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October 31, 2007

How To Avoid Credit Problems

Most people do not realize that having a good credit rating in today's economy is very valuable. Having a bad credit rating can result in having a negative financial profile that can cause many problems when you have a legitimate need to borrow money. Consider trying to purchase a home without a mortgage. A bad credit rating can adversely affect your application for a home mortgage. It is essential that you value your credit rating in order to be able to have the necessary use of credit that will enable you to live the life your wish to enjoy. Here are a few tips to avoid getting into credit problems:

1. Avoid the need for status to overcome your common sense. It is very easy to succumb to temptations of having what the "Jones's" have. It is nice to be able to say you have that big screen T.V. with all the technological advantages offered today, but it all comes with a big price tag. Is it really necessary and affordable? How much debt do you have to go into to get these technical marvels? Consider how much interest you will be paying out by buying it on credit. Calculate the bottom line, which includes the price of the object plus the interest you will have paid when you finish paying off the item. Is it really worth that dollar amount? If you add enough items purchased on credit, will you be able to afford all the monthly payments on top of your usual monthly expenses like mortgage, water, telephone, etc? Wouldn't it be better to put aside an amount each month until you have the money to pay for each item outright?

2. Avoid raising the limits on your credit cards. If your limits are raised, this increases the temptation to buy more. Credit card companies often notify you that they are raising your credit card limit in advance. You simply need to call or write to them and refuse the increase.

3. Avoid co-signing loans for someone else. Co-signing for another person's loan can be risky in that if they default on the loan, you are the one responsible for repayment. Then if you cannot pay it reflects on your credit rating.

4. Try to pay more than the minimum requested payment on your credit cards. It is easy to be tempted to just pay the minimum payment, but this will stretch out the length of time to pay off the balance because you will be paying only the interest and not the principal amount charged. You do not want to still be paying off the item even after it has long been discarded.

5. Before getting any credit card, make sure you know what the rate of interest charged on purchased items will be and what the annual fees are. Rates can vary widely among cards. If you must have a credit card, shop around for the one with the lowest rates.

6. Use credit cards only for emergency purposes.

7. If you do find yourself in a situation where your payments become unmanageable, consider taking out a debt consolidation loan. Many banks and financial institutions offer these loans to help you get back on track. What happens in this case is that the lender pays off all your existing creditors and combines the balance amounts into one payment, which results in you having a lower monthly payment.

8. If your personal status changes, let your lender know. In other words, if you and your spouse divorce you are partially responsible for any debt that you have accumulated together. It is not wise to let your responsibility for these loans affect your credit rating.

Your good credit standing can affect the rest of your life. It can affect you in being able to get a mortgage to buy that house you have dreamed of or the car you have always wanted. It can also affect your marriage in that money worries are the cause of many marriage break-ups. Using the above tips, learn to control your credit rating wisely.

October 29, 2007

Tips for Purchasing Life Insurance Wisely

Today's family does not only need to think about how they are provided for on a day-to-day basis, but also to consider what would happen if one of the primary income earners died. How would the rest of the family survive such a tragedy? What would happen to that family's future goals and dreams? Life insurance coverage may be unpleasant to contemplate, but it is a crucial part in planning for your family's future. Here are a few tips to consider when thinking about making a wise life insurance purchase:


The main people who need life insurance are ones who have others depending upon them for income support. In other words, if you have a spouse who requires your income to help support them or if you have children, you should have life insurance. Also, if your spouse is a non-wage earner, it may be advisable to have life insurance coverage on them. If your spouse dies you still may need to provide for child care, housekeeping duties or other expenses that would result from their death.


You need to consider how much life insurance you should have to adequately protect your family in case of the untimely death of the bread-winner. The general rule of thumb is to have five to eight times the amount of your annual salary. So if you earn $60,000 per year, multiply that amount by five (the least amount you should have) to have a policy face value of $300,000.


It is advisable to purchase a single policy per family, and put the entire coverage amount on that policy. You can add coverage on your spouse in the form of a rider on the primary policy. Why is this advisable? Generally life insurance policies have a fee for processing and administration for each policy taken out. A primary policy with a spousal rider would be more economical in that separate polices would mean separate administration fees added on.


In most cases, life insurance on children is not necessary. However, it may be advisable to purchase a child rider attached to primary policy in order to cover burial expenses in the case of your child's death. No one wants to make money if their child dies, but having enough to cover burial expenses can relieve a little of the burden a parent will ultimately face at that tragic time.

Purchasing a life insurance policy that has a savings portion attached for the child's future education should be looked at very carefully. In most cases, purchasing a rider on the primary policy and saving for the child's education in a separate investment vehicle will yield a better rate of return.


Many financial experts agree that adding a savings portion to your life insurance may not be the best way to invest your money. Life insurance should really be just about that--protection for loss of income in the event of untimely death. Investing your money in a separate investment vehicle usually earns a higher rate of return.


Generally extra options added to your policy means that the cost of your life insurance premium may go up. This could result in you not be able to get the most amount of life insurance to adequately cover your family. An exception to this may be a Waiver of Premium benefit. This provides for payment of your premium if you become disabled for a period of time.

Ultimately, take into consideration what your family will need if you were not there to provide for them. Consider the long-term goals you have for your children, such as saving for university. Your goal when buying life insurance is to get the best value for your money. Keep this in mind when purchasing your life insurance policy. The decisions you make when buying your policy today can seriously affect your family and their quality of life in the event of your death.

October 26, 2007

How Important Is It To Have Life Insurance?

One of the hardest experiences we ever face in life is dealing with the loss of a loved one. But, at this crucial time each of us must overcome our overwhelming feelings and deal with the hard issues at hand, those being the final arrangements. It is hard enough to deal with the death at hand, but it would be harder still to have to worry about the costs involved with the funeral arrangements. That is one reason why life insurance is so important. Having a life insurance policy ensures that at this crucial time you will not have to worry about the costs involved with a funeral, which can add up to a lot of money. There is the price of the coffin, burial plot, funeral home, luncheon, grave monument, etc. At this time, it is hard enough to do all that has to be done without distressing yourself over money.

But, having the final expenses taken care of is not the only reason to have a life insurance policy. If it was your spouse who passed away and they were the major bread-winner of the family, losing their income could greatly alter your life. You already need to deal with your loss, but having to change your lifestyle could make it even more difficult. The money you receive from the life insurance policy could be invested so that you could receive an income equal to that of your dying spouse in order that you would not have to alter your lifestyle. Then you would have enough to cover the bills that you need to pay, the same as before the death occurred.

Not having a life insurance policy can also affect your children and their future. Again, if it was your spouse who died, their income will not be available to help pay for your children's upbringing and future education needs. Let's face it. Raising children in this day and age is not cheap. Having to pay for food and clothing, as well as all of their extra activities, is important. Keeping your children in the activities they are used to also makes it easier for them to carry on with their more normal lifestyle. Keeping their lifestyle as close to what they are used to as possible will help them in overcoming their own grief. Money from the life insurance policy can also be put aside to be used for their university or college in later years. In this case, for your children's benefit, it is equally important to have life insurance on both parents. Even if the mother is a stay-at-home mom and she is the one who passed away, you will need to replace her duties in babysitting fees, house-cleaning services, etc.

One more issue with life insurance is the one in whether or not you should have a policy on your children. Many people scorn this saying that they do not wish to benefit monetarily in any way from their children's death. No one wants to gain anything from the death of their child. This does not have to be the case, but a small policy (enough to cover the final funeral costs) will enable you to better handle the grief without having to worry about the final expenses.

Although not one likes to think about losing a loved one, or having to pay a small monthly premium for a life insurance policy, as shown above, it can be very important to have one.

October 24, 2007

What Fees Are Included in the APR or Annual Percentage Rate?

Financial lenders calculate the APR or annual percentage rate using a formula that takes into consideration the various expenses associated with the mortgage. Some fees are always calculated into the equation while others are never included. In fact, some fees are considered when calculating the APR by some lenders, but not by others.

This disparity leads to a misleading comparison and increases the difficulty for borrowers in selecting their lender. Perhaps one of the best ways to understand the APR or annual percentage rate is to look at the fees that are included in the calculation as well as those that are associated with a transfer of real estate but not included in the APR calculation.

The fees that are usually included in the APR are:
• Loan processing fee- the fee charged by the lender in order to process the mortgage.
• Document preparation fee- typically paid to the lender or lender's agency for preparing the sale documents.
• Underwriting fee- usually goes to a paid staff member.
• Discount points- the points that a borrower pays to receive a lower interest rate.
• Origination points- the points that a borrower pays to receive a specific interest rate.
• Private mortgage insurance cost, if applicable- the fee that is charged to obtain private mortgage insurance if the down payment is less than 20 % of the value of the home.
• Pre-paid interest amount- the initial amount of interest that is charged on the mortgage.

The fees that are included in the APR some of the time are:
• Credit life insurance cost or the cost of the insurance premiums for a policy that pays the mortgage in the event of the mortgage holder's death.
• Loan application fee or the fee that is charged to process the application.

Fees that are rarely included in the APR because they usually go to third parties are:
• Attorney fee- if one is used.
• Notary fee- typically a minimal fee.
• Title fee- charged by the title company.
• Recording fee- charged by the government office to record the transaction.
• Escrow fee- applied only to first mortgages.
• Credit report- charged by the credit bureau in order to process the report.
• Appraisal fee- charged by a professional appraiser when warranted.
• Transfer taxes- charged by the government for the transfer of the real estate property.
• Document preparation fees- charged by the realtor.
• Home inspection costs- typically paid by the prospective buyer of a property to a legitimate home inspector.

October 22, 2007

Private Mortgage Insurance or PMI

Private mortgage insurance is often referred to as PMI. Since many homeowners are required to purchase PMI, it's an important term to understand. Essentially, PMI is intended to provide financial security to the lender in regard to his share of the financial investment. When the down payment on the home is below a certain percentage (20%), PMI is required in order to provide the security or collateral required for the mortgage.

Should the homeowner go into default and fail to make his required payments on the mortgage, the lender is protected. Likewise, should the homeowner be unable to amass a down payment large enough to satisfy the 20% scenario, he can still acquire a mortgage and thereby purchase his first home.

PMI is purchased through a private insurance company and since it is tacked onto the mortgage payment, it essentially increases the amount that a homeowner has to put out each month on top of the monthly portion of taxes, homeowner's insurance, and mortgage payment. The premium or monthly payment is typically added to the mortgage payment.

In the event that a homeowner reaches a point that he has paid a sufficient amount into the principle portion of his mortgage to reach a loan balance of 80% of the home's appraised value at the time of its purchase, he is in a position to cancel the PMI. However, certain conditions must also be met including no late payments 30 days or longer within the last year and no late payments of 60 days duration or longer within the last two years. If these conditions are met, then the homeowner can request a cancellation of the PMI from his lender.

In order to avoid paying PMI, potential homeowners who have less than the required 20% of the home's value for a down payment often take out two mortgages. With the primary mortgage, the homeowner places the minimum 20 % down payment to avoid PMI. This amount is much smaller and more affordable than it was when the homeowner was contemplating only one mortgage.

October 19, 2007

Home Selling Tips - On the Cheap

Let us say that you decide to sell your home. Maybe you need a larger or smaller home, or you are transferring to a new location due to employment. Or like so many people today, you are retiring. No matter what the reason, you choose a real estate agent, sign all the paperwork, and sit back to wait for a buyer. Wrong!

Your real estate agent can advertise your property, display photos on a web page, set up a virtual tour, contact people who live in the area, etc., but you should become your agent's partner. There are many inexpensive ways you, the seller, can insure a buyer chooses your home over the one for sale down the street.

First of all, set your price realistically. Your agent can supply comparable listings for homes currently on the market and recently sold to help you arrive at a reasonable selling price. If you do that, your home should attract potential buyers, but that will not guarantee a sale. However, if you follow the suggestions below, you could be packing to move in a short period of time. These recommendations will not break the bank, but they will make a huge difference in finding a buyer.

Start with the outside - yard, fencing, garage and sheds, and landscaping. These are what potential buyers see first, and good impressions count. Many buyers have been turned off by an unkempt yard, grass that needs mowing, tools and toys scattered everywhere, plants choking on weeds, and broken down vehicles taking up space. Some buyers will ask to see the next home without even viewing the inside of yours. Clean up, clear up, and put up.

Drain wading pools into the street to avoid mud puddles in the yard. Keep a spa or pool clean and inviting. If you are using a garage or shed for storage, stack boxes neatly against the walls to let buyers see how much room there is. Take a hard look at the complete premises. Remove fussy yard art and wind chimes that clang loudly or are in need of repair. Replace torn door and window screens. Repair cracked or broken windows. Store firewood neatly away from your home, but within reach for use on a cold or rainy night. Keep pet areas clean and remove pet fecal matter daily. Or consider farming out your pets until your home sells. Shore up sagging rain gutters. Fill cement cracks in patio floors and driveways. Remove oil stains.

Teach your children to park their bikes and scooters in a designated place after use. Replace missing roof tiles and shingles. Remove soot and brush out chimneys and wood stove piping. Keep trash cans out of sight. If necessary, build a small fenced or latticed area to hide trash cans. Clean the barbecue. Nothing like the smell of grease or seeing built up food particles stuck to the grill to make buyers wonder what else you have neglected. Use a pressure nozzle to hose down your home, especially getting rid of spider webs near window and door frames. Contract with a pest company to spray the premises on a monthly basis.

Inside your home, pay attention to the walls, ceilings, windows, doors, appliances, and flooring. Clean door surfaces inside and out. Do not forget the jambs. Fingerprints can build up over time. Be sure door handles and locking mechanisms work smoothly. Repaint doorway trim if it is starting to look shoddy. Clean windows inside and out until they gleam. Remove cobwebs from vaulted ceilings and those hard to get at areas behind stairwells, under stove hoods, all the way back on closet shelves, and around lighting fixtures. Move and clean under and behind large appliances. Be sure appliances are all in working order. Clean out under the sinks. Put items you use often in plastic containers and put back under the sinks. It will be much easier to keep them in order and they will look neat when buyers open the cabinet doors. And speaking of cabinet doors, replace broken hardware on cabinets and drawers.

You have cleaned the outside chimney and wood stove pipes, now clean the inside. Use a cleaner such as TSP to remove soot from walls and ceilings. Clean carpeting and drapes and wash throw rugs and curtains. If frayed, replace them. Change heater filters monthly in winter. Provide kids with extra plastic storage bins to keep toys corralled. Uncrowd closets by storing off season clothing.

Remove and store large items not being sold with the home, such as chandeliers, sound systems, gun safes, and outdoor grills. Buyers who see these may expect them to be part of the sale. Hang mirrors in dark rooms to reflect light. Empty trash cans daily and do not let newspapers and magazines pile up. Keep cosmetics together in plastic bins in the bathroom and bedroom. Put dirty dishes in a dishwasher, not in the sink or on counter tops. Use light-colored lamp shades and replace burned out light bulbs. Remove Afghans and throws from couches and lounge chairs. Keep dirty clothing in hampers. Wash clothes more often, if necessary. Clean and wax sliding door tracks.

This next suggestion may seem a little harsh, but it is important. Remove family photos, awards and diplomas, religious symbols, and kids' artwork. Pack them up, since you will most likely be moving soon, anyway. Make it easy for the buyers to picture their family living in the home. In addition, you do not want to give the buyer an advantage over you. If they can surmise your income from diplomas, it may affect how much they offer for your home. If they believe you will have to move before school starts in the fall, they may feel you will take a lower offer just to get settled in your new home in time. If they think you practice a strange religion, they may not even make you an offer. In addition, do not leave prescription bottles out in the open. You do not want to give away family medical conditions that may bring in a lower offer.

Ambiance can also play a large part in your home sale. Set the mood for buyers. Do not let wet towels accumulate in bathrooms or spa and pool areas. Clean up one room a day. Spend 5 to 10 minutes spiffing up the bathrooms each morning. Quickly wipe down the shower after use. Put bills and personal mail safely out of sight. If you do not have a desk, perhaps a dresser drawer can be used. Buyers often open cabinet drawers to see if they work smoothly. Buyers who see a stack of unpaid bills may make a lower offer, thinking you might be desperate to sell. Or if buyers see that you just inherited $100,000 from Uncle Fred, they may figure you do not need a full price offer.

Unclutter your home. Keep it simple. Store large furniture that you can do without for a few months. You will have to pack everything when you are ready to move, so start early. Make sure buyers have an easy pathway to get through your home without stepping over or around furnishings and other items.

Place comfortable toss pillows on sofas and chairs for a homey feeling. Set out candles, even if you do not light them. The fragrance will still be noticed when people walk by. Play soft background music. Turn off the television and loud music when buyers are present. Open windows daily when the weather allows in order to air out the house. Refrain from using strong smelling odor eliminators. Some people are allergic to these scents. If you smoke, do it outside away from doors and windows. Be sure you have removed nicotine stains from walls, especially rooms with moisture such as kitchens and bathrooms. Put away expensive jewelry, silverware, and other items that you cannot or do not want to replace. Keep fresh flowers in bowls and vases to give a welcome look. Put a few drops of vanilla extract on a napkin and toss it in the kitchen trash. It will make the room smell nice.

Encourage your kids and spouse to help get your home ready to sell. After all, it is their home, too. Once a home is ready to sell, it is easier and faster to keep it that way on a daily basis rather than the stress of trying to quickly clean up from scratch before a buyer visits. Ask your agent to add a note to the listing sheet requesting a 20 to 30 minute "heads up" phone call so you can do last minute clean ups. And this is not to suggest you will always be home when buyers visit. In fact, it would be better if you are not at home so buyers can feel free to converse with each other and with their agent. Go shopping, return books to the library, visit a friend, or run errands. If you return and the potential buyers are still at your residence, wait in your vehicle or leave for another half hour. Real estate agents will appreciate your courtesy and cooperation. Of course, this advice does not apply if you are selling your property without an agent, in which case do not hover when showing your home. Give buyers some privacy to talk amongst themselves from time to time.

As you can see, there are no huge expenses with these suggestions. They just require some time and effort on your part. And do not drive yourself crazy if you get a call and you are in the middle of your six-year-old's birthday party with kids running here, there, and everywhere. Explain to the calling agent what is going on and let him or her decide if it would be appropriate to bring their buyer for a showing. Then, if they show up, do not sweat it. Everyone knows families have get-togethers from time to time. Be casual, welcoming, and charming and the buyers will not think anything less of you or your home. In fact, it can be something that will cause your property to remain in the buyers' minds. Your home will be remembered as the place where the kids were playing Pin the Tail on the Dragon.

October 17, 2007

Consumer Confidence: Do You Have Any?

According to a Gallup poll taken 8/13-8/16/07, Americans are suffering from a lack of confidence in the economy. "The new poll finds current economic ratings down to 33% excellent or good and the percentage saying the economy is improving sinking to 20%." A majority of Americans are feeling the economic slump.

What does this really mean? How is your consumer confidence? Are you discouraged by your economic outlook?

Consumer confidence is a huge concept that cannot be adequately measured by a poll. However, the opinion of the country is definitely important. The perception of the economy affects the financial choices that people make, such as whether they will invest and how they will spend their money.

It is important to spend time thinking about your own consumer confidence. If you are tuned in to economic problems, you can adjust your lifestyle to match the times. If you ignore the economic downturn, you can overextend your credit limits and accumulate too many debts, digging a hole that will be hard to climb out of. The economic problems should encourage you to be cautious about your financial decisions and to do what you can to protect your job.

For people who lose their job, the economic outlook can be even more depressing. Whatever you situation, if your personal finances or the national economy are bringing you down, it might be time to talk to someone. You can seek help from a financial counselor or get involved in social networks that will provide you support when times get rough. The worst thing to do is to feel alone when you have a depressed economic view of things. Another way to survive economic decline is to move closer to your family. In troubled times, you can reach out to loved ones for support and benefit from sharing expenses.

Stay informed but don't overload yourself with depressing financial news. Try to focus on other positive things in your life. Ride out the slump in the economy. Just remember that things will have to get better eventually.

October 15, 2007

Teaching Your Child to Save

Our mortgage payments are high. The bills are mounting up. School fees and kids activities don't come cheap. Most parents are both working--some with two jobs each. It is difficult for adults to have any money left over to save. So how can we possibly teach our children to save? It is extremely important, however, that we do teach our kids the lessons of saving-especially when the costs of tuition for schooling are rising, the cost for weddings today is astronomical, they will benefit from a head-start for a down payment on a house, or they may even need to start saving for their retirement from early on.

One of the most important rules in teaching your kids to save is to start early. Even from very young ages children receive money from grandparents, aunts and uncles, family friends, etc. Start a separate bank account for your child immediately. When your child is too young to spend the money for themselves, put all the money they receive as gifts into this account. When they are old enough to know what money is all about, it will give them a boost to know that they already have something to get them started. Also, you are being the savings role-model for them to follow and it shows that you are serious about the importance of saving money.

After your children are old enough to know what money is all about, make it a rule that any money they receive as gifts should be split. Part of that $10 that Aunt Ruth gave them for their birthday should be put aside into their bank account as savings (say a percentage of about 20% or $2) and the rest they can spend. Make the percent amount a constant on all money they receive, so if they get more ($25) then 20% of the $25 should be put aside. The child still gets the fun of spending most of the money as the gift was intended to do, but still learns that putting aside some of it is a requirement.

Show your child their bank book from time to time so that they can see the amount in it add up. They will be proud to see what they have accomplished.

Make it known that the bank account is for their future, not for the simple things that are presently on their want list. If they want a particular item that costs a lot, show them how to save for it outside of their bank account. Take them to the store to price the item (say it is a particular pair of running shoes that cost $120). When they receive money as a birthday or holiday gift of $50 from Uncle Joe, have them put the 20% into the bank account and the rest into a jar or piggy bank beside their bed. Then when Grandpa gives them money, the 20% again goes into their bank account, and the rest is added to the jar, and so on until the required amount for the shoes is obtained.

Encourage your children to get a job. Even young children can have chores to do around the house that you can pay them for, like taking out the garbage, sweeping up, raking leaves, cleaning the bathroom sinks, etc. The amount of the pay would be up to you. When they are very young, don't focus so much on the perfection of the job, but more on the requirement of them having to do the work in exchange for money. This teaches them responsibility for household chores as well as teaches them how to make and save money. Again, the 20% would go into their bank account and the rest they could spend.

Another way to get them to earn and save money is with your child's schoolwork. I know a lot of people don't agree, but isn't a child's job to go to school and earn good grades? If it is like an adult job, then encouraging them to get better grades by paying them for the level of grades they get is the same as an adult being paid for their accomplishments at work. So you could encourage your child to get better grades by paying them, say, $5 for every "A" they receive, $3 for every "B", $2 for every "C", etc. This not only encourages them to achieve better at school, but also gives them some more money into their bank account. The same 20% rule would apply.

Talk to your children about the importance of saving, and teach them the value of money. When they are old enough, probably in their early teens, have them read a book about the value of money. There are many good books out there on the subject. Pick one and have them read it. Then make up a simple test and test them on it to see how well they understand the important points. Again you can pay them for the results, 50¢ for each right answer, to ensure that they will actually read the book.

When your child is old enough and you deem that the time is right, you can turn the bank account over to them. This could be when they are starting college, when they are getting married, when they need a down payment for their house, or simply when you feel they are mature enough to handle it. Having this savings account could help them out a great deal in their future. But it like the old saying that says something like giving a hungry man a fish to eat today it a good thing, but that teaching him to fish is better. Giving your child the money they have developed in their bank account is great, but teaching them how to increase that amount is invaluable.

October 12, 2007

Technological Advancements and Economic Inequality

For the past two decades, the economy has experienced moderate inflation and fewer, less severe recessions. Technological advancements have helped raise productivity. Yet, these advances have mostly helped upper income workers. Why?

From 1973 to 2005, real hourly wages for individuals in the 90th percentile of income, typically those with college or advanced degrees, rose by 30% or more. For individuals in the 50th percentile or below, typically those with at most a high school diploma, real wages increased by only 5% to 10% (Source: FRBSF Economic Letter, December 1, 2006).

In large part, this increasing wage inequality is caused by a widening gap in wages between college graduates and those with a high school education or less. In spite of increased college enrollment, it appears that the demand for college graduates has been stronger than the supply. This increased demand is a result of increasing usage of technology, such as computers, which has changed the nature of work and the skills needed for that work. There is greater demand and higher wages for workers who have the skills to use these technologies effectively.

Another major factor in this inequality is increasing globalization of labor markets. The United States tends to export goods that use skilled labor and import goods that use less skilled labor. That places more demand in the United States for skilled labor and less demand for less skilled labor.

Job instability has also increased, which can affect a family's income. Approximately one in three workers change jobs every year, with approximately half doing so on a voluntary basis. Involuntary job loss results in unemployment for approximately four months, and new jobs typically pay 17% less than the former job (Source: FRBSF Economic Letter, December 1, 2006).

Due to all these factors, it is now increasingly likely for a family to experience a decline in annual income. The odds that a family will experience a 50% drop in yearly income has more than doubled since the early 1970s, rising to approximately one in six families (Source: FRBSF Economic Letter, December 1, 2006).

October 10, 2007

The Value of Your Social Security Benefits

For years, we've heard that Social Security benefits are at best modest and should not be counted on as our only source of retirement income. Sometimes, it's even suggested to completely forget about Social Security benefits when planning for retirement, because changes in the system will probably be necessary when the huge number of baby boomers start retiring. But the fact is that Social Security benefits are a very valuable benefit, especially since benefits are adjusted for inflation annually.

For instance, the maximum Social Security benefit in 2007 for workers retiring at full retirement age is $2,116 monthly. While that might not seem like that much money, consider how much you'd need to accumulate to generate that monthly income. A 66-year-old male would have to pay approximately $420,000 for an annuity that would pay $2,116 monthly for life with annual inflation adjustments, while a 66-year-old woman would pay approximately $468,000 (Source: Vanguard, 2006). Suppose you want to invest the assets yourself. A common rule of thumb is you should withdraw no more than 4% annually. Thus, to generate a monthly income of $2,116, you would need assets of $635,000.

While it's easy to dismiss the value of Social Security benefits, that value becomes apparent when you realize how much is needed to generate that income. Although no one knows how the Social Security system may change in the future, benefits currently paid are very valuable to retirees.

October 8, 2007

"Kiddie Tax" Age Gets Raised

The Small Business and Work Opportunity Tax Act of 2007, signed into law on May 25, 2007, raised the age limit for application of the "kiddie tax" to all children under age 19 (previously age 18) and to students under age 24, effective for tax years beginning after May 25, 2007. Just last year, the "kiddie tax" age limit was raised from under age 14 to under age 18. There is an exception to these new age limits. If the earned income of an individual over age 17 exceeds half of his/her support, the "kiddie tax" does not apply. Scholarships are not considered a part of this test.

The "kiddie tax" refers to the manner in which unearned income is taxed for children. In 2007, the first $850 of unearned income is tax free, the second $850 is taxed at the child's marginal tax rate, and any remaining unearned income is taxed at the parents' marginal tax rate. Once the individual exceeds the age limits, all unearned income is taxed as his/her marginal tax rate.

This change effectively eliminates a common college funding technique of gifting investments to the child as he/she approaches college age and then having the child sell the assets to take advantage of lower capital gains tax rates (5% if the child is in the 10% or 15% tax bracket, instead of 15%). Some families were planning to postpone asset sales until 2008 to 2010, when the long-term capital gains tax rate would be 0% for taxpayers in the 10% or 15% tax bracket.

Since the provision will typically not apply until 2008 for most taxpayers, individuals under age 24 may want to sell assets in 2007 to take advantage of the 5% capital gains tax rate. Another alternative would be to wait until a student turns age 24 to sell the assets. However, there is the possibility that the individual would immediately start working at a job that would put him/her in a higher tax bracket, so the 15% capital gains tax rate would have to be paid anyway. The capital gains tax rate is scheduled to increase from 15% to 20% after 2010, unless further legislation is passed.

To minimize the effects of this new provision, taxpayers with children under age 18 should reevaluate their investments, looking into investments that generate little or no taxable income. Another alternative, if you are saving for a child's college education, is to invest the child's assets in section 529 plans or Coverdell education savings accounts, which provide tax-free distributions as long as the funds are used for qualified education expenses. If the child has earned income, he/she can also set up a traditional or Roth individual retirement account.

Taxpayers who own a business may want to employ their children, especially those in the 14 to 24 age group, since earned income is not subject to the "kiddie tax" rules and is taxed at the child's marginal tax rate. There is added incentive to do so for students over age 17, because the "kiddie tax" rules won't apply for that year if the individual's earned income is more than half of his/her support.

October 4, 2007

How to Assess Stock Returns

When designing an investment program, your expected rate of return is a critical element in determining how much to periodically invest to help reach a future goal. Since no one can predict future returns, the expected rate of return is typically estimated based on an analysis of past returns for various investments. So what return can you expect in the future for stock investments? The average annual return for the Standard & Poor's 500 (S&P 500) for the period from 1926 to 2006 was 10.4%, but you don't want to simply use this return without determining whether it is reasonable for the future.*

A starting point for making that assessment is to review the equity risk premium. Since stocks are generally considered more volatile than bonds, investors typically expect a higher return. This excess return is called the equity risk premium. Although there are many complicated methods to calculate this premium, a simplified approach calculates the difference between total returns for large-company stocks and long-term government bonds.

For the period from 1926 to 2006, that difference was 4.5%.* However, the annual equity risk premium fluctuated significantly during this period. For the near future, is this a reasonable expectation? It may not be for a couple of reasons. First, even though price/earnings (P/E) ratios have declined, they still remain at high levels. Since corporate profits are not expected to increase as rapidly in the future, P/E ratios may not return to previous levels. Second, a significant portion of the equity risk premium results from dividends, which are at low levels. Third, investors can develop a preference for one asset class over another, which can drastically change the premium.

If the equity risk premium does decrease in the future, total returns will be lower than historical averages. Only time will tell if this will happen. However, it may be prudent to consider a lower return for investment programs than historical returns would suggest. To compensate for potentially lower returns, consider the following strategies:

Take a fresh look at your financial goals. Reevaluate your goals, how much you need to reach them, and how much you should be saving annually considering lower expected returns.

Save more of your income. If you can't count on returns to provide growth in your portfolio, you should compensate by saving more of your income.

Invest in a tax-efficient manner. Taxes are often a significant investment expense, so using strategies to defer the payment of taxes can make a substantial difference in your portfolio's ultimate size. Utilize tax-deferred investment vehicles, such as 401(k) plans and individual retirement accounts. Or emphasize investments generating capital gains rather than ordinary income.

Don't concentrate your investment portfolio in one category. Diversify so when one asset class declines, other assets will hopefully be increasing or not decreasing as much.

Evaluate your portfolio's performance annually. That way, if returns are lower than you targeted, you can make adjustments to your strategy to compensate for these variations in return.

* Source: Stocks, Bonds, Bills, and Inflation 2007 Yearbook. The S&P 500 is an unmanaged index generally considered representative of the U.S. stock market. Investors cannot invest directly in an index. Past performance is not a guarantee of future performance.

October 3, 2007

How to Evaluate a Stock Investment

You should thoroughly analyze a stock before purchase. However, if you pick up a company's annual report you can quickly become overwhelmed by all the numbers. What figures should you concentrate on when evaluating a stock? At a minimum, you should look for answers to these eight questions:

What are the company's earnings? Earnings per share (EPS) is the company's net income after taxes and preferred stock dividends divided by the average number of shares outstanding. Look for steadily increasing EPS, which shows a pattern of consistent growth.

How does the company's price relate to earnings? The price/earnings (P/E) ratio is calculated by dividing the company's stock price by EPS. It basically indicates how much investors are willing to pay for a dollar of the company's earnings. P/E ratios can be calculated using different earnings numbers. Trailing P/E ratios use earnings per share for the most recent four quarters, while forward P/E ratios use forecasts of future earnings per share. To get a feel for the reasonableness of a company's P/E ratio, review its historical P/E ratio, the P/E ratio of other companies in similar industries, and the P/E ratio of the market as a whole.

How does the company's book value relate to its price? A company's book value equals its assets less its liabilities, commonly referred to as stockholders' equity. Dividing the stock's price by its book value per share will give you the price-to-book value. Companies with low price-to-book values are often considered value stocks.

What is the company's return on equity? Return on equity (ROE) is calculated by dividing the company's income by its shareholders' equity. It is used to measure how well a company is utilizing capital retained in the company.

What is the stock's total return? Total return equals dividends plus or minus changes in stock price divided by your purchase price. This is the overall measure of the stock's performance and is useful when comparing one investment with other investments.

What is the company's debt level? The debt ratio is the company's outstanding debt divided by shareholders' equity, which measures how leveraged a company is. High levels of debt can make a company more vulnerable during economic downturns. Also take a look at the current ratio, which is calculated by dividing current assets by current liabilities. It is a measure of a company's ability to pay its current obligations.

What is the company's growth rate? A company's growth prospects can be evaluated using the price/earnings growth, or PEG, ratio, which is calculated by dividing the P/E ratio by the company's projected earnings growth rate. A PEG ratio of one is considered standard, meaning the growth rate is incorporated in the stock's price. A PEG ratio higher than one means the stock is trading at a premium to its growth rate, while a ratio of less than one may mean the stock is undervalued.

How volatile is the stock? Beta is a statistical measure of how stock market movements have historically impacted a stock's price. By comparing the movements of the Standard & Poor's 500 (S&P 500) to the movements of a particular stock, a pattern develops that gauges the stock's exposure to stock market risk. The S&P 500 is an unmanaged index generally considered representative of the U.S. stock market and has a beta of one. A stock with a beta of one means that on average it moves parallel with the S&P 500. A beta greater than one means the stock should rise or fall to a greater extent than movements in the S&P 500, while a beta less than one means it should rise or fall to a lesser extent than the S&P 500. Since beta measures movements on average, you cannot expect an exact correlation with each market movement.

The decision to purchase a stock can't be made solely from a review of financial ratios. You will also need to evaluate subjective factors, such as the quality of management, prospects for the company's industry, and where the company stands in relation to its competitors.


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