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June 24, 2010

Clamp Down on Your Spending Habits

If you're trying to increase savings, remember that savings are directly tied to spending -- the less you spend, the more you have to save. Some tips to help you clamp down on your spending include:

• Analyze your spending for a month. Are you surprised by how much you spend on dining out, groceries, entertainment, or clothing? Give serious thought to your purchasing patterns, looking for ways to reduce spending. Clean out your closet and really assess whether you need new clothes. Cut back on how often you dine out or at least go to less-expensive restaurants. Rent a movie instead of going to the theater. Make a list before grocery shopping and don't deviate from it. Look for coupons and sales before shopping.

You may scoff at these ideas for saving money, thinking you can't possibly add much to your savings. After all, you're just spending a few dollars here and there. But over a long time period, even modest amounts can grow to significant sums.

• Go over major expenditures also. When was the last time you comparison shopped your auto or homeowners insurance? Have you checked mortgage rates lately to see if you should refinance? Have you reviewed strategies to reduce your income taxes? Take a look at all major expenditures, looking for ways to save money.

• Make a spending plan and put it in writing. Budget for all major expenditures and resolve not to purchase items that aren't in your budget.

• Throw out your credit cards (or at least hide them for a while). Most people find it more difficult to spend cash than to charge a purchase. So, for the next couple of months, make sure to only purchase items with cash.

• Don't purchase items over a fairly low dollar amount on your first shopping trip. How often have you purchased something on impulse, only to realize when you got home that you really didn't need it? To control those impulses, compare price and value on your first shopping trip. Then go home, think about whether you really need the item, and purchase it on another trip. Often, you will find that you realize you don't even need to make the purchase.

• Think carefully before making major purchases. Often, upkeep and maintenance can add significantly to your costs. Consider a less-expensive car or a used car. Keep your car for four or five years instead of getting a new one every two or three years.

• Figure out the maximum amount you can afford for a house and then buy one substantially less expensive than that. Not only will you save on your mortgage payment, other costs associated with owning a home will be lower. Living well within your means is one of the best ways to ensure you have money left over for saving.

June 16, 2010

Estate Distribution to Grown Children

When your children were young, your primary concern was probably how to provide for them in the event you and your spouse died. Even though they may now be grown, your children are probably still the center of your estate plan. Just because they are adults doesn't mean that you have to leave their entire inheritance to them outright. Consider these factors first:

Do you want to distribute your estate gradually? If substantial assets are involved, you may want to set up trusts to distribute your assets gradually, such as in thirds when each child reaches ages 25, 30, and 35. You can always give the trustee power to make early distributions for items like paying for college, starting a business, or purchasing a home.

Have you selected a trustee carefully? If trusts are involved, you want a trustee who is impartial and will deal fairly with all your children. Think twice before naming one of your children as trustee. One sibling in a position to decide what happens to another sibling's inheritance can cause disagreements between them.

Have you thought about the consequences of a child divorcing? You probably don't want a portion of your assets distributed to an ex-daughter-in-law or ex-son-in-law, so special provisions may need to be added to trusts.

Have you considered how assets will be distributed among children? Perhaps one child is better off financially than your other children. Do you divide your estate equally or give less to the financially well off child? Children often feel a right to an equal share of their parents' estate, even if they have a substantial estate of their own. If you decide to make unequal distributions, be sure to explain why personally or in a letter left with your estate planning documents. Hopefully, this will prevent hurt feelings or disagreements among siblings.

Do you need to make special distributions to even out inheritances? Perhaps you have paid all college costs for some children, while other children have not attended college yet. You may want to ensure that all children receive a college education, and then distribute the rest of your estate equally among your children.

Should you coordinate your estate plan with your children's estate plans? If your children have substantial estates of their own, it may not make sense to leave additional assets to them. They may prefer those assets go directly to their children, helping to minimize family estate taxes.

Have you explained the need for estate planning to your children? Especially if you are leaving a substantial estate to your children, they may need to plan their own estates. You don't need to dictate what they should do with their estates, but gently remind them why they need an estate plan. After major life events, such as marriage, divorce, or a child's birth, remind your children to revise their estate plans.

June 8, 2010

Get Your 401(k) Plan On Track

To make sure you have sufficient funds for retirement, you need to get your 401(k) plan on track. To do so, consider these tips:

Increase your contribution rate. With investment values down and future stock market returns uncertain, you need to boost your savings to help increase the value of your 401(k) plan. Strive for total contributions from you and your employer of approximately 10% to 15% of your salary. At a minimum, make sure you're contributing enough to take advantage of all employer-matching contributions.

Rebalance your investments. You can't select your investments once and then just ignore your plan. Review your allocation annually to make sure it is close to your original allocation. If not, adjust your holdings to get your allocation back in line. Selling investments within your 401(k) plan does not generate tax liabilities, so you can make these changes without tax ramifications. Use this annual review to make sure you are still satisfied with your investment choices, and your allocation is still appropriate for your situation.

Don't raid your 401(k) balance. Your 401(k) plan should only be used for your retirement. Don't even think about borrowing from the plan for any other purpose. You don't want to get in the habit of using those funds for anything other than retirement. Similarly, if you change jobs, don't withdraw money from your 401(k) plan. Keep the money with your old employer or roll it over to your new 401(k) plan or an individual retirement account.

Seek guidance. It is important to manage your 401(k) plan carefully to help maximize your future retirement income. If you're concerned about the long-term impact of the recent market declines, call for a review of your 401(k) plan.

June 3, 2010

Coming to Terms With Stock Market Volatility

With all of the volatility in the stock market over the past few years, it can be difficult to determine how to devise an investment strategy to help reach your financial goals. To help you determine a reasonable rate of return to expect on your stock investments, it might be instructive to review some "facts" about the stock market:

The stock market's historical return can change dramatically depending on the period considered. For instance, from 1926 to 2008, the Standard & Poor's 500 (S&P 500) had an average annual return of 9.6%. From 1984 to 2008 (25 years), the average return was 9.2% and 6.4% from 1999 to 2008 (10 years).*

The market tends to revert to the mean. There is a tendency for the stock market, when it has an extended period of above- or below-average returns, to revert back to the average return. Thus, following an extended period of above-average returns in the 1990s, the stock market experienced a significant downturn, bringing the averages back in line.

History may not be a good predictor of future returns. The expected rate of return for your investment program is typically based on an analysis of past returns, since no one can predict future returns. However, realize that those returns may not be replicated in the future. During much of the stock market's history, the United States was in a substantial growth phase as it grew from a struggling nation to a superpower. Growth in the future may not approach those levels, which could dampen stock returns.

The pattern of actual returns affects your investment balance. Even if you get the average rate of return exactly right, your portfolio's balance will depend on the pattern of actual returns during that period. Some years will experience higher-than-average returns, while other years will have lower or even negative returns. If you experience high returns in the early years, your portfolio's value will be lower than if those returns occurred in the later years. If you encounter negative returns in the early years, you will have a higher balance than if those negative returns came in the later years.

Historical returns do not include several items that investors must deal with. Two of the most significant items not accounted for in historical returns are inflation and taxes. Over the long term, from 1926 to 2009, inflation averaged 3.0%.* Short-term capital gains are taxed at ordinary income tax rates of up to 35%, while long-term capital gains and dividend income are taxed at 15% (0% for taxpayers in the 10% and 15% tax brackets).

Investors have a difficult time earning historical returns. Several studies have found that investors' returns tend to lag the overall market, since investors have a tendency to buy high and sell low. One study found that the average investor's return is at least 2% lower than the market return (Source: Money, January/February 2010).

What does all this mean to an investor? When designing an investment program, use a conservative estimated rate of return, since it may be difficult to earn the historical returns of the past. It's easier to start out with a lower expected rate of return and find out later that your actual return is higher, which means you just need to save less. However, if you use a higher estimated rate of return than you actually earn, it may be difficult to increase your savings to make up for that difference.

Consider these strategies when designing your investment program:

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 based on 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. That may mean you'll need to work overtime or take on a second job to provide additional income. Another strategy is to reduce your living expenses and save the reductions.

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 or dividend income rather than ordinary income. Minimize turnover in your portfolio, so unrealized gains can grow for many years.

Adequately diversify your investment portfolio. Typically, you do not know which asset class will perform best on a year-to-year basis. Diversification is a defensive strategy -- it helps protect your portfolio during market downturns and helps reduce your portfolio's volatility. Diversify your investment portfolio among a variety of investment categories, such as stocks, bonds, cash, and other alternatives. Also diversify within investment categories.

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 2010 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 returns.


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