The Future of AllThingsFinancial - Part II

Well, I finally bit the bullet and set up an account with DreamHost to host AllThingsFinancial. I'm excited and nervous at the same time. I appreciate all the supportive comments from my first "Future of..." post. They (the comments) were very helpful and aided me in my decision-making. I'm very fortunate to be able to count most of my readers as friends. -JLP

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Let's Talk About Risk

In the investment world "risk" is defined as fluctuation. Of course, we are really only concerned with DOWNWARD fluctuation. Anyway, there are many different kinds of risks involved in investing. I'm going to take a couple of posts to talk about them.

I got the idea for this series of posts from Ric Edelman's book The New Rules of Money, which is a pretty good book (I can't say that about the rest of his books). Ric is a financial advisor and author. He also has a website.

So, what are the major types of risk? I'll list them first and then I'll go back and explain each one:

• Default risk - The risk that an investment will become worthless. Does this remind you of Enron or Worldcom? Those people who had all their wealth tied up in those two companies lost it all. However, this risk can be minimized through proper diversification. Had you owned Enron or Worldcom in a portfolio of stocks, the impact of their default wouldn't have been nearly as severe.


• Credit risk - This is the risk that an investment's financial stability might decline. Although this risk involves stocks, it is particularly important to bond investors. If you own a bond in a company who's credit rating gets cut by the bond rating services, the value of your bond is going to decrease. This is another type of risk that can be diversified away.


• Tax risk - The risk of loss due to taxes (income and capital gains taxes). Loss to taxes can be either postponed through tax-deferred accounts like 401(k)s, IRAs, and annuities. Loss to taxes can be eliminated with the use of a Roth IRA or Roth 401(k).


• Inflation risk - A very real risk faced by everyone (some have more exposure than others). This is the risk that an investment's purchasing power will be eroded by rising prices. This is a very real risk to someone invested in interest-bearing accounts. Stocks have been shown to handle inflation risk pretty well as long as the inflation is low to moderate.


• Interest rate risk - The risk that interest rates will rise. If you buy a bond today for $1,000 that pays you 4% per year and then interest rates rise to 4.5%, your bond is worth less than the $1,000 you paid for it. Why? Becuase why would anyone want to pay you $1,000 to earn $40 per year when they could buy a bond for $1,000 that pays $45 per year?


• Currency risk - The risk that foreign currency exchange rates will rise. If you are a US citizen and have an investment in China and China's yuan increases in value against the doller, your investment will decrease in value. (This looks like an excellent follow-up topic)


• Political risk - This risk is related to currency risk. Political instability can be a substantial risk when investing in other countries - especially emerging markets. Diversification can reduce this risk.


• Market risk - This risk has to do with the price fluctuations of the market as a whole. There's not a lot that can be done about market risk except for ignoring it.


• Event risk - The risk that something unexpected and beyond management's control will cause the invesment's value to fall. September 11, 2001 is probably an the example most people think of.


• Prepayment risk - The risk that the investment's principal will be returned sooner than expected. Investors in callable bonds face this risk when interest rates decline.


• Extension risk - The opposite of prepayment risk. In other words, you might not get your principal back as soon as you expected.


• Opportunity risk - The risk that by investing your money in one place you are missing out on the returns "you could be getting" elsewhere. Diversification can rid you of most of this risk.

If you are like me, you probably didn't think there were that many different kinds of risks. These risks are all very real and should definitely be considered when making your investment plans. However, please realize that risk is natural and in most cases if you want a decent return, you are going to have to except some risk.

Tags: Understanding Risk, Risk, Investment Risk

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Carnival Submissions for Week 11

Man, it is hard to believe that we have done 10 carnivals already! Time flies when you are at the carnival! Anyway, AllThingsFinancial will be hosting Week 11 on Monday, August 29.

I NEED MORE SUBMISSIONS!

So, if you are a blogger and have a personal finance article that you would like to submit (preferably original material), please send me an email with the following info:

• Your Name


• Your Blog's Name


• Your Blog's URL


• Your Article's Title


• Your Article's URL


• Your Article's Trackback URL (if you have one. If you don't no biggie)


• Your Summary of the Article

Pick an article that you want lots of people to read and send it to me. My deadline is Sunday, August 28, at 5:00 PM Central Time.

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Gas Prices

First off, I hate paying high gas prices. I hate it with a passion. However, that doesn't mean we should be rash and blame whoever and whatever for higher gas prices. Really, we only have ourselves to blame.

My local paper has been inundated with letters from people who angry over gas prices. It is sad just how little most people know about economics. Here is one example from today's paper:

I don't understand the price-rising criteria for gasoline. If the station has already purchased the gasoline to sell at a set rate, why does the increase affect the gasoline already in the station's tanks. To me the increase should be on the gasoline that is ordered, not what is already there.

It's kind of like buying bread: On the shelf it's one price, by the time you get it to the checkout counter, there's an increase because of the instability of the flour market?

My response:

Using this woman's thinking, when prices decrease the opposite should be true. When prices fall, a gas station that might have paid more for their inventory would have to keep prices high until that inventory is sold and then they could decrease prices. I wonder how long that would work in the real world?

Although I'm not exactly familiar with the way gas stations set their prices, I would speculate that the reason we don't see wide swings in prices from station to station is to avoid long lines and shortages at some and gluts at others. I'm not saying I agree with it, I'm just saying that that is one way to look at it. I will say that it does seem that prices go up FASTER than they come back down.

Since we are on the topic of gas, I want direct your attention to a pretty good post on the Freakonomics blog critiquing an article (free registration required) that was in the past weekend's New York Times Sunday Magazine. Both (the NYT article and the Freakonimics' critique) are must-reads.

Tags: Gas Prices, Oil Prices, Freakonomics

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This Week's Carnival of Personal Finance

Dawn at FrugalforLife has done a great job hosting Week 10 of the Carnival of Personal Finance. Stop by and check it out.

AllThingsFinancial will be hosting next week's carnival. Please start emailing me your submissions (please include "Carnival Submission" in the subject line). My deadline for submissions is Sunday, August 28, 5:00 PM so that I can have the Carnival up at midnight on the 29th.

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Building Wealth Doesn't Get Any Simpler Than This

I'm a fan of Scott Burns. When he writes, I read it. Anyway, I noticed that he had an article on the Money Central website today. In that article he talks about how a person (a young person) can become a millionaire if they:

• Work four summers, starting at age 16


• Save the income in a Roth IRA account


• Invest it in a simple, low-cost equity portfolio


• Simmer slowly for 47 years


• Serve ungarnished (and untaxed) at age 67

He then goes on to explain how it can be done. Good information! This is the kind of stuff I like. I think we tend to spend too much time talking about what can't be done instead of focusing on WHAT WE CAN DO NOW!

Tags: Starting Young, Becoming a Millionaire, Investing

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AllThingsFinancial Mentioned in the Wall Street Journal

I just want to say thanks to Andrew Blackman at the Wall Street Journal for thinking of AllThingsFinancial when he wrote this column that appeared in today's Wall Street Journal. It's nice to get some recognition.

He did mention one thing that he didn't like about my blog and that's the fact that I don't have my articles categorized. I have to agree with him. I hate that too, but Blogger doesn't have that feature. That problem will be fixed once I change providers. Until then, I'll have to manually organize my posts.

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Posts Organized by Topic

Last Update: Wednesday, August 17, 2005

Blogger does not offer categorization so I have to do it manually. Also, you can use the Google Search box to search for specific topics on AllThingsFinancial. I have used it a couple of times and it works pretty good. More changes are coming.

Buying a Home (Mortgages)

The True Cost of an Interest-Only Mortgage
Comparing 15, 30, and 40-Year Mortgages
Beware of Interest-Only Mortgages

College Planning

College Funding Math - Part IV
College Funding Math - Part III
College Funding Math - Part II
College Funding Math - Part I
Paying for College via Income Shifting

Debt Management

Is There Such a Thing as Good Debt?

Financial Planning Basics

Understanding the Time Value of Money
How to Calculate the Present Value of an Annuity
How to Calculate Annualized Rate of Return
Twelve Key Elements of Practical Personal Finance
How Much Life Insurance do You Need?
Financial Planning Basics - The Net Worth Statement
Net Worth Statement - Part II
Net Worth Statement - Part III
Net Worth Statement - Part IV
Net Worth Statement - Part V
Financial Planning Basics - The Cash Flow Statement
Cash Flow Statement - Part II
Analyzing Your Financial Statements with Ratios
Analyzing Your Financial Statements with Ratios - Part II

Getting Started

Why it is Important to Start Saving When You Are Young

Investing

A Look Back at Index Returns
The Importance of Understanding Objectives When Investing

IRAs

Trusts & IRAs - Part 2
IRS Publication 590
Trusts & IRAs
Make Sure Your IRA Can be Stretched
Stretch a Small Roth IRA
Facts About the Roth IRA
Should You Leave Your 401(k) With Your Company?
The Beauty of a Stretch IRA - An Example
Stretching an IRA
IRAs
You Still Have Time to Make an IRA Contribution for 2004
The Beauty of a Roth IRA

Kids & Money

Great Resources for Kids
Roth IRAs for Kids
Teaching Kids About Business and Investing

Miscellaneous

Are Hybrid Vehicles Worth it?

Mutual Funds

What's a Wrap Account
Understanding Mutual Fund Fees
Questions to Ask Your Broker
Questions to Ask Your Broker Before You Buy a Load Fund
How Does an A-Share Mutual Fund Work?
Kiplinger's Mutual Fund Guide

Portfolios

Model Portfolios
How to Calculate Personal Rate or Return When Dollar-Cost Averaging

Retirement Planning

Ten Steps to a Richer Retirment
Are Americans Ready for Retirement
The Penalty of Starting Late

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Are Hybrid Vechicles Worth it?

First off, let me say that I am not talking about the economy car hybrids like the Toyota Prius and the Honda Civic. What I am talking about is the new hybrid versions of bigger vehicles.

Sarah Breckenridge of Smart Money wrote an excellent article in which she took four vehicles (Ford Escape, Honda Accord, Toyota Highlander, and Lexus RX) and compared the hybrid version of those vehicles with the standard version. I wanted to see how much a person could save (or not save) by buying the hybrid version over the standard version. Keep in mind that my numbers do not reflect maintenance costs or tax beneifts of hybrid ownership. I also made the assumption that the vehicles are driven 15,000 per year divided evenly between city driving and highway driving.

	Ford Escape Hybrid
	City MPG	Gallons Used	Price Per Gallon	Ann. Cost
City	33	227	$2.40	$545
Highway	29	259	$2.40	$622
Totals		486	$2.40	$1,166
Cost Per Mile				$.0777
	Ford Escape XLT
	City MPG	Gallons Used	Price Per Gallon	Ann. Cost
City	22	341	$2.40	$818
Highway	25	300	$2.40	$720
Totals		641	$2.40	$1,538
Cost Per Mile				$.1025

	Honda Accord Hybrid
	City MPG	Gallons Used	Price Per Gallon	Ann. Cost
City	29	259	$2.40	$622
Highway	37	203	$2.40	$487
Totals		462	$2.40	$1,107
Cost Per Mile				$.0738
	Honda Accord
	City MPG	Gallons Used	Price Per Gallon	Ann. Cost
City	21	357	$2.40	$857
Highway	30	250	$2.40	$600
Totals		607	$2.40	$1,457
Cost Per Mile				$.0971

	Toyota Higlander Hybrid
	City MPG	Gallons Used	Price Per Gallon	Ann. Cost
City	31	242	$2.40	$581
Highway	27	278	$2.40	$667
Totals		520	$2.40	$1,248
Cost Per Mile				$.0831
	Toyota Highlander
	City MPG	Gallons Used	Price Per Gallon	Ann. Cost
City	19	395	$2.40	$948
Highway	25	300	$2.40	$720
Totals		695	$2.40	$1,668
Cost Per Mile				$.1112

	Lexus RX 400h
	City MPG	Gallons Used	Price Per Gallon	Ann. Cost
City	31	242	$2.40	$581
Highway	27	278	$2.40	$667
Totals		520	$2.40	$1,248
Cost Per Mile				$.0831
	Lexus RX 330
	City MPG	Gallons Used	Price Per Gallon	Ann. Cost
City	18	417	$2.40	$1,001
Highway	24	313	$2.40	$750
Totals		730	$2.40	$1,752
Cost Per Mile				$.0971

It is important to note that the hybrid models are $4,000 to $5,000 higher in price, which is definitely something to consider. Based on my gas price of $2.40 per gallon, these hybrids won't pay for themselves for a number of years.

Questions? Comments? Did I miss something?

Tags: Hybrid Cars, Hybrid Vehicles, Comparing Hybrid Cars, Comparing Hybrid Vehicles

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Interesting Article About Blog Readers

This article was mentioned on Instapundit. The article talks about a survey called "Behaviors of the Blogosphere" that was conducted by comScore Networks. I have not yet had time to read the survey but hope to do so later today. Maybe blogging will pay off after all.

Tags: Behaviors of the Blogosphere, comScore Networks, com Score Networks

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Sorry for the Lack of Blogging

I have been really busy today. We have a fair coming up in October and I am on a committee in charge of finding volunteers to help park cars. It's a lot of fun trying to get people to volunteer their time. Anyway, my mission this week is to fill 20 slots and so far I only have 3 filled. Wish me luck.

UPDATE: Here are my calling stats from yesterday (Monday):

49 Dials
18 Not Available
13 Left Messages
13 No - They can't or won't be able to volunteer
3 Yes - They will volunteer
2 Maybe - They have to check their schedules (I'm not optimistic)

Considering that I am working off a membership roster (that is full of names of men that understand that this is a volunteer organization), these numbers stink. I hope I do much better today. Based on those numbers, I have a 6.12% "closing rate" (3/49 = .0621). In order to find 20 volunteers, I need to make 327 calls (20/.0612 = 327).

I have some good stuff in mind for this blog. Stay tuned...

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Tips on Cutting Gas Prices

Tonight, as I was catching up on my reading, I saw this article offering tips on how to cut your fuel costs.

We spend enough at Kroger to get $.10 off per gallon of gas. That $.10 is becoming a smaller and smaller discount percentage-wise, but every little bit helps.

I'm curious to know what my readers are doing. Got any tips you want to share?

Tags: Saving Money on Gas, Cutting Fuel Costs

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12 Years Ago Today...

My wife and I were married! A lot has happened in those 12 years. I'm sure the next 12 years will be just as much fun.

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We've Come A Long Way

I was out perusing the 'net when I saw this post. I'm so glad technology has improved so much since then. I can think of a lot better way to spend $8,000!

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Taking a Proactive Approach With Your Finances

I'm currently re-reading Stephen Covey's The 7 Habits of Highly Effective People. It is the kind of book that is good to read every year or so because the ideas it contains are that important.

The first habit discussed in the book is that of proactivity. According to the book, "proactivity means that as human beings, we are responsible for our own lives. Our behavior is a function of our decisions, not our conditions. We can subordinate feelings to values. We have the initiative and the responsibility to make things happen."

In that light, I would like to lay out what a proactive person looks like when it comes to personal finances.

When it comes to personal finances, a proactive person:

1. Takes responsibility for their financial situation.

2. Lives within their means.

3. Saves a significant portion of their income.

4. Invests their money prudently.

5. Does not chase after the hottest investment ideas.

I'm sure there are other attributes that could be added to the list.

I realize that I'm probably preaching to the choir when I talk about this stuff because if you are reading this blog, chances are you are serious about personal finance. If you stumbled across this blog, I hope the material it contains helps you become a proactive person when it comes to your personal finances.

Tags: The 7 Habits of Highly Effective People, Stephen Covey

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College Funding Math - Part IV

This is the last post in the College Funding Math series. Hopefully, by following the previous three posts, you have an idea of how to use math to figure out how to meet a goal. I also hope that you weren't bored to death by reading these posts!

In Part III, we figured out that with a beginning balance of $3,000, Hector's parents would need to save an additional $3,206 per year, invested to get 8% annual return, in order to meet his future college funding needs.

Now, with this post, I will show you an example of what all this looks like laid out in a spreadsheet. To conserve space, I had to abbreviate some of the titles for the columns. Here's a listing of each title means:

Age = Beginning Age, for this example Hector is 5.
Beg. Amt. = The balance at the beginning of each year. Since we have $3,000 already saved up, that is the beginning amount for the first year. We are also assuming that the deposits are made at the beginning of the year.
Ann Dep = Annual Deposit, which is $3,206. Deposits are made at the beginning of each year.
Total = The total of the Beg. Amt and Ann Dep. columns.
Withdrawal = Amount withdrawn to pay for college.
Ending Balance = (Beg. Amt + Ann Dep - Withdrawal) x 1.08

      Beg.    Ann            With-   Ending
Age   Amt.    Dep   Total   drawal   Balance
  5   3,000  3,206   6,206            $6,702
  6   6,702  3,206   9,908           $10,700
  7  10,700  3,206  13,906           $15,018
  8  15,018  3,206  18,224           $19,682
  9  19,682  3,206  22,887           $24,718
 10  24,718  3,206  27,924           $30,158
 11  30,158  3,206  33,364           $36,033
 12  36,033  3,206  39,238           $42,377
 13  42,377  3,206  45,583           $49,230
 14  49,230  3,206  52,435           $56,630
 15  56,630  3,206  59,836           $64,622
 16  64,622  3,206  67,828           $73,254
 17  73,254  3,206  76,460           $82,577
 18  82,577  3,206  85,782  $24,513  $66,170
 19  66,170  3,206  69,376  $25,739  $47,128
 20  47,128  3,206  50,333  $27,026  $25,172
 21  25,172  3,206  28,377  $28,377       $0

There you have it. It is pretty self-explanatory. However, if you have questions or comments about this series, please let me know and I'll be happy to answer them.

Once again, I would like to thank the UnknownProfessor at the FinancialRounds blog for his help with the formula. It is always nice to count a professor among your friends.

Tags: Saving for College, College Funding, Time Value of Money, Annuity Due Formula, College Funding Math, Planning for College

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College Funding Math - Part III

I'm sorry it has taken me so long to get this follow-up post done. I was basing my calculations for this exercise on an example from a financial planning book that I own. The book is WRONG! Anyway, I think I got it all figured out thanks to the help of the Unknown Professor (UP - pretty cool initials), who writes for the FinancialRounds blog. It is one thing to use a program to solve problems. It is quite another to solve problems using the actual formulas. UP came through for me and I really appreciate it.

In Part I of this series, I showed you how to use a formula to figure out how much your future college funding needs could be, using today's college tuition prices and an assumed inflation rate.

I followed up with Part II by showing you how to calculate how much you need now in order to meet those future needs. We discovered that a lump sum of $31,580, invested to get an 8% return, would fund four years of college for Hector.

The obvious problem with the lump sum is that there aren't a lot of people with $30,000 available to invest for college. So, in this post, it is my aim to show you how to calculate how much you need to save each year in order to meet Hector's college funding needs.

NOTE: I must warn you that the formula used to perform this calculation looks like something out of a scary movie. But, if you take it one step at a time, it really isn't that bad. I promise.

We are trying to figure out how much we have to save each year to meet a goal. The amount saved each year is called a "payment." So, we need to use a formula to calculate a payment. This formula involves two steps. First, we have to solve for the factor (or constant). Then we use the factor to solve for the payment.

The first formula looks like this:

[((1 + i)ⁿ - 1)/(i X (1+ i)ⁿ] X (1 + i)

i = interest rate or rate of return expected, which is 8% or .08.
n = number of years, which is 17
X = multiplication sign

Once we add in the appropriate numbers, the forumula* looks like this:

[((1 + .08)¹⁷ - 1)/(.08 X (1+ .08)¹⁷] X (1 + .08)

[((1.08)¹⁷ - 1)/(.08 X (1.08)¹⁷] X 1.08

[(3.7000181 - 1)/(.08 X 3.7000181)] X 1.08

[ 2.7000181 / .2960014] X 1.08

9.1216383 X 1.08

9.8513693

So, after all that, we find out that our constant is 9.8513693. Now we simply divide our goal, which is $31,580 by our constant to get our payment amount.

$31,580 / 9.8513693 = $3,205.65

So, we have found out that if we take the $3,000 we already have saved and add $3,205.65 to it at the beginning of each year at an 8% return, we will be able to fund Hector's college. Keep in mind that this $3,205.65 must be saved through Hector's college.

In Part IV of this series I'll show an example of a timeline so you can see how all this works.

*This is the formula for payments made at the beginning of the time period, called an "annuity due." The other formula is called an "ordinary annuity." For more on this, you can visit this website.

Tags: Saving for College, College Funding, Time Value of Money, Annuity Due Formula, College Funding Math

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What if Everyone Saved 10% of Their Income?

This is an interesting question raised by Hazzard over on the Everybody Loves Your Money (ELYM) Blog. Here's my 26.4 cents worth:

First I have a couple of questions:

1. Is paying off credit card debt and other consumer debt considered "savings?" It would make no sense for Americans to "save" 10% of their income while still holding so much consumer debt.

2. Is investing considered "savings?" I have not researched this topic enough to know if retirement savings through IRAs and 401(k)s and other savings vehicles is considered savings. (This would be a great time for an economist to offer up some information)

That said, I would think that initially, the savings would hurt companies that produce luxury goods and other unnecessary products that we buy. Banks, on the other hand would probably see an influx of new money from all these savers. Banks, sitting on top of a mountain of cash would probably buy other smaller banks.

Mutual funds and brokerage firms would also see increased deposits. It would be interesting to see how the stock market would reach an equilibrium since lots of companies would be hurt by America's new zeal for saving.

Since I am not an economist, it would be hard for me to project out what this would mean for our economy in the long-term. I welcome anyone with an economics background to comment. Also, be sure and check out the post and the comments on the ELYM blog that I linked to.

Tags: Economics, Savings

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My 26.4 Cents!

Okay, this is going to expose the "weird" side of me. My friends who read this blog (all 2 of them!) are already familiar with my sense of humor. Those of you who aren't, please forgive me.

I was just commenting on SavvySaver's blog about the subject of school uniforms. Anyway, at the end of my comment I wrote "That's my $.08 (adjusted for inflation)." Then I got to thinking: what is "our $.02 really worth once it is adjusted for inflation?

Surely we must adjust this to show the effects of inflation. Otherwise, our opinions become more and more worthless with each passing year. Nobody wants that! So, the question becomes what is our two cents really worth?

When did the saying "that's my $.02," start? What year? Let's say it started in 1930 (I really have no idea but I need a base year). If we assume an inflation rate of 3.5% for opinions, then our $.02 is becomes our $.264! Wow! Now instead of saying "that's my two cents," we should be saying "that's my twenty-six point four cents."

This is going to completely change the world. Every December the Opinion Research Foundation will have to make an upward adjustment so that we have an accurate measure of our opinions.

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College Funding Math - Part II

With the last post, we figured out that four years of college was expected to cost $105,655. Now we need to know how to reach that goal.

So that we don't have to keep referring back to the first post, here are the assumptions:

Assumptions: Hector (I figured we might as well have some fun with the name) is 5 years old and will start college when he is 18, which is 13 years away. You currently have $3,000 in Hector's college fund. One year at a public university currently costs $13,000 and we will assume that the college inflation rate is 5.0% (or .o5) per year. We will also assume that Hector will be in college for 4 years. We will assume the growth rate on the investment account is 8% (or .o8). Finally, we will assume that the annual amount saved will cease once Hector starts college.

Step 2 - Calculate the present value of four years of college

The costs for each of the four years of college are expected to be:

Year 1 = $24,513
Year 2 = $25,739
Year 3 = $27,026
Year 4 = $28,377
TOTAL = $105,655

In order to know how much we need now to meet these future expenses, we must discount them using our expected investment return, which is 8%. The formula for Present Value of a Lump Sum is:

Present Value = Future Value / (1 + ROR)^N
Future Value = $24,513
ROR = 8.0% or .08
N = 13 years
/ = the division sign

All plugged in, the formula looks like this:

Present Value = $24,513 / (1 + .08)¹³

Present Value = $24,513 / 2.7196237

Present Value = $9,014

What this tells us is that if we had $9,014 that we invested at an 8% return per year, we would have $24,513 in 13 years. We simply need to perform this calculation for each of the other three years of tuition and then add them together to get the total lump sum that we need NOW in order to fund Hector's college expenses.

Performing the calculation on the other three years of tuition, we get the following:

Year 1 = $ 9,014
Year 2 = $ 8,763
Year 3 = $ 8,520
Year 4 = $ 8,283
TOTAL = $ 34,580

So, this tells us that if we had $31,580 LUMP SUM (remember we ALREADY HAVE $3,000 SAVED UP, so the we only need $31,580 additional funds) to invest today at an 8% annual return, we would have enough to fully fund Hector's college education. The problem is that there aren't a whole lot of people who have an extra $33,159 sitting around to invest for college. Most people have to save smaller amounts each year. I'll talk about that in Part III.

Tags: Saving for College, College Funding, Time Value of Money

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College Funding Math - Part I

Today, I'm going to show you how to calculate how much you should be saving to meet future college expenses. It isn't that hard to do, but it will require some mathematical formulas that border on the complex. But, don't worry, I'll walk you through it so you aren't alone! So, here we go:

Assumptions: Hector (I figured we might as well have some fun with the name) is 5 years old and will start college when he is 18, which is 13 years away. You currently have $3,000 in Hector's college fund. One year at a public university currently costs $13,000 and we will assume that the college inflation rate is 5.0% (or .o5) per year. We will also assume that Hector will be in college for 4 years. We will assume the growth rate on the investment account is 8% (or .o8). Finally, we will assume that the annual amount saved will cease once Hector starts college.

Step One - Calculate the future expected cost of four years of college

This is a simple time-value of money calcuation, using the following equation:

Future Cost = Current Cost X (1 + Inflation Rate)^N

Don't let the formula scare you. We will plug in the numbers that we know:

Current Cost = $13,000
Inflation Rate = 5.0% or .05
N = Number of Years Away which is 13

So, after plugging in the appropriate numbers, the formula looks like this:

Future Cost = $13,000 X (1 + .05)¹³

We perform the following steps to solve for the Future Cost:

Future Cost = $13,000 X (1.05)¹³

Future Cost = $13,000 X 1.8856491

Future Cost = $24,513

So, we now know that in 13 years, the first year of college will cost $24,513. Since this is the amount for only for the FIRST year, we must run the calculation 3 more times, using the same formula as above but changing "N" to reflect the appropriate number of years away. NOTE: since the first year of college is 13 years away, the second year would be 14 years away, the third would be 15 years away and the fourth would be 16 years away.

After you run the formula for each year, you should come up with this:

Year 1 = $24,513
Year 2 = $25,739
Year 3 = $27,026
Year 4 = $28,377
TOTAL = $105,655

We now know that at a 5.0% inflation rate four years of college for Hector is going to cost $105,655. The next step is figure out how much you need to be saving to meet this goal. That will be the subject of the next post.

Tags: Saving for College, College Funding, Time Value of Money

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Ten Tips to Help You Avoid Investment Fraud

I saw this earlier and thought it was worth sharing. I put a link to the actual site so you can download and print out a PDF version of this list if you choose. This is targeted towards Senior Citizens but is still information that we all need to know. Thanks to the New Jersey Board of Securities for printing this up.

1. When in doubt, check it out.

Anyone offering financial advice or selling stocks, bonds, mutual funds or other investment vehicles in New Jersey must be registered with the New Jersey Bureau of Securities (BOS). Contact the Bureau to make certain the person is registered before investing any money. Ask if the State has taken any disciplinary action against the person.

2. If it sounds too good to be true, it probably is.

Investments offering very high rates of return should be questioned. Ponzi schemes, where money from new investors is used to pay high returns to only a few of the original investors, are on the rise. When this pyramid scheme collapses, most investors lose all their money.

3. You know me, so invest with me!

Con artists who claim they were referred by members of a club or organization to which you belong are a growing concern. They lower your guard by claiming to know people that you trust. The con artist may join a group and begin preying on its members. Check to make sure the person offering an investment is registered with the BOS.

4. Trust me! Would I LIE to you?

Ask if the person recommending a particular investment stands to benefit. If the person will make a commission or get a fee for selling a particular investment, you should consider whether his or her recommendation is unbiased and accurate.

5. You can see a lot by looking.

Read your monthly investment statements carefully. Any errors or irregularities should be reported in writing to the investment company at once. If the problem is not resolved, then contact the BOS immediately!

6. Keep all records safe and secure.

Keep all contracts, forms and orders that you sign or authorize in a safe, secure location. These documents are the paper trail that investigators may need to examine. In addition, keep copies of all investment correspondence in a safe place.

7. You’ve got the power!

Authorizing someone to invest on your behalf sounds convenient but lessens your control over your money. Understand what investment powers you are giving to someone before signing an agreement.

8. Let’s play follow the leader.

A favorite scam of con artists is the promise of high returns through access to the investment portfolios of the world’s elite banks. The negative publicity attached to these schemes has caused con artists to avoid explicitly referring to elite or prime banks. Now they underplay the role of banks by referring to these schemes as risk-free, guaranteed high-yield instruments or something equally deceptive!

9. Who knows what evil lurks in the Internet?

The Internet has reshaped our lives, but it also has become a prime hunting ground for scam artists. For example, one scam involves e-mail offers from individuals representing themselves as foreign government or business officials in need of help to deposit large sums of money in overseas bank accounts. Always know with whom you are investing and where their office is located by meeting them.

10. Never invest only on word-of-mouth advice.

Read and understand all documents. Take your time and be in control. You should ask for literature and other printed information to review that gives more facts about the investment being offered. If you are told you must act at once or lose out, walk away.

Source: New Jersey Bureau of Securities

Tags: Preventing Investment Fraud, Fraud

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The Pitfalls of Annuities

This comes from today's Wall Street Journal in an article($) about how states are cracking down on annuity sales. They list three pitfalls to annuities:

• Long-term surrender charges that can cost 10% or more of the value of the contract.


• Unfavorable tax treatment, since profits in annuities are taxed at ordinary income rates.


• No step-up provision, meaning that when passed to heirs, gains are taxed, unlike some other investments.

According to the article, last month New Jersey began enforcing its new Senior Citizen Investment Protection Act, which limits how long annuity sellers can impose surrender charges. The article also lists what other states are doing:

Overall, I think this is a good thing.

Tag: Annuities

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The Seven Common Denominators of Building Wealth

I'm on a The Millionaire Next Door kick. In the introduction, the authors list the seven common denominators among those who successfully build wealth (which are each given a chapter in the book):

1. They live well below their means.

2. The allocate their time, energy, and money effieciently, in way conducive to building wealth.

3. They believe that financial independence is more important than displaying high social status.

4. Their parents did not provide economic outpatient care.

5. Their adult children are economically self-sufficient.

6. They are proficient in targeting market opportunities.

7. They chose the right occupation.

In my opinion, the most important factor is number one, living below your means. Anybody can build wealth by living below their means and wisely investing the difference.

Tags: Determining if You Are Wealthy, Millionaire Next Door

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The Millionaire Next Door - Part III

The most popular posts I have done were in relation to the book, The Millionaire Next Door. Since the posts are now buried in the archives, most of you probably haven't seen the comments to my first two "millionaire" posts. You can check Part I and Part II.

The biggest critic of the book is Miguel, who says the following in his second comment:

"JLP,

Darned, I wrote a good response that seems to have disappeared into cyberspace. Well, here goes again if I can even remember what I said.

My biggest problem with the Millionaire book is that it purports to have conducted "research" on the topic. Sorry, but interviewing a bunch of old men in shopping malls who claim to be millionaires is not research by any meaningful definition. There is no scientific or statistical method here. They are an embarrassment to the field of demographics.

Why is that a problem? Cause people will draw inaccurate conclusions from the books. So, they claim as you say that "millionaires use restraint and don't fall for the material goods that most Americans fall for". That is complete BS. Like I said before, I am a millionaire. Did it before the age of 40. Most of my neighbors are millionaires. Some fit the book's profile, some don't. Personally, I like to eat out a lot, I like to vacation in the Hamptons, I like to travel to Europe, and I like owning a big house. I don't own a luxury car - In fact I don't own a car at all. I live in NYC and I rent them when I need them.

I will concede that the advice to "marry well" is quite sound. I married someone with a sharp eye towards saving & investment, budgeting & penny-pinching. We love the luxuries, but we don't pay retail for them.

My use of the word "conservative" was not in reference to politics, so there is no "liberal" version to be told. The authors are advocating a conservative life style for no other reason than they beleive its a good idea - it's their OPINION and it's not based on any real research.

There are plenty of millionaires who do not fit their lifestyle. So, then what is really the point of the book. I just think they are trying to promote fiction as non-fiction.

American likes to think of itself as a class-less society, and the book feeds right into that uniquely American mythology. That's exactly what people want to hear.

It's not that there aren't some decent concepts in the book. It's that if you don't know any better, you simply don't know what of their writing is BS and what of it is ok."

Thanks for the comment, Miguel.

Personally, I think Miguel is being particularly hard on the book. The point of the book is that "wealth" is not what we think it is. Rather, "wealth" (in financial terms) is our net worth. It's not how much we make, but what we keep from what we make that ends up making the difference.

I think EVERYONE can gain some insight from reading this book.

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Off the Topic of Personal Finance: JLP Asks...

What are some good books to read to boys in the 8-10 year-old category?

I enjoy reading to my boys. I'll read to my daughter as soon as she quits trying to eat the books! Anyway, over the last couple of years we have read:

1. The Mouse and the Motorcycle - Beverly Cleary
2. The Mayor of Central Park - Avi
3. Captain John Paul Jones - Ronald Syme
4. Mystery of the Midnight Message - Florence Parry Heide
5. Mystery of the Silver Tag - Florence Parry Heide
6. The Hidden Box Mystery - Florence Parry Heide
7. Mystery of the Vanishing Visitor - Florence Parry Heide
8. Mystery of the Mummy's Mask - Florence Parry Heide
9. Adventure of the Elements - Richard James III
10. Mystery of the Lonely Lantern - Florence Parry Heide
11. Henry Reed, Inc. - Keith Robertson
12. The Book of Virtues for Young Readers - Edited by William Bennett
13. Henry Reed's Baby-Sitting Service - Keith Robertson
14. J.C. Penney - Golden Rule Boy -
15. Thomas Paine - Common Sense -
16. The Book of Proverbs from the Bible (we are reading from the New Living Translation)

I have really enjoyed reading to them and I think they enjoy it too. I'm also learning cool things like:

Did you know that Thomas Paine was the FIRST person to ever use the term "The United States of America?"

Did you know that Thomas Paine received no compensation for writing Common Sense? He had all his profits from the book donated to the American cause for Freedom. Now that is a true Patriot and someone I want my kids to know about.

Do any of you read to your kids? If so, what do you read to them? Any recommendations?

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Shoulda, Woulda, Coulda - JLP Laments

I read in today's Wall Street Journal that Adidas is buying Reebok. A look at the latest quote shows Reebok is trading at nearly $57 per share. All I could think when I read the news was "coulda, woulda, shoulda..."

Why?

Well, way back in December 1999, Oprah Winfrey did one of her "Oprah Loves..." shows. Anyway, she went on and on about this particular shoe from Reebok. I remember sitting there thinking that this was going to be huge for Reebok. So, I went and looked up their stock price. They were trading around $8.00 per share. I seriously thought about buying 100-200 shares. But,... I DIDN'T.

Anyway, right after that Oprah show, the stock started moving up and six months later was trading in the mid-teens. One year after the show, it was trading at $23 per share - a 187.5% gain. Had I purchased the shares at $8 per share and held on to them until today, I would have had an annualized rate of return of just under 42% (not including dividends).

Oh well, such is life. Shoulda, woulda, coulda,... I guess.

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Another Cool Blog to Check Out

One of the things I love about blogging is all the cool stuff I come across. Today I came across a blog called CausticMusings by Maggie Wang. I love her post about the Millionaire Next Door. According to her bio, Maggie is a full-time video game level scripter and part-time illustrator fascinated by numbers, cats, computers, muscles, karaoke, and healthy foods that don't taste like sawdust.

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Alternatives to 529 Plans

The 529 Plan is still a great way to save for college. Parents can sock a lot of money away and the account can grow tax free (for now). However, many 529 Plans are run mutual funds who have loaded them to the max with fees. To make matters worse, a lot of the plans are sold by commission-based brokers, who may or may not have your best interest at heart.

There are alternatives to 529 Plans as this article by Penelope Wang, writer for Money magazine, points out. The article talks about the Coverdell Educational Savings Account (formally the Educational IRA), UGMA/UTMA custodial account, and Taxable accounts.

Of the three, the Coverdell is my personal favorite since it operates like an IRA. Your investment options are virtually limitless and you can utilize low cost investment vehicles like exchange-traded funds and index funds - something you won't find in 529 Plans.

Tags: 529 Plans, 529 Plan, Saving for College, Education Funding

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Female Personal Finance Bloggers

There are several personal finance-related blogs that are authored by women. Here's the list I have so far (the newest ones are marked with an *):

(If I have left anybody out, please let me know and I'll be happy to add you!)

TheBudgetingBabe
Clutter 2 Cash
Frugal for Life
Karen's Financial Progress Report*
Kate Spills the Beans
My Open Wallet*
MMB's Personal Finance Journal*
SavvySaver

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When to Fire Your Financial Advisor

Flexo at ConsumerismCommentary posted a link to an article on when to fire your financial advisor by Liz Pulliam Weston. I have written a couple of times on questions to ask before you hire, but never how to fire. Anyway, Liz has written an interesting article.

To keep you from making the wrong advisor choice in the first place, read this from the CFP Board.

Tags: Liz Pulliam Weston, When to Fire Your Advisor

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Look Before You Leap Into the Roth 401(k)

Could there be potential pitfalls to the Roth 401(k)?

According to this article by Jeanne Sahadi on the CNN/Money website talks about some of the drawbacks to investing in the new Roth 401(k) that will be available starting in January of 2006. The Roth 401(k) seems like a no-brainer until you consider the potential tax issues.

However, the younger you are, the more beneficial the Roth 410(k) seems to be. Why? Because the longer you have for your money to grow, the more likely you are to be in a higher tax bracket when you retire.

Also, Jim at Blueprint wrote a pretty nice piece about the Roth 401(k) a while back. He also links to a website called Roth401k.com that was set up specifically for the Roth 401(k).You may want to check it out.

Tags: Roth 401(k), Roth 401k, Retirement Planning

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Top 6 Reasons to Participate in Your 401(k) Retirement Savings Plan`

My wife's company sent this out today and I thought I would share it with you. I agree with all of them except number one. I think number one should stress the fact that you won't have to rely on Uncle Sam during retirement. Anyway, here they are:


6. You can increase your take home pay, really!

5. The "company match" can help your investments grow

4. Your money can go with you, job to job!

3. Your plan's investment choices are managed by professionals (except for parent company stock)

2. The plan allows access to maoney in an emergency

1. Automatic payroll deduction makes it easy to save

Tags: 401(k), 401k, Reasons to save in a 401k

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This Week's Carnivals

Steve at the InCashFlowWeTrust blog is hosting week 7 of Carnival of Personal Finance. Stop by and check it out.

Michael at SmallBusinessMarketingSystems is hosting this week's Carnival of the Capitalists.

Both of these are great resources. I urge you to stop by and check them out.

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