Category Archives: Investment Planning

Window offering salary loans

Should you pay off your loan or save?

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Yes.

Oh, but you wanted to know, which first? It’s a question that virtually every client asks me, but the answer is (as with so many things) it depends. So, I’m going to suggest you work through this checklist.

You should always pay off the minimum required payment on your loan. If you don’t do that, you’re in a world of hurt and that’s a topic for another time. But I’m going to assume that you can scrape up at least a little more than that and you’re wondering where you should put it. BTW, I’m going to be thinking mostly of education loans, but this advice also applies to credit cards and home mortgages.

  • Do you have an emergency fund?

Without an emergency fund, you’ll never get out of debt. We don’t know what the emergency will be, but we know that they come up fairly regularly. See my post here for more discussion. No emergency fund, no extra loan payoff.

While I like to see an emergency fund of 3-6 months necessary expenses (including loan payments!), it can take people just starting out a couple of years to build to that level. A $1,000 emergency fund is barely survival (one vet bill or car accident deductible can easily wipe that out.) Once you have at least $3-$5,000 in your emergency fund, you can begin to consider other possibilities, but I can’t advise going whole hog until the fund equals at least your health insurance deductible + out of pocket max + rent, utilities, and loan payment for however long it might take you to find a new job.

  • Are you contributing enough to your employer’s retirement fund to get the match?

If your employer matches your contribution, that’s a 100% return on your money up to the amount of the match, e.g., if you contribute 1.5% and they match it at 1.5%. If you contribute 3% and they match 1.5%, that’s a 50% return. (We could keep going—you contribute my recommended minimum of 10%, they match at 3%–30% return). No legit credit card or high interest loan is going to charge you 30% interest. Plus, you get an additional return on this investment and maybe a tax deduction, although I recommend you go with a Roth option if you have it.

Before paying extra on any loans, you should contribute anything you can scrape up until you at least get the full match.

  • Are you saving enough for retirement?

This is actually a different question than the one above. You need to be saving 10% of your income toward retirement, and more if you didn’t start until your mid-30s or later. Until you can put away at least 10%, in most cases I recommend you focus on retirement savings rather than early loan payment.

  • What’s the interest rate on the loan compared to your investment return?

As a rule of thumb, I use 5% as a basic cut point. If you’re a dummy and keep all your money in a savings account, you’re earning .5%-2%, so take it and pay off the loan. But let’s say you have a pretty good investment (maybe, quality mutual funds) and you’re earning an annualized rate of 6-8%.

What’s the interest rate on your loans? Credit cards at 22%? Pay them off as soon as you can. I still recommend that you contribute to the retirement plan first, but maybe only for the minimum match until you get rid of the high interest payments.

Student loans at 6-7.75%? As soon as you’re contributing at least 10% to retirement savings, start attacking these loans. They’re as high or higher than you’re going to earn from investments. Even if your employer only matches at 1.5% and you’re contributing 10%, you’re making 15% immediately + investment gain. However, I can wrap my mind around going after these once you’ve secured the minimum match. It’s not a numbers answer, it’s what will make you feel better.

Student loans at 3.25-4%? I wouldn’t rush to pay these off before term. You’d be better off saving more, even if it isn’t in a retirement account—a quality balanced or target date fund should produce better returns. However, if you have managed to accrue an emergency fund of 6 months fixed expenses, a “goals” fund for whatever your goals are (kid’s college, house down payment, etc.) and you just really want to be debt free, then you should do what will make you feel better. These are pretty far down the totem pole, however.

Mortgage? Mortgage interest rates are really low right now, so in most cases there’s no financial reason to pay them off rather than investing any excess money. There are a couple of exceptions: let’s say you have a big bonus or sudden inheritance, and your family might qualify for college financial aid. You might be better off paying off or paying down the mortgage since the value of the house isn’t counted on the FAFSA (it is on the CSS-Profile), whereas an investment account will be counted as available for paying.  The second situation is retirement: most people I talk to feel better when they own their home outright at retirement, since it’s probably the biggest monthly outlay. Just be sure you  have enough for unexpected repairs before you clean out cash to pay off the mortgage. You don’t want to be back borrowing on a line of credit at a higher rate.

As with all things financial, your mileage may vary. There are a lot of moving parts to consider when contemplating loans, and achieving the right balance isn’t the same for everyone. But that’s why people talk to a financial advisor, no?

Ukulele

What I learned at Ukulele Camp that applies to finances

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I’m pretty die-hard about DIYing everything I can. Yes, I know there’s a lot of argument that you should pay someone to do things while you’re out earning more per hour at something else, but I don’t buy it entirely. First of all, most of us spend plenty of time scrolling Facebook, binge-watching Netflix, and staring into the refrigerator. None of that is billable time.

There are a lot of projects that just require brute force and minimum skills—I’ll paint my bedroom over a weekend before I pay someone $800 to do it. However, I draw the line at danger (painting the trim on my second floor from a loooong ladder), back-breaking difficulty or heavy hauling (digging post holes and installing a fence), or things that I’m not confident about learning from YouTube (installing a new kitchen faucet and drain).

I’ve had quite a few music lessons over the past, um, decades, so I have been pretty convinced that I could teach myself to play ukulele and guitar from the huge number of books, YouTubes, and online courses available. And, they’ve worked pretty well. Feeling somewhat confident, I went to a few jam sessions at the Old Town School, where I discovered I had miles to go before I cheep. I definitely needed some real-time instruction.

This weekend we trucked up to Midwest Uke Camp in Olivet, Michigan. I came home, not only reinvigorated about playing, but about the place of music in life in general—playing, performing, singing, dancing. With all the grinding away, I had lost sight of the pure joy of it all. And since November, 2016, I think I’ve lost sight of some of the joy available in life. As so many blues masters knew, no one can take music away from you.

But, like everything else I do, I did see some parallels between the very delightful Uke Camp experience and our financial life:

  • When there are a lot of choices, you can’t swoop up everything.

For some time slots, there were 3 or 4 classes I wanted to take. I tried to find out who was a good teacher (all of them!) or offered something particularly appealing. No matter how much you wish, you can’t take more than one—and you probably can’t afford to hook on to every good investment. Go with what you can, given what time and knowledge you have available.

  • It’s not possible to make the optimum choice every time.

There was one class where, maybe, I could have chosen better. The teacher’s style just wasn’t right for me, although his music, omg… But that doesn’t ruin the whole selection, nor the other seven or eight choices I made. Similarly, for every given number of choices (investments) you make, some will not turn out as well as you expect. And some will perform far better—who knew I loved Django Reinhardt gypsy jazz? You have to look at the total experience (performance), incorporate what you learned, and try to do better next time, where you will make mistakes again. Improvement is not perfectly linear, but it should lurch in the right direction.

  • In person makes a difference.

I adore self-study. I can make all kinds of mistakes and make them LOUD, and no one will hear me, except for my dog. When she sees me grab the uke, she immediately asks to go out.

Nevertheless, there’s a lot to be gained from the personal interaction with a good teacher. They can correct subtle mistakes in real time, come up with a trick that solves your individual problem, and there’s the serendipitous addition of techniques and information they just happen to think of that’s not in their books or videos. A good teacher always knows more than they’re putting in print. That’s the chief benefit—the individualization. Sure, you can learn a lot about playing (and financial planning) from a pre-fab program, but at some point, you need it to apply to you, particularly. I think online lessons, websites, asset allocation programs, and all that jazz are great, but everyone has some unique challenges. In fact, if you come to the professional already having a good background, you can probably get more benefit from the one-on-one.

The interaction with other people can often give you new insights and ease your mind about how you compare. It’s oddly comforting to see other people struggling or making and recovering from mistakes. I’d love to see more opportunity for people to be part of investment clubs.

  • Seize the opportunities when offered

The best teachers may not be back. The event probably will not go on forever. It can be hard to find fiduciary, fee-only advice. The crowd was mainly older than 50 and so many said they wished they’d done it, younger. I hear it all the time about financial planning, too. Don’t put it off—neither playing an instrument nor making a financial plan are as difficult as they seem in your imagination.

Ugh! UTMAs and UGMAs

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I’m not sure why anyone has these accounts anymore, but they do. I mostly see them during divorces, where one spouse has tried to transfer money to the kids in hopes of keeping it out of the divorce joint property. Technically, these accounts are considered property of the children (not marital), but as with so many other financial issues, it’s largely up to what the attorneys are able to negotiate.

Funding these accounts is a pretty poor idea in most cases, however. What you’re doing is putting all the money in the kid’s name: they’re entitled to it at 18 to do whatever they want with it, and all the earnings are taxed at the parents’ rate. It used to be that as long as earnings stayed below a certain amount, the earnings were taxed at the kid’s rate so it was once a decent strategy to avoid some tax, as long as you could trust your kid not to burn through it by the time they were 18 and two months.

That tax dodge evaporated years ago, but somehow these accounts are still hanging around. Unless you’re trying to shaft your spouse, or have a child actor who’s earned the money themselves but needs some supervision, I don’t think there are many good reasons to have such an account.  They’re considered 100% the property of the child for college financial aid determinations, also.

How can you get the money out of it? The account has to be used for the benefit of the child (once funded, it’s their money), but as long as you can prove that’s how you used it, you’re fine. You’ll have to pay taxes on any gains from the sale of investments, but it’s unlikely the IRS will check up on how the money itself was spent—it’s your kid that could sue you, and hopefully that won’t be a factor.

Once upon a time I had such an account for my daughter, when the taxation was still favorable. I liked it way back then because there was no obligation to spend it on college, and I was certain my brilliant kid would get a full ride scholarship. Ha-ha. Obviously that was before I was a financial planner. We never did accumulate much in college savings in the account, being dunderheads at the time, and I eventually cashed it in to purchase her harp. She hasn’t sued me yet.

Probably the easiest way to clean out the account, besides covering tuition, music lessons, instruments, sports equipment, computers…is to move the money into a 529 plan. If you have significant gains, you’ll have to pay taxes (now playing world’s smallest violin) because 529 deposits have to be in cash. At least the (new) investment will be growing tax free.

If your child has actual earned income, you can also deposit some of the funds into a Roth IRA (up to $5,500/year depending on their earned income). They can withdraw money for college with no early withdrawal penalty, but they will need to pay taxes on any earnings withdrawn. Although they own the account once they’re adults, the tax and withdrawal penalties may slow them up a little. Also, $10,000 can be used as a down payment on a first time home purchase.

For some odd reason, most of these lingering UTMAs are also invested in savings accounts, where they’re earning practically zero for years now. I think they’re just places where people thought they were going to park some cash for college, then mostly forgot about them.  So, if you still have these accounts, resurrect them and put them to work for your kids. College is going to take whatever you can scrape together.

In case you’re wondering what these letters stand for, UTMA is Uniform Transfer to Minors Act and UGMA is Uniform Gift.