on the are that they: a 3.5% rate on the entire $12,000. rate on the amount between $1,001 principal, or balance in your account, for minimum Provide and $9,999, and the highest only to encourage you to keep your money •  balance of a safe on the remaining in the bank—although you don’t earn $10,000 and . place to $2,000 all that much even in periods when rates $12,000 on deposit. accumulate are high. When rates are low, earnings money for your are essentially nonexistent. $12,000 3.5% short-term goals But savings accounts are important to $10,000 your financial security, and the way you • Work well as rainy use them best is by adding to them on a day and emergency $8,000 regular basis, every week or every month, funds so you accumulate a substantial balance. $6,000 3.5% on $4,000 entire 33.1%.1% The Truth in Savings Act requires all banks to disclose the annual percentage (APY) you would amount earn and fees you would pay clearly so you can make an informed comparison. $2,000 $1,000 isn’t it interesting? $0 2.5% When banks advertise of which are affected by TYPES OF ACCOUNTS for 10% of your gross income is a good interest rates for their the monetary policy the Bank and credit union savings accounts place to start. If you can boost it to 15%, savings accounts, they Federal Reserve Bank NOMINAL generally come in three varieties: regular that’s even better. Anything you’re contrib- include the nominal is following. When savings, also called statement accounts, uting to a retirement savings plan at work rate and the annual RATE borrowing is expensive, money market accounts, and certificates counts toward the total. And whenever percentage yield you earn a little more of deposit (CDs). All are similarly insured you get a bonus or other cash payment, (APY). The nominal, on your savings. When but differ from each other in certain ways. it’s smart to save at least some of it. or named, rate is the borrowing costs are Regular accounts earn interest at the If you’re for a specific goal, find rate they pay. The low, you earn less. lowest rate but have the fewest restric- out what it will cost and divide the total by APY is what you earn The APY depends tions. You can withdraw when you like the number of months remaining before over a year, in dollars on the or transfer money to another account in you need the money. That will tell you and cents, expressed the bank pays and the your name. What you can’t do is pay a how much you have to save each month. as a percentage of compounding method third party directly from the account. Because there’s a tangible reward for the your principal. it uses. When interest Money market accounts are hybrids, effort you’re making, saving may be easier. The nominal rate, compounds, it is added combining some checking account fea- It may also help you to save regularly if which won’t vary much to the existing principal tures in a savings account. Specifically, you have a fixed amount direct deposited from bank to bank at to become the new you can write up to three checks or from your paycheck to a savings account any given time, depends base on which the Interest % make three electronic transfers to a third rather than having the full amount go on what banks are next interest payment Rate party each statement period—typically into checking. If that’s not possible, you earning on the loans % is figured. The higher a month. You earn interest at a higher can always arrange a regular debit from they make and on what the rate and the more Compounding % rate than on regular savings, provided your checking to your savings account. it costs them to borrow often it compounds, % you always keep the required minimum from each other, both the greater the yield. balance on deposit. Otherwise you may Safe-Deposit Boxes lose interest and owe a fee. Safe-deposit boxes are designed for keeping CDs are time deposits, which means important papers and objects such as deeds, Pluses of Savings Minuses of Savings you must leave your money on deposit Accounts Accounts jewelry, birth and marriage certificates, plus for the term to which you agree or pay a list of your valuable possessions. Most banks • Handy way to accumulate money for • Other kinds of accounts, such as CDs a penalty by forfeiting interest. CDs rent them for anywhere from $15 to several short-term goals, emergencies and money market funds, pay more— typically earn the highest rates of any hundred a year, depending on size. • Money in a savings account can sometimes much more—interest bank account, but they can never be However, you can use the box only during reduce—or eliminate—charges on • Most banks discourage small savings used as transaction accounts. regular banking hours. And the box may be your checking account accounts by not paying interest below sealed if you die, limiting access to valuables • Bank savings are FDIC-insured for up a minimum balance and/or by charging ACCUMULATING SAVINGS for your surviving family—including your to $250,000 per depositor for several service fees that can erode the interest you There’s no golden rule establishing how spouse—until your will is legally filed. different types of accounts earn, actually costing you money to save much you should be saving, but aiming +- 19 PA Y banking banking CD: Certificate of Deposit CDs are popular investments because they live up to their promise of safety.

When you put money into a bank CD, D ROLLOVER AT you expect to get it back at a specific M E O time, plus the interest it has earned. AT F OR UR In return for that security, you agree ITY to leave your money on deposit for a SWEEP fixed period, typically six months to five years. The minimum deposit is PAY TO often $500, but there’s rarely a ceiling, or upper limit. In investment terms, the money you put in is known as your principal. The length of the CD is its term, and the time it matures, or ends, an 18-month period. Each time a CD bank requires a minimum balance for free compound daily, monthly, quarterly, is its date of maturity. matures, you roll it over for another checking and other services, you may con- or some longer period. year so the ladder continues. clude that using at least some of your CD what happens at Maturity There are several good reasons for principal to maintain that level is smart. using cds When a CD matures, you decide what this approach, including having a lump Additionally, when interest rates are If you have regular expenses, like tuition you want to do with the principal. But sum available every six months if you low, it’s probably best to concentrate on payments, or anticipate a large cost at you have to tell the bank in writing need the cash. This makes particularly relatively short-term CDs so that you’re a specific time, you can time your CDs what action to take within the time good sense if you’re using CDs as your in a better to take advantage of to come due when you need the money. limit it imposes. If you wait too long emergency fund. In addition, if rates rising rates in the future. Banks may be flexible, too, if you ask or never give instructions, the bank can have dropped when one CD matures, for a special term. For example, if you roll over, or reinvest, your CD for the you’ll be reinvesting only a portion of THE LANGUAGE OF CDs are planning to buy a house in seven same term but at the current rate. the total at the lower rate. You can make wiser decisions about months, you may be able to get a You might ask for a rollover in any CDs when you’re comfortable with custom seven-month CD at a better case, but if you need the money, or if the STRATEGIC choicES what some key words mean. rate than a regular six-month variety. 6 m to new rate will be lower than the interest You can choose CDs from any insured Yield is the amount you earn in 5 yrs you’ve been earning or that you could bank or credit union and be confident interest during a year, expressed as a per- HOW COMPOUNDING WORKS earn on a different investment, you that your money is safe. What you have centage of the principal. It’s often reported You can see how compounding increases might decide to get out of CDs. In that to decide is what makes the most finan- as annual percentage yield (APY). the value of your savings in the example case, the bank can sweep, or move, the cial sense for you. You may find that an Interest rate is the percentage of below, where interest is added quarterly: money into another of your accounts, online bank pays a higher rate and decide principal added to your CD to produce it to another bank for a to put your money there. Or, if your the yield. If the interest compounds, the First Base amount fee, or send you a check. APY will be higher than the interest rate. quarter + Interest With most CDs, the rate is fixed. With BUILDING A LADDER 18M LADDERING others it may be flexible, or could change Second = New base amount One smart approach to buy- although there is usually a floor limiting quarter + Interest ing CDs is using a technique how low it can go. Floating rates are known as laddering. Instead Rollover pegged, or linked, to a published interest Third = New base amount of putting a large sum into 12M at rate, such as that on a US Treasury note, quarter + Interest a single CD with a specific Maturity and go up or down as that rate changes. term, you split your principal Compounding occurs when Fourth = New base amount quarter into three or more CDs that 6M the interest you earn is added to the + Interest mature in a stepped pattern— principal, forming a new base on which perhaps every six months over future interest is calculated. Interest may = Value after one year

• The yield is higher than on • You pay no charges for • Your money is locked in at a • You may earn more with other bank accounts a bank CD specific rate, even if interest other non-bank options rates go up • Knowing what you’ll have • Changing economic • The new interest rate may REWARDs and when you can take it conditions do not reduce risks • You will probably lose some be lower when you reinvest, of CDs out lets you plan for future what you earn on an of CDs or all interest that has or roll over, your CD cash needs existing CD accumulated if you take If your bank is taken over your money out early •  • You can choose a term that’s • Your CD is insured by by another bank, your CD suited to your financial goals the FDIC or NCUA term or rate may change +20 – 21 credit credit Using Credit When you borrow money to pay for something or use a card to charge a purchase, you’re using credit.

Using credit means being able to pay you’re using and the amount of competi- for the things or services you need tion the creditor has in attracting your or want by borrowing the money. When you pay with credit, you agree to repay the lender the amount you Principal have borrowed. You also typically pay + % Interest a finance charge, calculated as a percent- = Finance Charges age of the amount you borrowed, for the opportunity to use the credit. Loans and lines of credit, of which business. It’s often linked to the interest credit cards are the best-known exam- rates that are current in the economy ple, are the types of credit people use at large, particularly the prime rate, most often. Loans allow you to borrow which lenders use as a benchmark rate. a specific amount as a lump sum and In general, finance charges on credit repay over time. Lines of credit give cards are figured at a higher—sometimes you revolving access to a fixed sum of much higher—rate than the rates on able to take advantage of sales, avoid CREDIT REGULATION money. Revolving means that as soon most loans. carrying large sums of cash, or shop Legitimate credit providers are regulated as you repay what you have borrowed, Other factors influence the finance conveniently by phone or online. by the US government and the states you can borrow it again. charges you pay, including your credit On the other hand, if you regularly where they operate. The laws, which reputation or assumptions a potential charge more than you can afford to have evolved over time, require the Credit Partners creditor makes about you. If a creditor pay, the finance charges can add lenders to offer credit on an equal basis, Two parties are involved in making credit believes there’s a risk that you may substantially to your expenses, and disclose credit terms and conditions, work, the consumer, or user of credit, , or fail to repay, the rate you’ll in the worst of circumstances drive and avoid unfair and deceptive practices, and the creditor, or supplier of credit. have to pay for credit may be higher you deeply into debt. including hidden fees and unreasonable And unless you have informal arrange- than what someone who seems to pose Similarly, a car loan or lease can expenses. The law also governs liability ments with family or friends, getting less risk pays. enable you to replace an old car with for unauthorized use of your credit card credit usually involves an agreement one less apt to need expensive repairs. and details procedures for resolving you make with a evaluating credit use But you can also find yourself repaying billing errors and other disputes. such as a bank or a credit union. People use credit in different ways. Some a loan on a car or other property that’s Among the problems that need greater Customarily, the partners agree on of their choices work better than others. no longer serviceable. Or worse yet, if regulation is marketing of expensive and the amount of credit available and the Credit cards can be a convenient way you over-commit yourself and can’t pay, unnecessary add-on services, like identity conditions under which it will be repaid, to simplify bill-paying. If you charge you may lose the property entirely. theft protection and credit monitoring. as well as the fee the creditor will charge a number of different purchases, you for advancing the money. Since credit is a can make a single payment. If you common phenomenon, those agreements regularly pay in full and on time, there’s twoc fa es of credit are generally standardized. But that doesn’t usually no finance charge. And you may Credit has enabled many people to live But credit does have a downside. mean that the terms are identical from accumulate rewards points if your card better by paying for goods or services as Although many people use credit wisely, issuer to issuer. It’s important to under- offers such a program. You may also be part of their regular living expenses rather some owe more than they are able to stand what the credit will cost, expressed than having to wait until they could repay. It may be that they’ve used credit as an (APR), and afford to make the purchase. It’s more to buy food and gas as usual but have to do some comparison shopping. After available today to a broader range of lost their jobs or are burdened by major all, any creditor to which you apply will Arthur Morris people than it customarily was in the past. medical expenses. It may be that they’ve check whether you’re a good risk before originated the installment In fact, most Americans use credit in been unrealistic about what they can making money available to you. loan. His Morris Plan, one form or another: afford, or that they haven’t recognized the first to make credit About 80% of US how deeply in debt they are. available credit available to the average households have Whatever the Creditors are willing, and often eager, to citizen, began in 1916 credit cards, most reason, the advance you the principal, or money you despite common people who buy consequences borrow, because they make money on wisdom that lending homes have a are costly and the finance charges you pay, especially money to working , put access to if you stretch out the payments over an people was doomed and about 60% of future credit extended period. Creditors figure the to failure. Today, it’s hard college students at risk. finance charge by adding a percentage to imagine how the US (or their parents) of the principal to the amount you owe. economy could function use loans to help The percentage, called the interest rate, without credit. pay tuition. varies, depending on the type of credit 22 23 credit credit

the credit costs you Credit Cards nothing—provided your A TIMELY ISSUE card has a . If your payment arrives by 5 p.m. of the Access to revolving credit doesn’t have to make your A grace period allows GRACE due date, the card issuer must consider it card users who have PERIOD timely, which means on time. If it’s due on head spin. paid their previous a weekend or holiday, you have until 5 p.m. balance in full to on the next business day. But don’t cut it When you apply for a credit card, For example, if you have a credit avoid interest on purchases made during too close. you sign an agreement with the card limit of $3,500 and charge purchases the current billing cycle. Cards aren’t issuer—usually but not always a bank— of $1,500, your available credit is required to provide to repay amounts you borrow against $2,000. If you repay the full amount, a grace period, but if Payment Information your credit limit, a dollar amount that your available credit returns to $3,500. you regularly pay on Statement Balance the issuer sets. Each time you make a If you repay $500 instead, your avail- time it’s worth look- Minimum Payment Due purchase you reduce the amount of able credit is $2,500. ing for one that does. $2,422.67 Minimum Payment Warning: $25.00 If you make only the minimum payment each period, you credit available. But amounts you This revolving cycle of borrowing, However, if you will pay more in interest and it will take you longer to pay off your balance. For example: repay are applied to the credit limit repaying, and borrowing again can pay only part of and available to borrow again. continue indefinitely as long as you pay your outstanding If you make no You will pay off additional charges at least the minimum you owe on time. balance, you owe the balance shown And you will using this card and end up paying interest on the on this statement each month you pay.... an estimated in about... unpaid amount. total of... You also owe Only the minimum 12 years interest on any payment $4,444.00 purchases during $83.00 3 years the month begin- $2,988.00 ning on the day of the purchase. The most common method for calculating the amount of interest you owe is based Do you regularly pay just a PAY $0000 •  BALANCE on the daily outstanding balance in portion of the outstanding balance % Interest your account, with this amount com- each month? pounding daily. If the answer to the first question is Your billing statement includes a yes, you may need just one card with a chart with a warning about how much grace period. If the answer to the last interest you’ll owe if you pay over three question is yes, then what you want is years or pay only the required minimum. a card with the lowest possible APR e The latter is not a pretty picture—and c for which you qualify. n the calculation assumes you don’t use the na e But if it sometimes takes you a little i rg card for additional purchases. If you go F a longer to pay a large bill, consider using h on spending, the problem gets worse. C two cards: one with a grace period that % INTEREST If you want to see what it would you’ll pay off in full for most charges, cost you to repay an outstanding bal- and another, with a low APR, that you ance by making minimum payments, use for large purchases. In fact, you check out the credit card calculator at might investigate applying for a card www.federalreserve.gov. For example, from the retailer where you make a assuming you owed $5,400 with an APR major purchase if you can avoid interest of 18%, it would take you 36 years to entirely by making all scheduled pay- THE CREDIT CYCLE repay, and you’d owe $14,063 in interest. ments on time. One caution: just Every credit card has 12 billing periods time a major purchase for just after never be late with these that end on or about the same date the closing date and take advantage of a CHOOSING A CARD payments or the interest- every month—though that date varies credit float. That means you won’t have You may decide that free deal may evaporate from card to card. When the period to pay for purchase until the following using just one credit and you’ll be facing a hefty ends, the card issuer prepares a state- statement’s due date—generally about card will meet your interest charge. ment that details all of your purchases seven weeks in the future. needs, but there may and since the previous statement, be times that using WORD TO THE WISE calculates your outstanding balance, THE COST OF CREDIT two would be a more Credit card issuers market and sets the minimum payment and It’s true that you may pay more for buy- economical choice. To their cards aggressively, the payment date. The payment date ing with a credit card than you would help you decide, ask yourself: often offering lower-than-average APRs, must be the same date every month and if you paid cash. That’s the cost of Do you always pay your credit card called teaser rates. They may also encour- at least 21 days after the bill is posted convenience. But the additional cost of •  bill in full and on time each month? age you to transfer existing balances. online or mailed to you. using revolving credit—if there is one— You’ll want to confirm what the actual Your statement will tell you when depends on how you pay your bill. Does it sometimes take you a number •  rate will be when the low rate expires the billing period ends, or closes. That’s If you’ve paid your previous bill in of months to pay off a major purchase, and the cost, if any, of balance transfers. handy information, because you can full and on time, and you do so again, such as an appliance or furniture? 24 25 credit credit

KEEPING DATA SECURE Using Cards The data that’s required to process credit and It may be hard to imagine life without credit cards, but debit card transactions is stored in a computer interest begins to accrue immediately at chip embedded in the card or on a magnetic you need a strategy for using them. a rate that’s higher than your card’s APR strip on its back. Chip cards—or EMV cards, for purchases. One way to avoid this an acronym for Europay, MasterCard, and situation: simply don’t choose a PIN for Credit cards are everywhere. But proba- may make you seem like a greater risk Visa—are fast replacing strip cards for a your credit card since you can’t make bly the smartest thing is to avoid having to new creditors. sound reason: They provide significantly cash withdrawals without one. too many of them. The more cards you Cards from retail stores may pose greater fraud protection. In the next phase of this transition to a global card standard, have, the more you may be tempted to the biggest danger since not only do CARDS WITH ANNUAL FEES spend, and the harder it may be to keep they tend to have higher APRs, but the even more secure chip-and-PIN cards will Should you choose a card with an track of when the bills are due. What’s stores make it so tempting to apply for replace chip-and-signature cards and annual fee? You may not want to, as it more, having too much available credit and use their cards by offering discounts. dual-interface chip cards will work at either increases the cost of using credit. It’s also a point-of-sale (POS) terminal relatively easy to find a card with a com- or tapped against petitive APR and no up-front charge. a scanner. The argument in favor is that some CASH cards with annual fees may offer attractive benefits. Among these are affinity cards cospon- sored by the issuing bank and another organization, either for-profit or nonprofit. If you use the card regularly and charge large amounts, the card’s added features, such as frequent flier miles or contributions to a nonprofit you care about, can be a advantages offset the added cost. They plus. But you’ll want to be sure that these may, but they don’t always. And not all affinity cards carry an annual fee.

VS.

ALTERNATE IDENTITIES Some cards with well-known names aren’t are less likely to find yourself in a situ- credit cards at all, but charge cards. You ation where at least one of your cards use them as you do credit cards to make won’t be honored. Occasionally a retailer purchases, but your agreement requires will accept one type of card but not the you to pay your bill in full each month. other, which can be a serious inconve- If you fall behind, you may be charged nience if you don’t carry both types. interest, blocked from using the card, or BEATING EXTRA COSTS Consumer Financial Protection Bureau both. You may also find that no additional SECURITY AT A COST By paying all outstanding balances in full at www.consumerfinance.gov. charges will be approved if you have a If you have trouble qualifying for a and on time, you can keep your credit Further, thanks to the Act, you can’t large outstanding balance even though credit card, you may be able to arrange costs under control by escaping finance be charged an inactivity fee for not using you’re not given a specific credit limit. for a secured credit card by opening a charges and avoiding penalty fees. your card. And, you can be charged an Charge cards generally have an annual savings account and keeping a balance Thanks to the Credit CARD Act of over-limit fee for spending more than fee, which can be substantial in the case equal to your credit line. The account 2009, a late payment fee must be what your credit limit only if you agree to of premium cards offered by particular guarantees the issuer will be repaid. the Federal Reserve Board calls “reason- have the card issuer pay amounts that issuers. The cost may be worth it, However, you may find that the fees able and proportional,” which means, are over your limit. It’s wiser not to. though, if the benefits it provides are most secured cards charge reduce the among other things, that it can’t be more things you would otherwise have to pay actual credit you have, limiting their than the minimum payment that was CASH ADVANCES for, such as access to airline club facilities usefulness. And since using a secured due. The Fed limits the charge for a Be very careful about taking cash or rental car insurance if you travel a lot. card won’t help you qualify for a first violation to $25 and to $35 for a advances with your credit card. While it One approach is to use two cards: conventional credit card unless the second violation within six months. may feel a lot like using a debit card, the one a credit card and the other a issuer reports your use to the If you’re charged more, you should reality is very different. Not only do you card. That way you have access to the credit reporting agencies, you may complain to the issuer and then to the pay an upfront fee for the advance, but advantages that each may provide and be better off without one.

26 27 credit credit

BE PREPARED Card Rights If you want to know more about the credit protection laws that establish your card rights, visit www.federalreserve.gov and search for “credit You’re protected against excessive charges protection l aws.” What you learn can be a good defense against potential and deceptive practices. credit card problems.

Things can go wrong when you use credit cards. You may be a victim of L ost or Stolen Cards scammers who make a business of If your credit card is lost or stolen, and someone uses ripping off other people’s credit and it, the Fair Credit Billing Act limits your liability to are notoriously successful at it. You $50 if the card is used and zero if only the number may be hounded by debt collectors is used. In fact, most card issuers don’t hold you for bills that you never incurred responsible for any charges. But you should notify or have paid in full. And you may be the issuer as soon as you realize the card is missing frustrated by unresolved billing errors, to eliminate any questions about whether or not the which credit-centered legislation charges were yours. dating back to the Truth in Lending Act of 1968 has tried to address. As a first step, you need to review Cancelling Your Card and be sure you understand the terms By law, you can cancel your card and avoid paying the of any credit arrangement you make, annual fee as long as you notify the lender in writing including the updates you’re sent. within 40 days of receiving the bill for the fee. Typically the agreement is in fine print and seemingly endless detail, despite the Credit CARD Act requirement that issuers provide relevant information Purchases You Didn’t Make and “in plain language in plain sight.” Other Billing Errors You’ll also want to keep your receipts, You have 60 days to notify the lender in writing about check them against your next statement, credit card billing errors. This includes wrong amounts and notify the issuer immediately if you of credit extended, wrong goods or services, incorrect spot errors or find charges you don’t rec- payments or credits, computational errors, or any ognize. Even if it turns out you made the other disputed charges. purchase, it doesn’t cost anything to check. Card companies have 30 days to respond and up Most card issuers respond promptly if to 90 days to resolve the problem. They can’t stop you there’s evidence of fraud. They usually cancel from using your card while investigating the problem your current card and provide a new one to and can‘t release a bad credit report on you based on prevent future misuse. Many issuers are also the disputed charges if you pay the rest of your bill. proactive: They’ll notify you if they see unusual And if they don’t respond, they can’t collect the activity, based on your normal card use. You disputed amount or finance charges. can do your part, by letting your issuer know if you’ll be traveling overseas, for example, or making an exceptionally large purchase. Defective Merchandise You can legally refuse to pay for defective merchan- MAKING CHANGES dise if it cost more than $50, and you were unable to If you find dealing with your credit issuer resolve the problem with the merchant. The purchase difficult, you can always switch to more user- must be made in your home state or within 100 miles friendly provider, ideally a cheaper one. Unless of your mailing address, though companies are flexible you’ve had credit problems, it should be easy on this matter. The price and mileage restrictions don‘t to establish a new relationship. If your new rate apply if the card issuer advertised the product or was is lower and there’s no fee for a balance transfer, involved in the purchase. you may want to move your outstanding balance. Better yet, simply pay it off.

Never give your card to write the number on your Be careful with your Never make your PIN 11 number (or card) to check for them. And there’s 22 receipts and billing 33 available to anyone. Don’t anyone unless you are buying no need to put your phone, statements. Thieves can write it anywhere a thief may have something or making a reser­ name, or address on a credit use your number to charge access to it. It’s also essential to vation. Since merchants can’t card receipt. In some states, purchases or even order use a PIN others can’t figure out charge your account if your it’s illegal for a retailer to new cards. easily. But it has to be one you check bounces, there’s no reason ask you to do this. can remember.

28 29 CREDIT CREDIT

LINES OF CREDIT for example A personal line of credit is a type of Loans revolving credit, similar in many ways to a If you have a $10,000 line of credit, you have You can arrange to borrow and repay the money you need credit card. It lets you write special checks access to that money over and over, as long as for the amount you want to borrow, up to you repay what you use: for specific expenses. a limit set by the lender. The credit doesn’t $ 10,000 Line of credit cost you anything until you access the – $ 6,000 You borrow When you need money to buy a car, a specificterm , or length of time, line. Then you begin to pay interest on = $ 4,000 Available credit the amount you borrowed. You must pay college tuition, fix up your home, or with interest. But the details of each + $ 1,000 You repay repay at least a minimum amount each anything else that requires an immediate individual loan can affect how much = $ 5,000 Available credit cash outlay, you are often able to borrow you can borrow and how much the month plus interest, but you can repay the amount from a lender such as a loan will cost you. more, or even the whole loan amount, Advantages bank or a credit union. If you know how whenever you want. Whatever you repay Only one application Whether it’s an installment loan •  different types of loans work and the •  becomes available for you to borrow again. Instant access to credit or a line of credit •  particular features they offer, you’ll be Banks and credit card issuers some- Disadvantages in a better position to look for the one • Whether the interest rate is fixed times offer lines of credit automatically • Potentially high interest rate that will be best suited for you. or adjustable to people they consider good customers. Easy to borrow more than you can In some ways, of course, all loans But that doesn’t mean you have to •  Whether the loan is secured easily repay are alike. You borrow money, called the •  borrow if you prefer not to. or unsecured principal, and agree to pay it back over

INSTALLMENT ADJUSTABLE FIXED REVOLVING SECURED

INSTALLMENT LOANS regular schedule, usually once a month. When you take an installment loan, you Installment loans are also called closed- FIXED RATE ADJUSTABLE RATE borrow the money all at once and repay end loans because you must pay them Many installment loans have a fixed An adjustable rate loan has a variable it in set amounts, or installments, on a off by a specific date. rate. The interest rate and the monthly interest rate. When the rate changes, payments stay the same for the term usually every six months or once a year, of the loan. the monthly payment also changes. SECURED LOANS UNSECURED LOANS Advantages VS.Advantages Your loan is secured when you put An unsecured loan is made solely on • Installments stay the same • Initial rate lower than fixed rate up collateral, or property, to guarantee your promise to repay. If the lender • Easy to budget payments • Lower overall costs if rates drop repayment. The lender can repossess thinks you are a good risk, nothing but • The cost of the loan won’t increase • Annual increases usually controlled the collateral if you fail to repay. Car your signature is required. However, No surprises Can be easier to qualify for loans and home equity loans are the the lender may require a co-signer, who •  •  VS. Disadvantages Disadvantages most common types of secured loans. promises to repay if you don’t. Since un­secured loans pose a bigger risk for • Interest remains the same, even if market • Vulnerable to rate hikes lenders, they may have higher interest rates decrease • Hard to budget for increases rates and stricter conditions. • Initial rate higher than adjustable rate • Could cost more overall • Not always available

CHOOSING A TERM principal, reducing your cost even more. But if 3 YEAR 4 YEAR 5 YEAR The term of a loan is critical to the cost of you’re concerned about being able to afford the borrowing. Assuming the same principal and larger payments on a shorter-term loan, paying Number of monthly payments 36 48 60 interest rate, you always save money with a somewhat more interest with a longer loan may Amount of each payment $456.33 $352.28 $290 shorter term because you pay less interest, be wiser than risking the possibility of default. though the monthly payments are larger. What’s Here’s an example that illustrates the Total repaid $16,427.88 $16,909.44 $17,400 more, some shorter-term mortgage loans offer effect of term on three $15,000 car loans of lower rates than longer-term loans with the same different lengths. Total interest paid $1,427.88 $1,909.44 $2,400

30 31 CREDIT CREDIT

Contrary to popular belief, an IOU is not a The Substance of a Loan binding promise to repay a loan. American When you borrow, you want to know how much, legal interpretation considers it merely an acknowledgement that money is owed. for how long, and at what price. I.O.U. Whether you need a loan only occasionally Usually you request a specific The amount financed, receive. In addition, the lender or borrow on a more regular basis, you’ll HOW MUCH loan amount. The lender can or the principal, is what you may require you to use part be concerned with the same basic things: approve it, reject it, or offer you borrow. However, you may not of the loan amount to pay off • The amount you’ll be able to borrow CAN YOU a smaller amount. Sometimes­ actually get the entire amount another loan or to purchase • How long you’ll have to repay BORROW? you need to apply to more than that is approved. That’s because insurance to cover the loan if • What the interest charges will be 1. one lender to find one that will the lender will usually subtract you should die. approve your request. You may any application fees, credit- Some loans have built-in limits. For have to pay an application fee check fees, or other costs of example, if you borrow money to buy each time. the loan from the amount you a car, the maximum you’re eligible for is determined by the price of the car. If you borrow to pay tuition, there is The cost of a loan is determined Sometimes lenders are eager The loan’s term is a major often a per-year or four-year total that by the amount you borrow, to lend, and offer lower rates factor, because the longer it is, you can finance. Home equity loans are HOW MUCH the term, and the annual or waive the fees. While you the more interest you pay. Your generally capped at 80% of your equity, WILL IT percentage rate (APR) probably can’t time your need goal should be to borrow no and loans in excess of $50,000 may be that the lender offers. How- to borrow to coincide with those more than you need, at the more difficult to arrange. COST? ever, you may be able to find a occasions, some borrowers apply lowest available APR, and with Loans may also have built-in terms. 2. loan at a better rate if you inves- for home equity lines of credit the shortest term over which Car loans rarely last for more than five tigate what various lenders are when lenders promote them. you can afford to repay. years, in part so that the vehicle hasn’t charging before you apply. outlived its usefulness before it’s paid off. Home loans tend to last 15 to 30 years. The interest rate you pay, on the other hand, is affected by two key The terms of repayment are In some cases, including principal in a lump sum. Most factors: the current rate for similar WHEN DO part of your loan agreement. some college loans, you may lenders allow you to prepay loans, which can vary widely from year In most cases, you pay interest pay only interest for a specific a loan at any time. Some charge to year, and your credit score, which is YOU HAVE and some of the principal on a period and then begin to repay a prepayment penalty, usually determined by how you’ve used credit TO REPAY? regular schedule, usually once the principal. In others, you pay about 2% of the amount in the past. Higher scores usually mean 3. a month. only interest for the term of the borrowed, although many you are able to borrow more easily at loan and then repay the entire states prohibit this practice. the lowest rates currently available.

THE LOAN AGREEMENT In many cases, you may have Failing to live up to Another way lenders can When you take a loan, you’re com- WHAT IF YOU to pay a late fee if your the agreement is called collect if you default is by mitting yourself not only to repay, payment arrives after the defaulting on the loan. taking, or setting off, but to repay on a specific schedule. DON’T PAY payment due date, and you The lender may have the right the amount owed from any Those details are spelled out in the ON TIME? should expect to be penalized to repossess and sell the prop- checking or savings account loan agreement, or loan note, a 4. if you send a payment check that erty you put up as collateral. you have with the lender. detailed document the lender provides. is returned for nonsufficient Lenders may also impose a When you sign it, you’ve agreed to its funds (NSF), better known as stiff penalty if you default. And, terms and conditions. The fine print a bounced check. if they hire a collection agency may be off-putting, but you should or , you’ll have to pay for read it carefully. It explains exactly those services, too. what you’re getting—and getting into. CHECK YOUR CREDIT STANDING your credit standing regularly, by rotating though IT ALL BEGINS WITH THE APPLICATION Before applying for a loan, it’s smart to check the agencies so that you look at a different one Loan applications may vary, but they all ask for the same basic information: your credit report with one of the three major every four months. The information isn’t identical credit reporting agencies—Experian, Equifax, Employment Someone at work may be asked to verify your employment, and you may be from agency to agency, but major problems will asked to provide recent paystubs and returns. or TransUnion—to confirm there’s no negative show up on all three. information that you should be prepared If you find errors, which do occur more Accounts You may be asked for your credit card account numbers and balances, for to explain. often than you might think, you should work your banks’ and securities firms’ names, account numbers, and balances. You can access this information for free to have them resolved before applying for a from each agency once every 12 months at loan. Each site explains the procedure to follow References You may need business and personal associates to supply references. www.annualcreditreport.com or by calling and what your rights are if those errors are 877-322-8228. In fact, it’s a good idea to check not corrected. 32 33 credit credit

On Track With Credit So while there may be a reason to get a ballpark sense of your FICO score WHEN FREE ISN’T FREE Your affects what it costs you to borrow. before applying for a major loan, in most An online search for free credit reports and cases checking your credit reports scores will direct you to sites that claim to Your credit history includes the way Primary predictors regularly for problems and errors provide them for free but actually don’t. Many you’ve used credit in the past and of a below-average is all you need to do. entice you to sign up for credit monitoring or information in the public record. Both score are making other services you don’t need and those with- influence how lenders evaluate your payments more than out an obvious price tag want your personal creditworthiness, or how responsible 30 days late, having data for marketing purposes. they believe you will be about repaying defaulted on a loan, what you borrow. and using more than Your history is updated regularly in a 50% of your available credit report and summarized in a credit credit. Several new score by each of the three national credit applications for credit reporting agencies: Experian, Equifax, can also be a problem, and TransUnion. They make your report though multiple que- and score available, for a fee, to retailers, ries for a specific type banks, insurance companies, landlords, of credit within a short potential employers, and others who are period—for example, a mortgage loan— IF YOU’RE TURNED DOWN The Fair Credit Reporting Act requires approved recipients and use the informa- generally count as a single request. If your application for credit is rejected, the agency to investigate your claims tion to evaluate their credit risk in hiring Other score providers use different the lender to whom you applied must and get back to you with its findings, or doing business with you. formulas and sometimes a different give you the principal reasons for turn- although it doesn’t have to correct the Lenders and potential employers, in number range. A Vantage score, for ing you down, plus provide the credit information if it determines it’s accurate. particular, go beyond your credit report example, falls between 501 and 990. score and the name and contact If the information isn’t corrected, and score in evaluating your applications. If the score provider uses only information of the credit you have the right to add an explanatory But—fair or not—a compromised credit information in your credit report, as agency on whose report comment of up to 100 words that must report and a poor score make qualifying most do, your age, income, employ- the score was based. be included in all future reports. for credit, finding a job or an apartment, ment history, race, ethnicity, marital You’re entitled to You can also file a complaint or buying insurance much harder. status, or similar details are not a free copy of the with the Consumer Financial factored into your score. Neither report, based on the Protection Bureau at www. A SCORE C RD are any financial transactions rejection, if you ask consumerfinance.gov/complaint. A credit score is a three-digit number cal- that aren’t credit based, includ- within 60 days. culated using a proprietary algorithm that ing rent payments. However, If the report has IMPROVING YOUR RECORD crunches the data in your credit report. , , or an error, notify the If your credit history isn’t as strong FICO scores, which range between 300 court judgments against lender right away as you’d like it to be, you can repair and 850, are the oldest, best known, and you that are in the and follow up with it, though it may take a little time. most frequently used. Higher scores are public record are the credit agency better. Roughly 20% of credit users have part of your following the direc- • Limit the number of scores over 780 and another 20% below report. tions on the website. credit cards you use, 620. The average is about 720. charge less, and make There are five main factors in every credit card and every FICO score: loan payment on time. • Payment history—basically • Develop and follow a plan whether you pay on time for paying off outstanding debt, starting with debts on How much credit you’re using •  which you are paying the • How long you’ve been using credit highest rates. • The types of credit you use CHECK THE SCORE? • Don’t stop using credit, Unlike free credit reports from because regularly meeting How much new credit you’ve •  www.annualcreditreport.com, you your obligation to pay is applied for recently generally must pay for your credit key to demonstrating score if you want to know what it is. you’re responsible. But there are issues, in addition to cost. 750 For example, score providers create 700 800 different versions of your score for ARE THERE ERRORS? Based on a ten-year study, the Federal Trade Commission (FTC) reported that 26% of the people in 550 different users by weighting the factors in their formula in different ways. In their sample reported at least one major error in at least one of their three credit reports. Of that group, the reports of 79% were changed and 20% saw their credit scores improve enough to be 300 850 addition, scores change all the time, if FICO CREDIT SCORE usually not dramatically. And scores offered a lower interest rate on a car loan. from different providers vary as well.

34 35

820 credit credit

Coping With Credit Problems ONE LOAN FROM MANY The interest rates and fees on In some cases, you may want to consolidated loans tend to be high, The key is to act before you find yourself in serious investigate loan consolidation. In that especially since you already have case, you take a new loan large enough damaged credit. And some loan financial trouble. to pay off your existing debt, so that consolidators impose a large pre- you owe just one lender rather than payment penalty if you want to Losing your job, coping with serious many. But unless you can confirm pay off the debt early. illness, and going through a divorce can THE DOCTor IS OUT that the cost of the new loan will be The one place consolidation threaten your economic security and People who call themselves credit doctors less than the combined costs of your may make the most sense, and is undermine your ability to keep up with claim they can restore your credit reputation. existing loans, you may be facing apt to be reasonable, is with federal your credit obligations. So can spending Don’t believe it, especially if they promise you greater hardship. student loans that you take directly more than you can comfortably afford to won’t be required to make any changes in from—and consolidate with—the repay. While you may be able to juggle your spending habits. Their approach is never government. creditors for a time, sooner or later, you better than quackery, and it’s often fraud. could find yourself in serious trouble. One preventive measure is to build an emergency fund, accumulating at least and leaves you even shorter of cash, six months of living expenses in readily but it could affect your job security or accessible accounts. Some combination chances of promotion. You could also of relatively short-term certificates of be responsible for paying court or deposit (CDs) and US Treasury bills will collection costs. generally work. The goal is not to touch the money except in a real emergency. BEING PROACTIVE Ideally it will last long enough to get If you owe more than you can repay, ask you back on your financial feet. your creditors to change the terms of your credit agreements. They may agree RED FLAGS to add the amount you are behind to The most effective way to handle the end of a loan, reduce your monthly evolving credit problems is to recognize payment, or both. This approach will the danger signals, not ignore them: extend the repayment period and cost you more in finance charges, but it may Your debts, including your keep you from drowning in debt. mortgage if you have one, And don’t wait too long to act. In are more than 40% of your many cases, including most mortgage monthly income. loans and student loans, it’s possible to work out repayment only if you You’re making only the have not defaulted. Information minimum payment on your about possible remedies for repaying credit cards. federal student loans is available at You’re skipping some payments www.studentaid.ed.gov. For mortgage entirely every month. issues, begin by checking with your lender or loan servicer. The servicer WHAT ABOUT BANKRUPTCY? Bankruptcy does You’ve borrowed up to your is the bank or other organization to Bankruptcy is the last resort for provide legal protection credit limit on one or more of which you make payments. resolving credit problems, a from your creditors, your revolving credit accounts. You may want to seek professional harsh but legal remedy for resolves most though help from an accredited credit counselor You’re using savings or preventing financial disaster. not all debts, and may who can help create a payment plan. investment accounts to pay In general, bankruptcy is a prevent the loss of your You need to be careful in selecting some- your monthly bills. three-step process: home, depending on the one to work with, as qualifications vary. jurisdiction in which it is You’re putting off essential Before you choose, be sure you know You file a petition in 1 handled. And bankruptcy medical or dental treatment. the kinds of advice the counselor will 1 federal or state court saying does offer you the chance to start again. provide and what the service will cost. that you are insolvent, which means On the other hand, your financial Unless you can increase your income You may want to search online to see you have no to pay your debts. affairs are public knowledge, hashed or cut your expenses, you could find if any complaints or other problems out in court and part of the public yourself in a situation from which it’s emerge when you type in a prospective You work out a repayment plan 22 record. Your credit standing is seriously difficult to extract yourself. counselor’s name or agency affiliation. with your creditors and the court. damaged, you forfeit assets, and some If you default, your income tax You can also check with the National bankruptcy debts still remain outstanding. refund can be withheld to pay your Foundation for You discharge your debts, or settle 3 It’s essential—and in some cases debts and your wages can be garnished, (www.nfcc.org) or the Association 3 them, typically for less than the mandatory—to consult an experienced which means a percentage of your of Independent Consumer Credit full value of what you owe. attorney before filing for bankruptcy. paycheck is withheld to pay your Counseling Agencies (www.aiccca.org) creditors. It’s not only embarrassing for a referral in your area. 36 37 home finance home finance Buying a Home To buy or not to buy? It may be more complicated than you think.

Is now the right time to buy a home Estima te what you can afford to spend by instead of renting? Should you sell the reviewing your budget, consulting with your home you’re living in and buy another financial advisers, and comparing the results one? The answers to these questions are of several online home-buying calculators— always a combination of financial and though the calculators may ask for informa- personal priorities, sometimes prompted tion you don’t have, such as estimated real by a new job or a growing family. estate taxes and insurance costs Start looking at homes in your price range A BUYER’S CHECKLIST in areas you have identified as places you’d If you’re thinking seriously about like to live buying, you’ll want to: Evaluate how much you have for a down Unless you qualify for a Federal payment, either from savings or potential Housing Administration (FHA) mortgage, commute. The catch is that good schools using www.annualcreditreport.com to profit from the sale of your current home a Department of Veterans Affairs (VA) and good transportation don’t necessarily be sure there are no potential credit home loan guarantee, assistance through go hand-in-hand. problems that might make it harder for the Community Reinvestment Act (CRA), In the final analysis, flexibility is key to a lender to approve your application. If EQUITY CHANGES or another government program—includ- finding a home that meets your financial you find a major error that could hurt EQUITY CHANGES ing people buying in rural areas and people and personal needs. So is waiting for the your creditworthiness, try to have it with disabilities—you should expect lend- right opportunity. resolved by following the directions on ers to require a 20% cash down payment. the credit reporting agency website. VALUE: $400k When estimating what you can afford, THE BUYING PROCESS Then shop around for the lowest MORTGAGE remember that you have to include real Most homebuyers pay part of a home’s annual percentage rate (APR) being $200k $200k estate taxes, whichEQUITY can vary dramatically purchase price, called the down payment, offered for loan term you want. If you 50% EQUITY $200k $200k from place to$2 place.00k If you have children, in cash, and use a mortgage loan from a already have an account with a potential note that higher real estate taxes may bank, credit union, mortgage banker, lender, you’ll want to start there, asking if be correlated with a good public school or other lender to close, or finalize, you would be eligible for a preferred rate. $ system. But paying higher taxes may be the purchase. cheaper in the long run than paying for At least six months before you ASKING FIRST private school. The same is true about expect to apply for a mortgage loan, The customary approach to applying for VALUE: $300k proximity to public transportation if you you should check your credit report a mortgage is to wait until you find the MORTGAGE home you want to buy and then look for $100k$100 a lender. But you may want to investigate k $200k$200k IT’S ALL ABOUT EQUITY $100,000 divided by the $300,000 preapproval. This means you apply for 33% EQUITY When you make a down payment on value) would increase to 50% (your a mortgage loan before you have chosen a home, that amount determines your $100,000 plus the $100,000 divided by a property. The lender will let you know $ equity, or the percentage of the property $400,000). That is, you’d owe around whether or not you’re approved and how you actually own. The more you put $200,000 on a home worth $400,000. much you’ll be able to borrow. down, the greater your equity. And, as But, if the home’s market value Preapproval is often a good idea since VALUE: $250k you pay off the mortgage loan principal, decreased to $250,000, your equity you can shop with more confidence when your equity increases. When the loan is would shrink to 20% if you still owed you know how much you can afford to MORTGAGE $50k$50k fully paid, your equity is 100%, and the $200,000. And the value dropped spend. Preapproval can also make you a $200k$200k home is yours, free and clear. below $200,000, as it could in a serious more attractive buyer, 20% EQUITY But there is another factor at work in market downturn, your equity would as the building equity: the market value of real drop to 0% and you would actually seller can $ estate, which changes all the time. That owe more than the home was worth. be confi- means your equity can increase if the That’s known as being underwater. dent that market value of your home increases. While real estate values don’t change you can VALUE: $200k But, the reverse is also true. If the market overnight, you don’t pay off a loan’s get a loan. But there are fees involved, value drops, your equity could shrink, a principal that quickly either. In fact, it as there are with any loan application, MORTGAGE $0 situation that a large number of home- takes more than 20 years of a 30-year so you don’t want to take this step until $200k$2 owners faced during the fiscal crisis loan to pay off even half the principal. you’re serious about buying. 00k starting in 2008. The prospect of price changes in the Another approach is to seek pre- In a simplified example, assume that housing market shouldn’t drive you qualification. In this case, a mortgage a home you bought for $300,000 with away from buying. The changes often lender confirms that you will probably UNDERWATER a $200,000 mortgage grew in value to work in your favor. But the potential be approved and for how much but does $400,000. Your initial equity of 33% (your for a loss in value is worth considering. not make a commitment to lend. 38 39 HOME FINANCE HOME FINANCE

type specs: futura extra bold Making an Offer 11pt Pay There are often twists and turns, and even some bumps, binder on the road to buying a home. 00

Home prices are negotiable, but the amount. In a slow market, in contrast, Negotiate bargaining power you have—or would the successful bid may offer significantly type specs: price with like to have—depends on the level of less than the asking price. futura type specs: extra bold futura type specs: activity in the real estate market, the One way to be in tune with the 11pt extra bold seller futura type specs: 11pt number of homes available in your market is to work with an experienced extra bold futura 11pt extra bold price range, and sometimes on how real estate professional who is sensitive 11pt eager the seller is to make a deal. to the type of property you are looking 00 In a strong real estate market, or for and the housing prices in different 00 one where homes sell almost as quickly communities within the region. You can 00 00 Have property as they are available for sale, the person also do some checking on your own, inspected who ends up acquiring the property is by noting how long “For Sale” signs are often the one who offers the price the posted and how many houses are for sale, seller is asking, or sometimes a higher as well by tracking real estate websites. Make Renegotiate

type specs: an offer futura your offer if there extra bold 11pt Ask your are problems type specs: broker forfutura extra bold 00 11pt information COMING TO TERMS If your bid is accepted, you normally make 00 Like housing prices themselves, offer a small payment, often in the $1,000 Choose a prices reflect the market. In a strong range, to secure your commitment. The market, you risk losing out entirely if you amount—and what this payment is house that fits make an offer significantly lower than the called—vary from place to place around Do your own asking price. What you don’t want to do the country. In some areas, it’s called a your needs in the excitement of negotiation is to bid binder, in others a good-will payment, type specs: research more than you can comfortably afford to and in still others, earnest money. futura extra bold pay or than you believe the property is In most cases, the amount is 11pt really worth. On the other hand, if real applied to the initial cash payment estate is moving slowly—which can you owe if you sign a contract. If the 00 happen for many reasons—you may be deal falls through, you often—but not Brokers and other real estate able to negotiate significant savings by always—get the money back. It’s a good representatives are typically paid a opening with a very low bid. idea to ask before you make a payment. percentage of the sales price for nego- To come close to the market price, or tiating the sale of a listed home. If the what the house will actually sell for—in LOOKING FOR PROBLEMS professional who sells the home works contrast to the asking price that the Once your offer is accepted, you should for a different firm than the listing seller would like to get—you can check arrange for a licensed building inspector broker—which is often the case—the the history of comparable homes that to evaluate the property. Your lender or HOW THE PROCESS WORKS two firms share the commission. have sold recently in the same neighbor- real estate agent may recommend a firm In general, a home is listed, or put up In fact, you don’t pay the selling hood. You can also find out when the or independent contractor, or you can for sale, at the best price the seller thinks broker’s fee. The seller does, though the seller bought the home and what it cost check local listings. someone will pay, given current market purchase price reflects that cost. Some at that time. That information is avail- The inspector’s job is to uncover conditions. There’s no official pricing—and buyers hire a buyer’s agent to represent able in local government offices and any serious structural or maintenance very similar houses may be listed at differ- them in the transaction. That agent’s fee sometimes on real estate websites. problems that could require expensive ent prices. Some sellers consult several real may be a percentage of the listing broker’s You may also try to evaluate how repairs. If there are cracks in the estate professionals and agree to list with fee or be paid separately by the buyer. eager the seller is to get rid of the prop- foundation, water damage, substandard the one who suggests the highest price. erty. For example, some sellers may have electrical wiring, or a leaky roof, you Most homes are listed with the MAKING AN OFFER already purchased another home or are may want to reduce your offer or local Multiple Listing System (MLS), When you find a home you’d like, you moving out of the area and are eager to withdraw it altogether. which means that any licensed real tell your agent you want to make a bid, close a deal. The same is true if the home You’ll pay a fixed fee for the inspec- estate professional—not only the or price offer. Unless the owner is selling has been on the market for a longer- tion, typically several hundred dollars. listing broker—can show the home to without a broker, you don’t make the than-average time, and the sellers are But you’re likely to get your money’s prospective buyers and negotiate the offer directly. If there are negotiations getting anxious about finding a buyer. worth, especially if anything needs work, sale. A small number of sellers offer and several rounds of offers, all of them The sellers may also be settling an estate since evidence from the report may help their property directly to buyers. are handled through your agent. and want to conclude a sale quickly. you negotiate a lower price for the home. 40 41 HOME FINANCE HOME FINANCE

DIFFERING VALUES SETTING THE RULES Signing a Sales Contract Themarket value of a property is the Buyers or sellers can add contingencies, or amount you’re willing to pay to buy it. conditions, to a real estate contract that must The terms of a purchase are spelled out in a legal contract Theappraised value, on the other hand, be met if the agreement is to be finalized. the buyer and seller sign. is what a real estate appraiser working Buyers may demand that certain repairs or for a lender believes it is worth, based on improvements be made. Sellers may want the comparable houses in the community right to sell to another bidder after a specific and his or her judgment and experience. date if financing is not final. The appraised value determines the size of the mortgage loan a lender will provide. If it’s less than you need to buy of the purchase price and may be less. the home, you may need to increase The balance of the down payment is your down payment, find another due at the closing. As soon as your offer is accepted, the seller’s agent or lender, or change your plans. If the sale falls through, you may or lawyer will begin preparing a formal contract for you to may not get the deposit back, depending sign. It will detail all of the key terms of the sale: on whether or not there is a contingency THE SELLER’S clause to this effect in the contract. • The amount that is due AGENT & Unless a contingency is standard prac- THE • The property that is covered by the price, including tice, such as one voiding the contract if BUYER’S any appliances or furnishings ATTORNEY the buyer can’t find a mortgage, one or AGENT & • When the sale will be finalized the other party may not be willing to • What contingencies, or situations, would void the agree to including it. ATTORNEY agreement, such as your inability to get financing There’s no way to predict how long within a certain period contract negotiations may take. They Most of the language in the contract is standard— can move along briskly, but they can commonly known as boilerplate—but there may be some also be stalled if you, the seller, or your very specific provisions as well. For example, the sellers representatives can’t agree on all the may want to make the sale contingent on their being able details. And since there are a number of to move into their new home on schedule. people involved—the seller, the seller’s agent, the seller’s attorney, you, your agent, and your attorney—making even minor changes to the agreement and getting them approved can take time. One risk you face is that until the contract is signed, the seller may receive a higher offer and reject yours. The period before you sign is probably the last opportunity you’ll have to revise your offer if the inspection has turned up any problems with the home. This means you’ll want to have FINALIZING THE CONTRACT the report in your hands before the When representatives for you and the contract discussions end. GETTING EXPERT ADVICE seller have agreed to the terms of the It’s important that you hire an contract, you both sign the document. FREE AND CLEAR TITLE experienced real estate attorney to The ContractYou typically make a cash down pay- You, as the buyer, must be able to obtain review the sales contract before you ment to the seller’s agent, which is held a free and clear title to the property. The sign. The document’s language is in reserve in an escrow account until title provides assurance that no other specialized, and may include some the sale is finalized. The amount of the person, organization, or government has conditions that favor the seller rather required payment is stated in the con- any legal or financial claim that would than you. You don’t want to agree to The Contracttract, and varies based on local custom. limit ownership rights. Without this title, anything that could cost you extra The maximum is rarely more than 10% you take the risk of losing the money time or money, or that might limit invested in the property should there ever your rights. or the other approach is standard in NEGOTIATION UNDERWAY be a court-imposed settlement requiring You may want to ask your financial the area where you’re looking, and the Sellers may be willing to accept a reduced the new owner to make good on a claim. adviser, real estate agent, or lender to amount may not be negotiable. You price or to hold part of the mortgage if you’re To obtain this title, you pay a title recommend a real estate attorney. Or may also have to pay for the services of unable to borrow the full amount, especially company or title attorney to examine if you’ve worked with an attorney in a your financing provider’s attorney, again if they’re eager to sell. Real estate brokers the public record for any outstanding different capacity, you may want to ask depending on local custom. Using the may agree to a reduced commission if a claims against the property and provide him or her for a recommendation. provider’s attorney may be a cost-saving sale is stalled over price, especially if a title insurance to protect your lender’s An attorney may charge an hourly alternative, but hiring your own legal representative from the listing firm is interest in the property. You can also rate or a set fee calculated as a percent- representative is a better idea and worth handling the transaction. protect your equity by buying owner’s age of the purchase price. Generally, one the added cost. coverage for an extra charge. 42 43 home finance home finance

OTHER ROUTES TO OWNERSHIP IF YOU’RE TURNED DOWN Qualifying for a Mortgage There are other ways to buy. You may want If your application is turned down, there to investigate a rent-to-own arrangement or are a number of steps you can take. Being able to buy a home usually depends on being able consider buying at auction. to borrow. When you rent-to-own, you sign a • You might apply to a different lender, contract with the owner that gives you an as loan criteria vary among lenders. option to buy, with some or all of your lease • You might look for a less expensive payments being credited toward the agreed- home that will still meet your needs. upon sale price. There are potentially some drawbacks, though, including the possibility • You might work with a mortgage broker the sellers will change their minds if real to find a lender, though there will be a fee. estate prices go up, so be sure to have an REVISED RULES experienced local real estate lawyer review the contract before you sign. The Consumer Financial Protection Auctions, where you can buy homes that Bureau (CFPB), acting on the changes have been repossessed or are being sold to mandated by Congress in the Dodd- settle an estate, can help you find a great Frank Act, prohibits qualified mortgages house at a great price. But there are serious from including negative amortization risks for inexperienced buyers. Unless you’re provisions, interest-only payments, serious about becoming an auction expert, balloon payments, terms longer than you may do better looking for short 30 years, or points and fees in excess of sales—homes that 3% of the loan amount—though third- are being sold below party costs, including title insurance, value so that the taxes, and filing fees are exempt from sellers can pay off the 3% rule. Negative amortization occurs when interest you haven’t paid Lenders evaluate, or underwrite, your that judgment, the lender hires a their loans at a price is added to your outstanding principal. mortgage application to decide if you’re professional appraiser to evaluate the their lenders have There are exceptions, including a good risk. In general, what they want property both on its own merits and agreed to accept. those for mortgages in rural areas. And to see is: in relation to comparable properties. different rules apply to subprime loans, Creditworthiness depends on A down payment, or initial cash payment, which have higher-than-market APRs. how you have used credit in the past, of 20% or more of the purchase price that use statistics from comparable But if you have questions about the including loans and lines of credit. purchases by comparable buyers to terms of a mortgage you’re offered, No more than 28% of your gross annual Lenders use both a credit report and provide an objective measurement of consult your lawyer and contact the income needed to pay PITI—principal, a credit score based on the report to the risk of approving your application. CFPB at www.consumerfinance.gov. interest, homeowners insurance, and make this assessment. property taxes Some lenders may use information on your rent and utility payments and A strong credit report, without late THE WAITING GAME It can take up to 30 days after you’ve other contractual spending to evaluate payments or defaults Within three days of applying for a submitted a completed application to get the risk you pose. This is known as mortgage loan you should be mailed a an answer from a lender, though the wait A debt-to-income (DTI) ratio of no more alternative documentation. They Loan Estimate that describes the details may be shorter. If you’re approved, you’ll than 43%, which means that you need no may also use automated underwriting of the loan for which you applied. You’ll get a written commitment letter stating more than 43% of your gross annual income systems, which are software programs to pay your mortgage plus your other debts want to review it carefully to confirm the terms of the loan agreement and how that it’s accurate. You can review a long you have to set a closing date. A history of regular employment at a sample document that includes hints on If your application is successful, you full-time job what to look for and definitions of key should try to lock in the interest rate words at http://www.consumerfinance. that’s available at the time it’s approved, MEETING LENDER STANDARDS Capacity gov/owning-a-home/loan-estimate/. with the understanding that if rates drop You may hear the criteria that lenders You may want to apply to two or you’ll actually finalize the purchase at use in evaluating your application for a perhaps three lenders and use the Loan the lower rate. Some lenders charge a fee mortgage loan described as the big three. Estimates they provide to compare the for a lock-in, which you can ask about Capacity addresses your ability to ollateral offers and potentially negotiate a lower when you do your initial research. have enough cash for the down payment Collateral rate or lower fees. and closing costs, keep up with the loan Remember, though, payments, and still have some assets in that these numbers reserve. In general, capacity depends are estimates, and on your current monthly income, your Creditworthiness they could change investment assets, and your other somewhat by the financial obligations. actual closing. Collateral is the value of the property that you plan to buy. A lender requires = Being Quali ed Quali ed that it be worth at least as much as you’re borrowing to buy it. To make 44 home finance home finance

PAYING OFF YOUR LOAN You repay a mortgage loan in a series The primary drawback to a larger down The Cost of a Mortgage of monthly installments over the term, payment may be cutting too deeply into your The cost of a mortgage depends on the amount you a process known as amortization. Over savings, making it difficult to cover other expenses. the first few years, most of each pay- Consider a shorter loan. With a borrow, the APR, and how long you take to repay. ment is allocated to interest and only a 22 shorter term, you pay less interest overall small portion to paying off the principal. on the same principal. You may also qualify for a By year 20 of a 30-year mortgage, the Since monthly payments somewhat lower APR, which would reduce your amounts allocated to each equal out. spread the cost of a mort- total cost even more. But your monthly payments And, by the last few years, you’re paying gage loan over an extended are higher than if you choose a longer term. So mostly principal and very little interest. period, it’s easy to forget you run the risk of committing yourself to larger payments than you can afford. the total expense. For CUTTING MORTGAGE EXPENSES example, if you borrow The amount you borrow, the finance Make more payments. You can $200,000 for 30 years at 3 charges—which combine interest and 3 pay more than the amount required by 6% interest, your total fees—and the time it takes you to repay your contract, either by making more payments repayment will be around are the factors that make buying a home or paying an extra amount with each regular $431,680, more than expensive. So finding a way to reduce payment. If you do the latter, be sure to make two and a half times one or more of them can save you money. it clear that the extra amount should be used to the original loan. reduce principal, not prepay interest. Lenders may Make a larger down payment. What seems like 1 offer a bi-weekly payment plan, but managing the minor differences in 1 The less you borrow, the less interest you’ll pay. Since the interest is calculated on a smaller extra payments yourself gives you more flexibility the interest rate and may reduce the loan faster. can add up to a base, your payments will be lower. And if your down payment is at least 20% of the purchase However, you might earn more by investing lot of money Lano Amount the money than you would save by paying off the over 30 years. price, you won’t be required to purchase private (Principal) mortgage insurance (PMI), which adds to your principal faster, particularly since you’d still end up At 7%, the total paying most of the interest. repaid would be The amount you borrow. This is the borrowing costs. $479,160, about amount plus interest that you must $47,480 more than repay over the term of the loan. The effect of the term on a $100,000 mortgage at the 6% rate. INTEREST Monthly amount at different interest rates Term 6% 6.5% 7% 7.5% Interest is the percentage of Term 15-year $1,688 $1,742 $1,798 $1,854 (Length of + principal you pay to borrow. It’s the Loan) the primary component of the APR, 30-year $600 $632 $665 $699 and is determined in large part by The longer the term, Total payment the lower the monthly the current cost of borrowing in the payments, but the economy and your creditworthiness. Term 6% 6.5% 7% 7.5% more you’ll pay 15-year $303,840 $313,560 $323,640 $333,720 in total. PoINTS 30-year $431,640 $455,040 $479,160 $503,280 Re at (PrEPAID INTEREST) Over time, a lower + Interest that you prepay at the A Point Well Taken The taxes, which are based on the interest rate will have closing. Each point is 1% of the Lenders might be willing to raise a loan’s assessed value of your property and the the greatest impact 1 loan amount. For example, on a interest rate by a fraction (say ⁄8% or municipality’s tax rate, typically pay for on overall cost. 1 $90,000 loan with two points, ⁄4%) and lower the number of points— public schools, police and fire protection, you’d prepay $1,800. or the reverse—as long as they make highways, and a raft of other govern- the same profit. The advantages of fewer ment services. Assessed value, which is FEES points are lower closing costs and laying determined by an assessor working for Fees include application fees, loan out less money when you’re apt to need a particular municipality, usually differs, origination fees, and other initial it most. But if you plan to keep the at least to some extent, from both the + costs imposed by the lender. house longer than five to seven years, market value and the appraised value. paying more points to get a lower inter- There is also the cost of homeowners Bottom line: Any est rate will reduce your long-term cost. insurance, which your lender will of the factors will require to protect its investment and increase the overall OTHER COSTS OF OWNING which you should have to protect your cost, but a higher inter- THE COST Principal and interest are major compo- equity. You may also be required to est rate and longer OF YOUR HOME nents of the cost of buying a home, but have flood insurance, which is separate. term will have the = they aren’t the only ones. You’ll also In most cases, your monthly mortgage greatest impact. owe real estate taxes, which can vary payment includes all four costs, typically dramatically from state to state and shortened to PITI, for principal, interest, from region to region within a state. taxes, and insurance. 46 47 home finance home finance

teaser rATES However, in evaluating whether The introductory rate you pay for you’ll be able to afford the mortgage, Mortgage Rates the first months of an adjustable-rate the lender must calculate your monthly Mortgages can have either fixed or adjustable rates, or mortgage is almost always lower than payment at the highest amount it could the actual cost of borrowing the money. possibly be within the first five years of sometimes a combination of the two. What it means for the borrower is not the term, not what that amount would only a few months of relief but also lower be at closing. The interest you owe on a mortgage loan may closing costs. The effect is to make mort- be calculated just once or adjusted many times. gages more accessible to more people. With a fixed-rate loan, the total you’ll owe is What it means for the lender is being determined at closing. With an adjustable-rate able to adjust the rate upward when the loan (ARM), the amount changes as the cost introductory period ends, while staying of borrowing changes. competitive with other lenders. Fixed-Rate Adjustable-Rate Mortgages Mortgages Fixed-rate or Pluses ARMs were introduced in the Pluses conventional • You always know your loan 1980s to help more buyers • Low initial rates (sometimes mortgages have been costs, so you can plan your qualify for mortgages, and to called teaser rates) reduce around since the 1930s. budget more easily protect lenders by letting them your closing costs and early The total interest and pass along higher interest costs monthly payments monthly payments are • Your mortgage won’t increase to borrowers. set at the closing. You if interest rates go up • Your interest rate will drop if repay the principal How ARMs Work interest rates go down and interest in equal, MINUses An ARM has a variable interest usually monthly, • Initial rates and closing costs rate: The rate changes on a MINUses installments over a are higher than for ARMs regular schedule—such as once • It’s hard to budget housing 15-, 20- or 30-year a year—to reflect fluctuations costs, since monthly payments period. You know • Your monthly payments may in the cost of borrowing. Unlike can change at adjustment from the start be larger than with ARMs fixed-rate mortgages, the total Interest costs rise after the what you’ll pay cost can’t be figured in advance, •  • You won’t benefit if interest teaser rate expires and for how long. rates drop, but have to re- and monthly payments may rise In most finance to get the lower rates or fall over the term of the loan. • You may have to pay more cases, you can Lenders determine the new interest if rates go up renegotiate the rate using two measures: loan to get a lower An index, which must be a published rate if borrowing costs drop. If •  figure, like the rate on one-year US A WORD OF you sell your home, you can pay Treasury securities or the cost-of- WARNING off your loan early, though there funds indexes. Be sure to check the The size of your may be a prepayment penalty. index. Some fluctuate more—and down payment, your change more rapidly—than others employment history and earnings record, Hybrid Mortgages The margin, a predetermined percent- •  your credit score, and age, such as 1.5%, which is added to Choosing between a fixed-rate or an adjustable- for the entire 30 years. That’s because the lender the amount you want the index to determine the new rate rate mortgage isn’t an all-or-nothing proposition. isn’t limited by a long-term agreement to a rate to borrow all affect the In fact, there are hybrids that offer certain that may turn out to be unprofitable. C apped cOSTS interest rate you’re offered. advantages of each type while softening some The lower rate also means it’s easier to qualify If that rate is higher than All ARMs have caps, or limits, on of their drawbacks. for a mortgage, since the monthly payment will the rate the lender is the amount the interest rate can change. Among the most popular are mortgages that be lower. That’s a real plus, especially if you’re a advertising, ask for an An annual cap limits the rate change offer an initial fixed rate for a specific period, first-time buyer. explanation. If you’re not each year, usually to two percentage usually five, seven, or ten years, and then are For people who plan to move within a few convinced, you may want to points, while a lifetime cap limits the adjusted. The adjustment may be a one-time years, especially if it’s within the period during apply to a different lender or change over the life of the loan, typically change, to whatever the current rate is. More which they’re paying the fixed rate, there’s the complain to the Consumer to five or six points. typically, the rate changes regularly over the added appeal of paying less now and not having Financial Protection Bureau Be careful: Lifetime caps are based balance of the loan term, usually once a year. to worry about what might happen when the (www.consumerfinance.gov) on the actual cost and not on the intro- One appeal of the multiyear mortgage, adjustable period begins. In fact, the typical if you suspect discrimination. as these hybrids are often called, is that the mortgage lasts only about seven years. Then ductory rate. For example, with a 4% borrower can get a lower rate on the fixed-term the borrower moves or refinances and pays off teaser rate and a 6.5% actual interest portion of the mortgage than if the rate were set the balance. cost, your rate could go as high as 12.5% with a six-point lifetime cap. 48 home finance home finance

there’ll be money available as the bills PAYING YOUR SHARE The Closing come due. You typically split some of the annual costs These prepayments may go into an of owning the home with the seller. For Before you can open the door to your new home, escrow or impound account—basically, example, suppose you buy a home on June 1, you must close the transaction. a parking place—from which your pay- and the seller has paid school taxes for the ments are withdrawn. In many states, year on December 1. The seller would absorb the law requires that escrow accounts six months of the tax bill—the length of time When you’ve chosen a home, your THE MONEY TRAIL pay interest, though the rate is typically spent in the house that tax year—and you financing is in place, and the paperwork When closing is over, you begin to make low. State laws may also require that would reimburse him or her for the other six is done, only the closing—sometimes your monthly mortgage payments. It at least one month a year your escrow months, when you’ll be living in the house. called the settlement—remains before probably will feel a lot like paying rent. account should hold no more than one- In this case, if the tax was $2,500, you’d owe you get the keys to your new home. This But it’s different: You’re buying some- sixth of your total tax and insurance the seller $1,250. process varies from state to state and thing of value with each payment. bills. Typically, it’s the month following sometimes even within the same state, Basically what happens is that you the month your largest bill is paid. following local tradition. mail a check or, more frequently, arrange an electronic transfer of money from real THEMES AND VARIATIONS your account to the account your lender

A closing is typically a meeting of all the has designated to receive the payment. INSURANCE DEC. estate parties involved in the transaction, or their At least once a year, and sometimes more representatives. This includes you, your often, you’ll get an account statement tax lender, the real estate agent, your attorney, detailing what you’ve paid and where the seller, the seller’s attorney, represen- you stand in building your equity. Your V.

tatives from the title company and the tax-deductible interest payments will NO ESCROW survey company, and perhaps others. be listed separately. You should save During the meeting, which may be these statements as part of your run by the attorney for your lender or permanent record. by a settlement agent, you and the seller sign the documents that legalize the transfer of the property, the seller is paid, and you write checks to cover all the remaining charges. The process is different when settle- ment is handled by an escrow agent. Then there isn’t a gathering of the interested parties. Representatives for the buyer and seller sign the required papers, hand over the checks, and mail the documents to you when the transaction is completed. AUG. OFFICIAL DOCUMENTS You should receive a Closing Disclosure from your lender three JULY days before the scheduled closing. AT YOUR SERVICE This five-page document details the In many cases, the lender who provides servicer of the loan. This firm keeps terms of the loan, provides important your financing continues to collect your records of your payments, recalculates disclosures, and itemizes all its costs, payments as long as you live in your payments due on ARMs as required, including projected monthly payments

JUNE home. But sometimes the contract is and reports information on your tax- and closing costs. These numbers should PREPAYING THE BILLS sold to another provider. If that happens, deductible expenditures to you and the match the ones provided on the lender’s You may be billed separately the terms of your agreement don’t Internal Revenue Service (IRS) using Loan Estimate. If you find any errors or to cover real estate taxes and change, but the address to which you IRS Form 1098. have questions about any of the terms,

insurance, or those amounts AY send your payment does, and so do the follow up immediately. M may be itemized on your payment people you deal with if questions arise. WHAT CLOSING COSTS COST You should review the other essential invoice each month. Typically, you When you sign your initial financing On average, closing costs are 2% to closing documents, too, including the make the first payment toward agreement you must be told whether 3% of the amount you’re borrowing, promissory note, the mortgage—also these expenses at the closing and your contract can be sold and what your though they could be 6% or more in known as a deed of trust or security a little more than one-twelfth provider’s past practice has been. Some areas where property taxes, state trans- document—and the deed, in advance. of your annual total with each providers routinely sell and others don’t. fer fees, or both, are high. Since these You’ll find sample copies of the forms, APR. of your monthly payments. If your contract is sold, the bank or costs must be paid in cash, you need with explanations, on the Consumer This process guarantees other company that to anticipate them in calculating what Financial Protection Bureau website collects your payments is known as the you can afford to spend on a home. (consumerfinance.gov/owning-a-home). MAR. FEB. 50 JAN. 51 home finance home finance

a daily basis. You want someone Owning a Home you’re comfortable with and who A home can be both a big responsibility seems interested in doing the job. and an enormous satisfaction. HOMEBUYER BEWARE It’s always a good idea to make sure any contractor you hire is licensed, When you buy a home, you’re making a has insurance, and carries industry- personal as well as a financial investment. recognized credentials. Both the It’s your job to maintain your home so National Association of Home Builders that you’ll be comfortable living there. (www.nahb.org) and The National The repairs and improvements that are Association of the Remodeling Industry a landlord’s responsibility when you (www.nari.org) have listings of member rent are yours when you own. Equally contractors on their websites. You can important, you must live up to the also check with your community leaders financial terms of your mortgage loan, or the local Better Business Bureau if you which always requires you to make your don’t have personal recommendations. monthly payments in full and on time. And always be on your guard for KEEPING UP TO DATE unscrupulous people who take advantage of homeowners, particularly those who If you fall behind on your payments, you may be uncertain about what work run the risk of foreclosure. That means should be done. These people often use the finance provider has the right to re- scare tactics to convince you to hire them possess the property and sell it to recover for any number of jobs from paving amounts that are still due. If that driveways to replacing windows to happens, you may lose all the money whatever they think of next. you’ve invested, plus do serious damage to your creditworthiness. USEFUL INFORMATION The key is not to wait if you If you’ve just bought your find yourself having trouble making first home, you might want payments. As soon as you realize you to download a copy of IRS may fall behind, you should arrange Publication 530, “Tax Information a meeting with your lender or loan for First-Time Homeowners” at servicer to explore your options. Do It Yourself Contractor www.irs.gov. It can make it easier to You may be reassured to know that benefit from all the tax advantages that foreclosure isn’t attractive to financing come with owning your own home, providers either. It takes time and costs it’s small. If you wait, repairs generally TAKING ON BIGGER JOBS such as deductible mortgage interest money. Most would much rather work cost significantly more. If you want to make major repairs, and real estate taxes. with you to stretch out your payment If you’re not confident of your or renovate or remodel your home, Remember that a home doesn’t schedule or find some other way for ability to detect potential problems, you’ll need to find experienced, reliable have to be a single-family house. It can you to meet your obligations. But you you can hire a professional to do the contractors by asking family, friends, be a co-op, a mobile home, or even a shouldn’t begin to make partial, or initial check-up. Or, you might refer to and neighbors for recommendations. houseboat if that’s where you live. reduced, payments until your contract has the inspection report you received when Be sure to ask about the kind of work been officially changed to reflect the new you bought your home for a list of the they hired the contractors to do, and terms. Unauthorized partial payments items the inspector looked at. And you how happy they were with the results. could be rejected, putting you in default. should start identifying a list of repair Once you’ve got a short list of You can seek advice from a HUD- experts. Sooner or later you’re likely to contractors, ask each one to submit a certified mortgage counselor whose need a plumber, an electrician, and an bid. A bid is a legal offer to do a job for advice may help you find a workable appliance-repair company. a specific amount of money. The bids solution. You can find more information should be very detailed, including the at www.hud.gov. You should also contact materials the contractor plans to use, a the NeighborhoodWorks organization timeline for when it will be completed, at www.nw.org. and how the clean-up will be handled. As you evaluate the bids, weigh ZONING RULES AN ANNUAL CHECK-UP FOR quality against cost. The lowest bid, Many local governments have strict building A HEALTHY HOME though attractive, might rely on low- and zoning rules that may limit the additions At least once a year you should check quality materials or might rush the job and renovations you can make to your home. the major mechanical and structural in order to cut costs. You should also You might need to get approval or a permit areas of your home, including the consider how you feel about each of from the appropriate local committee heating and air conditioning systems, the candidates before you make a or agency before starting construction. the plumbing, roofing, gutters, doors, final decision. Remember that you Typically, you’ll have to pay a fee, based on windows, and stairs. Keep in mind have to work with your contractor on the estimated cost. that it’s easier to fix a problem when 52 53 HOME FINANCE HOME FINANCE

That risk is the chief reason to be one or more percentage points, to the very cautious about using home equity index to determine the new rate each Home Equity Borrowing borrowing—lines of credit in particu- time it’s adjusted. It may happen once lar—to pay ordinary expenses. If you’re a year or sometimes more often. If you need to borrow, a usually offers the using the money to make improvements best rates, plus the advantage of tax savings. in your home, pay tuition bills, or meet REVERSE MORTGAGES other major expenses, and include loan For older people with lots of equity repayment as a regular item in your but limited income, a reverse mortgage Home equity loans let you borrow using budget, home equity borrowing can may seem to be an appealing alternative the equity you’ve built up in your home be a wise choice. But if you’re in the to selling their home. A reverse mortgage as collateral. You can often borrow ATTRACTIONS position of not being able to repay, allows owners to borrow against the more money at a lower interest rate you’re exposing yourself to losing value of their home, so that they can than with other types of loans. And, in The are easy to get •  everything you’ve invested in your continue to live there. The loan does many cases, you can deduct the interest home—and having no place to live. not have to be repaid until the home you pay on the loan when you file your • The rates are usually is no longer the borrower’s primary tax return, reducing the actual cost of lower than on residence. However, the borrower must borrowing still further. Most of the other unsecured loans pay insurance premiums and real estate interest you pay, on car loans or personal DANGERS taxes to keep the loan in good standing. loans, for example, isn’t deductible. The interest is tax They can be very You can apply for insured reverse You can choose between: •  •  deductible, though expensive when you mortgages through lenders who • Home equity loans, sometimes there may be a cap and consider total cost are approved to offer Home Equity known as second mortgages other restrictions. Check Conversion Mortgages (HECMs) You risk losing your backed by the Federal Housing • Home equity lines of credit with your tax adviser •  home if you default Administration (FHA) or from a HOME EQUITY LOANS limited number of other private lenders. The amount you can borrow With a home equity loan, you borrow a time full payment of principal due at on the payments depends on your home’s appraised value, lump sum, usually at a variable rate of some set date. Or, you may make inter- Even if the value of the current interest rate, the age of the interest, although some fixed-rate loans est-only payments for a specific period, •  youngest borrower, and the amount of are available. You pay off the debt in and then begin to pay principal as well. your home decreases, the initial mortgage insurance premium. installments, just as you repay your Most credit lines have an access the amount of your In addition, FHA lenders impose caps mortgage, with some of each payment period, often five to ten years, during loan stays the same on the amount they will lend. going toward the interest you owe and which you can borrow, and a longer While interest rates quoted on reverse the rest toward the principal, or loan payback period. The longer you take to mortgages can be similar to those for amount. At the end of its term, or repay, the more expensive it is to borrow. FINDING A LOAN other mortgages, there are additional payment period, the loan is retired. Home equity loans are generally avail- fees and charges that can make them You may have to pay closing costs WHAT YOU CAN BORROW able. Banks offer them, and so do credit more expensive than other types of on your loan, just as you did for your As a general rule, you can borrow up to unions, mortgage bankers, brokerage loans. Lenders must provide a Total first, or primary, mortgage. But lenders 80% of your equity in your home with houses, and insurance companies. Annual Loan Cost (TALC) disclosure may offer loans with no up-front a home equity loan. For example, if you You can start by checking rates and that estimates the average annual cost as expenses as part of a promotional deal. owed $75,000 on a home appraised at terms advertised by local or online banks a percentage of the loan, and borrowers You might also be offered ateaser rate, $250,000, your equity would be $175,000. and making some phone calls to see must be counseled by a HECM approved or a period of low interest, as an In most cases, you’d be able to borrow up what’s available. But before you commit counselor. You can find a list at www. incentive to borrow. If that’s the case, to $140,000, or 80% of $175,000. yourself, you should get a description— hud.gov or by calling 800-569-4287. the lender has to tell you the actual Some home equity lines of credit, in writing—of the rates, the term, and Federal regulations enacted to cost, or annual percentage rate (APR), especially those offered without closing the other conditions of the loan. protect both borrowers and the FHA and when the temporary rate ends. costs or other up-front expenses, are require a financial assessment before capped at a fixed amount, often $50,000. SETTING THE RATE a loan is approved and an escrow HOME EQUITY LINES OF CREDIT While you use the loan, your equity is Each lender sets the terms and condi- account in some cases. They also limit Home equity lines of credit are actually reduced by the amount you owe. When tions of loans it makes, though the the amount that can be withdrawn in revolving credit arrangements, which it’s paid off, your equity is restored. basic elements are usually similar. If the first eary of the loan. you can use in much the same way you However, if your home loses some of its the loan has a variable rate, it must use a credit card. Your credit line, or value during the loan period, you still be tied, or pegged, to a specific public limit, is fixed, and you can access by owe the full amount you borrowed. index. The lender adds amargin , often A TIMELY ISSUE check or debit any amount up to that If your payment arrives by 5 p.m. of the limit. Whatever you borrow reduces BEWARE THE RISK due date, the card issuer must consider it what’s available until you repay. Then While home equity borrowing has many timely, which means on time. If it’s due on you can use it again. advantages, it has one serious drawback: If a weekend or holiday, you have until 5 p.m. The terms of repayment vary, and are you default, or fall behind on repayment, on the next business day. But don’t cut it spelled out in your agreement. In some you could lose your home through fore- too close. cases you begin to repay principal and closure. That means the lender takes over interest as soon as you borrow, or the property and sells it at auction. That’s activate the line. In others, you pay true even if you’ve made all the payments interest only, with a balloon, or one- on your first, or primary, mortgage. 54 home finance home finance

TYPES OF COVERAGE If you own a single family home, there WHAT’S A PICTURE WORTH? Insuring Your Home are five types, or forms, of coverage. The Often, the answer is a lot. It’s smart to take most basic form, which provides the photographs and videos of your home and Insurance protects your investment in your home and least coverage, is known as dwelling fire. its contents and store them in a secure your mortgage lender. The most popular form, according to place—either in another location or in a the National Association of Insurance fire-proof, water-resistant home safe. In case Commissioners (NAIC), is the Special, of a loss, the photos can help support your When you have a mortgage loan, you HOW MUCH INSURANCE? which offers the most comprehensive claims about the value of your losses. must have homeowners insurance. But Insurance companies require you to protection. The other three are Basic, you’d want the insurance anyway, to cover your home for at least 80% of its protect against potential damage to your value, an amount that will be less than the insurer you choose, home and its contents. In the language its market value because you are not but also on: of an insurance policy, you’re buying insuring the land on which the home is RAGE MOST VER E Your credit history protection against perils. Some policies built. It’s almost always wiser to insure 5 TYPES OF C OV •  cover named perils—the ones they for 100% of its value, an amount the SPECIAL • Your history of filing claims specifically identify, such as fire—while insurer determines. BROAD and the history of claims other policies cover all perils except the There’s generally a INSURANCE previously filed for the home ones they specifically exclude. formula that determines MOTIFIED BASIC PROTECTION • Security systems and devices You can buy homeowners insurance how much coverage in the home through a licensed agent who sells prod- a homeowners policy 80% DWELLING FIRE ucts from several insurance companies, will provide for your OR MORE LEAST • The other policies you own an agent who represents a single insurer, personal possessions with the insurer or directly from a company that sells (sometimes called contents coverage), The deductible you choose its products online. What coverage any other buildings on the property, Modified, and Broad. A Modified policy •  costs, or the annual premium, can vary and loss of use. You choose the level of is designed for older homes with features A deductible is the amount you’re significantly, depending on the insurer coverage you want for liability in case that would make the cost of rebuilding responsible for paying out-of-pocket for and the type of coverage. So can con- you are sued for injury or damages that greater than the market value of the home. each loss. After you meet the deductible, sumer service, particularly when you occur on the property. You may also be Some policies insure the replacement the insurer pays the amount of the submit a claim for a loss. It’s important able buy added coverage, called policy value of your home, or what it would remaining claim it determines is appro- to compare several quotes from different endorsements, for perils, such as floods, cost to restore it, while others cover the priate. The higher the deductible you insurers, taking both price and service earthquakes, or for expensive possessions, actual cash value. The latter is generally choose, the lower your premium will be. into account, before you buy a policy. that aren’t otherwise covered. less generous—and less expensive— What you need to weigh is the benefit because it may not provide enough of a lower premium against the prospect money to actually replace your former of having to cover a larger portion of a home, having discounted its value to loss yourself. reflect age and use. One of the advantages of talking AFTER A LOSS to a number of agents is that you can If your insured property is damaged by compare their advice on the form of one of the perils against which you’re insurance that would best suit your protected, you file a claim with your needs. You may use a fee-only insurance insurer asking for money for the repairs. consultant who provides advice but does The faster you file, and the more back- not sell policies and so has nothing to up information you provide, the more gain from the decision you make. quickly your claim should be resolved. If you’re already working with a If you have loss that costs only a bit , he or she may provide more than your deductible, you may useful guidance. And, to get started, decide not to involve the insurer at all. you can download a copy of NAIC’s There may be little to gain and some- A Consumer’s Guide to Home Insurance thing to lose by filing a claim. Insurers at www.naic.org. have the right not to renew a home- owners policy when its term ends, and THE COST OF COVERAGE one reason for doing so is the number What you pay for homeowners of claims you have filed, even if those insurance depends on a number of claims are for legitimate losses. factors, particularly the characteristics Once you do file a claim, the of your home, the type of coverage, and insurance company’s claims adjuster will contact you to assess the damage FAIR WARNING and report the findings to the insurer. You should always check an insurer’s If you don’t agree with the adjuster, or financial reputation with a rating company with the settlement you’re offered, don’t Benjamin Franklin organized the first fire insurance company in and any complaints about it with your state’s hesitate to object. In the worst-case North America in 1752. It’s still doing business in Philadelphia. insurance department. situation, you can appeal the decision to your state insurance department. 56 57 financial planning financial planning

A financial plan is a game plan Financial Planning that evaluates your current Six out of When you plan, you identify financial goals and assets and debts, identifies ten Americans the things you want (or need) rate a steady source of develop strategies to meet them. to provide for, and lays out retirement income as their a strategy to pay for them. primary financial goal. When you do financial planning, you’re Developing the plan is one looking toward the future, specifically at thing. Sticking to it is another. building the kind of financial security A DEFENSIVE you’d like to have and being able to BACKUP afford the life you want to live. But to Planning is also important plan successfully, you also have to evalu- because it helps you ate the present, including the financial anticipate and handle choices you’re making now. Otherwise the obstacles that come it’s too easy to find yourself making between you and your goals. random decisions that won’t move you toward your goals effectively, or that may even interfere with achieving them. BEAT It’s never too soon, or too late, to Seek a strong return begin. Financial planning is important, INFLATION has averaged whether you’ve just started working or 3% since on your investments are thinking seriously about retirement. 1926. And it should be a continuing process, so If your investments provide a return that you can evaluate your progress, revise higher than the inflation rate, you’ll be your goals, and update your strategies. in a much better position to afford the Without planning, you run greater things that are important to you. financial risks. You may not have enough money in reserve to meet expenses you’re Tax planning expecting, like the down payment on a MINIMIZE can help to Choose tax-deferred home or the price of a college education. TAXES reduce what and/or tax-exempt You may have to revise your retirement you owe. investments plans. Or you might leave your family without enough to live comfortably if You can take advantage of tax-deferred something happens to you. investments to postpone taxes and make tax-exempt investments to avoid them. planning strategies Trusts may also reduce the taxes your heirs In financial planning terms, creating will owe down the road. Liquid a strategy means defining the steps investments you’ll take to have the money you Create an emergency are those need to pay for the things you want. fund with investments PLAN FOR you can To begin, you need a clear sense THE UNEXPECTED quickly turn you can liquidate easily of what your goals are, and what into cash. they will cost. You have to evaluate the assets you already have and With an emergency fund plus adequate health find ways to increase the amount and life insurance as hedges against unexpected you’re saving and investing. While expenses and illnesses, you’re less vulnerable to planning doesn’t guarantee success, potential hardship. failing to plan is virtually certain to bring disappointment. SEEKiNG aDVicE of financial institutions compete to provide the The biggest danger isn’t making a mistake services their customers are looking for. by choosing the wrong approach. It’s in doing Among the places you can turn to for help DEFINING YOUR GOALS nothing. Many people take advantage of pro- with financial decisions are: Planning is important because it helps you identify a range of goals fessional advice in drawing up a financial plan Registered investment advisers (RIAs) that you’re working to achieve: and putting it into action. You can work with an •  Short-term goals Mid-term goals Long-term goals adviser from the beginning, consult a number • Certified public accountants (CPAs) of different advisers, or choose someone to  You may focus on things you You may have expenses to You probably have hopes Financial planners hope to have in a couple of meet several years in the future, for a comfortable retirement, execute the decisions you make on your own. •  years, like a new car or a like tuition payments or a the opportunity to go places In fact, a major advantage of working • Insurance brokers regularly with an adviser is the added incentive  new home. vacation home. and do things you’ve always Brokerage firms wanted, or a chance to provide it can provide to get started and stay focused. •  security for your heirs. Help is increasingly available, too, as all types • 

58 59 FINANCIAL PLANNING FINANCIAL PLANNING Making a Financial Plan Choosing an Adviser If you’re looking for a financial adviser, you’ll want to set up some criteria to help you evaluate A financial plan is a working document that can be as the people you may work with. Among the questions you can ask to help you make a choice: flexible or as focused as ouy want it to be. How much experience have you How are you paid? had working with clients that Some advisers are paid commissions on the Whether you work with an adviser starting point. Advisers, for example, share my situation and goals? products they sell, some receive flat or hourly to create a plan, use computer-based usually ask to see recent income tax Ten years of experience isn’t too much to fees for their service, and some are paid a software, tap into a financial planning returns, a summary of your investments, expect, especially if you’re new to investing. combination of fees and commissions. site on the Internet, or devise one on information on your retirement plan, What’s your background Will you explain how the your own, you’ll need to use some basic and your life insurance policies. and expertise? investments you recommend financial documents to establish your Some advisers develop a detailed You’ll want to work with an adviser who will help me achieve my goals? written plan, also called a personal has a strong reputation in the field, either You’ll want an adviser who’s willing and able financial analysis. The document as an individual or as an employee of a to explain how investments work and why summarizes the information you’ve respected company, and appropriate they’re suited to your needs. provided, includes an overview of credentials. How will I know if my various financial planning strategies, What kinds of investments do investments are producing and recommends specific investments you sell most often? the results I want? or other steps you should take to Be wary of an adviser who emphasizes one Advisers should provide regular reports on achieve your objectives. or two types of investment products instead the status of your accounts and be willing If you prefer, you can request of a broader range of traditional and perhaps to explain how well your investments are a simpler approach, and receive some alternative investments. performing and what adjustments to consider. a letter summarizing the goals you’re working toward, the approach to investing THE RISK ISSUE BEATING INFLATION you want to take, and Financial planning almost always Conquering the effects of inflation, or the type of invest- involves making investments. One the gradual increase in what things cost, ments the adviser issue you’ll have to resolve is the kind is one reason financial planning is so recommends. of investment risk you’re comfortable important. Because prices rise, money taking. The choice ranges from very doesn’t buy as much this year as it did little to a great deal, with a broad last. Ten years from now, it will buy middle ground between the extremes. even fewer of the things you need. Conservative tend to That means to maintain the protect their principal to the extent same standard of living, you need an that’s possible while hoping to realize equivalent increase in income every year. enough return to outpace inflation. One way you may achieve that is by They may prefer insured certificates of investing money so it earns more than deposit (CDs), US Treasury issues that the rate of inflation, even after you’ve they hold to maturity, and securities paid the taxes on your earnings. What OWNERSHIP: ONE OF THE KEYS TO PLANNING such as high-rated bonds, blue-chip you have left of your earnings after infla- stocks, and balanced mutual funds. tion is called your real rate of return. The kind of ownership you select for property and other assets determines what you can do with Aggressive investors are willing to them, how vulnerable they are to creditors, and what happens to them after you die. Laws are put their principal at greater risk for the ASSESSING PROGRESS complicated and vary from state to state, so you should seek professional advice. potential of realizing a higher return and At least once a year, you and your Type Features greater growth. They may invest in new adviser should evaluate the investments or troubled companies, higher-risk bonds, you’ve made to see if they’re providing Individual (or sole) • You own the asset outright and a range of alternative investments. the return you expected. If not, it may Joint tenants • You share the asset equally with one or more joint owners Moderate investors emphasize be time to make some changes to your with rights of • At your death, the assets automatically transfer to joint owner(s) growth over safety, though they typically portfolio. But keep in mind that what’s survivorship You generally can’t sell property without consent of joint owner(s) prefer to limit the percentage of their happening in securities markets will •  portfolio assets committed to higher-risk have a major effect on how individual Tenants in • Each owner holds a part, or share, of the whole investments. They may select a variety of investments perform. common • Individual shares can be sold, given away, or left as owner wishes securities and other products, including If the economy is healthy and the Tenants by • You must be married some alternative investments. markets are prospering, your investments entirety • Mutual consent is needed to divide or sell the property The risk of investing too conser- should reflect that strength. But if invest- At death the property goes to the surviving owner vatively is limiting your ability to ments overall are lagging, yours are •  realize your goals. But investing too likely to lag as well. A diversified port- Community • In the nine states with community property laws, most property aggressively, especially as you get older, folio of investments helps you manage property acquired during marriage is owned equally by both partners increases the potential for losing money some of the market risk that every • Once property becomes community property, it remains so even in a market downturn without leaving faces, though it doesn’t if you move out of the state time to recoup your losses. That’s risk guarantee a positive return. you may not want to take. 60 61 financial planning financial planning

it doesn’t take much Managing Your Cash Flow To create an emergency fund, multiply your monthly take-home pay times six to find the amount you want to save. Then decide how much you can reasonably With planning, you can manage your spending afford to put aside each pay period to reach that amount as quickly as possible. to cover immediate needs and still invest for long-term goals. Funds in reserve Irregular income, unexpected repair bills, Your finances are in constant motion. medical expenses, or loss of your job Even as money comes in from employ- can pose special cash flow problems. ment and other sources, it goes out It pays to have a safety net— for regular living expenses like customarily six months of food and shelter, and for periodic living expenses—set aside bills like taxes and insurance. in an emergency fund. This in-and-out movement is You can use your credit card to called your cash flow and the spending cover some emergencies when they plan you create to manage that flow is happen, but interest charges will increase called a budget. Budgeting has a bad the cost dramatically if you repay over reputation because it’s often equated an extended period. If you can withdraw with denying yourself things you want. from your emergency fund when the But it’s an essential part of financial credit card bill is due, you can combine planning and not as difficult or the convenience of charging with the restricting as you might think. economy of paying in full. Whatever the reason you need money Household Budgets from your emergency fund, you should Using last year’s expenses as a base, you esti- replenish it as quickly as you possibly mate how much you will spend this year can, even if it means sacrificing some for housing, food, transportation, and so immediate pleasures. It’s the only way to forth—including the large bills like insur- be prepared for the next emergency. ance that you pay quarterly or annually. If your expenses are higher than your TRACKING YOUR SPENDING income or you want to invest more, you To budget effectively, you have to know can review what you’re spending to see where your money is going. It’s relatively where you can cut back. The simpler easy when you pay bills electronically or and more realistic your budget, the by check, since you have a record. Your more likely you are to follow it. credit card statement can be helpful as well, with each charge and amount Regular expenses listed. What’s harder to track is the cash Weekly Food, transportation, you take at the ATM—and it’s often household supplies, childcare cash spending that gets you into budget trouble because it can be hard to track. Monthly Housing, utilities, phone, You might keep a daily spending loan repayments record for several weeks, using either an Quarterly/ Insurance, taxes app on your smartphone or a small note- annually book. You may be surprised at what you discover about where your money goes. Other Medical and dental expenses, If you have children, encourage repairs, entertainment them to be part of the budgeting process, from allocating income to various family expenses to keeping the part income plays track of spending. It’s a great way Your income determines the amount you can afford to to learn about money. spend on the necessities and pleasures of life. To keep your cash flow positive, which means having money left at the finding money Have a percentage of your salary Reinvest all the money you make on end of a pay period to spend as you wish, you may want to 11 44 allocate income first to those essentials that have a fixed to invest deducted from your paycheck and invested your existing investments, automatically price, such as housing and loan repayments. You can If you’d like to invest in an employer sponsored retirement plan. if you can. then allocate to essentials with variable costs, more of your house- Transfer a regular amount to an investment Pay off your credit card balances. Then put such as food and clothing, where you can hold budget, but 22 account when you pay your bills each month. 55 an amount equal to what you were paying reduce your spending more easily aren’t sure how to in interest into an investment account. Invest any money you get from gifts, if you are running short. get started, consider 3 these suggestions: 3 bonuses, or extra jobs.

63 financial planning financial planning

Your Net Worth fair market value When you’re calculating what your personal assets are worth, the number Your net worth statement is a snapshot of where you stand to use is their fair market value. That’s the price a willing, rational, and financially at a given point in time. knowledgeable buyer would pay for things you are willing to sell.

AssetsWhat You Own LiabilitiesWhat You Owe Currently and Long term Short-term Cash reserve debts are assets include Assets Liabilities your current the money in your Current aMOUNT for example bills: credit checking, savings, Estimated card charges, personal loans, and money market accounts, CDs, Mortgages $160,000 Value for example income and real estate taxes, Treasury bills, and the cash value of Bank loans 0 and insurance. Your present your life insurance policy. Cash in banks & money market accounts $20,000 Car loans $7,000 credit card balances are Investment generally included, even if

assets Amounts owed to you 0 Lines of credit $3,000 you regularly pay your entire include stocks, Stocks/bonds $14,000 Charge accounts $1,800 bill each month. bonds, mutual funds, retire- Mutual funds $15,000 Margin loans 0 Long-term debts are ment plans, annuities, and other Certificate of Alimony 0 mortgages investment products. deposit (CDs) $8,000 Taxes owed: and other Personal loans that you repay in install- IRAs $40,000 assets Income $21,000 ments over several years. Employer retirement are your Real estate $3,200 accounts possessions. other perspectives (vested interest) $135,000 Other 0 Some—like antiques, stamp collec- When potential lenders tions, and art—may appreciate, Real estate: Other liabilities: assess your application— or increase in value. Others—like Home $200,000 College loan $7,000 which includes a net cars, boats, and electronic worth statement—to equipment—depreciate, Other 0 Insurance $3,500 decide whether you or decrease in value over time. Business interests 0 Business loan 0 qualify for a loan, they Real estate look at what you already Personal property* $30,000 includes your Ttalo owe. But they may also home and T oTAL Assets $462,000 LIABILITIES $206,500 calculate what you might other land owe if you charged as and buildings. * Includes furnishings, jewelry, collections, cars, security deposit or rent, etc. the starting point As part of deciding how to pursue aSSEtS MINUS LIABILITIES your financial goals, you should take a look at where you stand right now. You If your net worth is negative, assets Net Worth do that by adding your —such turning it around by paying off short- Using net worth statements much as you could on all as cash, investments, and retirement term debt should be your financial Figuring your net worth is not only a critical first step your credit cards and drew plans—in one column and your planning priority. in financial planning. It will also come in handy in many on all your potential lines liabilities —or debts—in the other. If it’s positive, you’ll want to look at financial situations. For example: of credit. Then subtract your liabilities from how your assets are divided among cash, What most lenders your assets to find yournet worth. investments, and real estate and perhaps • Mortgage lenders require a statement of your assets and like to see is a net worth Net worth doesn’t measure cash flow, make some changes. Your age, goals, and liabilities as part of the application statement that shows but there’s a clear relationship between amount of risk you’re comfortable taking • College financial aid is based on your net worth, so substantial savings and how you spend your money and what are important factors in determining the you’ll have to report your assets and liabilities when your investments, and limited your financial picture looks like. If most appropriate focus. For example, children apply—except not retirement accounts debt. Investments mean your assets outweigh your liabilities, if you’re starting your career, it may be • Loan and line-of-credit applications usually require net that you have resources you have a positive net worth. If your growth in your investment portfolio, or, worth statements to tap in an emergency, liabilities are larger, you have a negative if you’re nearing retirement, a combina- • Certain high-risk investments may require that you have including assets that could net worth. tion of growth and income. a minimum net worth—often $1 million or more be sold to pay your debts. 64 65 financial planning financial planning

flexibility in choosing investments. You reduce—though not eliminate—the Paying for College may also realize tax savings in certain costs of borrowing. cases by paying college expenses with You and your child must complete a Once you fit all the pieces together, you’ll have a clearer interest you earn on US savings bonds. comprehensive federal loan application, Better yet, you don’t have to select the FAFSA, to qualify for an under- view of how funding your child’s education works. just one method. You can create a graduate loan. But the good news is savings plan that combines several of that federal loans have made it possible There’s no doubt that the cost of higher But it’s equally true that while the options and takes advantage of their for many more students to afford a education has increased dramatically in saving may not be easy, there are a most attractive features. college education. recent years. Yet, perhaps surprisingly, number of programs designed not only Federal Direct loans—Stafford for the number of students enrolling in to encourage you to put money away IT’S A GRANT WORLD students and PLUS for parents—are all types of institutions has increased for college but to provide tax benefits if It’s the unusual person who doesn’t available from the government. You as well. One reason may be that addi- you do. In fact, you may already have enjoy receiving a gift. And the best can find detailed information on tional education makes financial sense. a plan to accumulate the money you gift a college student—and his or what loans are available and how to Another may be the commitment—and anticipate needing. her parents—can receive is a grant or apply at www.studentaid.ed.gov, a sometimes sacrifice—that families are Among the most widely available scholarship. Grants directly reduce US Department of Education website. willing to make in order to pay for the choices are those that share the 529 the amount of your child’s education You can borrow money elsewhere as opportunity that education provides. label: college savings plans, state prepaid expenses and, unlike loans, never have well, which you may opt to do if federal But a third, and possibly equally power- tuition plans, and the private college to be repaid. Grants make up about funding doesn’t meet your needs. One ful factor, is that families can turn to prepaid plan. Another alternative is the 40% of all financial aid that college of the issues you’ll have to weigh in a number of sources to help them Coverdell education savings account students receive. About half of the accumulating loans—even for a good cover the cost. (ESA), which has lower contri- grants in any year come from private cause—is the long-term responsibility bution limits but more institutions or individual colleges and they impose on you and on your child. THE ROLE OF SAVING universities, while others are provided Whether you’re a by public institutions, including certain MAKING COMPROMISES brand new parent states and, in the case of Pell grants, The other thing to remember about or you’ve had the federal government. paying for college is that there are many lots of One challenge may be determining routes to an undergraduate degree. the requirements a student must meet While some students finish their to qualify for a grant. Certain grants, college education at one school within practice such as Pells, are need based. Others are four years, many don’t follow that pat- as a mom or merit based, which means they’re given tern. For instance, students may begin at dad, this probably in recognition of the student’s achieve- a local two-year public college and then isn’t the first time you’ve ment. Still others may take both the transfer to another public institution or thought about saving for student’s merit and need into account. to a private college. They may attend college. It’s hard to avoid In most cases, students are offered school part-time throughout the year the bottom line: Colleges grants after they’ve been accepted at a for five or six years rather than full-time and universities, as well college or university, but sometimes a during the fall and spring semesters for as the federal government, school or organization will offer a grant four years. Or they may select a school consider it your responsi- as an incentive to attract your child. You that expects students to combine time bility to contribute to can check with the high school guidance in class with paid internships. your children’s higher office and organizations you belong Certain circumstances may also education expenses. to for a list of potential provide you with different ways Without at least some scholarships. You might to reduce the overall cost of your savings, meeting that also discover lists COST OF child’s education. For instance, obligation may not online—though few someone in your extended be possible. of these lists are really BORROWING family might provide housing useful. Beware of sites for your child to live off campus that ask you to pay a at a school he or she wants to fee to access their files: attend, perhaps in return for COLLEGE RESOURCES There’s no reason to pay doing certain chores. Or your You can look to a number of websites for help to find scholarships. child may accumulate advanced in planning for your child’s education. placement credits or take some • www.studentaid.ed.gov BUYING TIME required courses in the summer Guidance on the process of applying to Unlike grants, higher educa- to reduce the length of time it and paying for college. tion loans must be repaid. Like takes to graduate. • www.collegeboard.com other loans, they accumulate Obviously, decisions such as these Inf ormation on college costs, scholarships, interest, so that borrowers end must be collaborative or the likelihood and entrance exams. up repaying more than the amount of their being successful is slim. But • www.collegesavings.org they actually spend on tuition, room, if you and your child can talk frankly Valuable information about 529 savings board, and other expenses. But the about your shared goals and the financial and prepaid plans. federal government offers both parents realities, you can find a way to achieve and students guaranteed loans that can what you both want. 67 financial planning financial planning

THE SUN MAKING WITHDRAWALS DOESN’T SET 529 Savings Plans A 529 savings plan beneficiary Withdrawals from a 529 savings plan can use the assets in the plan at are tax free as long as they’re used to pay Once you know how 529 plans work, you’ll be ready any qualifying institution, including for your beneficiary’s qualified education to pick the plan that’s right for you. graduate or professional school. There’s expenses, which include tuition, books, no age limit. Or, at any point, you fees, school equipment, room and board, can switch the beneficiary to as well as any technology needs. Opening a 529 account couldn’t be easier: You can make contributions in lump any member of the You can arrange to have your benefi- You can enroll in a plan by simply com- sums or in regular installments. They can extended family. ciary’s qualified expenses paid directly by pleting a brief application and making work equally well, so you can choose the your plan, or you can pay the expense a minimum contribution. Many plans approach that suits your financial situation. yourself and request reimbursement allow you to enroll online through their Making contributions in installments later. Either way, it’s up to you to match websites, or you can complete an appli- may put less strain on your overall budget. STA Y ON TRACK all qualified expenses with withdrawals cation with your financial professional. But the amount you end up with depends when you file your federal income tax When you contribute to a 529 savings But that doesn’t mean you should on how much you put in each month— return each year. Your plan will provide plan, your plan manager pools your enroll in a 529 plan blindly. Every and how your investments perform. an annual statement that details your money with that of other plan par- plan is a little different, so you should On the other hand, making lump-sum contributions, earnings, and withdrawals ticipants to invest in a portfolio that’s research the key features of each plan contributions creates a larger investment for the year. If your withdrawals exceed allocated according to a specific invest- you’re considering. Then you’ll be sure base, which means the potential for faster your qualified expenses for the calendar ment track. You can choose from among to find the plan that works best for you. growth over a long period of time. But year, you’ll have to calculate the percent- different investment tracks provided by large contributions are usually not fully eli- age of earnings on which tax and penalty your plan manager: THE ROSTER gible for a state tax deduction, and annual payments are due. Several key players make each 529 gifts of more than $14,000 per beneficiary • Age-based tracks gradually real- savings plan work: in 2016—or $70,000 once in five years— locate to shift the investment focus CHOOSING THE RIGHT PLAN • Individual states sponsor 529 savings could require you to file a gift tax return from growth to preservation as your Here are some questions that may help plans. They’re also responsible for for the year you make the contribution. beneficiary nears college age. You identify the plan that’s best for you: choosing a plan manager and Any earnings in your account are deter- can usually choose an aggressive, • Does the plan offer investment determining the rules and limits mined by how the assets are invested, what moderate, or conservative age-based choices that suit your needs? surrounding their plan. the return is, and what you pay in fees. track, which determines how your • How much will you owe in • The plan manager, which may be portfolio is invested initially. enrollment, sales, and annual fees? a company, brokerage Can you deduct contributions Professional help Fixed tracks remain the same over •  firm, or insurance company, handles •  from your state income tax? You can open a 529 college savings plan time. While these tracks are often all transactions and investments Will earnings be exempt from state directly or with the advice and assistance of either 100% equity or 100% fixed- •  within your account. income taxes if you invest in this plan? an investment professional. Someone with income, you can choose several As account owner, you’re responsible Does the plan accept out-of-state •  experience in evaluating plans can help you different fixed tracks to allocate •  for naming a beneficiary, making participants? analyze the investment tracks, compare your assets. contributions, choosing an pros and cons, and perhaps provide the • How have the plan’s investments investment track, and managing encouragement you need to enroll. Some You may switch investment tracks performed in the past? withdrawals. professionals work on a fee-only basis, while as often as twice a year, though it’s not • How long are you required to hold beneficiary • Your can attend any others earn a commission if you buy a specific always the best approach. Rather, you can an account? accredited US college, vocational, plan through them. always put new contributions in a differ- • What are the minimum and or graduate school to which he or If you buy directly, you assume respon- ent track. With certain plans, you may maximum contribution limits? she is admitted. sibility for doing your own research and also be able to customize your account • Can anyone contribute to the plan? choosing the plan that’s best for you. One by choosing from among different invest- You may want to start by looking at CONTRIBUTING advantage is that the overall cost is likely ment options within each track. And if the plans offered by your own state, since Contribution limits vary from plan to to be less. your plan’s investments consistently per- tax benefits may be especially appealing plan and often reach $300,000 or more. form below your expectations, you can if your state income taxes And, if you approach the contribution switch plans once every 12 months. are high to begin with. limit of one plan, you can always open another in the same beneficiary’s name.

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5 29 Y STATE SPONSOR PLAN SAVIN M MANAGER GS AN ACCOUNT O OWNERWNER PLAN PL FINANCIAL PLANNING FINANCIAL PLANNING

If you’re enrolled automatically, the compound, the larger they have the Planning for Retirement percentage you contribute is set initially potential to grow. by the plan, as is the way your contribu- It’s never too early to take retirement seriously. tions are invested. But you always have KNOW YOUR LIMITS the right to contribute more if you wish, Congress sets an annual maximum on up to the annual limit that applies, and contributions to employer plans and You can start saving for retirement as manages the fund to produce to choose any of the other investments IRAs, though what you contribute to soon as you begin earning income. It’s the return it needs to make the pension available through the plan. an employer plan doesn’t reduce the a smart move even if your retirement is payments owed to you and other plan amount you can to put in an IRA, or many years in the future. You can take members. ON YOUR OWN WITH AN IRA vice versa. You don’t have to contribute advantage of savings plans that allow In a defined contribution plan, IRAs are voluntary, so you must take the full amount that’s permitted, but, you to defer taxes on your earnings, and you, your employer, or both contribute the initiative to open your account with the more you can afford to put away, sometimes on your contributions, or to money to a retirement account in your a bank, brokerage firm, mutual fund the larger your account has the potential avoid taxes entirely if you follow the rules. name. The retirement income you’ll company, or insurance company, and to grow over time. There are two categories of tax- receive is not guaranteed. Rather, it contribute as much as you wish up to If you’re 50 or older, you’re entitled to saving retirement plans: those offered depends on the amount that’s contrib- the annual limit. The financial institu- make additional catch-up contributions by employers and individual retirement uted, the way the contributions are tion where you open your IRA is its even if you’ve contributed the maximum accounts (IRAs) that you open on your invested, and the return the investments custodian, which involves holding the every year you were eligible. The added own. Even if you’re part of an employer provide over time. account assets, acting on your instruc- money can give your account value a boost. plan, you can contribute to an IRA, One advantage of a defined contribu- tions to buy or sell investments, and Contribution limits, or caps, which are taking advantage of both ways to accu- tion plan is that it’s often portable, which providing regular statements of your higher for employer plans than for IRAs, mulate retirement assets. means you can take your account balance IRA’s value. But a custodian has no are indexed to inflation and may increase In addition, you may want to invest in with you if you change jobs. That’s not responsibility for the choices you make. as frequently as every year. In some years, taxable accounts to make your retirement the case with defined benefit plans. As with defined contribution plans, they’re unchanged, but they have never even more financially secure. You have what your IRA is worth when you’re been reduced. For example, in 2017, the more flexibility at every stage, from add- BEING PART OF THE PLAN ready to retire depends on the amount cap for most defined contribution plans is ing money to taking it out. And while If your employer offers a pension plan, you have contributed, the investments $18,000 plus $6,000 catch-up, while IRA you’ll owe taxes on your investment you’re generally included in the plan auto- you’ve chosen, and the way those invest- caps are $5,500 and $1,000 catch-up. income, the rate you pay on much— matically, though you may have to be on ments have performed. Timing is also Different limits apply to defined benefit though not all—of it will be lower than the job a minimum length of time, be a a factor, since the longer contributions plans and certain small-company defined the rate you pay on ordinary income. full-time employee, or both, to be eligible. contribution plans. Participation in a defined contribu- EMPLOYER PLANS tion plan is generally voluntary, so Employers may sponsor a retirement you may have to sign up. Increasingly, plan for their employees if they wish. however, employers are automatically There are two basic plan types, and most enrolling everyone who is eligible and employers offer one type or the other, offering the alternative of opting out. though some employers offer both. In most, but not all, defined con- A defined benefit plan, better tribution plans, you defer a percentage known as a pension plan, promises a of your pay, which is deducted from certain level of income when you retire. your paycheck. These contributions are The way your pension is calculated is invested in the investments you select described in the plan and is usually from among those available through the based on what you’re earning at the end plan—typically mutual funds, managed of your career, the number of years you accounts, target date funds, company work for the employer, or frequently stock, and investments, both. Your employer contributes to and although other choices may be available.

THE PLANS 401(k) Thrift Savings (TSP) AT A GLANCE • Employees of businesses that • Federal employees and There are several varieties sponsor plans employees of companies of defined contribution plans, • Matching contributions offering plans including the ones mentioned optional • Matching contributions for federal employees, here. With all except SIMPLEs, 403(b) others optional contribution limits are the • Employees of nonprofit, same and balances can be tax-exempt organizations SIMPLE moved between plan types • Matching contributions • Employees of companies if you change jobs. The type optional with fewer than of plan you’re eligible for 100 workers Section 457 depends on where you work. • Matching contribution • State and municipal workers required • No matching contributions 70 financial planning financial planning Employer Plans dISTRibution basics When you take a new job or retire, you ask to withdraw will be withheld to Retirement savings aren’t just nice to have. can leave the balance of your retirement cover what you’ll potentially owe to the account with your previous employer, IRS. What’s more, you could be liable They’re essential. roll it over to a new employer’s plan if for a 10% tax penalty on the entire the plan accepts rollovers, or roll it into withdrawal if you’re younger than 59½. When you choose to participate in an you can withdraw any earnings in the an IRA. All three alternatives maintain If your account is in an employer’s employer’s retirement savings plan, that’s account free of federal income tax pro- the tax-deferred status of the assets. plan or you’ve rolled it over to a tax- just the first of several choices you’ll vided you are at least 59½ when you leave The option that’s best for you deferred IRA, you generally must begin make. You’ll also need to decide how your job or retire and your account depends on a number of factors, includ- to take RMDs when you reach 70½. The much you’ll contribute as has been open at least five ing the investment choices available, amount you must withdraw each year is well as select investments years. The contributions the administrative and management determined by your age and the balance from the plan’s menu. aren’t taxed at withdrawal costs, and personal preferences. It can in the account at the end of the previous And that’s not all. either since you’ve already be smart to consult an independent plan year, which is often, but not always, A number of employers paid the tax. With a financial adviser as well as the human December 31. who offer a tax-deferred tax-deferred account, in resources office where you work to seek The exception is that you can post- 401(k), 403(b), or TSP contrast, you pay income comprehensive, unbiased advice. pone withdrawals if both of these also offer a tax-free Roth taxes on all withdrawals If you’re leaving your job for any conditions apply: alternative. The Roth has at the same rate you pay reason, including being let go or • You are still working for the the same annual contri- on ordinary income. retiring, you also have the right to employer sponsoring the plan bution limit, menu of You may be able to take a lump sum distribution in cash, investment alternatives, divide your contribution though it’s rarely a good idea. Any taxes • You or your spouse don’t own and required minimum between a Roth and a that have been deferred must be paid more than 5% of the company distributions (RMDs) tax-deferred account, when you file your tax return for that you’re working for after you turn 70½ that and you can convert a year. In fact, 20% of the amount you tax-deferred accounts tax-deferred balance to have. But there are also a Roth, although you’ll significant differences. need to pay the tax that’s With a Roth, you due. But you can never contribute after-tax transfer money from a income—rather than Roth to a tax-deferred the pretax income account. If you choose you contribute to a tax- a Roth, any employer deferred account—so matching contributions your current tax bill is go into a parallel tax- not reduced. However, deferred account.

TErms and A ROTH FOR YOU? when the In a defined contribution plan, Whether or not a tax-free Roth is a wise vesting requirements do not apply to any conditions choice for you depends on your age, your vest fits money you contributed or the earnings As a condition of participating in a retire- current tax rate, what you anticipate will If you’ve been part of an employer’s on those contributions. That amount is ment plan and postponing taxes or, with happen to tax rates in the future, and the retirement plan and leave your job always yours. But if you’re vested, you a Roth, avoiding them entirely, you agree other types of retirement investments you for any reason, what happens to your have the right to any matching contribu- that you won’t withdraw from your plan have. It may pay to consult your tax and account? That depends on the type tions your employer made plus account before you reach at least 59½, investment advisers before making of plan it is and how long any earnings on those though you may qualify for an exception this decision. you’ve participated. contributions. if you retire between 55 and 59½. You’re entitled to benefit If you’re vested You may be able to borrow from your from your participation if in a defined benefit account balance if your plan permits repay any outstanding loan balance in full you’re vested, meaning plan, you’ll be eligible loans. The loan, plus interest that is almost immediately or it is considered a you’ve worked for the for a pension when charged at market rates, is repaid with withdrawal and becomes taxable. employer for the required you’re old enough to regular deductions from your salary. vesting period. The vest- qualify, based on the However, if you leave your job, you must ing period for each type of employer’s rules. It’s plan is set by federal law, worth keeping track of and can never be longer ROLLOVER any pension accounts, than six years for a defined ROLLOVER IRAas the income could LEAVE contribution plan or seven be a welcome addition years for a defined benefit ROLLOVER IRAto your retirement BALANCE plan. It can be shorter at budget, even if it’s the employer’s discretion. only a modest amount. 72 LUMP73 SUM FINANCIAL PLANNING FINANCIAL PLANNING

WHICH IRA FOR YOU? MAGI cap is $186,000, phased out at In addition to having earned income, you $196,000. Married couples filing sepa- IRAs: What They Are must qualify to deduct your contributions rately have a MAGI cap of $0 to $10,000. to a traditional IRA or contribute to a Roth While you can’t deduct your IRAs are easy to set up—but not always easy to understand. IRA. The rules are different in each case. contribution to a Roth IRA, taxes on If you’re single, you qualify for a fully earnings in your account are deferred as IRAs, or individual retirement accounts, • All traditional IRAs are tax deferred, deductible IRA contribution when you they accumulate, and you make tax-free are tax-deferred, personal retirement which means you owe no tax on your file your federal income tax return if withdrawals if you qualify. In most cases, plans. You can contribute every year earnings until you withdraw you were not covered by an employer that means you are at least 59½ and have you have earned income whether or not sponsored retirement plan during that had your account open at least five years Roth IRAs are also tax deferred, so you participate in an employer’s retire- •  year. If you were covered by a plan, you before you withdraw. you owe no tax on your earnings as ment plan. There are two types: the may be able to deduct some or all of they accumulate. Withdrawals will be traditional IRAs, to which contributions your contribution based on your modified IT’S YOUR ACCOUNT tax free if you follow the rules may be deductible or nondeductible, adjusted gross income (MAGI). It’s easy to open an IRA. All you do is and the Roth IRA. If you’re married and file jointly, either fill out a relatively simple application of you can deduct provided by the mutual your own contri- fund company, bank, Deductions are gradually WEIGHING THE CHOICE bution if you are brokerage firm, insur- phased out if you are covered If you have a choice of which IRA to open, you’ll want to weigh the pros and cons: not covered by a ance company, or other by a retirement plan retirement plan at financial institution you ROTH TRADITIONAL IRA work. But if either choose to be custodian Nondeductible Deductible of you is covered of your account. by a plan, the Because IRAs are PROS • Tax-free income • Tax-deferred earnings • Immediate tax savings other’s right to self-directed, meaning at withdrawal • No tax due at on tax-deductible a deduction that you decide how to • No required withdrawal on contributions invest the money, you’re withdrawals contributions • Tax-deferred earnings responsible for following the rules that govern the is reduced CONS MAGI limits Not deductible Tax due at withdrawal accounts. Basically, that •  •  •  gradually if Not deductible Tax due at withdrawal on contributions and means putting in only •  •  your joint MAGI Requirements to on earnings earnings the amount you’re enti- •  is over $186,000 qualify for tax-free Required withdrawals Required withdrawals tled to each$62 year. 67 You72 •  •  and eliminated withdrawal beginning at 70½ beginning at 70½ $61K $71K must also report your if it’s over contribution to a tradi- $196,000 in tionalSingle IRA taxpayer to the IRS, 2017. If you’re $5,000 For 2017. on $4,000Form 1040 or 1040A both covered, the if it’s deductible and on DO YOU QUALIFY FOR A ROTH IRA? limits are $99,000 Form 8606 if it’s not. and $119,000 in 2017. You qualify for Partial You don’t qualify You can invest your IRA$0 money any Eligibility for a Roth IRA$61K is based$753K $58K $63K Married deduction a Roth Roth for a Roth way that is available through your$52K custo- $58K $62K on your filing status and MAGI, with $4,000 dian including individual securities,Income funds, higher income limits for married couples$59K $64K $69K Modi ed $98K and bank products. The things ouy can’t filing a joint eturnr than for single filers. SINGLE Adjusted $118,000 $133,000 buy are fine art, gems, non-US coins, and In 2017, the MAGI cap is $118,000, Married filing jointly $0 collectibles. And you can sell investments Gross Income phased out at $133,000, if you’re single. in your IRA account without paying tax$80K $85K $100K If you’re married and file jointly, the Income on$5,000 your gains until you with- Modi ed draw from your account, but there may be transaction costs. MARRIED Adjusted $186,000 $196,000 $685K $95K $105K Gross Income January Last You can contribute to your A SWEET DEAL you can contribute as much as you want, First day day to deposit IRA in a lump sum or spread The only requirement for opening an up to the cap. But you can’t contribute to deposit for prior year the deposit out over the year. IRA is having earned income—money more than you earn. You may put in the whole you make for work you do. Your total lump sum amount the first day you can, annual contribution is limited to the SPOUSAL ACCOUNTS January 1 of the tax year you’re making annual cap. That’s $5,500 in 2017, If your husband or wife doesn’t work, but the contribution for, to give your money whether you choose a traditional IRA you do, you can put up to the annual limit WHEN TO CONTRIBUTE the longest time to grow. A good alter- or a Roth. If you’re 50 or over, you can into a separate spousal IRA in addition You have until the day taxes are native is adding a certain amount every also make an additional annual catch-up to your own contribution. The advantage due—usually April 15—to open an time you’re paid. What you want to contribution of $1,000. for the nonworking spouse is being able IRA and make the contribution for the avoid is planning to contribute on the Any amount you earn qualifies, and to build an individual retirement fund. previous tax year. last possible day and forgetting to do it.

74 75 financial planning financial planning

fixe d or variable? takes responsibility for paying as prom- Annuities Deferred annuities are available in two ised. But actual payment depends on forms: those that pay a fixed rate of the issuer’s ability to meet its obligations. Tax-deferred annuities are another way to build your interest for the life of the annuity and With a variable annuity, you decide those that pay a variable rate. how your money will be allocated long-term retirement savings. When you buy a fixed annuity con- among a specific menu ofsubaccounts , tract, the insurance company that issues or annuity funds, offered by the issuer. When you purchase an annuity, or long- or employer-sponsored retirement plans. it guarantees payment of a fixed rate of Subaccounts are pooled investments, term insurance company contract, no That means you can build a substantial return during the build-up period and similar to mutual funds, with varying taxes are due on your earnings until nest egg for your long-term needs. How- a guaranteed income for life if you objectives and strategies. Variable you begin to receive income under the ever, putting money into an annuity annuitize, which means converting annuities give you the chance to poten- terms of your contract. There are no doesn’t reduce your salary or income tax your annuity into a stream of income. tially earn more than you could with a contribution limits on annuity the way tax-deferred employer plans do. The company invests your principal and fixed rate. However, the contract makes investing as there are with IRAs no payment promises, so you could also end up earning less if the markets are weak or you choose Building Up Paying Out poorly performing funds. You can choose a single premium You start collecting on your annuity with a lump-sum purchase, annuity investment during the or build your annuity account by Your annuity payout period, usually after you Checklist adding money regularly over a period contract defines retire. If you’re 59½ or older when for Annuity of time. During this accumulation the terms and payments begin, you owe income Investors phase, while the money is invested conditions: tax on your earnings. If you’re and you are not withdrawing, your younger than that, you’ll usually Consider annuities only if earnings in the account are tax deferred. • Amount of have to pay an additional 10% of you’re investing for the long premium the withdrawal as a penalty. term. Withdrawals before • Earnings at age 59½ face a 10% penalty deferred immediate fix ed or monthly lump-sum tax, plus income tax. OR OR annuities annuities variable rate payments payment Investigate the reputation With a deferred You buy an immediate You can get regular Or you can end your Method of payout of the company offering the annuity, you get the annuity with a single •  monthly payments contract and take a annuity to be sure it’s sound. benefit of tax-deferred payment and begin the • Fees and other for as long as you live cash distribution. You compounding for an payout period right investment costs or for a set period may lose money if your Compare surrender extended period, at away, or within the of time, such as ten plan imposes a penalty periods. Most annuities have either a fixed or variable first year. The amount or 20 years. for early withdrawal. surrender charges in the rate. When you’re ready of each payment is set first seven years. You can to begin withdrawals, by the terms of your Immediate Annuity payouts avoid annuities with lifetime the way you’ll collect contract. In the sense The most common payout options for both deferred surrender charges. is spelled out in the that an annuity provides and immediate annuities are: Look beyond the initial terms of your contract. regular income, usually Single life, which pays a set sum per month as rate if buying a fixed-rate Usually it’s in regular after you retire, these long as you live. When you die, the payments stop. annuity. Approach unusually monthly installments, plans resemble employer Life or period certain, which covers your lifetime high rates with caution. but it may be in a fixed sponsored . or a set number of years, whichever is longer. Your number of lump-sum You can also buy an heirs get the balance if you die before the term is up. Look for maximum payments. The part of immediate annuity Joint and several, which makes payments for your flexibility on getting your your payout that comes to provide a lifetime lifetime and the lifetime of your joint annuitant. money out. You can avoid from earnings is taxed stream of income for annuities that don’t offer a at your regular tax rate. another person. lump sum or give you a lower interest rate if you take one.

looking at the bottom line Weighing the issues Research the fees and Annuities are popular ways to save for retirement, but they also have critics who argue that other Immediate annuities provide the security of a regular annuity charges and avoid investments give you more for your money. It pays to look at both sides: income for people who are uncomfortable managing their paying more than 1.5% to 2% annually. Pluses Minuses investments. But they have some potential drawbacks: Compare costs. Some • Tax-deferred compounding • Some variable annuity contracts have high • If you choose a single life annuity and die within a annuities cost more than • Guaranteed income stream with fixed-rate fees and other expenses few years, the company keeps the balance of your others offering a similar contract based on claims paying ability • Some annuities impose stiff surrender charges money and your heirs get nothing. rate and income stream. of issuer • Taxes are due at regular income-tax rates, • With variable annuities, there is opportunity not the capital gains rate • Your annuity income may not keep pace with inflation. for growth of principal that may keep up with • Income from fixed-rate contract may not keep • The seller, usually an insurance company, may not or exceed the rate of inflation up with inflation fulfill its part of the contract. 76 77 FINANCIAL PLANNING FINANCIAL PLANNING

Social Security estimates that slightly more than 25% of 20-year-olds will become disabled Social Security before they turn 67, double the percentage who will die within the same time span. For most, For more than 75 years, Social Security has been a source the only disability insurance for which they’ll be eligible will come from Social Security. of monthly retirement income. We’ve Got Your Number Social Security was introduced in Social Security account, you’ll be mailed When you’re registered with Social Security, your nine-digit number usually stays the same for life, 1935 in the aftermath of the Great a statement once every five years or you even if you change your name. Depression to provide a safety net of can request a copy at any time. The first three digits The second group The last four digits are regular income to retired and disabled If you discover your record is wrong— indicate the state where you of digits doesn’t have a assigned in numerical­ order, for workers and their families. It’s a manda- and it sometimes is, especially if you work applied for a card. The number particular meaning—though example 7091, 7092, 7093, and tory plan, requiring most employees, more than one changes as more cards are issued they are related to the order so on. One exception: Twins, trip- their employers, and the self-employed job—you can To be eligible for in that state. in which cards are issued in lets, or other multiple siblings to contribute a percentage of their salary ask that it be cor- Social Security a region. don’t get numbers in order. to support the program. In return, they, rected. You’ll have benefits, you must their spouses, and sometimes their to supply some contribute to the dependents are eligible for retirement, evidence for your system for a total of disability, and survivorship benefits. claim, such as ten years or be the The program has been updated and the W-2 income- spouse or dependent expanded over the years, to include reporting forms of someone who does. more workers and provide added ben- that you file with efits. , the healthcare plan for your income tax. With that information, $200,000 pay an additional 0.09% in counts what you earn over most of your people over 65, was added in 1966. In you should have no trouble correcting Medicare taxes on amounts over that working life, specifically the 35 years in 1972, benefits were indexed to inflation, the problem. In fact, the SSA encourages figure, but the employer’s rate does not which you earned the most. As with other so that as the cost of living goes up, your people to check their annual earnings increase. If you’re self-employed, you pay pensions, though, the more you’ve earned, Social Security payments increase too. records carefully, since recent errors are both parts but can deduct half the total the higher the amount you’ll receive. easier to fix than long-existing ones. when you file your federal tax return for Although the dollar amount of your BUILDING A RECORD the year. benefit is based on your average earn- When you enroll in Social Security, FINDING HELP To be eligible for benefits, you need ings, the percentage of earnings your your account is open though it isn’t You can call the SSA helpline at to accumulate a total of 40 credits over benefit will replace is higher for people activated until you begin working. Then, 800-772-1213 for assistance. Or, you your working life. You acquire credits who earned less over their lifetimes, in every year the amount you contribute is can make an appointment at your local at the rate of up to four each year for keeping with the mission of providing recorded. Because what you’ll ultimately Social Security office. Either way, you earning at least the required per-credit at least a basic level of financial support. collect is based on what you pay in, it’s should have copies of your most recent minimum dollar amount, which is reset You can use the Retirement Estimator important that the record is accurate. statement and back-up evidence to each year. at www.ssa.gov to calculate a sense of the The Social Security Administration support your claim. It’s not a speedy benefit you can expect to receive based (SSA) creates a Social Security earnings process, but it’s worth the time. GETTING MONEY OUT on your earnings record and the age at statement if you are 25 or older and People born before 1938 could collect which you apply for benefits. However, haven’t yet begun to collect payments. PUTTING MONEY IN full Social Security benefits when they this is just an estimate. Your actual You can access a copy of your current Every year you earn income, you and turned 65. But full retirement age benefit could vary, based on how long statement by creating a secure, pass- your employer are taxed equal percent- (FRA) increased to 66 for anyone born you continue to pay into the system, word-protected account at www.ssa. ages of your earnings, as required by between 1943 and 1954 and is increas- what your future earnings are, and any gov/myaccount. The statement reports the Federal Insurance Contribution Act ing again gradually for anyone born changes to the system itself. what you’ve contributed each year and (FICA): 6.2% up to an annual earnings between 1955 and 1959 until it reaches estimates the monthly benefit amounts cap for Social Security and 1.45% of 67 for those born in 1960 or later. TAXING BENEFITS you’ll qualify for at retirement or if your total earned income for Medicare. You can collect a percentage of your If your total income for the year, includ- you’re disabled. If you don’t open a my Employees whose wages are more than benefit if you retire at 62. But if you ing half your Social Security and your work beyond your full retirement age tax-exempt earnings, is greater than SOCIAL SECURITY FACTS and keep on contributing, the amount the level set by Congress, you owe of your benefit increases 8% each year federal income tax on part of your Social PEOPLE OVER AGE 65 RETIREMENT INCOME 59M people receive Social Security bene ts until you reach 70. Security benefits. The higher your total When you die, your surviving spouse income, the greater percentage of your 90% is entitled to your benefits unless he or she benefit is taxable, to a maximum of 85%. Income from would collect more on his or her own work About 20% of people getting Social 90% record. The exact amount your spouse Security benefits end up paying tax on Receive Social Security bene ts will be eligible for depends on what you part of what they receive. The Internal were collecting and how old he or she is. Revenue Service (IRS) provides a work- $ $ sheet you can use to figure out exactly CALCULATING BENEFITS how much of your benefit you must 47% OF Unlike most pensions, which calculate include in your taxable income. If you 22% OF IS RETIREMENT COUPLES INCOME your benefit based on what you’re earning pay estimated taxes, you’ll have to be sure SINGLES 70% at the end of your career, Social Security your installments cover what you’ll owe. 78 79 financial planning financial planning Life Insurance Evaluating your life insurance needs is a key part of financial planning.

There is no simple answer to the ques- tion of how much life insurance you A Few Things a need. As a starting point, it should be Fee-onlyFee-only enough to cover your final expenses. Insurance If you support a family, keep a Insurance household running, have a mortgage, Adviser CAN DO or expect your kids to go to college, ade- • Provide second opinion about policies quate insurance is essential to filling the you’re planning to buy financial gap left by your death. But if Tell you whether your existing insurer is you don’t have dependents, or they don’t • financially sound need your money to live on, your insurance needs may be very different. • Evaluate whether your existing policy or Older people may need less insur- annuity is appropriate ance if their financial obligations have • Help you select policies and choose been met—mortgages and college options and riders tuition are paid—and their investments • Negotiate lower commissions from your are producing income. On the other insurance agent hand, insurance may provide an impor- as settling large outstanding debts, more likely to let the policy lapse, put- tant benefit for a surviving spouse or to supporting elderly parents, or paying ting your dependents’ security at risk. cover potential estate taxes. pany websites, can be a good first step for college educations. Your investment Keep in mind, too, that the type One rule of thumb says that you need in helping you estimate the amount of assets may offset some of these needs, of coverage and the death benefit that five to seven times (or even ten times) coverage you need. But they can’t take and your survivors may have income are right for you at one stage in your your annual salary. But a lot depends you, as an individual, or your unique and assets of their own. So you’ll want life may not be appropriate at another. on your personal situation, dependents, needs, into account. to consider this information in figuring For example, while you have a mortgage and other sources of income. You’ll need to determine the expenses the coverage you need. and your children are young, you may you want the policy to cover. These may Equally important, you’ll need to need much more insurance than you CALCULATING NEED include the immediate costs related to choose a policy whose premiums fit do later. Changing needs are a good Life insurance calculators, which you your death, your dependents’ current within your budget. If you buy a policy reason to make an insurance review a can find on a number of financial com- living expenses, and specific goals, such you can’t afford or that restricts your part of a regular reassessment of your ability to cover other expenses, you’re financial plan. Roughing Out Your Life Insurance Needs To estimate the amount of coverage you need to replace 75% of your take-home pay for the years Underwriting is the process insurance companies use to assess you as a risk and decide if you would have been working, multiply your salary by the factor at the intersection of your salary they will sell you insurance. It’s based in part on the information you provide in the application. If you and your current age. In this example, it’s $720,000.* don’t tell the truth, your insurance may be cancelled, or the company may refuse to pay a claim. Annual pay Current age of person insured P aying the bill Risk vs. Cost (before taxes) 25 30 35 40 45 50 55 The cost of buying life insurance varies The cost of life insurance is largely $30,000 14 13 12 10 9 7 5 enormously, depending on the type you determined by the risk you pose to buy, the company you buy it from, and the insurance company, as shown on $40,000 13 12 11 10 9 7 5 how long the company thinks you are an actuarial table. These tables project likely to live. your life expectancy based on age, $60,000 12 12 11 9 8 6 5 Estimating the total cost can be gender, health, and life style. tricky, since the premium, or amount If you’re considered a high risk—for $80,000 12 11 10 9 8 6 4 you pay for some types of insurance, example, if you smoke, are overweight, may increase over time. Further, two or have a dangerous occupation or $100,000 11 10 9 8 7 5 4 companies may charge very different hobby—the company may charge you amounts for the same coverage. a higher pre­mium than other people $150,000 10 10 9 8 7 5 4 One way to do a search is to use a of the same age or gender, or refuse to fee-only adviser, who can help you sift insure you at all. $200,000 9 9 8 7 6 5 5 among the options and select the one However, if you are a nonsmoker that’s best for you. As a rule, life insur- whose health and life style make you *Doesn’t take into account any income survivors can expect from Social Security, investments, or other sources. More or less coverage may be needed, depending on individual family circumstances. ance provided through your employer likely to live longer, you may qualify is the least expensive, but may provide for lower rates that significantly reduce Source: Principal Financial Group only a portion of the amount you need. your premium and save you money.

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INSURANCE ONLINE Types of Life Insurance An insurance company’s website can be a help you estimate the coverage you need. And valuable resource, especially if you want to learn if you purchase a policy, you’ll probably be able You can buy life insurance that protects you for a limited more about the various types of life insurance to manage your account, make payments, or period of time or stays in effect until you die. the company offers. There may be a calculator to report a claim online.

All life insurance is alike in several ways. You pay pre- miums to a life insurance company in exchange for TERM its promise to pay a certain ue C ash val COMPARING amount of money, called ALTERNATIVES death benefit Insurance Insurance the , to the If you’re not certain whether beneficiary whom you term or permanent insurance designate when you buy the is right for you, it may help to insurance. The death benefit think about how you would is also known as the face answer these questions: value. The contract between As long as you pay the As long as you pay the you and the insurer is known premium, you’re covered. • Is a cash value account an as a policy, and it spells out premium, you’re covered. effective way to save for your the terms of the coverage. goals or might investments If you own the policy, be better choices? policyholder If you die, your beneficiaries If you die, your you are the . • What’s the comparative cost The rights of ownership receive the death benefit. beneficiaries receive of purchasing the amount allow you to: the death benefit. of coverage you need? • Change the beneficiary • Do you anticipate that or add other beneficiaries If you stop paying the your insurance needs will • Assign, or transfer, owner- premium, the policy ends If you stop paying the change significantly in the ship to someone else and you get nothing back. premium, you get the cash foreseeable future? • Borrow from the policy’s • Is there any reason to think account value, if it has one surrender value. you may be less insurable in the future than you are now? If you’re the person whose life is covered by the policy, you’re the insured. You can be both the policyholder and the insured, or you can own a policy on TERM INSURANCE Cash Value Insurance Types of policies another person’s life, provided you have Term insurance is the simpler and, at Cash value insurance combines a Despite the seemingly endless varieties, what’s known as an insurable interest. least initially, less expensive coverage. death benefit with acash value account there are two basic types of cash value In brief, that means you would suffer In exchange for your premiums, your funded with part of each premium you insurance: financial hardship if that person died. policy covers you for a specific period, pay. Earnings on the account’s assets are Whole life, sometimes called Similarly, someone with an insurable which could be as long as 20 or 30 tax deferred. If you die while the policy 11 straight life, is the most traditional. interest could own a policy on your life. years. If the policy is renewable, you is in force, your beneficiary receives The premiums stay the same for the length In most cases, the beneficiary owes may extend for an additional term the death benefit, which includes the of the policy. Once you’ve paid all the pre- no income tax on the death benefit without having to demonstrate you’re balance in the cash value account. miums, the policy remains in effect until that’s paid when the insured dies. in good health. However, many policies If you end your policy before you die, you die or, in some cases, turn 100. You are not renewable after you reach a the insurer will subtract any outstanding accumulate a cash reserve, but you have TYPES OF INSURANCE specific age, such as 70 or 75. At each loans you’ve taken against your cash no say over how the money is invested. Your policy may last for a specific renewal, the premium increases. value account, plus outstanding interest term, or period of time, and may be If you die during the term, and your and any fees, and send you the remain- 2 Universal life offers some flexibility. renewable. Or you can buy a cash policy is in force, the insurer pays the der, called the cash surrender value. 2 You can vary the amount of the value policy, also known as permanent face value. But if you are alive when the No death benefit will be paid. premium by applying a portion of the insurance, which means it covers you term ends, and you don’t renew, you are If the policy has been in force for a accumulated savings to cover the cost. You for as long as you’re alive, or at least no longer insured. number of years, it’s possible that the can also increase or decrease the amount until you turn 100. With either term Term policies may be convertible. In amount you receive will be larger than of the death benefit while the policy is in or cash value insurance, you must pay that case, you can turn your term policy the premiums you paid. If that’s the force. But you pay for this flexibility with your premiums on time to keep the into a permanent policy with the same case, you’ll owe income tax on the higher fees and administrative costs. policy in force. If you fail to pay, the death benefit, generally without having to difference between your cost and what Typically, there’s a guaranteed rate policy lapses and no death benefit demonstrate that you are in good health. you received, calculated at the same of return on the savings portion for the will be paid if you die. The premiums for a convertible plan are rate you pay on ordinary income. first year, and a minimum, or floor, for usually higher than for regular term. the life of the policy. 82 83 financial planning financial planning

long-term care insurance Long-Term Care Long-term care insurance provides coverage for chronic illnesses and long- Many people are concerned about long-term healthcare term disabilities that aren’t covered by Medicare. Look for policies that pay for themselves or their parents. for nursing-home care, care at home, and hospice or respite care for the things to chec When you’re doing financial planning, There are four ways to address terminally ill and their families. If you’re buying long-termk care for insurance, you have to think about some of the long-term care in your financial plan, In most cases, people think about you’ll want to ask these questions: things you’d rather not consider, such as since ignoring the possibility you’ll need buying the coverage in their 50s, or hat’s W the waiting period before needing long-term healthcare. You may care can have dire consequences: 60s, when the premiums are still payment begins? also be concerned about the costs of taking You can self-insure, which means affordable. By then, they may be able oes D the plan cover cognitive diseases? care of aging parents or disabled children. 11 you will pay for care yourself, an to trim life insurance premiums, Among the things that make plan- freeing up the money to pay for it. approach that works best if your Is there inflation protection ning for healthcare more complicated net worth is $5 million or more. If you’re considering the cover- than accumulating tuition money or age, you’ll want to examine what s I there a waiver of premium? You can count on family members allows you to stop paying while you’re using buying a home are its unpredictability 22 various policies pay as well as , which and its expense. You don’t know if you’ll or friends to provide care that what they cost. Make sure that the benefits? Medicare doesn’t cover. need care at all, or when, or for how your plan provides coverage s I there a You can anticipate relying on nonforfeiture clause long. And since healthcare costs have 33 for cognitive diseases such as you’ll get partial coverage based on what you tended to escalate more quickly than Medicaid after you have exhausted Alzheimer’s. Also check your did pay even if you let the policy lapse?, so that most other expenses, it’s difficult if not your resources. plan’s restrictive policies on impossible to predict what you’ll spend. payouts, prior conditions, ow H often are policies revoked after they 4 You can buy long-term care 4 insurance to help cover the cost. and other factors. are issued? You’ll also want to ask about inflation protection. While having it will probably qualifying add to the cost, the advantage for benefits of an inflation-indexed plan is that Some long-term care policies pay what you get at the point you begin to use the insurance benefits if your doctor considers it will be more in line with your real costs. A plan that may necessary. Other policies pay only if cover a large part of the daily nursing home cost this year will the insurer’s medical examiner agrees. probably cover much less of the total bill ten years from now. In most cases, the issue is whether you The most affordable coverage is generally available are able to manage what are described as through group policies provided by your employer the activities of daily living (ADLs) or some other association you belong to. You independently. These include getting in and out can get individual coverage from life of bed, moving around, eating, bathing, and using insurance companies, too, though the toilet. What you want is a policy that considers it may be expensive. you eligible when you have problems with just two ADLs rather than three or more. You should think twice before buying a policy that requires hospitalization prior to qualifying for benefits, since many people who need the coverage have chronic, deteriorating conditions that don’t necessitate a hospital stay. In addition, consider the policy’s restrictions on the quali- fications that care providers must have. If you want more flexibility in selecting providers, you may be willing to pay for a policy that provides it. LINKED BENEFIT POLICIES Other issues to consider are the length One alternative to traditional long-term of time you will be eligible for benefits, often care insurance is a life insurance policy that two to five years, and the elimination period, accelerates, or prepays, the death benefit if or how long you’ll have to wait after qualifying you need long-term care. This approach may for payments to begin. be especially attractive if you’re financially secure and like the idea that, if you use only a portion of the death benefit to cover your care, your heirs will receive the balance. That doesn’t happen with a long-term care policy.

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Estate Planning $ Your estate contains the assets you have accumulated by the time of your death. MAKING GIFTS In addition to your annual tax-free While much of the financial planning you can arrive at a fairly accurate estimate gifts, you can give away assets worth up you do is designed to help you and your as you start the planning process. to $5 million plus an annual inflation are, such as a grandchild or great- loved ones live the life you want, one Some assets, including those you own adjustment during your lifetime, though grandchild, may be subject to special aspect of it, called estate planning, deals jointly, your retirement accounts, and any part of the exempt amount you gift generation-skipping, and somewhat with what happens to your assets after the face value of your life insurance will reduces the amount you can transfer complicated, tax rules. you die. There are many ways to ensure go directly to your joint owner(s) or the free of federal tax at your death. that they’re transferred to the people or beneficiaries you have selected. Other You have to report gifts over $14,000 institutions you want to benefit, and assets must be given away while you’re per person to the IRS using Form 709 POWER OF ATTORNEY that potential hassles are minimized living or transferred by will, trust, or when you file your tax returns for the You may want to consider granting a durable or avoided. other legal document. year the gifts are made, but no tax is due or springing power of attorney to someone The actual value of your estate isn’t The advice of an experienced lawyer until the total reaches the cap. And the who could handle your finances and other calculated until after your death, but, who specializes in trusts and estates is government doesn’t care how you share matters if you were too ill or disabled to using your current net worth statement, always valuable and often essential to your assets—all as gifts, all as bequests, make your own decisions. You should consult achieve your goals. or a combination. with your lawyer about the pros and cons as Gifts you make to a relative at well as the process. least two generations younger than you

Estate on your life, or, if you have a very MY ESTATE Tax large estate, use a life insurance trust. My Due Investments Irrevocable trusts. If you move THE TAX ISSUE DEFENSIVE MEASURES assets into a trust that you don’t control and can’t change, their value While the most important aspect There are some strategies you can use Property is no longer part of your estate. But of estate planning is allocating your to reduce the value of your estate and you need professional help to create assets to your heirs, you can’t ignore so the potential for estate taxes. effective trusts, whether assets are Other the potential for estate taxes. Under Tax-free gifts. You can give gifts of transferred to them while you are Assets Retirement current law, federal taxes are due up to $14,000 to as many people as you alive or after your death. Plans on net estates valued at more than wish each year, totally tax free. If you’re Of course, any money you $5 million plus an annual inflation married, you and your spouse can give spend is no longer part of your My adjustment. In 2014, for example, Life twice that, or $28,000. Gifts to your estate either, though things you Business the amount is $5.34 million. A net Insurance spouse are always tax free, provided he buy with the money will be if they estate is what’s left after subtracting or she is a US citizen. There’s an annual have monetary value. tax-exempt bequests—including cap if that’s not the case. Gifts to quali- those to your spouse and qualifying fying charitable institutions are also tax charitable institutions—as well as free, though the annual amount you can GIVE IT OR WILL IT? the cost of settling the estate from give may be limited to a percentage of If you’re deciding whether to give someone a gift while you’re alive or leave the property in your the estate’s gross value. RAN your adjusted gross Iincome.NSU CE will,$ there are some things to consider, Those assets that pass directly to including the tax consequences. beneficiaries—life insurance, retire- Paying education or medical bills. $ ment plans, and half the value of You can pay another person’s tuition or property you own jointly with your medical bills not covered by insurance Outright gift Inheritance spouse—are included in your estate without incurring gift tax or reporting when it’s valued. So are assets in any the payment to the IRS if you pay it Value for Value is what you The value is stepped up, revocable trusts you have created, directly to the educational or medical income tax paid for it originally. or increased to what the property your share of a partnership or other institution to which the money is owed. purposes is worth at the time of inheritance. business, and money you’re owed. Insurance. If someone other than While only a very small percent- you owns the life insurance policy on What taxes Potentially capital gains tax on Capital gains tax if property is sold age of estates owe the federal tax, your life, the death benefit won’t be are due increased value will be due when likely to be less than if received as individual states may impose estate included in your estate. If you are the property is sold. No inheritance gift. Inheritance tax may be due. or inheritance taxes, or both, that current policyholder, you can assign tax due. Potential estate tax can’t Estate tax might reduce the size of are assessed against much more ownership to another person, have reduce size of gift. the inheritance. modest estates. your spouse or child buy a new policy Will 86 87 financial planning financial planning Making a Will A will is the primary tool in an estate planning toolbox.

A will is a legal document that allows also name you to transfer your property at your a guardian, death to your beneficiaries. who will The document details your bequests, assume identifying the recipients as specifically responsibility as possible and describing what each for them if their one is to receive. It’s generally wiser to surviving parent leave major bequests as percentages of is not able or your estate’s value rather than as dollar willing to care for amounts, as you can’t be sure what the them, or if you and your spouse die at value will be at the time of your death. the same time. Ideally, parents name the In preparing your will, you name an same guardian in their separate wills. ONE AT A TIME executor who will be responsible for It’s also a good idea to identify Whenever you create a new will, you carrying out the terms. The executor contingent executors and guardians should destroy the signed copy of any may be your spouse, an adult child or in case your first choices are unable or previous will. More than one signed will can create probate problems, even if one is children, a different relative, a friend, unwilling to serve—though you should THE PROBATE QUESTION or sometimes a third party, such as a never name anyone who has not agreed clearly more recent than the other. Unsigned Any property that is transferred by will lawyer. If you have minor children, you to take on this responsibility. copies or photocopies are not official and can be useful for reference. is subject to probate, which is the legal process of proving, or verifying, your will. Depending on the state, the court a relatively minor change—even if it that handles verification is called pro- has major consequences for one or more bate court, orphans court, or surrogates beneficiaries—you can use acodicil , a court. While it’s sometimes a routine legal document that amends an earlier matter, especially for small estates, one. The codicil must be witnessed and probate can be slow, sometimes should be attached to the existing will. perverse, and often costly, which What a will can’t do is transfer jointly give it a bad reputation. held property—which goes directly A clear, un- to the joint owner. Nor can it transfer ambiguous assets in insurance or annuity contracts, will has the employer sponsored retirement plans, or best chance individual retirement accounts (IRAs), of surviving which go directly to the beneficiary the probate Beneficiaries Guardian Executor you have named in the contract or plan process intact document. It’s important to keep those in case it is designations up to date, just as with your contested. The will, especially when there is a major most difficult change in your life, such as a marriage, situations generally MAKING IT LEGAL will may not serve as witnesses. Other a divorce, or the birth of a child. involve disinherited children and State laws spell out what’s required to rules may apply as well, which is why The other thing you can’t do in a will parents who have been involved in a make your will official, but laws vary working with a lawyer based in the state is disinherit your spouse unless there is contentious divorce. from state to state. If you change your where you live is essential. a valid prenuptial or postnuptial agree- While you can smooth the probate primary residence, you should create a You should sign just one copy of ment that spells out what he or she process by using a living trust to new will even if the provisions remain the will and file it with your lawyer, at receives if you die or the marriage ends. transfer most of your property, you the same. home, or in some other secure place, In fact, every state requires you to leave can’t avoid it entirely. You still need a You execute the will by signing it making sure to tell your executor where your spouse at least a minimum percent- will to handle the property that isn’t in the presence of two, or sometimes it is. A safe deposit box is not a good age of your estate’s value. In community in the trust and name an executor and, three, witnesses, who also sign it to choice as it may be sealed at your death. property states the rule may be somewhat if need be, a guardian. attest to the fact that you said it was different, as each spouse automatically your will and they watched you sign WILL POWER owns half of all marital property. NO WILL? it. The witnesses don’t have to read the A signed and witnessed will is valid In all states except Louisiana you Without a will, you die intestate. The court will or be told what it says. However, in but it is not written in stone. You can disinherit your children, but you decides what happens to your assets, without some states, a witness may not inherit can make changes any time you may want to specify that you are doing having to take your wishes into account. It’s anything that’s included in the will, want, provided you ensure that you’re so. Otherwise, a child who was omitted wishful thinking if you believe otherwise. and in others people mentioned in the following required procedures. If it’s could claim you simply forgot.

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C an you change a trust? Trusts A trust can be irrevocable—which means you can’t make changes once it’s set up—or Trusts shelter money for your heirs and provide for those revocable, meaning you can modify the terms over time. Their features include: who can’t fend for themselves. Irrevocable Trusts Revocable Trusts • No changes to provisions permitted • You can modify them until you die • You cede control over assets • You control assets and pay the taxes Trusts are legal entities—as corporations HOW TRUSTS WORK • Assets no longer part of your estate • You can transfer assets in and out easily are—that earn income, pay taxes, and • You cannot benefit from assets with no annual limits hold assets. The trustee administers the You can add but not remove assets Assets included in your estate trust, making investment decisions, •  •  paying taxes, and distributing the assets. You can give the trustee the authority to and the assets become the beneficiary’s match the distributions to the specific The Donor property. Until then, you or someone needs of your heirs. For example, you The Trust you name acts as trustee and manages Sets up the trust might identify funds for paying tuition •  • Earns income the trust for his or her benefit. or buying property. • Names the beneficiaries Holds assets The trust can make regular distributions,  •  Trusts for Special Purposes Names the trustees or it can be set up as an accumulation •  • Distributes assets A bypass trust, also called an exemption- trust, which retains and reinvests the • Transfers property to equivalent trust, is funded with assets income it earns for future distribution. the trust that are valued at up to the amount You can establish a trust for anyone you can leave to people other than your you want to provide income for: your spouse free of federal estate tax at the spouse, elderly parents, your children, time of your death. The actual dollar or a close friend. For example, a trust amount is not specified as it can change. might last for a parent’s lifetime, until The trust pays your surviving spouse the your children reach age 28, or until income from the trust. But the trust itself your grandchildren finish college. is not part of his or her estate. When your spouse dies, the assets pass to your trust planning The Trustees heirs. No estate taxes are due, even if Trusts can be effective estate-planning The Beneficiaries • Control the property the total accumulated value has grown tools in many different circumstances. in the trust to more than the amount you could leave But it is important to understand the • Receive the assets in the tax free. Your spouse can set up a similar different types of trusts and how they trust according to its terms • Manage the trust’s trust for assets in his or her name, effec- can work for you. investments tively doubling your tax-free estate. qualified terminable interest The trust or trusts that are appropri- Oversee distribution A • property (QTIP) trust ate depend on what you want or need of assets leaves your estate to to accomplish: complicated bequests, your spouse in trust, but lets you control , or tax savings. its disposition after your spouse’s death. No single trust can do it all. by putting the property into a living Your spouse receives the trust income, You might use trusts to handle trust and passing it directly to your heirs. are paid out. Or you can have a trustee but cannot use the principal or change transfers that can be complicated if If you want to leave money to people control how assets are divided among the beneficiaries you have designated. you use a will. For example, if you own you’re not sure can handle the responsi- a number of different beneficiaries, A charitable remainder trust benefits property in a state where you don’t live, bility, you can use a trust as well. Then depending on their circumstances or a specific charity—eventually. It has the you can streamline the probate process the trustee can control how the assets whatever criteria you establish. double advantage of a lifetime income from the trust’s investments for you Crummey Powers (or your beneficiary) and tax deductions TYPES OF TRUSTS By creating a trust using Crummey the year you contribute to the trust. At There are three major types of trusts: powers, you can take annual gift your (or your beneficiary’s) death, the 1 Inter vivos or living trusts are will. Trust provisions can also be kept exclusions for money you contribute principal goes to the charity. 1 set up while you are alive. When private. A will is a public document. to create or fund a trust. It works if the A charitable lead trust benefits a you die, the trust’s assets are distributed beneficiary—even a minor child without particular charity, which receives income Testamentary trusts are created to your beneficiaries according to the 2 a guardian—has the power to withdraw generated by the assets in the trust for the 2 by your will when you die and are trust’s terms. the gift within a fixed time period, often term of the trust. When the term ends, funded by your estate. They are admin- You can serve as trustee yourself, 30 to 60 days from when the gift was your heirs receive what remains. You can istered by trustees, whom you name in though you usually name a joint or suc- made. The beneficiary must be notified value the gift at a reduced rate, based on your will. cessor trustee to administer the trust of that right, and the money must be IRS tables, and save on estate taxes because­ Pour-over trusts when you die or if you are no longer 33 combine aspects on hand to be withdrawn if the option the benefit to your heirs is delayed. able. A living trust can strengthen your of both types: They are established is exercised. A life insurance trust is set up while intended beneficiary’s claim to poten- while you are alive specifically to receive If the beneficiary leaves the money you are alive to own your life insurance tially disputed property, as it is much assets, like life insurance benefits, that in the trust, it can be reinvested for policy. Your death benefit is paid to the more difficult to contest a trust than a are paid at your death. They can also potential future growth. You choose trust. But you should seek expert legal receive assets specified in your will. the time at which the trust will end advice before using this approach. 90 91 financial planning financial planning Health Insurance • Insurers must spend 80% of the premiums they Having the right healthcare coverage requires receive on medical care or provide rebates advance planning. • Children may remain on a parent’s employer-provided plans until they turn 26 Illness and injury can put a major who work for a small business or • Employers with 50 or more full-time workers must provide insurance that covers a minimum strain on your physical and emotional non-profit organization, have health MAJOR CHANGES of 60% of healthcare costs with a premium of health. And, unless you have adequate insurance as an employee benefit. If you The Affordable Care Act (ACA) has made no more than 9.5% of the employee’s income insurance, either can undermine your don’t have employer-provider insurance, major changes in healthcare coverage, and more financial security. The challenge is to you must buy individual coverage for changes are scheduled to phase in through 2020. • If you have individual coverage, it can’t be understand the coverage options avail- yourself and your family. If you’re 65, Among the most notable are these: cancelled if you stay current on your premiums able to you so you can choose one that or if you have certain disabilities, you’ll best fits your healthcare needs and probably be eligible for Medicare, the • Insurers must cover everyone who applies, However, if your plan was created before financial situation. federal health insurance program. But including people with pre-existing conditions March 23, 2010, its terms are grandfathered, Most people who work full-time for unless your spouse is also eligible, he who were previously uninsurable and these newly mandated provisions do not apply. a mid-sized or large employer, and many or she will need separate insurance. • All plans must provide free preventive care and at a minimum must cover at least ten essential benefits, including emergency care, maternity care, and mental health THE ACA DEBATE The ACA is controversial, to put it mildly. • Dollar caps on lifetime and yearly coverage In that way it is reminiscent of both Social have been eliminated Security and Medicare, two federal social programs that were bitterly contested when they were enacted. Though these are now Your insurer will pay a percentage, popular programs, what will happen with the typically between 70% and 80% of ACA remains to be seen. the cost it approves for the specific treatment—usually less than the amount you were charged. You pay platinum. Each level covers a different your share of the premium and must percentage of your healthcare costs, meet an annual deductible, after which from 60% with bronze to 90% with the insurer pays its share of your costs. platinum. Prices vary as well, with HDHPs are managed care plans the most comprehensive plans having with lower premiums but much higher the highest premiums. Plans with the deductibles than other plans—a $1,300 lowest premiums tend to have very minimum for individual coverage, and high deductibles. a $2,600 minimum for family coverage Premium credits and cost-sharing in 2016. There are also annual limits subsidies are available to those who on what you must pay in out-of-pocket qualify, making the cost of buying expenses—$6,550 for self-only and coverage more affordable. This includes $13,100 for family coverage in 2016. anyone whose income is up to 400% Both sets of caps tend to increase of the federal poverty line, which is slightly each year. about $90,000 for a family of four. In If you participate in an HDHP, you addition, there are limits to what you are entitled to open a health savings must pay in out-of-pocket expenses, EMPLOYER HEALTH PLANS for each visit. Most preventive care is account (HSA) and contribute pretax similar but not identical to the If you have coverage through your fully covered. The copayment is a fixed income to pay for qualifying but un- out-of-pocket caps on HDHP plans. employer, you may have a choice of dollar amount that the plan sets, often covered medical expenses. Any amount For more information about ACA plans, including managed care plans, one amount for your primary care pro- you don’t send one year can be rolled provisions, you can visit www.hhs.gov/ fee-for-service plans, and a high vider and a higher one for specialists. over to the following year. Healthcare or www.healthcare.gov. deductible plan (HDHP). If you see a provider who doesn’t In managed care plans, which participate, your plan may or may INDIVIDUAL COVERAGE could be either preferred provider not pay a percentage of the cost. You can purchase insurance either COBRA organizations (PPOs) or health main- An HMO, on the other hand, directly from an insurer or through a If you leave a job where you’ve had health tenance organizations (HMOs), you employs the plan’s doctors and other state, federal, or state-federal market- insurance, you may qualify for continued have access to a roster of participating providers and often owns the hospitals place, or exchange, established under coverage under the Consolidated Omnibus doctors. A PPO negotiates a fee for each to which you are admitted. Typically, the ACA. Budget Reconciliation Act, better known service with the healthcare providers visits to other doctors or facilities In most cases, you make two as COBRA. It’s not cheap—you normally pay in the plan, and your cost is whatever aren’t covered. choices when you use an exchange, 102% of your employer’s cost—but it can be share of the premium your employer In a fee-for-service plan, you can see among providers and among four levels a good interim solution. requires you to pay plus a copayment any doctor or service provider you wish. of coverage: bronze, silver, gold, and 92 93 INVESTING INVESTING

CHOOSING YOUR OTHER INVESTMENTS Investing You can find many other things to invest INVESTMENTS in, like options, commodities, real estate, By investing, you move from planning to action. Selecting investments that are right or private partnerships, if you’re looking for you depends on your financial for more variety or can afford to take goals, specifically what you expect added risks. But for most investors the When you invest, you buy things of you could lose some, or even all, of those goals to cost and when you basic three—stocks, bonds, and cash— value that you expect to increase your net your principal or earn less than you want to achieve them. Among the should be the core of any investment worth and help you realize your goals by: anticipate. This could mean you’re not things to consider in making your portfolio. High on the list of reasons significantly better off than you were Growing in value choices are the return you need, how for that advice are the federal and state •  before investing. Providing income to reinvest or spend much risk you’re willing to take, and regulations that govern their sale and the •  You can improve your chances Producing both growth and income whether liquidity is a factor. fact that they trade in organized public •  of investment success by learning as markets, such as stock exchanges. Investing can be extremely rewarding much as you can about how different RETURN This means if you need to liquidate if the average return, or earnings plus investments work and choosing among What can you your assets, you can sell these invest- growth in value, on your investments is them carefully. You can also benefit expect to earn on ments easily, although not necessarily positive over time. But you always take by investing strategically using asset an investment? at a profit. Selling other types of invest- some risk when you invest. For example, allocation and diversification. While the return ments may be slower or more difficult, an asset class has if they don’t trade in a public market. provided in the INVESTMENT BASICS past doesn’t guarantee its future WAYS TO INVEST There are three core investment The return on investment that they returns, understanding the historical Just as there are different types of categories: stocks, bonds, and cash. provide varies from class to class and performance of different classes lets investments, there are different types Each of these asset classes puts from year to year. But over time all three you decide on how much emphasis of investment accounts. your money to work in a different way. types have provided positive results. to put on each class as you build You can put as much money as you your investment portfolio. Growth wish in a taxable account each year and Stocks are is generally associated with stocks choose from a full menu of investments. ownership shares and stock funds, income with bonds, You pay tax on any earnings your invest- investors buy in and safety with FDIC-insured CDs. ments produce and on any gain in value a corporation from selling an investment for more than What’s the risk involved? you paid to buy it. Qualifying dividends Investing always means taking some and long-term capital gains are taxed at risks. To many people, the biggest a lower rate than your other income. risk is losing money, so they look for You may also have one or more tax- investments they consider safe. Usually deferred retirement accounts. You can that means putting money into bank postpone taxes on investment earnings CDs and US Treasury bills. The in a tax-deferred account until you with- opposite but equally important risk is draw. In some accounts you can also that your investments will not provide defer taxes on the amounts you invest. enough growth or income to offset When you do withdraw, the tax that’s the impact of inflation, the gradual due is figured at the same rate as you pay increase in the cost of living. One on other income. There are some limita- solution may be choosing a variety of tions: The annual investment amount investments with different levels of risk. is often capped, and in some plans the investment menu may be limited. You LIQUIDITY may also owe a penalty if you withdraw How accessible is early, which is usually before 59½. your money? Tax-exempt accounts are designed to If your investment help you pay for specific goals, such as Bonds are loans money must be retirement or education. If you follow investors make to easily available the rules of the specific account you’re corporations and Cash equivalent investments to cover financial using, no tax is due on any earnings in governments emergencies, you’ll the account, either as they accumulate or include certificates of deposit be concerned when you withdraw. You do pay tax on the (CDs) and US Treasury bills about liquidity, amounts you invest, and there may be lim- or how quickly its on amounts you can invest each year. MAKING INVESTMENTS with brokerage firms, mutual fund it can be turned to cash with little or You can invest directly in individual companies, banks, and insurance no loss of value. But when you invest Securities, by definition, are written stocks, bonds, and cash equivalents. companies. And you may have the for longer-term goals, liquidity is proofs of ownership, like stock or You can invest in mutual funds, and opportunity to invest through a retire- much less important. The most certificates. But as electronic records have exchange traded funds (ETFs) that ment plan your employer offers. The liquid investments, including CDs replaced paper, the term survives, to refer to own stocks, bonds, or cash equivalents. assets you own in all these accounts and Treasury bills, generally provide the investments themselves. You can open investment accounts make up your investment portfolio. the lowest return but the most safety. 94 95 investing investing

VO LAtiLITY EMP LOyer STOCK Volatility refers to sudden and potentially If you work for a publicly traded Investment Risk dramatic changes in an investment’s company, one of your retirement plan value. The more volatile an investment choices may be buying its stock. Or your There’s no such thing as a totally safe investment, but you is, the greater the opportunity for a big employer may make its matching con- can choose the level of risk you’re comfortable with. profit within a short period. But there’s tributions in stock. There may be good also a greater potential for a major loss if reasons to choose the stock, including the the price drops and you sell for less than fact that it gives you an opportunity to When you invest, you always take a you paid to buy. share in the success you’re contributing to. certain amount of risk. The most dra- THE investment Some investments are inherently But there are risks in tying your matic consequence is the possibility you volatile, including derivatives whose financial security too tightly to a single could lose some or all of your principal. PYRAMID value depends on the value of an under- source. At the worst, you could lose your But you also have to consider the more Risk is the result of volatility—how much lying commodity, such as oil or wheat, job and your 401(k) could take a big hit. probable risk that you won’t accumulate and how quickly the value of an investment and stock of A useful guideline is to keep your holding as much as you need to meet your changes—and uncertainty. new compa- to less than 20% of your account value. retirement needs. nies whose The two are interrelated. If you highest fortunes focus on reducing the risk of loss, you gains or may change usually reduce your potential return losses oTHER KINDS HIGHER RISK quickly based and long-term financial security. If you You can win big, OF RISK products, such as on an internal can tolerate some fluctuation in your but lose bigger, with futures contracts or some options, success or Beyond the risks of the invest- accounts’ values, the most productive risky investments. speculative equity investments, failure. Others ments themselves—for example, approach is often a middle ground, low-rated bonds, and certain com- may be vola- a new company that fails or an so that you include some investments modities generally expose you to tile only when established company that suffers with little risk to principal, a few with higher than average risk most of the the investment markets in which they severe losses—there are other considerable risk, and the majority in time. In some cases, you could lose trade are in turmoil. Still others are rarely risks you can’t predict or control assets that pose some risk but may more than your initial investment. if ever volatile. For example, the market but must be prepared for: also provide a strong return. prices of high-rated bonds typically The bottom line is that you have change slowly and within a limited range. to find the balance between too much Market risk One measure of a stock’s volatility is and too little risk that fits your goals MODERATE RISK depends on the state its beta, which links its price movement and your time horizon. of the economy as a Some investments pose greater risk to the average change in a control group at some times than at others. Stocks, whole. If the ESTIMATING RISK of stocks. The less risk you prefer, the tumbles, your stock investment will probably equity mutual funds, and ETFs, as a more likely you’ll be to choose stocks There’s no way to predict how invest- decline in value even if the companies whose group, may provide strong returns in with a beta lower than 1. Or, if you’re ments will perform in the future or the stock you own are making money. some but not all periods. Individual seeking greater risk and greater potential risks that may limit their return. But by stocks can expose you to major gains return, you’ll choose stocks with a beta looking at the way that an investment Currency or losses, based on a number of pre- higher than 1. or category of investment has performed dictable and unpredictable factors. The fluctuation is increasingly a factor in in the past, you can get a sense of the same is true of bonds and real estate. The risk of high yields level of return it’s reasonable to expect. investment risk, as more One cardinal rule for successful For example, if the annual return people put money into international investing is to know what you’re doing. on large-company stocks has averaged markets. If the dollar rises in value, for When the economy is down, and around 10% since 1926, it’s unrealistic LIMITED RISK example, the return on overseas investments interest earnings decline, you might to assume that future returns will aver- Investing in the stocks and bonds of declines—and vice versa. be tempted to seek an investment that age 20% or more, despite the fact that the largest and most stable issuers produces the same high returns to they have been that high or higher in and the funds that invest in them Inflation risk which you’ve grown accustomed. The individual years. It’s also true that they’ve poses more limited risk of major affects the value of risk is buying lower-quality investments been significantly lower—or negative— losses, but losses can and do occur fixed-rate investments (which pay more to attract buyers), or in about one-third of the years. in some periods. Even some invest- like bonds and CDs. If ments considered essentially free of investments you don’t know anything you buy when interest keeping your eyes closed default risk, such as Treasury issues, about. It’s a rates are low, the value of your investments good idea to One of the worst mistakes you can make can expose you to market risk. Lowest declines as inflation and interest rates rise gains or be skeptical as an investor is to ignore or underesti- because the old interest rate isn’t adjusted losses of any invest- mate the risks you’re taking, or to assume to keep pace. $10,000 in a savings ment described nothing bad is going to happen. The only LOWER RISK account at rates as risk free or thing that’s more risky is failing to invest Political The investments that pose the least below inflation will that promises turmoil because you’re afraid you could lose risk of loss are insured bank products be safe but will lose a dramatically is a risk because the money. Although you’re likely to suffer and short-term government issues. value over time. higher yield economies of different some loss of portfolio value in a market However, they typically expose you than better- nations are closely intertwined. Threats to downturn, in the next upturn you’re over the long term to inflation risk, known products. Even if it’s legitimate, the oil supply, for example, have disrupted positioned not only to regain lost ground which can be especially severe when it’s likely to have strings attached. the economy before and could again. but potentially to accumulate additional interest rates are low. account value provided you stay invested. 96 97 investing investing

figures for mutual fund performance are inflation rate. Your return needs to be Figuring Your Return reported regularly. You can compare how higher than the inflation rate if your well your investments are doing against investments are going to increase in Return is what you get back in relation to the amount those numbers as a starting point. value. In fact, real return is market Another factor to take into account return minus the inflation rate. you invest. when evaluating return is the current

You start out as an investor by choosing return, the average percentage that investments. Then you need to monitor you’ve gained on each investment over Figuring Return Is Not That Simple how your investments are performing a series of one-year periods. Figuring out the actual return on your investments • The time you hold specific investments varies. and whether you’re on track to meet For example, if you buy a stock for can be difficult because: When you buy or sell can have a dramatic your goals. As you evaluate your prog- $15 a share and sell it for $20, your effect on overall return. ress, you’ll need to be prepared to make profit is $5. If that happens within a • The amount of your investment changes. Most changes—by selling some investments year, your rate of return is an impressive investment portfolios are active, with money • The return on some investments—like and buying others—if certain ones aren’t 33% ($5÷$15=33.3%). If it takes five moving in and out. limited partnerships or real estate meeting your expectations. years, your average annual return will be investments—is difficult to pin down, • The method of computing return can vary. partly because they’re not publicly traded. As you monitor, though, you have closer to 7%, since the profit is spread For example, performance can be averaged to be realistic. If stocks in general are over a five-year period. You have to evaluate them by different or compounded, which changes the standards than you do stocks or bonds, struggling to stay positive, as sometimes rate of return dramatically, as the chart Sell at Profit Return including their tax advantages. happens, you’re can’t expect the stocks below demonstrates. or stock funds you own to provide a Year 1 $5 33% strong return. Selling them and substi- tuting others isn’t likely to improve your Year 3 $5 11% Compound vs. Average Rate of Return return, plus you’ll pay transaction costs. Year 5 $5 6.6% Here are six sets of investment returns totaling 27% over three years. While the average annualized Nor will selling everything and putting return in each case is 9%, compound annual returns vary significantly. The most volatile investment, what’s left in a savings account. Measuring Total Return number 6, provided the weakest compound return despite having the highest one year return, at By the same token, if the stock In addition to the income on your 40%, in part because it also had the lowest, or 5%, and that loss occured in the first year. market is gaining value, you may want investment, total return includes how to consider replacing a stock whose much your investment gains or loses return is still lagging. Another reason Investment 1 2 3 4 5 6 value measured by the change in its to replace a stock may be if the issuing market price. For example, your total company is in serious financial trouble Year 1 9% 5% 0% 0% –1% –5% return on a stock is not just the dividends from which it seems unlikely to emerge, it pays, but how much you would gain and you want to avoid deeper losses. Year 2 9% 10% 7% 0% –1% 8% or lose if you sold it. DESIGNING THE TEST Year 3 9% 12% 20% 27% 29% 40% Total The key to performance testing isreturn Income +/– Change in value = Average return 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% on investment (ROI), or what you get return back in relation to the amount you Compound return 9.00% 8.96% 8.69% 8.29% 8.13% 6.96% invest, called your investment principal. You don’t actually have to sell, or If you start out with $1,000 and end realize your gain or loss, to calculate up with $2,000, your return is $1,000 total return. It’s fine to figure it based on that investment, or 100%. If a on your unrealized gain. That’s also similar $1,000 investment grows to known as a paper profit or a paper loss. $1,500, your return is $500, or 50%— though of course you could also have getting a good return a negative return in any period. There’s no absolute standard that qualifies One of things you’ll want to know as ance of 500 large, widely held US But unless you hold different a specific figure as a good return. The you evaluate performance is how well companies. It’s the benchmark for large- investments for the same time period, average return on specific classes of your investments are doing currently in company US stocks and the mutual funds you can’t determine which has a stronger investments—small company stocks, for comparison with other investments that and ETFs that invest in those stocks. performance. What you need to com- example—over a specific historical period have similar characteristics and return Other benchmarks track small companies, pare your returns is the annual percent are a matter of record. And total return potential—two large US corporations, for long-term government bonds, types of example, or two telecommunications com- mutual funds, and every other market panies. That’s wherebenchmarks help. segment you can imagine in the United capital gains and losses A benchmark is an index or average States and around the world—including Investments, including real estate, that you term gain. But if you realize the gain within that reflects the changing value of a telecommunications companies. own are called capital assets. When you a year or less, it’s a short-term gain. particular or part of a Comparison with a benchmark pro- sell a capital asset at a higher price than you Long-term gains are taxed at a lower rate market, called a sector. The benchmark vides relevant information, however, only paid for it, the difference is a capital gain. than your regular income, which is also the rate serves as a standard against which to when the investment belongs within the If you sell at a lower price, you have a you pay on short-term gains. So if you can wait compare the performance of an invest- segment of the market that the benchmark capital loss. to sell until the year has passed, you improve ment that is part of that market or sector. tracks. You can usually find a list of rel- If you realize a capital gain after holding your investment income by reducing the tax For example, the Standard & Poor’s evant benchmarks by visiting the website the investment for more than a year, it’s a long- you owe. 500 Index (S&P 500) tracks the perform- of a company in which you’re interested. 98 99 investing investing

are low and corporate earnings are one asset class can not only offset losses in strong, stocks as a group have tended another, but, if they’re strong enough, can to produce robust returns while bond also provide a positive return for the year. Asset allocation is a strategy for building and managing returns were likely to be more anemic. Asset classes that produce their This is known assystematic risk. strongest returns in different economic your investment portfolio. By creating a portfolio of asset classes climates are described as having a low that respond differently to particular or negative correlation. In other words, An asset class is a group of investments managING RISK market and economic conditions—not they don’t respond the same way to a that shares specific characteristics that Although each asset class is made up all of which are likely to occur at the particular stimulus. For example, stocks differentiate it from other groups of many different securities, certain same time—you have a better chance of and cash equivalents tend to have a very of investments. Among the primary recurring market conditions affect an weathering some major losses without low correlation. When the interest rate distinctions are that each asset class entire asset class in a relatively predict- significantly reducing your potential for on T-bills is high, stock returns tend to puts your money to work in a different able way. For example, if interest rates long-term growth. That’s because gains in be limited or even negative. way than the others and exposes you to different types of investment risk. Asset allocation means dividing A LLOCation MODELS your investment portfolio among asset An asset allocation model is a blue- on an investor’s age, economic situation, Comparing different ways to allocate classes—primarily stocks, bonds, and print for spreading your investment and tolerance for investment risk, plus may help you determine the model that cash equivalents, but potentially capital among different asset classes. expectations about how the market is might be best for you. tangible property including real estate The most suitable model varies, based likely to perform. and precious metals, and derivatives, including options and futures contracts. Stocks—also called equities—include stock mutual funds and exchange traded funds (ETFs) that track stock indexes. Bonds include bond mutual funds and ETFs that track bond 40% Stocks indexes. Cash equivalents include cer- 60% Stocks tificates of deposit (CDs), US Treasury 80% Stocks 60% Stocks bills, and money market mutual funds. 80% Stocks 40% Bonds Generally you allocate on a per- centage basis, assigning part of your 25% Bonds 10% Bonds 25% Bonds 20% Cash investment principal to each asset class 10% CashBonds 15% Cash you’re using. For example, you might 10% Cash 15% Cash invest 60% in one class, 20% in a second, and 20% in a third. Or you aggressive conservative aggressive conservative might allocate one-third of the total An allocation, which may moderate A allocation, which moderate to each of three classes. be appropriate for young people or A allocation might assign may be appropriate for older people those with a steady source of fixed between 50% and 70% of the total to wanting to preserve capital and l ooking for results income, tends to emphasize equities, equities, depending on your age, your collect regular income, might assign Your allocation typically has a major with as much as 80% to 90% of the financial goals, and your other financial 40% of the total to equities, with the impact on your investment return. portfolio being invested in stock, resources, with the balance going to rest divided between bonds and cash, That’s because no single asset class stock mutual funds, and stock ETFs. fixed income and some cash. depending on the economy and an consistently produces the best return investor’s personal financial situation. every year, based on a number of fac- tors including what’s happening in the HO W ALLOCATION WORKS A TIME TO REALLOCATE investment markets and in the economy Once you have chosen an appropriate allo- Over time, you may want to modify A LLOCation CHOICES at large. And a class that has been strong cation—say that you decide to put 60% your portfolio allocation in response Stock has historically provided the strongest one year may be weak the next. of your assets into stock, 30% into bonds, to a number of different situations. return by doing well in some years, even though If you were invested primarily in the and 10% into cash—the next step is to put As you get closer to retirement, results have been flat or lost ground in others. class that was outperforming the others it into practice. For example, you might you may want to shift some of your in a particular year, your increased port- have $1,000 to invest. You’d use $600 to assets out of potentially volatile Bonds have produced strong returns in some folio value would reflect those gains. buy shares of a stock fund, put $300 in a growth investments, such as stock or years and weaker returns in others, though the But if in the following year or two that bond fund, and place the remaining $100 stock funds, into income-producing highs and lows tend to be less extreme than class underperformed, your portfolio in a savings account. The next time you investments that have tended to be with stock. value would be dragged down by the have $1,000 to invest, you do the same more stable in value. Cash equivalents usually provide the losses. The challenge is that while this thing. And, if you rolled over $10,000 You may want to reallocate smallest, but most consistent, returns. up-and-down pattern repeats regularly, from a 401(k) to an individual retirement your portfolio in response to major the timing is not predictable. account (IRA), $6,000 would go into stock life events that have an impact on Real estate tends to increase in value over Remember, too, that while asset funds, $3,000 into bond funds and other your financial situation, such as time, sometimes dramatically. It can lose value, allocation can help you manage risk, fixed-income alternatives, and $1,000 into getting married or divorced, having too, and real estate is illiquid, which means it it doesn’t guarantee a profit or prevent cash equivalents, such as US Treasury bills children, or changing jobs. may be hard to sell easily at the price you want. a loss in a falling market. (T-bills) or a short-term bond fund. 100 101 investing investing

a word of warning Diversification In addition to managing nonsystematic risk, one of the goals of creating a diversified portfolio is Diversifying means buying a number of to provide a more consistent return. But while investments within an asset class. diversification can help you manage risk, it doesn’t guarantee a profit or prevent a loss in a falling market. When you’ve selected the asset classes in which you plan to invest, the next step is diversifying, or choosing the specific investments within each class that you’ll INDIVIDUAL include in your portfolio. Those invest- MY LIO ments may be individual securities or SECURITIES PORTFO the mutual funds and exchange traded funds that invest in the individual securities. In fact, what many investors do is put together a combina- tion of individual securities and funds to gain broad exposure to the class. MUTUAL FUNDS There are two steps in the process: ETFs • Identifying securities and funds that are promising on their own merits • Putting together a combination of these investments to help manage risk while enhancing return not PEAS IN A POD You can expect securities that share FINER DISTINCTIONS defining characteristics to react in Most asset classes are defined in fairly much the same way to specific factors sweeping terms, such as US equities or or situations. For example, one of the long-term US debt. There are more than major determinants of the value of any is significant with any single bond, you they’re selected is more important than 4,500 listed common stocks that belong long-term is its credit can reduce your overall risk by buying how many you own. to the first category, several thousand rating. With a downgrade, its value an assortment of similar bonds. that aren’t listed, and more than 500 drops, and with an upgrade, its If, for instance, instead of owning DIVERSIFying with funds ETFs and 4,500 mutual funds that value increases. one bond you own a diversified port- A well-diversified portfolio is likely invest in stocks. Long-term US debt As another example, folio of bonds, then the credit quality to contain securities from various sub- includes several million corporate, fed- one of the key factors of some of the bonds may be upgraded classes—though not necessarily from all eral government, and municipal issues. that affects the value while the credit quality of them—within each of its asset classes. B Subclasses, or smaller categories, of a stock is the of others is downgraded. For example, short-term bonds, which A y within the broad classes typically behave quality of the y n Over time, the upgrades mature in less than a year, tend to be less n a a differently from each other even though company’s p p and downgrades may vulnerable to inflation risk than bonds m m they share the essential defining features management. o o equalize so that, overall, with 30-year terms. They’re also much less C C of the class to which they belong. Some the impact of credit likely to expose you to credit risk since For example, companies issuing compa- changes on your port- the issuer’s ability to pay will not be sub- equities can be divided by market nies have folio’s return is reduced. ject to as many changing factors. But in capitalization into large, mid, small, exceptional management and, as a result, In other words, a certain most environments they pay lower rates. and micro subclasses. Differences tend to outperform their peers. Other amount of credit risk One approach to consider is concen- in capitalization generally indicate companies have inferior management can be diversified away. trating your investment assets in mutual differences in growth potential, share- and tend to falter even though they may As an investor, it’s funds and ETFs. Because each fund is price volatility, and the likelihood that be producing comparable products or often hard to know which companies diversified in its own right, you don’t the issuing company will survive an providing similar services. are well-managed and which are poorly have the responsibility of choosing economic downturn. These are examples of asecurity- managed—except in hindsight. How- individual investments or concerns Other ways to distinguish equity specific risk, or, in the language of ever, in a diversified portfolio of stocks, about owning enough different securities subclasses are by industry, sector, asset allocation, nonsystematic risk. the effects of superior and inferior in any category. And because you can and valuation—that is, whether management tend to balance out. There- choose among a broad range of funds, they’re overpriced or underpriced LIMITING YOUR EXPOSURE fore the impact of management quality each of which invests to meet a particu- based on a criterion such as average The possibility of a downgrade in a is another nonsystemic risk that you lar objective, you can create a diversified price-to-earnings ratio—as well as long-term corporate bond’s rating that can reduce or even eliminate through portfolio of diversified funds. domestic and international issues. dramatically reduces a bond’s return diversification. But as part of your selection process, On the fixed-income side, differ- represents a significant source of risk. But adding investments randomly is you’ll want to evaluate the fees and entiators include taxable and tax-free Compounding the problem, it’s hard to unlikely to achieve the diversification other costs of owning the funds you’re status, interest rate, term, callability, predict when the credit quality of a par- you seek. The quality and range of considering. The higher the annual and rating. ticular bond will change. While this risk investments and the care with which expenses, the lower the return you realize. 102 103 investing investing

Investing in Stocks ho w do 300 250 Stocks are ownership shares, or investors make 200 equity, in a corporation. money? Sell 150 2 Investors buy stock 2 When you buy stock in a corporation, 100 you become one of its owners. If the to make money: company does well, you may receive Through dividend 50 11 Dividends part of its profits as dividends and see 11 payments while 0 the price of your stock increase. But if they own the stock JAN FEB MAR APR MAY the company fares badly, the value of $ your investment can drop, sometimes $ $ $ $ investor concerns 22 By selling the stock substantially. Some people hesitate to invest in the stock for more than they A stock has no absolute value. At market because they consider it too risky. Afraid paid to buy INVESTORS any given time, its value depends on of choosing the wrong stock or being battered whether the shareholders want to in a crash, they prefer to stick with investments hold it or sell it, and on what other they consider safe. some international stocks, whose investors are willing to pay for it. If The problem with that approach is that by finding P/E issuers are based in other countries lots of people want shares, the stock’s A stock’s price-to-earnings skipping stocks, investors are missing out on a Stocks with different market caps value will go up. If a company is losing reliable source of long-term gains. While you can (P/E) ratio is one tool investors use to •  money or a particular industry is doing always lose money in a single year or on a single evaluate a stock’s current price in relation to • Cyclical as well as defensive stocks poorly, those stocks will probably drop its potential for longer-term success. If the P/E stock, investors who have held a portfolio of Both growth and value stocks, as in value. Some stocks are undervalued, varies substantially from the market’s average •  stocks through any 15-year period since 1926 well as dividend-paying stocks that which means they sell for less than P/E, it’s wise to try to understand why. A very have always come out ahead. provide regular income analysts think they’re worth, while Usually, the greater danger is not sticking high P/E may be the result of great promise or irrational enthusiasm, while very low P/E may others are overvalued. with stocks. Investors who sell their shares KEEPING TRACK Investors’ attitudes are determined be the sign of hidden potential or imminent when the market drops, rather than riding out Your brokerage firm creates a regular by several factors: whether or not they collapse. That’s why P/E can never be the the downturn, are more likely to lose money monthly or quarterly statement reporting expect to make money with the stock, only indicator you check. than people who leave their portfolios alone, your current account value and detailing current stock market conditions, and or those who buy additional shares when all transactions in your account during the the overall state of the economy. prices are depressed. Another way stocks differ is how they period, including dividend or interest pay- THEW ORLD OF STOCKS perform in different economic environ- ments, purchases and sales, and any cash ments. Stocks described as cyclical tend infusions or withdrawals. The firm also Stocks as an asset class are all alike in known as market capitalization, or market to flourish when the economy is strong provides a confirmation for each trade, providing the opportunity to own shares cap. You find market cap by multiplying and suffer when it weakens. Airlines, the including the price and commission. in the issuing company and prosper if the number of outstanding shares by the hospitality industry, and other providers It’s smart to review these documents the company prospers. But within the current price of a share. Outstanding of nice-to-have but not essential goods to track how your portfolio is doing. overall class, stocks can be categorized shares are those that investors own. and services tend to be cyclical. Defensive Additionally, they can provide a heads- in a number of ways that differentiate The largest companies, calledlarge- stocks, on the other hand, are often more up to potential problems: unauthorized them from the others. caps, include some of the oldest and resilient in recessionary periods because trades, for example, or unexplained fees For example, some stocks are listed best known US businesses as well as a demand for their products and services and charges. on an organized market, such as the number of newer powerhouses, many continues. Utility, pharmaceutical, and New York (NYSE) or of them technology companies. Large- healthcare companies are examples. the Nasdaq Stock Market. Others trade cap prices tend to be less volatile than A further way to differentiate is BUY AND WATCH over-the-counter (OTC). One advantage those of small-caps or mid-caps. They between growth and value. Growth When some investors choose a stock, they keep of investing in listed stocks is that they are also more likely to pay dividends stocks are shares in companies that re- it through thick and thin, a strategy known as tend to be liquid, so you can sell when than smaller, often newer, companies. invest most of their profits to expand and buy and hold. Other investors buy and you wish, though not always at the price Smaller companies may provide more strengthen their business. Value stocks sell more frequently, which means they select you’d like. There’s also generally more growth in value as they expand. But they are trading at a lower price than would stocks they think are going to increase rapidly information available about listed stocks, may be less resilient in tough times because seem appropriate based on their assets in value. When the price goes up a certain which you can use to make an informed they have fewer financial resources. Mid- and market potential. That may be the percent—15% to 20% for example—they investment decision. caps share some characteristics of the case if the company has had financial sell and buy something else. Stocks can also be categorized by other two: greater growth potential on problems or if it is part of an industry Both approaches work. What works less well the size of the issuing company, or what’s the one hand but also less financial depth. that is out of favor with investors. is ignoring your portfolio. If you don’t pay atten- tion to how your stocks are doing, you could be keeping some that aren’t living up to the expecta- SIZE PERFORMANCE CHANGE BUILDING A STOCK PORTFOLIO A smart approach to investing in stocks tions you had for them when you invested. It Large Cap happens to everybody. The best solution is to sell Mid-Cap Growth is to create a diversified portfolio, with: Defensive your losers and identify new investments that Cyclical Value • Some domestic stocks, whose issuers have the potential to make your portfolio stronger. Small-Cap are based in the United States, and 104 105 investing investing

bulls and bears Within any phase of a market cycle, Taking Stock of Your Individual stocks and the stock the prices of individual stocks or the market as a whole gain and lose market as a whole can change direction Investments value in recurring cycles of growth for a time, rising in a bear market or and decline. Periods of growth are falling in a bull market, before reverting To invest intelligently, and to track how well you’re doing, identified asbull markets. Periods to the dominant trend. If prices drop you have to understand the language of stocks. when prices drop 20% or more from in the 10% range, it’s described as a their most recent high are known as correction. But a correction is just bear markets. The time that elapses that. It doesn’t necessarily signal the You can find current data on any stock You can request regular updates from the start of one bull market to beginning of a bear market. in your portfolio or on a stock you may on specific stocks or track an online the start of the next one, including The chief unknown with market want to purchase on the company’s portfolio, which may, but doesn’t the bear market phase, is known as cycles is how long the separate phases website as well as newspaper sites and have to, mirror the portfolio you a full market cycle. will last, which could be months or years. financial news sites. actually own.

Close tells you a stock’s volatility. The more volatile Price/Earnings ratio While P/E ratios can help $2.40 per share. If you owned Yield provides only a partial closing price for the previous a stock is, the more you can shows the relationship you evaluate a stock, P/E is 100 shares, you’d receive picture. Sometimes the yield day. Usually the daily make or lose within a relatively between a stock’s price and not the only factor to consider. $240 in dividend payments, can look very attractive—say differences are small even short investment period. The the company’s earnings for the probably in quarterly payments 10%—because price of the if the 52-week spread percentage of change is more past four quarters. It’s figured Cash dividend per of $60. Preferred stocks tend stock has fallen but manage- is large. significant than the dollar by dividing the current price share is an estimate of the to pay higher dividends. ment hasn’t adjusted the amount: a $5 change from per share by the earnings anticipated yearly dividend dividend downward. And Bid is the highest price a $5 to $10, a 100% change, per share. per share in dollars and cents. Percent yield tells you the some companies choose buyer offers, andask is the shows more volatility than a There is no ideal P/E Sometimes the prices of stocks percentage of a stock’s price paid not to pay a dividend, lowest price that a seller wants. $5 change from $30 to $35, ratio. A stock with a low P/E that pay dividends are less as a dividend. Here, the yield preferring to reinvest profits The difference between them a 17% change. ratio—say 10—may seem volatile than the prices of stocks of 2.8% means the annual per in new products or factories, is the spread. Bid and ask are in like a bargain. But the company with no dividend. Caterpillar’s share dividend of $2.40 is equal which may result in higher constant play throughout the Earnings per share could have problems that will yearly dividend is estimated at to 2.8% of the price. profits later. trading day. (EPS) is one measure of the hurt future earnings. company’s health. Investors Meanwhile, a stock with a ONLINE ALTERNATIVES (www.nasdaq.com) as well as on brokerage firm Highest and lowest see improved earnings per high P/E—say 37 or more— You can find current trading information— and news company websites. Many financial prices of each stock are share as a sign of increasing may seem overpriced. But it sometimes in real time but more often with publishers will customize a newsletter tailored shown for the last 52 weeks. profitability, especially when could be growing so fast that a 15 or 20 minute delay—on market web- to your specific interests, such as late-breaking The range between the prices there is a pattern of gains its future earnings will be much sites including the New York Stock Exchange news on the stocks in your portfolio or those you is a measure of the stock’s over several quarters or years. higher, justifying the price. (www.nyse.com), and the Nasdaq Stock Market are following.

106 107 investing investing

Other Ways to Trade Professional Analysis Technical analysts use past price Professional stock analysts use different patterns to predict how individual Some stock investors use leverage to increase gains, but methods to evaluate a stock’s prospects companies, industries, or the market and decide which ones they will advise as a whole will do in the future. they risk magnifying losses. investors to buy or sell. These analysts use charts or computer Fundamental analysts concentrate programs to identify and project price Experienced investors sometimes buy losses result from getting the direction on the economic health—the balance trends, usually in the short term. stocks on margin or sell stocks short, two wrong or having to wait a long time for sheet and income statements—of Many investors use a combination techniques that can boost profits though the anticipated change to occur. Like other individual companies, and on their of fundamental and technical analysis, they may also result in losses. The profits leveraged investments, for which you bor- management and their position in the the former to decide what to buy and occur when you anticipate correctly what row part of the cost, you must repay the industry, in order to forecast a stock’s the latter to decide when to buy it. a stock will cost in the future, and the loan regardless of how the deal turns out. future performance.

How buying on margin works How selling short works You buy stock Your purchase You borrow 100 You sell the 100 through the 1,000 shares at You You lose if shares from your shares at the $10 You You lose if margin account $10 each pro t if stock stock price broker price, getting pro t if stock stock price you open with price rises drops $1,000 price drops rises your broker Stock Value $15 Stock Value $10 Stock Value $7 Stock Value Stock Value The value of your Stock Value $12.50 Your $10 $7.50 investment break-even point Margin Shares you owe call your broker 100 100 100 $10,000 Shares Shares Shares

$5,000 Your cost to pay $2,000 back the shares $750 $1,250 Your broker’s investment Your pro t—or loss $5,000 $5,000 $5,000 before interest $250 $250 and other fees Pro t Loss

Buying on Margin MARGIN CALLS Selling Short What Are Warrants? To buy on margin, you must open a Brokers protect themselves against losses Selling short is selling a stock before When you buy a warrant, you pay a margin account with your broker and by issuing a margin call if the value of an you buy it because you think the price small price now for the right to buy a deposit the required minimum, often investment purchased through a margin is going down. To sell short, you use a certain number of shares at a fixed price $2,000, in cash or marketable securities. account falls below a specified percent- margin account, and borrow stock you during a specified period in the future. That gives you the right to borrow up age—never less than 25% and often don’t own from your broker. Ideally, For example, you might pay $1 a share to 50% of the purchase price of a stock 30% or higher. The call requires you to when the price drops, you cover your for the right to buy the stock at $8 within you buy through the account. deposit additional cash or securities to short position by buying the stock for five years. If youexercise , or use, your For example, if you buy 1,000 shares bring your equity up to the required level. less than you sold it for. You give the warrant when the selling price is $12, of a stock at $10 a share, you would use If you can’t afford to, or don’t,meet the stock to your broker to replace the shares you’ll be $3 ahead ($12 – ($8 + $1) = $3). $5,000 of your own money and borrow call, your broker can sell securities in you borrowed and pocket your profit. If the price of the stock is below the the balance. If the price goes up to $15 your account to cover the shortfall. In For example, if you sell short exercise price when the warrant expires, a share, you can sell, repay the $5,000 the example here, if your broker required 100 shares at $10 a share, the price the warrant is worthless. But before it you borrowed, and realize a profit of 30%, you’d have to add $100 to bring drops and you buy 100 shares two weeks expires, the warrant can increase in value $5,000, or 100%, minus commissions your equity to $2,100, or 30% of $7,000. later for $7.50 a share, you make $2.50 if the stock price rises. So it’s important and interest. If you invested just your profit per share (minus the interest to keep track of the underlying stock $5,000 to buy 500 shares, you’d have and commission you owe your broker). during a warrant’s life span so you can just half the gain—$2,500 or 50%— buying rights That’s approximately a 33% return. exercise or sell if it makes financial sense. before commissions but owe no interest. Companies sometimes offer their stockholders The risk is that the price of the stock Warrants are sold by companies that The risk, however, is that the price could the opportunity to buy more shares below might go up instead of down. Then you plan to issue stock, or by those that stay flat or fall. If it dropped to $7 a share, market price during a limited time period. may have to cover your short position want to raise cash by selling stocks and you sold to prevent further losses, These written offers, called rights, are by paying more for the stock than you they hold in reserve. Once a warrant is you’d absorb the total $3,000 loss because actively traded in many stock markets sold it for, so you could potentially lose offered, it has a life of its own, and can you’d still owe your broker $5,000. around the world. more than the amount you invested. be bought and sold as well as exercised.

108 109 investing investing Investing in Bonds Bonds attract investors because they usually pay regular interest income and pledge to repay principal.

Bonds are loans you make to corpora- a year or less to 30 years or more. The US savings bonds are often the first investment people tions or governments. Unlike buying longer the term, the higher the interest own, whether they were a gift or purchased with payroll deduc- equity stocks, or securities, which rate generally is, though the difference tions. Unlike other Treasury issues or municipal and corporate makes you a part owner, buying bonds, is not always significant. When the term bonds, savings bonds aren’t marketable and can’t be bought and debt or securities, makes you a creditor. ends, the bond matures, and the issuer sold among investors. Instead, owners hold the bonds for up to Bonds are called fixed-income repays par value. If not, the issuer is in 30 years before redeeming them for the principal plus interest. securities because they pay interest at default and investors generally lose at Interest accrues monthly and is paid at redemption, though a specific rate for a specific term, from least some principal. three months interest is withheld as a penalty on any savings bond that has not been held at least five years. Paper bonds that were issued before 2012 can be redeemed Types of Bonds or converted to electronic form using a program called Smart Type Description Features Exchange or held until redemption. The five-year penalty period doesn’t apply to conversions, and no income tax is due on converted amounts. Corporate Bonds are the major source of • Sold through brokers treasury issues Bonds corporate borrowing. Interest is taxable • High-quality, or investment- are backed by the general credit of Top-rated bonds pose limited •  grade, bonds are considered conserva- tronically in your linked bank account, the corporation. Asset-backed risk of default tive investments because you’re likely to and debits the account for new purchases. TION bonds are backed by specific Higher yield than government CORPORA • receive regular interest payments plus corporate assets like property bonds with similar terms the bond’s face value, or par, when or equipment. Sold in $1,000 units The current interest rate at Treasury auctions •  it matures. and the price of the 30-year bond in the Treasury bonds, notes, and bills are Municipal Millions of bonds have been issued Sold through brokers are considered benchmarks •  considered essentially free of default risk. of investor attitudes toward the economy. Bonds by state and local governments. • Pay lower interest rates than They are backed by the “full faith and General obligation bonds are comparably rated corporate credit” of the government, which has the backed by the full faith and credit of bonds and US Treasurys power to tax its citizens to pay its debts. Savings Bonds: Tried, MUNICIPAL GOVTS the issuer, and revenue bonds • Tax-exempt interest Corporate and municipal bonds are rated and True by the earnings of the particular • Sold in $1,000 units by independent rating services—the You can buy US savings bonds—up to project being financed. best known are Standard & Poor’s, $10,000 per series per person a year— Moody’s, and Fitch—which provide an through a TreasuryDirect account. US Treasury Intermediate (2, 3, 5, 7, and Sold through TreasuryDirect opinion about the financial stability of •  Series EE bonds pay a fixed rate of Notes and 10 years) term Treasury notes or brokers the issuer and assign a rating—from •  return, determined by purchase date, Bonds are a major source of government Highest credit quality AAA (or Aaa) to D. Any bond rated Baa •  for 30 years. funding as are long-term (30 year) • Inflation-indexed bonds (TIPS) or higher by Moody’s, or BBB or higher US Treasury bonds. offer income protection by Standard & Poor’s, is considered Series I bonds pay inflation-adjusted TREASURY •  • Sold in $100 units investment quality. Usually, the higher interest for 30 years. a bond’s rating, the lower the interest it You can invest as little as $25. must pay to attract buyers. •  US Treasury US Treasury bills are the largest • Sold through TreasuryDirect • There’s no commission, and no state Bills component of the money market, or brokers A voiding Commissions or local tax on the interest, and you where short-term (4, 13, 26, and • Essentially free of credit and The least expensive way to buy and don’t owe federal taxes until you US 52 week) securities are bought market risk sell US Treasury issues is without com- redeem the bond. TREASURY mission through the federal system and sold. Bills sold at discount Interest taxable at federal but You may avoid taxes entirely if you •  called TreasuryDirect. You set up an and interest paid at maturity. not state and local levels qualify to use the bonds to pay for your account and buy or reinvest online at Sold in $100 units child’s higher education. •  www.treasurydirect.gov. The system Agency Federal, state and local agencies sell • Sold directly through banks, deposits your interest and principal elec- Bonds bonds. The best known are federally or by brokers INF LAtion PROTECTION One risk of buying most bonds is that the income guaranteed mortgage-backed bonds • Marginally higher risk and What Are Junk Bonds? sold by Ginnie Mae (Government higher interest than you earn is fixed for the term of the loan. But if National Mortgage Association). Treasury bonds Investors willing to take risks for you buy inflation-indexed US Treasury notes • May require investment higher yields buy corporate or (TIPS), your principal is increased as inflation of $25,000 municipal bonds with low ratings— rises. That lets you maintain the buying power or no ratings at all—commonly provided by the fixed-income portion of your known as junk bonds. investment portfolio. But the principal also could decrease if inflation drops. 110 111 investing investing The Value of Bonds Some of the factors to consider in evaluating bonds as FINRA TRACE Corporate Bond Data potential investments are the purchase price, the interest Most Active Investment Grade Bonds rate, and the yield. Rating Issuer Name Coupon Maturity Moody’s/ Last Change Yield % S&P If you buy a bond at face value, or Understanding Bond Prices par, when it is issued and hold it until Corporate and municipal bonds are MORGAN STANLEY 2.125% Apr 2018 Baa1/A–/A 98.893 0.683 2.374 it matures, you’ll earn interest at the priced in decimals, as stocks are, with a LYONDELLBASELL 5.000% Apr 2019 Baa2// 110.556 –0.010 2.883 stated, or coupon, rate. For example, if par value of $1,000 as the base. A bond INDS N V you buy a 20-year $1,000 bond paying trading at 101.250 sells for $1,012.50 5%, you’ll earn $50 a year for 20 years. while one trading at 99.291 sells for BANK AMER CORP 6.000% Sept 2017 Baa2/A–/A 113.760 0.077 2.415 The yield, or your return on investment, $992.91. While many bonds move BANK AMER CORP 2.000% Jan 2018 Baa2/A–/A 98.179 0.151 2.437 will also be 5%. And you get your very little above or below par, investor $1,000 back. demand for a particular issue may drive KROGER CO 3.850% Aug 2023 Baa2/BBB/ 99.384 0.367 3.924 You can also buy and sell bonds its price substantially higher. Similarly, BBB through a broker after their date of if investors are selling a particular issue, PETROLEOS 5.500% Jan 2021 Baa1/BBB+ 108.550 0.050 4.152 issue. This is known as the secondary, or perhaps because its rating has been cut, MEXICANOS resale, market. There the price fluctuates, its price may fall well below $1,000. with a bond sometimes selling at more You can find information for PETROBRAS GLOBAL 4.375% May 2023 A3//BBB 89.570 –1.369 5.786 than par value, or at a premium, and the most actively traded investment FIN B V sometimes below, at a discount. grade, high yield, and convertible AB SVENSK EXPORT 3.250% Sept 2014 Aa1// 103.224 –0.045 0.297 Changes in price are directly tied to bonds by checking FINRA TRACE KREDIT - SWEDISH the interest rate of the bond. If its rate is at www.finra.org. TRACE is an EXPT CR higher than the rate being paid on similar acronym for Trade Reporting and bonds, buyers are willing to pay more Compliance Engine. In this report of actively traded In contrast, the bond issued by than par to get the higher interest. But For comparable information about bonds, the current yield on the Bank America Corporation with a if its rate is lower, the bond will sell for municipal bonds, check the EMMA Petrobras Global Fin B V bond that coupon of 6% has a current yield less than par. The higher the price you website of the Municipal Securities matures in May 2023 is 5.786%, or of 2.415%, or more than three and pay, the lower the yield, or what you earn Rulemaking Board (MSRB) at www. more than a full percentage point a half percentage points less. That’s on your investment. Similarly, when the emma.msrb.org. EMMA is an acronym greater than the coupon rate of because the last trading price was price is below par, the yield is up. for Electronic Municipal Market Access. 4.375%. But the bond is trading at 113.760, or $1137.60, a substantial US Treasury issues are a discount, or less than par, at premium above par. also priced in decimals, 89.570, or $895.70. Figuring Current Yield on Bonds but the par value of If you pay a premium for a bond, in the secondary market each bond, note, or bill buying t-bills BUYING TREASURY bondS you still earn the same interest that was paid when the bond is $100 rather than New US Treasury bills are sold weekly US Treasury notes and bonds are was issued at par. But since you paid more, the current $1,000. You can check through an auction process. Institutional the primary source of government yield—or the percentage of your investment—is less. for the latest data at investors, such as pension funds, submit borrowing. They’re sold regularly at TreasuryDirect.gov. For example, if you bought a bond with a par written bids indicating the rate they are auction in $100 increments. You can value of $1,000 and a 5% interest rate for willing to pay and how many bills they buy just one or $5 million worth at $1,040, the current yield would be 4.8%. What is ? want. One fund might offer 0.38%, for one time through TreasuryDirect or example, and another, 0.40%. Individual your broker. The auction schedule is $50 Interest The way to evaluate your investors can submit noncompetitive bids announced in advance on the website = 4.8% Current yield return on a secondary $1,040 Current market price through TreasuryDirect for the same auc- of the Bureau of the Fiscal Service market bond is its tion, and have the purchase price debited (www.fiscal.treasury.gov). yield to maturity. This directly from the checking account linked All notes and bonds pay a fixed How Yield Changes calculation is based on to their TreasuryDirect account. rate of interest that is set at auction. the interest payments Yield from a $1,000 bond Interest The government fills the competitive And you receive the total annual you’ll receive until the with an interest rate of 5% payment Yield orders at the lowest rate at which it payment in two equal installments. time it matures and can sell out the issue, and then fills all At maturity you get par value back, what you pay for the If you buy it at par $50.00 5% noncompetitive orders at the rate. For whether you paid more or less than bond, above or below value of $1,000: example, if the cut-off rate is 0.40%, all $100 to purchase them. its par value. Your broker bidders at that rate and lower get bills. You can sell your notes and bonds If you buy it at a discount $50.00 6.25% can tell you a bond’s yield When the bills mature, par value is before maturity by transferring them price of $800: to maturity or you can deposited to your linked bank account to your broker, dealer, or bank. check online resources, or rolled over into new bills of the same The price you receive for selling If you buy it at a premium $50.00 4.17% including www.finra.org term. The difference between the price may be higher or lower than the price price of $1,200: or www.emma.mrsb.org. you paid and the amount refunded or you paid to buy. To learn more, you reinvested is the interest you earned. can visit www.TreasuryDirect.gov. 112 113 INVESTING INVESTING

CALLABLE BONDS can lose expected income if their bonds Special Types of Bonds Some bonds are issued with a call are called, since they may have to reinvest provision, which means the issuer has their money at a lower rate. There’s something for everybody in the . the right to repay principal before matu- Investors generally prefer bonds with- The challenge is finding the best choices forou. y rity and avoid repaying the interest out call provisions. However, sometimes that would have been due during the to make their callable bonds more attrac- remainder of the term. Information tive, issuers offer to pay apremium , or You can choose different types of bonds about the first date on which a bond amount above par, if they exercise their to meet your financial needs, whether can be called is included in the offering. right to call. The only drawback is that you’re investing for college, looking for Issuers will sometimes call bonds when if the premium price is higher than the tax-free income, or want to limit risk to ZERO-COUPONS interest rates drop, so they can reduce price you paid to buy, you may end up principal. That’s why it’s important to have HAVE SOME DRAWBACKS the cost of their debt. Investors, however, with a potentially taxable capital gain. a sense of the variety that’s available, the You must pay taxes, or ison credited, the interest special features they offer, and what their 11 that accrues potential advantages and drawbacks are. each year even though you don’t CONVERTIBLE BONDS receive it. This doesn’t apply if your Convertible bonds offer you the option ZERO-COUPON BONDS zero-coupons are in a tax-deferred of acquiring stock instead of getting your retirement account or you buy tax- principal back at maturity. The terms Zero-coupon bonds can be attractive exempt municipal zero-coupons. of the exchange—generally a certain investments because they’re sold at a number of shares for each $1,000 bond deep discount to par value, making them The prices are extremely volatile 22 ondary market, so you and when the conversion can be made— more affordable than other corporate or in the sec are spelled out in the initial offering. municipal issues. But there’s a message in may lose money if you don’t hold If the stock’s price falls, and you Convertibles appeal to investors who the name. Coupon, in bond terminology, them to maturity. choose not to exercise your right to think a corporation is growing and that means interest and, as the zero indicates, convert, the bond is still likely to have the price of its stock is going up. The you receive no interest income during a value. That’s more protection than if question is whether the potential for zero’s term. Instead, the interest is paid One approach to using zeros is to you’d bought the stock outright. buying stock is worth the lower interest. in a lump sum at maturity along with buy them to mature when you need cash Two potential limitations are: The initial interest rate is lower than your purchase price. The accrued interest infusions—one for each year a tuition the rate on other bonds with similar Convertible bonds are among the least plus the issue price equals par value. payment will be due, for example. •  ratings being issued at the same time. protected if the issuer defaults, so that you’re But they typically provide higher yields unlikely to recover principal than while offering an • Many convertibles have call provisions, so if opportunity to benefit from growth in the price of the stock begins to rise, the issuer are passed the stock’s value. might recall the issue before you could convert through to the bondholders. That’s different INSURED BONDS ASSET-BACKED SECURITIES from income from a more reasonable cost Some municipal bonds have individual bonds, than you could if you were their principal and interest which pay interest twice a buying individual bonds. payments guaranteed by year and repay principal at maturity. But investing in bond an insurance company. In Asset-backed securities are fixed- Asset-backed securities tend to provide funds isn’t the same thing exchange for that security, income investments, as individual a slightly higher yield than bonds with as buying a bond. When the bonds pay a lower rate bonds are. But instead of being the similar ratings and terms. But because you buy a bond fund, of interest and the insurance debt of a single corporate or govern- they are more complex than single secu- ND you’re buying shares of company collects a fee from BO ment issuer, an asset-backed security rities, it can be more difficult to assess the fund, not the bonds the issuer. One catch: If the is constructed by combining debts of credit risk, which is the risk of default. that the fund owns. And insurer has financial problems, individual borrowers into a package, a These investments may also be bond fund managers it could jeopardize the pay- process known as securitization, and vulnerable to interest rate risk. If don’t usually buy and ments you expected. selling slices of the package to investors. interest rates go up, loans made before hold bonds until they Asset-backed securities may bundle the increase pay a lower rate than what’s mature. Rather, they automobile, credit card, education, currently available. That means the mar- BOND FUNDS trade them, sometimes or mortgage loans. Mortgage-backed ket price of a MBS or other asset-backed You can buy bond mutual frequently, in an effort securities (MBS) are the most common, security would drop. If the opposite funds rather than individual to provide both yield and the best-known and least contro- occurs and rates drop, investors may bonds. Most funds invest in and capital gains. When versial MBS are Ginnie Maes, issued confront prepayment risk, which means specific types—like inter- $ interest rates move higher, by the Government National Mortgage borrowers pay off their loans early, mediate-term municipals, the value of the bonds Association (GMNA), a corporation reducing investors’ interest income. long-term corporates, or the fund holds can drop that’s part of the federal government. A more complex type of asset-backed bonds of a particular state. and trades can produce As the borrowers repay their loans, security, called a collateralized debt obli- Perhaps the major BO capital losses. So the price typically every month, those amounts— gation (CDO), is constructed from a pool advantage of using bond ND you get when you redeem a combination of principal and interest of MBS. A CDO is rarely appropriate funds is that you can build your shares may be more that’s characteristic of loan repayment— for, or marketed to, individual investors. a diversified bond portfolio at or less than you paid. 114 115 investing investing

LONG-TERM INVESTMENTS That doesn’t mean you should stick Investing in Mutual Funds Mutual funds are better suited to meet with a fund if its returns lag behind your expectations if you treat them as those of its peers over several years or if A mutual fund sells shares to raise the money it uses to long-term investments. For example, your investment goals change. But you those that emphasize growth may change should probably plan to hold funds if invest in a portfolio of securities. very little in value in the short term, but their disappointing results reflect what’s may produce substantial returns over an happening in the market as a whole or When you invest in a mutual fund, In an actively managed fund, a extended period. The same is true for in the segment of which they’re a part. your money is pooled with that of other professional manager chooses the stocks funds that emphasize value, or inexpen- As the market cycle evolves, you’ll be investors and used to make investments or bonds based on recommendations sive securities that have the potential in a position to benefit if you still own that are appropriate for the objective the from the fund’s team of research analysts. to be worth more in the future. But shares as their value rises. The risk, of specific fund is designed to achieve. If it’s an index fund, the fund invests in frequent buying and selling increases course, is that the fund’s value may not For example, a stock fund may buy the stocks or bonds included in the your trading costs and can reduce return. rebound with the market. stock in small companies to provide particular index the fund tracks, such long-term growth in value. Or a bond as the Standard & Poor’s 500 stock fund might buy intermediate-term index (S&P 500) or a Barclays Capital What To Look For bonds to provide current income. The corporate bond index. • Performance • Risk • Costs securities a fund holds are known as its How much the fund returns, How likely you are to earn If you pay high commissions underlying investments, and they whether the returns are money or lose it. Risk isn’t or fees, less of the money make up the fund’s portfolio. consistent, and how they bad if you’re investing for you put into your account mutual fund stack up against the returns the long term and you can is actually producing of comparable funds. Be tolerate some setbacks investment income. For company wary of any fund whose without selling in panic if example, if you pay a reputation is based on one the fund drops in value. 5% commission on each or two stellar years and $1,000 you put in, only $950 eight or nine dull ones. of it is actually invested. Investors buy shares in the fund professional The fund invests the fund manager money in a range The of securities Investors The Successful investment adds Investments The fund pays value to the fund and distributions to PAYING DISTRIBUTIONS benefits the investors the investors When a mutual fund collects dividends or interest paid by its underlying invest- ments, it distributes the money as income to its shareholders. Similarly, if the fund makes a profit by selling investments for more than it paid to buy them, it distributes capital gains. Load vs. Open-end vs. You can choose to receive these No-load Funds D ollar Cost Averaging Closed-end Funds distributions in cash or reinvest them to If you buy a mutual fund through a Dollar cost averaging means investing a In an open-end fund, the more shares buy additional shares in the fund. Either broker, it will probably be a load fund, fixed amount on a regular schedule, no you—and other investors—want to way, the payments are taxable in the year which means you pay a commission, matter what’s happening in the financial buy, the more shares the fund sells. they’re paid unless you own the fund typically between 2% and 5%. With markets. That way, the price you pay If you want to sell your shares, the in a tax-deferred or tax-free account. a front-end load you pay when you evens out over time, and you never pay fund buys them back at their current In that case, reinvestment is automatic make a purchase and sometimes on only the highest or lowest price. net asset value (NAV). and no tax is due until you withdraw. your dividend reinvestments as well. For example, if the price per share Closed-end funds are traded on All funds are equity investments, With a back-end load you pay when varies over a year from $10.65 to $8.45, the major exchanges. There is a fixed including funds that invest in bonds. But you redeem, or sell, your shares. With you will have bought some high and number of shares available because your fund distributions are taxed based level-load funds, you pay a percentage some low. In the long run you may come the fund raises its money all at once. on the original source of the income. of assets each year. out better than by trying to pinpoint the Shares may trade at a discount from or So income from interest is taxed at the No-load funds, which you buy moment the price hits bottom or tops premium to their net asset value (NAV), same rate as your ordinary income, while directly from the mutual fund company, out. Dollar cost averaging doesn’t mean, depending on demand. Most funds income from qualifying dividends paid have no commissions, but some funds though, that you can’t lose money, or that invest in a single country—like a by most US corporations is taxed at the may charge fees to cover sales and that you can’t realize a better return if you Mexico fund—are closed-end. same rate as your long-term capital gains. marketing costs. invest at the beginning of a market rise. 116 117 investing investing

filling a need It’s a Fund-Filled World One reason mutual funds appeal to many Impact investing attracts investors people is that funds offer a way to invest committed to addressing pressing social If you’re looking for simplicity and variety, mutual funds relatively easily. And, because the funds do and environmental issues while realizing the research, make the buy and sell deci- a positive return. may be the solution you’re seeking. sions, handle the paperwork, and provide regular updates on performance, funds take and add to an account mean that Mutual funds simplify what many designed to meet a specific goal, your some of the complexity out of investing. you can put your money to work investors, maybe you included, find decisions are limited to choosing the funds Equally important, the relatively more quickly though your return is most intimidating: Figuring out what to you’ll invest in and tracking how well small amounts of money required to open not guaranteed. buy and when to sell to meet particular they’re doing in meeting your expectations. goals or objectives. Because each fund is

reen Tax-Free Sector G Families of Funds Income G lobal Growth Funds Funds Funds Funds Most mutual fund companies offer several Funds Funds different funds, known as a family, and let you move money back and forth among them. Individual funds within a family have different G investment goals and strategies, reflecting the Money rowth & different interests of investors. One caution: International Income Index Balanced Market Funds Profit or loss from exchanges among funds must Bond Funds Funds Funds be reported to the IRS just as if you redeemed or Funds Funds sold the shares outright. Many investors own funds in several different families, choosing those with the best performance records or with the investment goals best suited to their needs.

DIVERSIFIED OPPORTUNITIES to change, when it will reach its most investing overseas Among the attractions of mutual funds on the other hand, means buying securi- conservative point, and when the fund Mutual funds and exchange traded are the diversification they can add ties that other managers are avoiding. expects investors to start to withdraw. funds (ETFs) are convenient and often to an investment portfolio. The funds As important as diversification is, how- cost-effective ways to diversify your themselves are diversified. For example, ever, remember that it doesn’t guarantee a EXCHANGE TRADED FUNDS portfolio by investing in international a typical stock fund might own 100 profit or prevent losses in a falling market. Exchange traded funds (ETFs) resemble markets. You can find a range of stock or more different securities within the mutual funds in some ways and indi- and bond funds, from the broadly based category in which it invests—say large- TARGET DATE FUNDS vidual stocks in others. With an ETF, to the narrowly focused, offered by a company stocks, small-company stocks, A is a fund of funds you buy and sell shares in the collective number of fund companies. The mutual or a combination of stocks and bonds in with a very specific objective: to build performance of a portfolio of stocks or funds may be either actively managed or a balanced fund. Even if some of these account value that will ultimately bonds included in an index—similar to index funds, while nearly all ETFs are underlying investments are not perform- generate income that helps to provide trading shares in an index fund. Each index funds. ing to their potential, others may be a more financially secure retirement. ETF has a net asset value (NAV) calcu- The advantages of investing abroad strong enough to offset that weakness and It’s constructed from a number of differ- lated the same way that a mutual fund’s include the opportunity to benefit from provide a positive return for the fund. ent funds, usually from the same family, NAV is calculated. economic growth in various parts of In addition, because there are so and over time the emphasis is shifted But you trade ETFs as you do stocks, the world as well as providing a hedge many types of funds available, each with from a focus on stock funds—which are as prices change throughout the day. against disappointing results at home. its own objective and investment style, equated with growth—to a focus on bond And you can use traditional stock trad- And using funds to expand your port- you can combine a number of different funds—which are equated with income. ing techniques, including stop and limit folio means that tax and other issues funds to create a diversified portfolio of The fund companies that sponsor orders, margin purchases, and short sales. are handled for you. But you do have equity and debt. target date funds offer several funds One major advantage is that ETFs to be aware of the risks that fluctuating A fund’s investment style describes simultaneously, each with a different don’t have to sell shares to accommodate currency values and political unrest the approach it takes to choosing end point, or target date. They’re typi- shareholder redemptions, minimizing pose to your return. investments. For example, following a cally spaced in five- or ten-year intervals: portfolio turnover and the potential tax core blend style or , a fund would buy 2015, 2020, 2025, 2030, and so on. consequences of resulting capital gains. Socially responsible both growth investments and value You select the one with the date closest And they tend to have lower expense funds attract investors with investments to take advantage of two to the date you plan to retire. ratios than most mutual funds. strong political or social approaches that tend to be successful at Among the things to consider with On the other hand, you may pay a commitments who want to different times though infrequently at a target date fund in addition to its fees brokerage commission each time you invest in companies whose the same time. The logic is that the fund and past performance are the allocation trade an ETF unless you buy through a policies they agree with. is ready for whatever is happening in the that the fund aims for at its target date, brokerage firm that waives commissions investment markets. A contrarian style, whether the allocation will continue on at least some ETFs. 118 119 investing investing

Anatomy of a Prospectus Fees Affect Your return or losses are credited to your account. When you invest in mutual funds, The higher the fees, the more earnings By law, mutual funds must provide detailed information you pay a number of fees that don’t potential you sacrifice. apply when you own individual secu- Operating expenses, which include before they accept your money. Dissecting a fund’s rities. While you may be able to avoid management fees and administrative prospectus reveals its inner workings. some fees, including redemption fees, are quoted as an expense ratio, fees for selling within a restricted or percentage of a fund’s net assets. Mutual fund companies provide a ment. Annual and quarterly reports give period, you can’t avoid asset-based Ratios vary from company to com- prospectus for each fund they offer. details about past performance as well as operating expenses that all share- pany, and from one fund to another It includes a statement of objectives, a the fund’s investments. Companies will holders pay. They’re calculated within the same fund. Trading costs, description of how the fund operates, a also supply a Statement of Additional daily and subtracted from the fund’s which also affect return, are not summary of its investments, risks, expense Information (SAI), which has detailed net assets before investment gains included in the expense ratio. ratio, and information about its manage- financial information, if you ask for it. A PRIMARY SOURCE Front-load funds charge you more A mutual fund must provide a prospectus than the NAV to buy because commis- when you buy shares in the fund, but it’s sions are figured in, but they may pay FUND PERFORMANCE smarter to request a copy or read it online you straight net asset value when you sell. before you buy. If the fund offers a Summary Prospectus, Fund holdings – Expenses it will provide what you need = in a more accessible format. # of Outstanding Shares NAV Take a look at the section Risks describing the fund’s objec- tives and the strategies it uses to achieve FUND PERFORMANCE them. Funds that seem similar can pro- You can evaluate fund performance duce very different results based on the by looking at three factors: Fees investment approach the manager uses Change in NAV and what’s happening in the economy as •  a whole. For example, a small cap growth • Total return fund is likely to have a stronger return Yield Strategy than a small growth value fund in some •  periods and a weaker return in others. An increase in NAV is a positive sign This section also explains which, if any, because it means the value of the under- derivative investments the fund uses and lying investments has increased, while a how it invests to offset risk. decrease in NAV means a loss in value. All mutual funds expose you to But because NAV is also affected by the investment risk that can have a major number of outstanding shares and fund impact on return. In discussing risks, a expenses, it’s not necessarily the most prospectus focuses on those that have reliable performance indicator. MAKING AN ASSESSMENT particular relevance for the fund, such A fund’s total return is the percent- As you evaluate mutual funds before adding them to your as interest rate risk for a long-term bond age it has increased or decreased in portfolio, you might want to ask yourself these questions: fund or exchange rate risk for an inter- value, including reinvested distributions. Is the fund’s objective compatible with your investment goals? national fund. Funds report this figure for various time •  In discussing fund performance over periods, though these results may not be • Has the fund provided consistently strong returns when the past ten years, or as long as it has identical to your actual return based on compared with funds making similar investments? existed if it’s less than ten, the prospectus the date you invested and other factors. Are you comfortable with the fund’s risk profile? identifies thebenchmark or benchmarks For periods longer than one year, return •  against which it measures its performance. is annualized and reflects composite • What is the fund’s expense ratio? It’s typically a major market index. Of gains and losses over the period. • If it’s actively managed, what’s the current manager’s tenure course, past performance doesn’t guarantee Fund yield is the amount of income a and how is he or she viewed in the fund community? future results, but it does illustrate how the fund provides as a percentage of its NAV. fund has fared in market ups and downs. With that information, you can • How is the fund rated or ranked by independent financial compare similar funds to each other or analysts, including Lipper, Morningstar, and Standard & Poor’s? What A Share Costs evaluate a fund’s total return and yield The dollar value of one share of a fund’s in relation to the other ways you could What you’re looking for are funds whose investment stock is its net asset value (NAV). It’s have invested your principal. In making objectives are important to you, and that have strong figured by adding up the value of all the comparisons, you can use a market performance histories, levels of risk you can live with, fund’s holdings, subtracting expenses, index that’s appropriate for the type of and low expense ratios. In general, actively managed and dividing by the number of outstand- investments the fund makes, such as funds are more expensive than index funds, and inter- ing shares. If you buy a no-load fund, the S&P 500 for large company funds, national funds are more expensive that domestic ones. you pay the NAV when you buy shares. or an appropriate mutual fund index. 120 121 investing investing

what options cost If you buy options, you start out The premium, or nonrefundable price with a debit. That means you’ve spent Options and Futures of an option, depends on a number money you can recover only if you sell To add some variety to your portfolio, you might consider of factors: your option or exercise it. In those cases, • The type of underlying instrument the you subtract the cost of the premium options and futures. option is on from any income you realize to find your net profit. The difference between the underlying As a seller, on the other hand, you Options and futures contracts are indexes, interest rates, currency values, •  instrument’s price and the , or begin with a credit because you collect derivative investments. That means their and futures contracts. You can buy what it would cost to exercise the option the premium. If the option is never price at any given time depends on the futures contracts on agricultural or finan- exercised, you keep the money. changing value of the underlying prod- cial products, natural resources, interest • The current state of the financial markets uct, also called an instrument. You can rates, and currency values. And you can and what’s expected to happen buy options on stocks, stock and bond buy either to hedge or to speculate. • The time remaining until expiration

Options may be a right or Futures are obligations to an obligation to buy or sell buy or sell A is a deal you make now to buy or sell a If you buy options, you may choose to buy or sell. If you sell commodity in the future. options, you may have to buy or sell. When you buy or sell a futures contract, they leverage their purchase, which means Buying an option gives you the right stock options, which means you you’re making a deal now to buy or sell a investing a small amount—often 10%—to to decide whether or not you want to buy own the underlying stock and have it product in the future. But product prices, purchase a futures contract worth much or sell an underlying instrument, such as available to sell. In addition, you collect and therefore contract prices, can change more. For example, a speculator might buy shares of a stock, a futures contract, or various a premium when you sell the options. dramatically during the life of the contract a wheat contract worth $17,500 for $1,750. financial products, at an agreed-upon price, as a result of changes in supply and demand called the strike price, before a specific converting trades as well as other market pressures. offsetting contracts expiration date. You lose only the Options can be sold for a profit before The futures market benefitshedgers , While some futures contracts result in premium, or the price of the option, if the expiration date or neutralized with who produce or use commodities or who commodities changing hands, most you don’t exercise, or act on, the option. an offsetting order. Unlike most futures own large investment portfolios, because contracts are offset when the investor But you may be able to buy at a good price, contracts, though, options tend to be they want to avoid risk by locking in a price. buys an opposing contract. That is, some- hedge potential losses, or offset your cost. exercised when the underlying item For example, a baking company might buy one with a contract to buy offsets it Selling an option means you must reaches the strike price. That’s because a futures contract to buy wheat at a set by buying a contract to sell the go through with a trade if an investor who part of the appeal of call options—stock price so that a potential crop failure won’t same product. bought the option decides to exercise it. The calls in particular—is that they can be increase its production costs. One of the reasons that futures most common, and least risky, options for converted to actual investments, often Speculators, on the other hand, aren’t trading can be so hectic is that profit individual investors to sell are covered at an attractive price. interested in the commodity, but buy and or loss can depend on very small price sell futures contracts because they’re willing differences, which must be acted on to take risks that prices will rise or fall in the quickly. And if prices drop sharply, it direction they predict. They can make—or can be difficult to act quickly enough What Kinds of Options Are There? lose—large amounts of money because to prevent big losses. All options fall into two broad categories: puts and calls. You can buy or sell either. Calls Puts BUY The right to buy the underlying The right to sell the underlying instrument at a fixed price until instrument at a fixed price until where you trade (go long) the expiration date the expiration date You can trade futures contracts on com- by investing in managed futures modities exchanges, futures and options accounts. Most futures transactions, SELL The obligation to sell the under- The obligation to buy the exchanges, certain stock markets, and especially trading in financial futures lying instrument if the option underlying instrument if the over the counter. While some individual like currency values and interest rates, (go short) holder exercises the option option holder exercises the investors participate in the market, are carried out by institutional investors, (known as writing a call) option (known as writing a put) they’re often more likely to get involved such as pension funds or mutual funds.

122 123 INVESTING INVESTING

MORE THAN JUST RETURN a place for you to live. You get tax breaks on your Investing in Real Estate It can be harder to figure the return on a real mortgage interest and your local taxes. And you estate investment—especially if the property won’t owe capital gains tax on up to $500,000 You may buy property to stake a claim, but real estate is is also your home—than on other investments profit when you sell ($250,000 if you’re single), also a good way to diversify your portfolio. you make. Part of your investment cost pays for if you meet the requirements to qualify.

Investing in real estate can range from owning your home to being a partner in a major con- struction project, and from buying a cabin in the woods to owning a castle in Spain. If you borrow, or use leverage, to pay for your investment, selling at a profit can mean a healthy return. But leverage also magnifies your losses if prices go down. A primary appeal of real estate invest- ing has been that prices have some- times increased substantially, though a primary drawback is that VACATION AND it’s sometimes hard RETIREMENT PROPERTY EMPTY LAND RENTAL PROPERTY to sell, especially Second homes appeal to investors who buy them either as an investment Called unimproved or raw property, empty land is Rentals are traditional real estate investments. at the price you or primarily for their own use but welcome the extra income that renting usually the most speculative and the least liquid The key to making money is to charge at least want, when the real can provide. Complex rules limit their usefulness as tax shelters, and real estate investment. If you pay high taxes or enough to cover the mortgage, insurance, estate market is weak. overbuilding has cut resale value in some areas. have big carrying costs, it’s hard to make money. taxes, and repairs. Among the advantages of Real Estate Investing rental property: You can deduct all your repair and THE PLUSES AND THE MINUSES LIMITED PARTNERSHIPS •  Limited partnerships invest in income- improvement expenses up to the amount • Provides a hedge against inflation • May be difficult to sell quickly producing properties, often of a of rent you collect. You may also be able particular type like shopping malls or to deduct losses on your investment • Permits tax deductions in some cases • May be overpriced in some markets and against your regular income.  undervalued in others low-income housing, or in a specific • Produces sizeable profits in some markets in geographic area. • Buying rental property to fix up and some periods • Subject to zoning laws, environmental issues The appeal is that severallimited sell can produce a big profit if the partners pooling their money can invest market is right, but frustrations and in larger properties with the potential big losses if it’s not. REAL ESTATE INVESTMENT TRUSTS for greater profits. The limited partners have no management responsibility and But there are also potential Listed or traded REITs are funds that trade profitability depends on the underlying no liability beyond their investment. disadvantages: like stocks and resemble mutual funds. Your value of the properties and the quality of Nontraded limited partnerships, investment is pooled with other people’s, the management. including nontraded REITs, are restricted • If rents drop or space stays empty, you and the REIT invests it. Equity REITs buy properties that produce to high-net worth investors and estab- could end up losing money instead of For many people REITs are attractive real income or have growth potential. Some buy lished for a set period of time, often profiting from your investment. estate investments because the trust makes only certain types of property, while others seven to twelve years. Most have large • Owning rental property makes you a the investment decisions, it’s easy to trade diversify. In general, well-established equity fees, are difficult—maybe impossible— landlor d, which requires an investment the shares, and the yields can be high. REIT REITs have been better investments than to get out of, and provide no assurance of time and energy. share prices fluctuate in response to market mortgage REITs, which invest in real estate of return on investment. But they may conditions, the distributions the trust pays, loans, start-up offerings, or hybrid REITs that provide large distributions, plus portfolio and changes in real estate values. Long-term combine equity and mortgage investments. diversification because their returns aren’t linked to equity markets. R124 EIT 125 taxes taxes

return preparers are required to have Paying Taxes GIVE AND TAKE a preparer tax identification number In most cases you can deduct the cost of tax (PTIN) and pass a competency test and Taxes pay the bills of the government that collects them. preparation, including software programs, tax compliance check. There are also tax publications you purchase, and electronic enrolled agents, who are accredited by filing fees. You take the deduction for the the IRS and certified by the Treasury, The basic structure of US tax law—a taxes, and Social Security and Medicare tax year you actually incur the cost, which is and licensed or certified public accoun- progressive tax system under which taxes, as required by the Federal typically the year following the one for which tants (CPAs) who are tax specialists. The those with larger pay tax at Insurance Contribution Act (FICA). the return is due. more complex your tax situation, the a higher rate than those with smaller Union dues, if you owe them, are also more important it becomes to work incomes—has been in place since withheld. And you can choose to have income taxes. Among other things, you with a preparer who has extensive the 16th amendment to the US contributions to employer sponsored can download publications and forms, experience with similar situations. You Constitution was adopted in 1913. retirement savings plans, premiums for use the interactive tax assistance link, may also want to consult a tax attorney But tax provisions change all the time, health insurance, and amounts for other and e-file your return. You can also call and coordinate a collaboration between as Congress passes new laws that expand benefits or obligations withheld from the IRS to order forms and publications, your preparer and your financial adviser. or amend the Internal Revenue Code your paycheck as well. ask questions, and find help resolving Before you choose a preparer, how- (IRC), sets new tax rates, and authorizes You receive a copy of IRS Form W-2 filing and tax issues. ever, you should check the firm’s or the way that tax revenue is spent. from your employer every January that The Volunteer Income Tax Assistance individual’s credentials and get answers TheInternal Revenue Service (IRS), reports your income, including any extra (VITA) program provides IRS-certified to questions such as: which is part of the US Department benefits you received and the amounts volunteers to work with taxpayers who of the Treasury, interprets the revenue that were withheld. You file copies of What training and certification do need help preparing and filing their •  code through a series of regulations, the W-2 with your federal and state tax you have as a tax preparer? returns, including the elderly, disabled, collects the taxes that are due—primar- returns and keep one for your records. and those with limited English skills. One Will you be available to answer ily through payroll withholding—and •  of the program’s main goals is to make sure questions throughout the year? provides the forms and instructions HELP FROM THE IRS that these taxpayers know about the credits that you use to file your return. The IRS website, www.irs.gov, is a What help will you provide if and deductions they’re entitled to claim. •  Federal income taxes valuable resource for answers to many I am audited? There’s also a separate Tax Counseling aren’t the only money of the questions you may for the Elderly (TCE) program. How much will preparing my that’s withheld from have about federal •  You can check return cost? your pay. So are state Publication 910, “IRS and local income Guide to Free Tax Services,” for more information.

PROFESSIONAL HELP Professional tax preparers charge a fee to prepare your return and help you reduce T IME TO E-FILE your tax bill by capitalizing According to the IRS, more than 128 million tax returns—about on relevant provisions of 83% of all returns—were e-filed in 2015. Professional tax return the IRC. Registered tax preparers with 11 or more clients must e-file their returns. Those taxpayers who don’t use a preparer can either e-file for free on the IRS website or use tax preparation software to e-file. highlights in the History of Income Tax

1862 1909 1943 1953 1986 2000 The first income taxes A constitutional Withholding was The agency’s Congress passed a The IRS made major struc- were imposed by the amendment was introduced in 1943 name was major overhaul of tax tural changes, the biggest US government to proposed to permit to provide a steady changed from legislation, the Tax since 1953. It instituted pay for the Civil War. a personal income stream of income Bureau of Internal Reform Act, which had four operating divisions: Collected between tax. It was ratified by to fund the costs of Revenue to more than 300 provi- and Investment, Small 1863 and 1871, they the required 36 states waging World War II. Internal Revenue sions and took three Business and Self-Employed, were very unpopular in 1913 and became Service. years to implement. Large and Mid-Sized and were repealed law. Taxes have been Limited electronic filing Business, and Tax-Exempt in 1872. collected ever since. of tax returns began. and Government Entities. 126 127 taxes taxes Completing a Return From total income to Tax owed Adjustments are amounts you can When you’re ready to file, you add up your income and Total income subtract from your total income for figure out what, if anything, you owe. – Adjustments certain retirement, education, and self- employment expenses, alimony, and = A djusted Gross moving expenses. You file your income tax return either you’re eligible for certain credits, electronically or on paper using the deductions, or exemptions. Income Adjusted gross income (AGI) is your form that best suits your income and The instructions also refer you to income minus adjustments. If your the deductions or credits you’ll claim. IRS publications that provide more AGI is more than a certain amount set Each form comes with its own set information, and to the supplemental by Congress, you can’t deduct your IRA of instructions, explaining line by line forms that you may need to contribution, and your adjustments, what to do. There are also a number of file as backup. exemptions, and itemized deductions workcharts to help you make detailed Adjusted gross may be limited. calculations or resolve whether income – Exemptions and Exemptions reduce your income by deductions letting you subtract a fixed amount of money for yourself, your spouse, and = taxable Income each of your dependents. Exemptions are reduced for some taxpayers based on AGI and are eliminated entirely for others.

Deductions are amounts you can Income tax you owe subtract for certain personal expenses. Which Forms Do You File? – C redits Most taxpayers use the standard Each line on the 1040 that + Other taxes you owe de­duction, which is a fixed dollar requires an additional form tells amount set for each year. Or, you can you which one to attach. = total tax itemize, or list, your deductions and subtract that amount subject to TY PES OF INCOME AGI limits. Your total income Taxable income is the amount on includes all the tax- which you owe tax. You look up the able income you receive tax using the tax tables (for amounts during the year, including: Total tax Withholding and up to $100,000) or figure what you • Wages, salary, tips, and – owe using the tax rate schedules. other income you earned estimated-tax for work you did payments Credits are subtracted from the tax you • Investment income, owe. The childcare credit and credit for including income withdrawn = ref und or the elderly and disabled let you subtract from tax-deferred accounts payment due money you paid other people to care • Income from pass-through for your dependents, up to a set limit. corporations and partnerships, rental real estate, trusts, and farming Other taxes include amounts you may • Alimony owe that aren’t accounted for in the • Unemployment compensation When you barter, you income section, such as taxes on house- • Pension income and Social exchange something hold employment and self-employment. Security benefits you have for some- • Any other income the IRS has not thing you need, or Payments include amounts that were listed specifically, including gambling you exchange a service withheld and forwarded to the IRS, winnings and the value of bartered services you can perform for a estimated tax payments, and certain service you need done. credits not subtracted earlier. Money you have from certain other No money changes sources is typically not taxed. This includes hands. But legally Refund or tax payment due is deter- most gifts, tax-exempt interest, child-support you must report the mined by subtracting your payments payments, many scholarships and fellow- value of the goods or from the total tax that’s due. If you’ve ships, some government benefits, and services you received paid more than you owe, you get a death benefits from life insurance policies. A as income. refund. If you haven’t paid enough, detailed discussion of taxable and nontaxable you must pay the outstanding income appears in IRS Publication 17, balance due. “Your Federal Income Tax.” 128 129 taxes taxes

rate—39.6%—applying to Tax Status and Brackets the top bracket. The rates for the other brackets in 2016 are There’s a two-step process for determining the rate at 15%, 25%, 28%, 33%, and 35%. The portion of your which you pay income tax. income that falls into each bracket is taxed at the rate for The income tax you owe SINGLE TAXPAYER WITH A that bracket. the federal government For example, if the last depends on two factors: TAXABLE INCOME OF $120,000 dollar of your taxable income your filing status and the falls into the 28% bracket, highest of seven possible you’d pay some tax at 10%, No tax on tax brackets into which $120,000 some at 15%, some at 25%, No state income tax earned income a portion of your taxable and some at 28%. The top rate income falls. at which you pay is called your STATE AND LOCAL TAXES There are five categories marginal rate. That’s in contrast to Everyone who earns income in the of filing status: your effective rate, which you calculate United States, and US citizens who earn by dividing your total tax by your income elsewhere in the world, must pay Single 28% of $28,850 = •  $8,078 taxable income. Your effective rate is federal income taxes. You also pay state Married filing •  always lower than your marginal rate. income taxes unless you reside in one of jointly the seven states that don’t collect them: Married filing •  DIFFERENT TAX BITES Alaska, Florida, Nevada, South Dakota, separately As an example of how the system Texas, Washington, and Wyoming. Head of household •  works, a hypothetical single taxpayer Two others—New Hampshire and Qualifying widow(er) $91,150 •  with a taxable income of $120,000 Tennessee—tax interest and dividend with dependent child would pay $26,637 in taxes for tax income but not earned income. You must follow IRS year 2016, crossing four tax brackets. The good news is that you can guidelines in selecting the Her marginal rate is 28%, and her deduct any state and local income taxes one that most accurately effective rate is 22%. A married couple you’ve paid when you file your federal reflects your situation as filing a joint return with the same tax return, provided you itemize your of December 31 of the $120,000 of taxable income would deductions. That helps to reduce your tax year. Some options owe $21,543 across three tax brackets. taxable income, though it may make can save you money, That’s a marginal rate of 25% and an you vulnerable to the AMT. such as filing as head effective rate of 18%. of household instead 25% of $53,500 = $13,375 In contrast, if each person of a OTHER TYPES OF TAXES of single, if you qualify. married couple earned $120,000, for a All but five states—Alaska, Delaware, Others may cost more, joint total of $240,000, they would owe Montana, New Hampshire, and such a filing separately $54,613, or $1,339 more than if each Oregon—and many local governments rather than jointly if of them were single. Their marginal rate charge sales tax on the value of most or you’re married. would be 33% and their effective rate all of the goods and services you pay for. Taxable income is 23%. Married couples who file separate And most states or local governments divided into seven brackets returns may pay at higher marginal and levy property taxes on the value of real with floors and ceilings set effective rates because the income ranges estate or personal property, or both. annually—though the top for each bracket are smaller than for These taxes pay for public services, such bracket has no ceiling—and either single or joint filers. as the public school system and police, generally adjusted upward $37,650 fire, and sanitation services. each year to account for ALTERNATIVE MINIMUM TAX Federal and state governments also inflation. In fact, there Thealternative minimum tax (AMT) charge excise taxes on the manufacture, are really three sets of is a parallel tax system that was created sale, or use of certain products, such as seven brackets: one to ensure that high-income taxpayers tobacco, petroleum products, alcohol, set for married filing 15% of $28,375 = $4,256 couldn’t avoid paying their fair share of car rentals, and hotel rooms. jointly and qualifying taxes by capitalizing on tax loopholes. The federal government imposesgift widow(er)s, one for head It hasn’t actually worked that way, as and estate taxes on assets transferred of household, and one many loopholes still exist. But what has from one owner to another if the total for single and married $9,275 happened is that the AMT increasingly value of those assets reaches a certain filing separately. affects middle-income taxpayers with limit. In 2016, it’s $5,450,000. The perfectly legitimate but higher-than- exceptions are gifts to qualifying chari- THE RATE YOU PAY 10% of $9,275 = $928 average exemptions or deductible table organizations and to spouses who Each bracket is taxed expenses. These include state and are US citizens. However, annual gifts of at a different rate, with local taxes, mortgage interest, or rental up to $14,000 to an individual are feder- the lowest rate—10%— income. To determine what you owe, ally tax free. (Both those limits will be applying to the bottom TOTAL TAX DUE = $26,637 you must figure your tax both ways adjusted for inflation over time.) Some bracket and the highest Tax rates for 2016. Brackets cover different ranges of income in different tax years. and pay the higher amount. states also have estate or inheritance taxes. 130 131 taxes taxes

and file a joint return, if you pay self- employment tax, or if you have a high- ROLL THOSE DICE Prepaying income job or substantial investment If you have more than $5,000 in gambling income. The IRS provides worksheets winnings, or collect 300 times the amount Taxes to help you come as close to the right you bet on any wager, 25% of your take must number as you can. It may help to be withheld for taxes. And that rate goes up to By the time you file your have your previous year’s tax return 28% on winnings as small as $600 if you don’t handy, especially your itemized deduc- give the payer your Social Security number. tax return or request an tions (Schedule A) and your interest But there is good news, of sorts. You can extension, most of your tax and dividend income (Schedule B). deduct gambling losses up to, but not more You can also use the IRS Withholding than, your winnings. You have to itemize your bill has already been paid. Calculator at www.irs.gov/individuals/ deductions and support your claims with IRS-Withholding-Calculator. a detailed Most people prepay the income tax accounting they owe through payroll withholding, ESTIMATED TAXES of your quarterly estimated payments, or a If your withholding doesn’t cover the activities. combination of the two. This isn’t taxes you owe, or you have nothing because they want to, but because withheld because you’re self-employed, the IRS generally requires it. In fact, unemployed, or live on unearned income, the IRS may impose a penalty if the you must pay estimated taxes four times balance due on your tax return exceeds a year, in April, June, September, and You can recalculate the tax you owe the amount you prepaid by more than January using IRS Form 1040-ES. each quarter to find what you must 10%, or, in some cases, more than The first payment is due for the pay in each remaining installment. You $1,000. first quarter in which you have taxable may owe a penalty if you underpay a What’s more, if your AGI for the income. You can pay everything you quarterly amount even if you end up previous tax year was more than DEALING WITH THE W-4 expect to owe at that time or you can with a refund when you file your return. $150,000, you must prepay either 90% Your employer determines the amount pay in installments. It’s fairly easy if It’s probably smart to work with a tax of your expected tax or 110% of what to withhold from your earnings based your income is predictable, but more adviser who specializes in this area. you owed in the previous tax year. on the information you provide on difficult if it’s not—as may be the case IRS Form W-4. You must complete this if you’re self-employed. U NUSUAL SITUATIONS HOW WITHHOLDING WORKS form whenever you begin a new job and If you’re expecting a substantial one- If you earn wages or a salary, taxes are should revise it any time your personal time payment in addition to your generally withheld from each paycheck or tax situation changes. regular salary or wages—perhaps a and from any bonuses and commissions. In addition to your name and Social retroactive payment as a result of a Taxes are also withheld on sick pay you Security number, you indicate your renegotiated contract or a back pay receive from your employer as well as marital status and choose the number of adjustment—you may want to redo from unemployment compensation. allowances you claim. While providing your W-4 to temporarily increase the With some other types of income, that information seems pretty straight- number of allowances. That way, you the situation is more complicated. forward, it’s sometimes a challenge. can potentially avoid having more For example, the way your employer One reason is that you’re trying to withheld than the tax you’ll owe. accounts for tips you receive or taxable come as close as you can to aligning Once you receive the payment, you fringe benefits, such as the personal the amount that’s withheld with what simply go back to the number of use of an employer’s car, may mean you’ll actually owe in taxes for the year. allowances that more accurately not enough is withheld. You must Having too much withheld means reflects your normal situation. also decide whether to authorize with- you’re making an interest-free loan to But you don’t want to claim holding from any pensions, annuity the federal government. But having too too many allowances as a general payments, and Social Security. little withheld means you risk a big tax practice. If the IRS uncovers a There’s a detailed discussion of bill and maybe a penalty. chronic problem with with- withholding issues in Section 4 of IRS Deciding on your allowances can be holding, it may issue what’s Publication 17. It pays to take a look. complicated if you work two or more known as a lock-in letter to your jobs, if both you and your spouse work employer that specifies the maxi- mum number of allowances you may claim. There is an appeals DUE DATES process if you don’t agree. In most years, tax returns must be filed by April 15, though you can apply for an automatic extension FYI until October 15. All taxes owed The IRS publishes a detailed must be paid by the April date discussion of tax prepayment even if the return isn’t in Publication 505, filed until October. “Tax Withholding and Estimated Tax,” which is updated each year.

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important as the tax implications. USING PRETAX DOLLARS Tax Planning Here’s what you need to know: If your employer offers aflexible spending account (FSA) as an optional A capital gain is money you realize •  employee benefit, it’s a tax-saving You can legitimately reduce the tax you owe by for selling an investment for more opportunity you probably don’t want than you paid to buy it. A capital planning ahead. to pass up. An FSA lets you set aside loss occurs when you sell an invest- pretax income to pay for uncovered ment for less than it cost you. The most effective way to pay the least withdrawal. But you may be paying at healthcare expenses, including copays, tax that you are legally obligated to a lower tax rate when you take money • If you’ve owned an investment for deductibles, prescription drugs, and pay is to make financial decisions with out than you were when you put it in. more than a year before you sell, you many over-the-counter medications that an eye to their tax consequences. For In some sense it’s a gamble, but thanks have a long-term capital gain or loss. meet the IRS standards for treating or example, one way to reduce your to the power of compounding, it’s pos- If it’s been less than a year, you have preventing disease or illness. current income tax is to contribute to sible to come out significantly ahead, a short-term capital gain or loss. An FSA usually works on a calendar a tax-deferred retirement account, such even if tax rates have increased. year. To participate you contribute, Long-term gains are taxed at a lower as an employer-sponsored plan. Your Or, if you want to avoid mandatory •  through payroll deductions, as much as rate than your ordinary income, contribution reduces the income that’s taxable withdrawals from your retire- you think you’ll spend during the year, while short-term gains are taxed as reported to the IRS and as a result, the ment savings, you might put your up to the maximum of $2,500. If you ordinary income. The long-term current tax you owe. Any earnings in retirement money in a tax-free Roth IRA. and your spouse are both eligible to rate is determined by your adjusted the account are also tax deferred. While you’ll contribute after-tax income, participate, each of you can contribute gross income (AGI), and may be 0%, Of course, when you take money your withdrawals will be completely up the $2,500 limit. 15%, or 20%. Surcharges may apply, out of the account after you retire, you’ll free of federal income tax provided your There is one risk: If you don’t again depending on your AGI. owe tax on the full amount of your account has been open at least five years use the money during the year for and you’re at least 59½. Similar tax sav- • You can use long-term capital losses eligible expenses you may forfeit it. ings are available for college savings with to offset long-term capital gains, or However, employers may offer either a Tax-deferred a Coverdell education savings account short-term losses to offset short-term two-and-a-half month grace period into Retirement Account (ESA) or a 529 college savings plan. gains, on a dollar-for-dollar basis. the following year or allow you to access Unused losses can be carried over up to $500 of any unspent money in INVESTMENT PLANNING from one tax year to the next. that year, removing some of the pressure Investment decisions have tax conse- of using up your balance. So, as you make investment deci- quences, although minimizing taxes Using an FSA does involve substan- sions, you may want to postpone sales should be only part of your overall tial paperwork, but it can provide real when feasible to qualify for the long- investment strategy. The investment tax savings. For example, suppose you term gain rate and sell some assets with risk you’re willing to contributed the full $2,500 and spent capital losses at the end of the tax year take, the return you it all on covered expenses. If you were to offset some gains. TRUST can reasonably expect, in the 33% tax bracket, you would DOING WELL FUND and the impact of the effectively have saved $825. In the BY DOING GOOD transaction on your Tax-free ROTH IRA 25% bracket, the saving would be $625. You are entitled to deduct portfolio diversification Retirement Account If you want more information, check gifts you make to qualified are all at least as IRS Publication 502, “Medical and charitable, religious, and Dental Expenses.” educational organizations. The way you make the gift can have tax consequences. For example, you’re likely to save on taxes by giving assets you own directly to the orga- nization you want to benefit fsa rather than selling the assets and making a cash gift. The tax consequences of bequests you make to individuals, such as those X DUE to children and grand- TA AVOID A WASH SALE children, can be reduced as If you sell an investment that has well by making those gifts lost value to offset your capital gains, in certain ways. Among the but plan to buy it back because you think examples are creating trusts it has future promise, you need to be and avoiding the generation- g careful to avoid the wash sale rule. skipping tax. Working with ch n In brief, the rule says that a potential offset experienced legal and tax c a ti s is disallowed if a substantially identical o rita fset in advisers as you make your nt ble of ga investment is sold and then repurchased, plans is always wise and rib tal or purchased and then sold, within 30 days. sometimes essential. utions capi 134 135 taxes taxes

How Long Should You Keep Your Records? Keeping The IRS usually has three years— called a period of limitations—to Type of record How long to keep it audit your return, so Records you should keep all Most records of At least three years, seven the relevant records at income and expense if possible To report what you owe and least that long. But it’s defend against a possible audit, important to keep some Investment other Until three years after records longer. than real estate you sell you need a year’s worth of records. If you’ve under- reported your income Real estate (initial Until seven years after Just after the start of the new year, must have back-up for your expenses if by 25% or more, the cost, improvements, you sell you’ll begin receiving a host of tax you plan to itemize deductions or claim IRS has six years to costs of selling) documents. These include official third- adjustments or credits. audit your return. And party notifications, such as a W-2 that Expense records should include the if you don’t file, or you Tax returns At least six years, reports your salary or wages and a full person or organization that was paid, file a false return, they ideally forever range of 1099 forms that show your date, type of expense, and business have forever. investment, retirement, and miscel- purpose. Regular entries in an electronic laneous income. You may also receive a or paper expense log are a valid record 1099-Q that reports tuition payments, in most cases, thought there are special WHO IS AT RISK? and Schedule K-1s or Form 1065s that recordkeeping requirements for tips, In reality, only about 1% of all tax send no originals report partnership gains or losses. business use of a car, travel and enter- returns filed in any year are audited, If you’re providing backup documentation of The IRS expects you to report the tainment, and non-cash charitable though some groups of people are your expenses or deductions, never send your information shown on these documents, contributions. You’ll also need receipts audited at a higher rate. The IRS focuses originals to the IRS. Instead send photocopies. which it matches to copies of its own. for expenditures over $75 if the IRS on high-income individuals, those with They could get lost and aren’t ever returned. In addition, you must keep your own asks for them. pass-through income from partnerships Either could pose a real problem if you need records of earnings from other sources, There are individual IRS publications and S corporations, non-citizens with the information in the future. such as rental income, freelance dealing with most recordkeeping topics, significant US earnings, and anybody work for which you don’t receive a which you can find using the Search who tries to claim there’s no legal THE APPEALS PROCESS 1099, or royalties. Similarly, you button on the IRS website. requirement to pay taxes. You have the right to ask for a review Factors that may trigger an of any audit findings with which you audit include: don’t agree. You appeal first to the WHAT’S AN AUDIT? examiner’s supervisor and then to the Deductions that appear to be too An audit is an IRS examination of your tax return •  IRS Appeals Office. IRS Publication 5, large for your income and supporting records to determine if you’ve reported “Appeal Rights and How to Prepare a Income and expenses for which there your situation correctly. The agency’s going-in position •  Protest if You Don’t Agree,” outlines the is no third-party reporting combines a strong suspicion that you owe additional process. You can represent yourself, An unusually large tax refund tax with the belief it will recapture substantial revenue. •  though it may be wiser to use a qualified Real estate rental losses Otherwise, the IRS probably wouldn’t bother. •  tax professional to handle the appeal. Form Overseas bank accounts 1040 IRS computers score all individual returns •  As a last resort, you can take your using a complex, secret discrimination index func- In the past, home office deductions case to court, though most litigation tion (DIF) formula developed by its National Research were often questioned. But beginning is expensive and slow. Depending on Program to identify returns that are candidates for with returns filed in 2014 there’s a the size of the claim and whether you audit. There’s also an Unreported Income DIF to iden- simplified method for claiming the have paid the disputed amount, the case tify returns that are likely to be concealing income. deduction. If you follow these guide- is heard in tax court, a federal district Both formulas are based on specific criteria that have lines, you’re much less likely to raise court, or federal claims court. The court been weighted for the probability of error or evasion. an IRS eyebrow. of last resort is the US Supreme Court.

A TAXPAYER’S BILL OF RIGHTS TY PES OF AUDITS IRS Publication 1, “Your Rights As A Taxpayer,” The IRS conducts three types of audits, is often described as a taxpayer bill of rights plus what it calls an adjustment. With because it spells out the rules the IRS must an adjustment, you receive a notice— follow in questioning your return or handling CP-2000—that you owe additional tax. an appeal. It’s worth reading. You have the right to appeal, which A correspondence audit A field audit is conducted you must do in writing within is done by mail. The IRS by an IRS revenue agent 60 days. If you agree, however asks you to send specific An office audit is held in your home, office, or reluctantly, that the IRS is records to back up your in an IRS office with tax professional’s office if right, all you have to do is return. If the documents a tax auditor. You are that person is entitled to write a check. support your entries, the told which areas of your practice before the IRS. matter may be resolved in IRSreturn will be examined Your entire return and all your favor. But you may and whatTAXPAYER materials to supporting documents are well owe additional tax. bring with you. subject to examination. 136 137 INDEX INDEX

Beneficiaries...... 68, 82-83, COBRA...... 92 Default...... 22, 33-34, A 86, 88, 90-91 Collateral...... 30, 44, 54 36, 52, 54 Beta...... 95 College planning...... 66-69 Demand ...... 8 Account statement(s)...... 16, 24-25, Billing period/cycle...... 24 Grants...... 67 Department of Housing and 103 Bill payment...... 8-9, 11, 14, 22 Loans...... 67 Urban Development (HUD)...... 50 Adjusted gross income (AGI)...... 74 Bitcoin...... 15 Saving for...... 66, 68-69 HUD-certified mortgage Alternative documentation...... 44 Bond(s)...... 94-96, 100-103, Commodities...... 95-97 counselor(s)...... 52 Amortization...... 47 110-116 Community Reinvestment Act...... 39 Department of Veterans Affairs AMT...... 131 Coupon...... 112 Compound interest...... 18, 21 (VA)...... 38 AnnualCreditReport.com...... 35 Insured...... 115 Compounding...... 21 Deposit account...... 18 Annual percentage rate Investment grade...... 111-113 Consumer Financial Protection Derivative(s)...... 96-97, (APR)...... 23, 25-26, 33, Par value...... 112-114 Bureau (CFPB)...... 9, 17, 100, 122-123 39, 46-47, 54 Prices...... 111-115 26, 35, 45, 49 Direct debit...... 9, 14, Annual percentage yield Ratings...... 102-103, 111-113 Convertible bonds...... 115 Direct deposit...... 7, 10, 16-17, 19 (APY)...... 18, 20 Terms...... 110-111 Corporate bonds...... 94, 102, Diversification...... 94, 102-103, Annuities, types of...... 76-77 Types of bonds...... 102, 110-115 110, 112-113 119, 125, 135 Fixed rate...... 77 Value of...... 112 Correlation...... 101 Dividend(s)...... 95, 104-105, Single premium...... 76 Bond funds...... 100, 115 Coverdell education savings 107 Variable rate...... 77 Brokerage firm(s)...... 55, 94, 105 accounts (ESAs)...... 66 Qualifying dividends...... 95 Appraiser...... 43 Account statements...... 105 CREDIT...... 22-37 Down payment...... 38-39, 43-44, Assessor...... 47 Budget...... 38, 62-63, 81 Credit agreement...... 22-23, 28, 36 47, 49, 58 Asset allocation...... 94, 100-101 Bull market/bear market...... 107 Credit card(s)...... 6-7, 14-15, 24-29 Asset-backed securities...... 114 Affinity cards...... 27 Asset class(es)...... 94-95, 100-103 Annual fees...... 27 E Assets...... 64-65, C Card rights...... 28-29 86-87, 89-90 Secured credit cards...... 27 Earnings per share (EPS)...... 106 Association of Independent Callable bonds...... 115 Credit CARD Act...... 26, 28 Electronic banking...... 6-14, 16, 63 Consumer Credit Counseling Capital gains/losses...... 95, 98, 116, Credit counselor(s)...... 36 Alternative payment Agencies (AICCCA)...... 36 119, 135 Credit history...... 34-35 systems...... 14-15 Audit...... 136 Car loan...... 22 Credit limit...... 24, 27, 36, 54 ATMs...... 6, 10-12, 16, 63 Automated clearinghouse (ACH)...... 8 Cash...... 94-95, 101 Credit line...... 54 Bank cards...... 12 Automated underwriting...... 44-45 Cash advances...... 26 Creditor(s)...... 22-23, 36 Debit cards...... 12-13 Automatic teller machine Cash equivalents...... 94, 100-101 Credit rating...... 102-103 Online bill payment...... 7 (ATM)...... 6, 10-12, Cash flow...... 62-63 Credit regulation...... 23 Electronic fund transfer (EFT)...... 13, 16 16, 63 Certificates of deposit (CD)...... 7, 11, Credit report...... 33-35, 39, 44 Electronic money...... 14-15 ATM fees...... 10, 16 18-21, 36, FICO score(s)...... 34-35 Electronic Municipal Market Withdrawals...... 10-12, 63 94-95, 100 Vantage score(s)...... 34 Access (EMMA)...... 112 Certified check...... 17 Credit reporting agencies.....27, 33-35, 39 Emergency fund...... 20, 36, 58, 63 Certified public accountant Credit score...... 32, 34, 44, 49 Equity...... 38-39, 51, B (CPA)...... 59, 127 Credit union(s)...... 6-7, 11, 20, 54, 96, 102, Charge cards...... 27 30, 55 104, 110, 124 Balloon payment...... 45, 54 Checking account(s)...... 7-13, 16-17 Insured accounts...... 7 Equity investments...... 96, 102, Bank(s)...... 6-21, 30-31, 34, Available funds...... 8 Creditworthiness...... 34, 39, 44 104, 110, 124 55, 94, 96 Choosing accounts...... 11 Credit Union National Home equity...... 38-39 Account insurance...... 7 Fees...... 10-11, 13, 16 Association (CUNA)...... 11 Home equity loans...... 32, 54-55 Available funds...... 8 Minimum balance(s)...... 10 Custodian...... 71, 75 Escrow...... 43, 50-51 Bank fees...... 10-11 Nonsufficient funds...... 9 Estate planning...... 86-91 Bank services...... 6-7, 11, 17 Overdraft...... 9, 12 Estate taxes...... 86 Types of accounts...... 7-11, 18-21 Overdraft protection...... 9 D Gifting...... 86-87 Types of banks...... 6-7 Special checks...... 17 Power of attorney...... 87 Bank card(s)...... 7, 12 Stop payments...... 9 Date of maturity...... 20-21 Trusts...... 87, 90-91 BANKING...... 6-21 Substitute checks...... 9 Debit card(s)...... 7, 10, 12, 16, 26 Wills...... 87-89 Bankruptcy...... 34, 37 Closing costs...... 44, Debt securities...... 110 Exchange traded fund(s) Benchmark(s)...... 99, 121 50-51, 54 Debt-to-income ratio (DTI)...... 44 (ETF)...... 94, 96, 99-100, Closing statement (HUD-1)...... 50 Deductible interest...... 50, 53-54 102-103, 119

138 139 INDEX INDEX

Inflation...... 58-59, 61, Investment strategies...... 100-103, F G 95-97, 111 105, 117, 121 Inflation rate...... 99 Asset allocation...... 100-101 Fair Credit Billing Act...... 29 Good faith estimate (GFE)...... 45, 50 Inflation risk...... 98-99, 103 Buy and hold...... 105 Fair Credit Reporting Act...... 35 Grace period...... 25 Insufficient funds...... 8 Diversification...... 102-103 Fair market value...... 65 Insurance...... 7, 18, 20, 33, 38, Dollar cost averaging...... 117 Federal Deposit Insurance 44-45, 47, 55-58, Investment style...... 61, 118, 121 Corporation (FDIC)...... 7, 17-18, H 80-83, 86, 91-93 Investment value...... 97 20, 95 Health...... 58, 92-93 Federal Housing Administration Health maintenance organization Homeowners...... 38, 44-45, 47, 55-57 (FHA)...... 38, 55 (HMO)...... 92 Life...... 58, 80-83, 86 L Federal Insurance Contribution Health savings account (HSA)...... 92 Insurance companies...... 34, 94 Act (FICA)...... 126 Home equity borrowing...... 54-55 Insured bonds...... 115 Laddering...... 20 Federal Reserve...... 6-8, 13, Home Equity Conversion Mortgage Interest...... 18-22, 25, 30-33, Lender(s)...... 30-39, 43-45, 18, 26, 29 (HECM)...... 55 46-49, 50, 110-115 49, 50-52 Federal Reserve Bank(s)...... 7-8, 18 HECM counselor...... 55 Interest rate(s)...... 18-22, 30-33, 37, Leverage...... 106, 123-124 Regulation E (Reg E)...... 13 HOME FINANCE...... 38-55 46-47, 54-55, 96, Liabilities...... 65 Federal Trade Commission...... 35 Homeowners insurance...... 38, 44-45, 110-115, 122-123 Life insurance...... 80-83, 91 Fees...... 26-27, 33, 37, 47, 55-57 Adjustable rate...... 30-31, 48-49, 54 Calculating need for...... 80-81 39, 45-47, 55 Claim(s)...... 56-57 Blended rate...... 19 Cash value...... 82-83 Application fees...... 33, 39, 46 Coverage, types of...... 56-57 Caps...... 49 Cash surrender value...... 83 Bank fees...... 9-13, 17 Cost of...... 57 Fixed rate...... 21, 30-31, 48, 54 Death benefit...... 82-83 Credit card fees...... 26-27 HUD-1...... 50 Floating rate...... 21 Fee-only adviser...... 80 Credit check fees...... 39, 46 Teaser rate...... 25, 49, 54 Insurable interest...... 82 Late fee(s)...... 26, 33 Tiered rate...... 19 Premiums on...... 81-82 Mutual fund fees...... 103, 117, 121 I Internal Revenue Code (IRC)...... 126 Ter m...... 82 FICO score...... 34-25 Internal Revenue Service (IRS)....51, 118, Types of...... 82-83 Impact investing...... 119 Finance charge(s)...... 22, 26, 29, 33, 47 126-128, Whole life...... 83 Income...... 128-129 Financial plan(s)...... 59-61 130, 132-133, 135 Universal life...... 83 Adjusted gross income FINANCIAL PLANNING...... 58-91 Forms...... 126, 132-133 Limited partnerships...... 125 (AGI)...... 129, 135 FINRA Trade Reporting and Publications...... 127-128, 132-133, Line(s) of credit...... 7, 9, 12, 22, Income tax...... 126-137 Compliance Engine 135-137 30-31, 33, 54-55, 65 Alternative minimum tax (TRACE)...... 112-113 Taxpayer assistance...... 127 Liquidity...... 95 (AMT)...... 131 529 plans...... 66, 68-69 Withholding calculator...... 133 Loan(s)...... 6-7, 22, 30-33, Audit(s)...... 136-137 Account owner...... 68 INVESTING...... 94-125 36-37, 43-49, Brackets...... 130-131 Choosing...... 69 Investment earnings...... 95 54-55, 114 Credits...... 127-129 Contributing to...... 68 Investment market(s)...... 95, 97, Adjustable rate...... 31 Deductions...... 127-129 Investment tracks...... 69 105, 107 Car loan(s)...... 32 Estimated...... 129, 132-133 Withdrawing from...... 69 Bull and bear...... 107 Fixed rate...... 31 Exemptions...... 129 Fixed-income investments...... 100, Correction...... 107 Home equity loan(s)...... 32, 54-55 Filing status...... 130-131 102, 110 Market cycles...... 107 Installment loan(s)...... 30 Federal...... 126-137 Flexible spending account Investment portfolio...... 61, 94-96, 100, Mortgage loan(s)...... 34, 36, History of...... 126-127 (FSA)...... 135 103, 106, 111, 119 38-39, 43-47, 51 Rates...... 130-131, 133, 135 Foreclosure...... 34, 52, 54 Investment risk...... 61, 94-97, 100-103, PLUS loans...... 67 Recordkeeping...... 136-137 Full retirement age (FRA)...... 79 108-109, 111, 114-115, Prepayment of...... 33, 37, 48 State and local...... 131 ...... 109 117, 120-121 (s)...... 30, 54 Withholding...... 126, 132-133 Futures contracts...... 96, 100-101, Credit risk...... 103, 115 Stafford loans...... 67 Index...... 49, 99 122-123 Default risk...... 96, 111 (s)...... 36-37 Individual retirement Hedgers...... 123 Inflation risk...... 97, 111 Unsecured loan(s)...... 30, 54 accounts (IRAs)...... 70-71, Offsetting trades...... 123 Interest rate...... 114 Loan amount...... 33 74-75 Speculators...... 123 Market risk...... 97, 112 Loan application(s)...... 32, 39 IRA custodian...... 71, 75 Nonsystemic...... 102-103 Loan consolidation...... 37 Making contributions...... 75 Prepayment...... 114 Loan note (agreement)...... 32-33, 54 Spousal accounts...... 74 Security-specific...... 102 Loan servicer...... 36, 51-52 Types of...... 74 Systemic...... 101

140 141 INDEX INDEX

Ratings...... 120 Prepaid debit cards...... 15 Compounded return...... 99 M Types of...... 116-119 Prequalification...... 39 Real rate of return...... 61, 99 Underlying investments...... 116 Price/Earnings ratio (P/E)...... 102, Return on investment (ROI)...... 98 Managed futures...... 123 105-106 Total return...... 98, 121 Margin...... 48, 55 Prime rate...... 22 Reverse mortgage(s)...... 55 Margin account...... 108-109 N Principal...... 20-22, 30, 33, Revolving credit...... 24, 31, 36, 54 Buy on margin...... 108 46-49, 54, 96, 98, Risk...... 30, 61, 94-97, Margin call...... 108 NASDAQ...... 104 100-111, 121 100, 102-103 Selling short...... 109 National Credit Union Professional advisers...... 59-61, 68 Market capitalization Administration (NCUA)...... 7, (market cap)...... 102, 104-105 9, 11, 20 S Large-cap...... 104 National Foundation for R Mid-cap...... 104 Credit Counseling (FNCC)...... 36 Safe-deposit box...... 19, 88 Small-cap...... 104 Net asset value (NAV)...... 116, Real estate...... 38-55, 95-96, 99, Savings accounts...... 7, 18-19 Market value...... 43 119, 121 101, 124-125 Securities...... 95 Matching contributions...... 97 Net worth...... 64-65 Appraised value...... 39, 55 Securitization...... 114 Maturity...... 20 New York Stock Exchange Assessed value...... 47 Social Security...... 78-79, 128 Minimum balance...... 11 (NYSE)...... 104 Bid...... 40 Benefits from...... 79 Minimum payment...... 25, 36 Nominal interest rate...... 18 Binder...... 41 Contributions to...... 78 Modified adjusted gross income Nonsufficient funds (NSF)...... 9-10, 33 Brokers...... 42-43, 50 Earnings statement...... 78 (MAGI)...... 75 Buyers/sellers...... 38-39, 45 Taxes on...... 79 MoneyGram...... 17 Closing (Settlement)...... 43, 50-51 Socially responsible funds...... 119 Money market accounts...... 7, 19 O Inspection of...... 41, 43 S&P 500 Index...... 99, 116, 121 Money orders...... 17 Market value...... 39 Stock(s)...... 94-96, 98-111, 115 Mortgage(s)...... 7, 34, 36, Office of Comptroller of the Rental property...... 125 Cyclical...... 105 38-55, 81 Currency (OCC)...... 6 Sales contract...... 42-43, 55 Defensive...... 105 Adjustable-rate (ARM)...... 48-49, 51 Options...... 95-96, 100, Title...... 43, 45 Domestic...... 102, 105 Applications...... 44-45 122-123 Value of...... 38-39 Employer...... 97 Cutting expense of...... 47 Calls...... 122 Real estate investment trusts Growth...... 105 Fixed-rate...... 48 Expiration date...... 122-123 (REITs)...... 124-125 International...... 102, 105 Hybrid (or multiyear)...... 48 Premium...... 122-123 Reallocation...... 101 Large-company...... 96, 99 Mortgage loans...... 34, 36, 38-39, Puts...... 122 Rent-to-own...... 45 Small-company...... 104 43-47, 54-55 Strike price...... 122-123 ...... 58, 70-79 Value...... 105 PITI...... 44, 47 Outstanding balance...... 25 Employer plans...... 70-73 Stock exchange(s)...... 95-97 Points...... 46-47 Over-the-counter (OTC)...... 104 Individual retirement Stock funds...... 95, 98, 100 Private mortgage insurance Ownership, types of...... 60 accounts (IRAs)...... 70-71, 74-75 Subclasses...... 102 (PMI)...... 47 Social Security...... 78-79 Qualifying for...... 44-45 Retirement plans...... 70-75 Rates...... 48-49 P Automatic enrollment...... 70 T Term of...... 45-47 Contribution caps...... 71, 74 Municipal bonds...... 110, 112, 114-115 Participating physician Catch-up contributions...... 71 Target date funds...... 118 Mutual funds...... 94, 96, organization (PPO)...... 92 Distributions from...... 73 Taxable investing...... 95 99-100, 102-103, Payee/Payer...... 8 Required minimum Tax-deferred investing...... 58, 95, 134 116-121, 123 PayPal...... 15 distributions (RMDs)...... 72-73 TAXES...... 126-137 Actively managed...... 116, 119-120 Payroll cards...... 17 Roth options...... 72, 74 Taxes...... 36, 38, 45, 47, 58-59, Distributions...... 116, 121 Pell grants...... 67 Tax advantages of...... 70-75 86, 95, 126-137 Expense ratio...... 120-121 Personal identification Types of...... 70 Gift and estate...... 86, 131, 134 Fees...... 103, 117, 121 number (PIN)...... 11-13, 27, 29 Vesting...... 73 Income...... 36, 126-137 Fund portfolio...... 116 PITI...... 44, 47 Return...... 58-59, 61, 94-102, 111, Real estate...... 38, 45, 47, 54, 131 Index...... 116, 119-120 Point of sale (POS)...... 12-13 117, 120-121 Sales...... 131 Objectives...... 118, 120-121 Popmoney...... 14 Annual percent return...... 98 Tax-exempt investing...... 58, 68-69, Prospectus...... 120-121 Preapproval (of loan)...... 39 Averaged return...... 99 95, 134

142 143 INDEX BANKING

VIRGINIA B. MORRIS is the Editorial Director of Lightbulb Press. She oversees the development of all of the company’s financial education content. A noted expert on , Virginia serves Tax planning...... 134-135 as a consultant on investor education, participates in Tax preparers...... 127 Y financial planning workshops, and creates financial Teaser rate...... 54 literacy curricula. Technical analysis...... 108 Yield...... 21, 97, 107, Virginia has written more than thirty books on Term...... 20, 30-31, 33, 39, 112-114, 121 45-47, 54, 110, 114 Percent yield...... 107, 112-113 financial subjects, as well as articles, white papers, ...... 8 Yield to maturity...... 112 and the content for financial literacy websites. She is TreasuryDirect...... 110-113 responsible for Lightbulb’s distinctive and accessible Trusts...... 90-91 approach to explaining investing and personal finance, from the basics of money Charitable...... 91 Z management to sophisticated investment products and strategies. Crummey powers...... 91 Guide to Money & Investing, Guide to Donor...... 90 Zero-coupon bonds...... 114 Among her Lightbulb Press titles are Trustees...... 91 Understanding Personal Finance, Welcome to Your Financial Life, A Woman’s Guide Types of...... 90-91 to Investing, An Investor’s Guide to Trading Options, Guide to Understanding Direct Truth in Lending Act...... 28 Investments, and the Lightbulb Dictionary of Financial Terms. Truth in Lending disclosure...... 45 Virginia holds a PhD and an MA from Columbia University and a BA from Truth in Savings Act...... 18 Beaver College. U KENNETH M. MORRIS is the President of Lightbulb Underwriting...... 81 Press. Since founding the company in 1990, Ken has US savings bonds...... 67, 111 fostered the company’s role as a leading provider of US Treasury...... 36, 94-95, 100-101, financial education guides and content. He has 110-111, 113 championed the use of plain language and informative Auctions...... 113 graphics and has overseen the development of Lightbulb Bills (T-bills)...... 36, 94-96, 100-101, content for electronic devices. 110-111, 113 Bonds...... 110-111, 113 Previously, Ken spearheaded major programs to simplify Notes...... 110-111, 113 complex business and legal documents, including financial TIPS...... 111 statements, tax forms, contracts, and insurance policies. In addition to his work on financial literacy websites, Ken has co-authored several V Lightbulb guides, including Guide to Money & Investing, Guide to Understanding Personal Finance, A Woman’s Guide to Investing, and Guide to the Information Age. Vesting...... 73 Volatility...... 96-97, 102, 114 Ken holds a PhD and MA in English from Columbia University and a BA with high honors from Cornell University. W Warrants...... 109 LIGHTBULB PRESS develops and publishes financial education guides and Wash sale...... 135 content for consumers and financial professionals. The company’s signature guides, Western Union...... 17 which combine straightforward language with colorful, informative graphics to Wills...... 88-89 clarify complex financial information, have introduced millions of people to Codicils to...... 89 personal finance and investing. The company publishes over 35 titles in print Executor...... 88 and digital formats on a broad range of topics that are customized for businesses, Guardian...... 88 demographic groups including children, and market regulators. Probate...... 89 Lightbulb has been creating imaginative yet practical financial literacy and investor education programs since its first guide was introduced in 1990.

144 145 GUIDE TO PERSONAL FINANCE provides clear explanations of the sometimes complex issues, questions, and decisions that are part of everyday finances. This essential guidebook contains the information you’ll need to make smart decisions about every- thing from banking and using credit wisely, to home finance, financial planning, investing, and taxes. The Guide is the perfect resource for becoming your own personal finance expert.

• Banking • Mortgages $ $ $ $ $ $ • Financial Planning

• Credit • Taxes $0.00 • Investing ISBN 978-1-933569-09-3 MORRIS 90000>

& • Paying for Tuition MORRIS 9 781933 569093

Lightbulb Press, Inc. lightbulbpress.com Phone: 212-485-8800 VIRGINIA B. MORRIS AND KENNETH M. MORRIS GUIDE TO UNDERSTANDING PERSONAL FINANC E

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