Everyday Finance Archives - Page 2 of 8

Should I Invest In The Latest Trend?

FOMO (fear of missing out). I’m sure you’ve felt it before while being bombarded with headline after headline about everyday people striking it big with relatively little investment in the latest investment fad.

Take this one for example, “Idaho teenager becomes a millionaire overnight by investing $1,000 in Bitcoin” It’s so easy a teenager can do it!

Before you know it, you’re sucked into the hype and putting money into something you barely understand.

But whether it’s cryptocurrencies, cannabis stocks, or whatever fad is the topic of conversation right now how do you determine if you should really be jumping on the bandwagon?

Investing versus Speculating

You need to understand the difference between investing and speculating.

An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.
Benjamin Graham, The Intelligent Investor

One of the worst mistakes someone can make is speculating with their money when they think they are investing.

The only way you can consider yourself an investor is if you develop strict investment guidelines to follow and actually understand the company you are investing in. Without that, you’re just relying on luck.

Keep Your Lizard Brain At Bay

Another thing you’ll want to be aware of is that primitive part of your brain that functions purely off of emotion.

Our brains are hard-wired for thrill-seeking. Think about rollercoasters, haunted houses, gambling, and speculative investing. They all cause our bodies to release dopamine throughout our system which makes us feel good.

It’s this part of your brain that is going to make it difficult to follow any investment guidelines you’ve put in place.

Timing Is Everything

Even if you’re the next wunderkind of investing, it won’t matter much if you’re late to the game. Just look at what happened with Bitcoin a few years ago.

Early adopters — the ones who rode the wave as euphoria grew and knew when to get out — were the ones who came out on top.

Speculators who bought near or at the peak, hoping that the rise would continue, were caught with their pants down as the value plunged seemingly overnight.

Is It Right For You?

The idea of striking it big with just a little bit of money and effort is appealing. Just like winning the lottery.

But unless you on track with your financial goals, and have the disposable income to play with, I recommend focusing your efforts on the only true way to build wealth which is saving!

The True Cost of a New Car

For most Americans, going to a dealership to pick out a new car is a special moment.

Usually, there is a reason behind it — a treat to yourself for getting a promotion, an upgrade for a growing family, or maybe just a mid-life crisis — and the feeling you get when finding “the one” is hard to beat.

But before you give in to your impulsive drive, it’s worth taking a look at the true cost of that new car smell.

First, be careful about framing

Would you rather spend $999 now on the new iPhone XS or only pay $41.99 per month for the next 24 months?

$1,000 out of pocket right now sounds like a lot! But heck $42 per month, that’s just giving up dining out once or twice a month. Easy!

Choosing the subscription-based method seems like it’s easier, but after it’s all said and done, you’ve actually spent more money than if you would have just paid for it upfront.

You need to keep in mind that auto-dealers will play the same framing game, but the numbers are on a much greater scale.

ONly $50 more per month

Let’s say you’ve used an online calculator and found that you could borrow $25,000 for around $466 per month on a 5-year loan at 4.5%, which fits into your budget. Keep in mind the total amount you’ll pay over the life of the loan is $27,964 ($2,964 in interest).

You go to your local dealership to look for cars in the $25,000 price range when a salesperson approaches you and asks, “what are you looking to spend each month?”. To which you reply, “around $450 to $500”.

Now that the salesperson has your “top end”, they begin showing you cars in the $27,000 and $28,000 range and will likely say something to the effect of, “look, you can $3,000 more worth of car for only $50 more per month? Is that really going to break your budget?”.

What they’ve done is shifted your focus away from the overall cost and toward the incremental change that it will have on the payment.

If you borrow $28,000 for 5-years at 4.5%, the monthly payment may only be around $50 more ($522 per month) but you’ll end up paying $3,320 in interest over the life of the loan.

Or just finance for longer

What can be even worse is if you stick to the monthly budgeted amount and the salesperson says, “You can always extend the term of the loan which gets you BELOW your target budget! In fact, you can borrow $29,500 for 6-years at 4.5% and the monthly payment will be around $468 which is right where you want to be at!”.

Quite the compelling story. But what the salesperson forgot to mention is that you’ll end up paying $33,716 over the life of the loan and $4,216 of which is interest. That’s $1,252 more in interest than if you would have stayed with your original amount.

Sadly, it seems like this scenario plays out often.

According to Experian, about 85% of new cars are bought with financing and the average loan term is 69.03 months. Research by R.L. Polk & Co. says that the average length of time drivers keep a new vehicle is 71.4 months — around 6 years.

So what happens at the end of the 6 years? Most people have become so used to having a car payment, they do it all over again!

The tradeoff

What are you really trading off when you continually borrow for a mode of transportation?

I would argue that you are missing out on years of compounding interest and eventually having enough money to spend your time as you please, for however long as that time lasts (AKA retirement).

For fun, let’s pretend that instead of spending $466 per month on a car payment for the next 30 years you contributed that to a Roth IRA. 30 years is the equivalent of owning six cars in your lifetime, which is the average.

Assuming a very conservative annual growth rate of 3%, at the end of 30 years you’ll have accumulated $272,234! Using a slightly higher growth rate of 6% and that amount jumps to $470,444!

Is that new car smell really worth almost half a million dollars?

Roth or Traditional?

An important part of saving for retirement is deciding whether to put money into a Roth retirement account (401(k) or IRA) or a traditional retirement account.

Choosing your retirement savings type wisely could help you avoid paying more taxes than necessary.

Think of yourself as a farmer

A Roth account holds “after-tax” money — or money you have already paid the income taxes on. Its qualified distributions are tax-free: you pay taxes on the seeds, but the harvest, which is hopefully much larger than the initial plating, is tax-free.

A traditional retirement account has pre-tax money: you don’t pay income taxes on the seeds (either by taking a tax deduction or deferring from your paycheck before taxes); you pay the income taxes on the harvest — when you withdraw the money.

When you are making the decision where to invest your retirement savings, consider the following four areas:

Is your tax bracket lower today than your tax bracket will be in retirement?

Anticipating tax rates can be difficult since no one knows how Congress may change tax rates in the future. If you believe you are earning less today than you will in the future (for example, you’re just starting in a career), then a Roth account may be the best option.

On the other hand, if your income is at its peak, a traditional account may be the best option.

Another option is to consider splitting your savings between traditional and Roth depending on your current asset mix (traditional vs. Roth vs. taxable).

Does your employer match your retirement contributions?

If yes, then your employer is already contributing to a traditional 401(k), so consider contributing to the Roth 401(k) to diversify your retirement account types.

Who are your beneficiaries?

If you are leaving money to charities, consider using a traditional retirement account since the charity is exempt from income taxes.

If your children are your beneficiaries, consider whether your children will be in a lower tax bracket after your death than you are now.

Some people choose to give their children the additional gift of prepaying the taxes and leaving the children tax-free money in a Roth account.

Will your required minimum distributions (RMDs) provide more money than you need?

If you already have money saved in a traditional retirement account, the government will require you to take minimum distributions at age 72.

On the other hand, a Roth IRA requires no distributions at a certain age, which means the money can continue to grow tax-free until you need it.

Diversifying your retirement savings between traditional and Roth accounts can be important because during your retirement you can choose to withdraw taxable money from your IRA or tax-free money from your Roth IRA.

Just like a farmer plants different types of seeds, you may want both traditional and Roth retirement funds to choose from when you are retired.

Should I DIY or Pay For A Service?

When it comes to DIY repair jobs and other housework, I always calculate if it makes financial sense for me to actually do it myself or not.

Take for example this paint transfer on my car.

Determine the Cost.

I’ve done my fair share of routine maintenance to my car and figured doing it myself would be a cheaper alternative than taking it to an auto body shop.

It only took me a few minutes of searching on the internet to find exactly what I was looking for, a video tutorial on YouTube.

I began looking around the garage for the things I needed. Luckily, I already had most of the required materials but for illustrative purposes, let’s pretend I didn’t have any of it.

If I had to purchase all of the items for this job, I calculated that it would have cost around $70. The best part is that all of these products can be used over and over.

I predicted that the job would take around an hour. Using the average hourly rate of a personal financial advisor in Indiana, that would be $45 of labor.

After looking at the total estimated cost for me to do the job, which was $115 ($70 + $45), I decided it was worth my time to attempt the repair myself.

I followed the video’s instructions and, as predicted, a little while later I was scuff-free!

The Value of Time and Money.

So what does this have to do with finance? Well, a lot, actually.

Calculating the trade-off of doing a project on your own versus outsourcing the work plays a huge role in making everyday budgeting decisions. And the smarter decisions you make with your time and money, the happier you’ll end up being.

Money Isn’t Everything.

Of course, there are other, non-monetary, factors to consider before deciding to outsource a task or not.

It may not make a lot of economic sense to mow your own lawn, but many people find it therapeutic and enjoy doing it themselves.

Along those same lines, it may not have saved me a lot of money to remove the paint scuff from my car, but I appreciate the challenge of learning a new skill.

Avoid The Underpayment Penalty

As a financial advisor, I look at a lot of tax returns. I’m usually looking for key tax information that guides long-term tax planning. But, something that I’ve noticed is an uptick in people owing an underpayment penalty to the IRS.

I’m not sure what is causing the increase – a byproduct of the recent tax changes? – but if it’s impacting you there are a few ways that you can avoid the penalty and save yourself a few hundred dollars.

What is it, how does it happen, and am I paying?

You owe an underpayment penalty if you didn’t pay enough taxes throughout the year. This can happen even if you are a salaried employee.

Most of the time, employees have taxes withheld from their paychecks and the employer sends them to the IRS. But if you claim the wrong number of allowances on your W-4 you could end up underpaying.

Also, if you a regular employee and have income from other sources you could also be underpaying.

It’s even easier to underpay if you’re self-employed, a freelance worker, or retired. You don’t have taxes withheld as you earn income. You’re required to make estimated quarterly payments based on what you earn, which can be variable. This makes it easy to miscalculate the taxes owed or even skip a payment on accident.

You’ll be able to tell if you’re paying an underpayment penalty by looking at line 24 on page 2 of Form 1040. If there is a number there, it’s likey from an underpayment of taxes.

How to avoid it

Generally, most people will avoid the penalty if they:

owe less than $1,000 in tax after subtracting their withholdings and credits
had no tax liability the previous year
paid at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller
for high-earners, it’s 90% of the current year or 110% of the prior year, whichever is smaller

The penalty may be waived if either:

you experienced an event, like a natural disaster, that caused the underpayment or,
you are retired (after reaching age 62) or became disabled during and the underpayment was due to reasonable cause, not willful neglect

You’ll have to submit the request for the waiver in writing when you submit your tax return.

If none of the above apply to you, you can’t undo what’s done. You’re stuck with an underpayment penalty but you can take steps to avoid one going forward.

If you’re a regular worker, start by increasing your withholdings on your W-4 so that more tax is taken out of each paycheck. Here is a link to the IRS’s tax withholding calculator to help you determine the amount, https://www.irs.gov/individuals/tax-withholding-estimator

If you’re a worker with income from outside sources, also consider increasing your W-4 withholdings, or make estimated tax payments to cover your taxes. I think that having the amount withheld from your paycheck is much easier than writing quarterly checks to the IRS.

If you’re self-employed, a freelancer, or retired be sure to make your estimated payments for the current tax year by the deadlines. I recommend setting up an automatic monthly transfer from your checking (or business checking) into a separate account that’s earmarked for your estimated payments. That can help you avoid a cash squeeze when it’s time to send the checks in.

If you’re retired and have IRAs, you can more taxes withheld from each distribution from you IRA. This works especially well if you are taking required minimum distributions (RMDs) but don’t need the income.