What Happens When The Fed Raises Interest Rates?

Finance Gourmet on March 27, 2015

There has been a lot of talk recently about the Federal Reserve raising interest rates. First, remember that the Federal Reserve only actually sets interest rates for banks. Specifically, the Fed sets two interest rates. The first interest rate, called the Discount Rate, is the interest rate the Fed charges banks for an overnight loan. The second rate is called the target rate, and this is the interest rate the Fed tries to achieve via the open market operations.

Since the monetary crisis that started off the Great Recession, the Federal Reserve’s target interest rate has essentially been zero. The purpose of such a rate is to make it more worthwhile for banks to lend money. The idea is that more money in the economy stimulates additional growth. The economy is still growing very slowly, but it is still growing, which brings us to raising interest rates.

Interest Rates Growth and Inflation

fed raising interest ratesIn physics, basic equations come with the caveat that they are true, on a friction-less plane, in a vacuum. In other words, if there is no gravity or wind resistance. Such calculations are useful for understanding concepts, but would be devastatingly inaccurate for use in the real world. Likewise, many economic concepts can be reduced to simplicity by ignoring a host of real world factors.

Once we ignore all of the other influences on the economy, we get the concept that if money is cheap (interest rates are low), then consumers and businesses will spend it on new equipment, new goods, new services, etc. This spending allows other consumers and businesses to have money to spend, and so on and so forth. This is considered “stimulative”, which means that it helps the economy grow.

If the economy grows too fast, then inflation occurs (again, this is only in the simplest of models, there are a lot of real world factors that matter here as well). Inflation occurs because money is “cheap.” That is, too many people have too much money. If we use the equally simple model of supply and demand, it looks something like this:

Widgets cost $100. With low interest rates and lots of spending, then a lot of people have extra money to spend on widgets. Since more people are buying widgets, there is more demand, and the company will raise the price of widgets accordingly. When this happens across the economy prices rise, and inflation occurs.

To prevent this, the Federal Reserve can do the opposite of lower interest rates. When the Fed raises interest rates, then it becomes more advantageous to save some of that money rather than spend it. Also, it becomes more expensive to borrow money, so consumers and businesses are likely to cut back spending rather than expanding their credit.

Back to our widgets, if the demand falls (or better yet, never increases enough to generate higher prices in the first place) then prices stop rising and inflation is “tamed.”

Target Inflation

In reality, inflation cannot be stopped. More people means more goods and services and more labor. There simply has to be more money to accommodate this. Thus, the Fed’s goal is not necessarily to eliminate inflation, but rather to keep it small. A growing economy is an inflationary economy, all other things being equal.

The trick for the Fed is to allow growth and a little inflation without allowing too much.

For some, the time to start raising interest rates is now.

What Happens When The Fed Raises Interest Rates?

When the Fed raises interest rates, the effects can take some time to come online. This is the difficulty of the Federal Reserve’s job. They must predict both what their actions will cause, and how long those effects will take to impact the economy, while also predicting what the economy itself will do in the mean time.

For consumers, the results tend to show up first in their credit card interest rates. Most credit cards have a variable interest rate equal to some benchmark interest rate plus some amount. So, when the Fed raises rates, the interest rate charged by your credit card goes up.

Likewise, banks will raise interest rates for new loans. That means instead of being able to afford a $35,000 car, maybe you can only afford a $32,000 car loan. Home loans are eventually effected to, indirectly.

Overall, the economy should slow its growth and prevent inflation.

The million dollar question is when it the right time. Too soon, and the economy stagnates or falls back into recession. Too late, and inflation takes hold before rates can rise.


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Finance Gourmet on March 23, 2015

Retirement planning is actually incredibly simple and straightforward for most people. However, it can quickly sound complex because of all the edge cases, exceptions, and possibilities that really only affect a small number of people. If you eliminate all of that noise, however, there really isn’t much to the average American’s financial plan. Follow the following information and there really is no reason you can’t make your own simple retirement plan.

Obviously, every situation is different. If you have unusual circumstances such as a coming inheritance, money in trusts, or other legal situations, this plan won’t work for you. If you have regular income, a family, and just need a plan, this is perfect for you.

Do It Yourself Financial Plan

simplify retirement planningOne of the things that quickly complicates financial planning is the idea that you have to predict how much income you will need in retirement. This step is a waste of time for 90 percent of people.


Because, for most people retirement saving and investing is about how much they can save, not how much they will need. To put it another way, consider this. If I tell you that if you can save $10,000 per month, you will have an amazing retirement, does that help you?

It only helps if you actually CAN save $10,000 per month. It’s completely irrelevant if you can only save $2,000 per month, or even $7,000 per month. Projecting your retirement needs is a fools errand. Not only is that number a complete guess, but it will change greatly over the course of your life.

Instead, for a simplified retirement plan, focus on how much you can save. Chances are you need to save more than what is comfortable for you, but you can’t do it today. So, what should you do?

Enroll in your 401k plan. No matter what you think you see or hear about better options, for 90 percent of working Americans, nothing is better than your 401k plan. What’s more, for most Americans, the maximum amount that you can put in a 401k plan is more than you have the ability to actually save anyway. So, just ignore all of that other stuff and start socking away as much money as you can in your 401k savings plan.

If you are contributing the maximum percentage, or if you are maxing out the highest possible 401k contribution for the year, skip to advanced retirement planning.

How Much Should You Save For Retirement Calculator

The next thing that overly complicates retirement planning is calculating how much you need to save. That number is based upon the previous calculation about how much you will need. Don’t bother. Trust me when I tell you that unless your expenses are a very low percentage of your income, then it is virtually impossible to over-save for retirement. In other words, just save as much as you can. If you’d rather see numbers than trust me, read on.

The maximum 401k contribution for 2015 is $18,000, or $1,500 per month. Put another way, that’s 10% for a person making $180,000.

Do you make $180,000 or more for the year?

If not, stop worrying about other kinds of retirement plans and load up your company 401k plan with as much money as you can afford to save for retirement.

For the best retirement, you’ll want to be saving 10 percent of your income at minimum. Can’t afford 10%? Most people can’t, at least not right away.

Here is how to build your retirement savings.

First, start by setting your 401k contribution as a percentage instead of a flat amount each paycheck. The result is that every time you get a raise, your contribution amount automatically increases thanks to the way percentages work. But, that’s not good enough if you aren’t already contributing 10%.

So, second, every time you get a raise, increase your contribution percentage by 1% until you reach 10 percent.

That’s it.

Do that, and you will have the best retirement you can afford.

Do I Need Advanced Retirement Planning?

That wasn’t so bad, was it? But, now you are thinking, about that one thing you read about. And, what about a Roth IRA, or shouldn’t I worry about…

Stop right there.

Let me break it down for you, in numbers, realistic financial advice style.

First, unless you are maxing out the full annual 401k contribution every year, chances are very unlikely that you are going to need to worry about your taxes in retirement. That means you don’t need to worry about getting any tax-free retirement income from things like a Roth IRA, or other tax-deferred retirement plan.

Unless you are maxing out your full 401k contribution, you most certainly do not need anything like an annuity, whole life insurance, or anything else to manage your taxes in retirement.

Fact: Unless you are in your 20’s and already pumping money into your 401k, chances are you will retire with around $1 million.

Fact: In order to never outlive your money, you’ll want to keep your withdrawal rate in retirement around 5 percent.

Fact: 5 percent of $1 million is $50,000 per year.

Fact: You do not need a way to “manage your taxes in retirement” if you are only have $50,000 per year in income.


  • $1,000,000 in retirement nest egg.
  • Withdraw 5% per year = $50,000 as taxable income (all gains inside account still tax-deferred).
  • Standard deduction for a couple (assuming you are married) = $12,600.
  • Taxable income = $37,400
  • Income tax on $37,400 for married filing jointly = $4,687 (2015 tax tables)

That’s an effective tax rate of a little less than 10%.

Do you pay less than 10% in taxes today?

Then, you are coming out ahead by getting the tax savings now versus a Roth IRA, or any other tax-free later retirement program.

If you retire with less than $1 million, then you have even less of an issue.

What about inflation? All of the numbers above will adjust with inflation, but there is a catch. Your salary, your taxes, and your final retirement number in the future will all be hire, but the end result is the same because those numbers tend to move up together over time. So, if you are 25 now, yes, you’ll retire with more than $1 million thanks to inflation. Of course, you’ll need 5% of whatever that amount is in order to live like the same as $50,000 gives you today.

If you have more than $500,000 in your 401k retirement plan today, or if you are maxing out your 401k contributions, you may need more advanced financial planning. Otherwise, stick with loading up your 401k until you either:

  • maxing out your 401k contributions and still want to save more for retirement


  • your retirement account balance is $500,000 or higher and you are more than 10 years from retirement

Coming soon:

I’ll be putting together an advance personal retirement planning guide soon, or make an appointment with a professional financial advisor. With that much money, you’ll be sure to get the attention you need.

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Finance Gourmet on March 19, 2015

According to a recent CNN article, the Social Security Office still has active (that is, not official deceased) numbers and records for 6.5 million Americans age 112 or older. There are only 35 total people living worldwide who are that age.

The problem?

social security numbersThese, so called, zombie social security numbers could be used, along with a fake birth certificate (or a lot of makeup) to create fraudulent IDs, credit cards, bank accounts, you name it. And, since the numbers are active, but not being used, no one will even be around to complain that accounts are being opened in their name.

The truly funny part about this is that the fix is so difficult, brought to you by the people who do bureaucracy best. If you aren’t a government employee, the (partial) fix is as easy as writing a small computer program. There are apparently 12 people that age still actively drawing Social Security benefits. If the total number of 112-year olds is even remotely accurate, than less than 20 people world-wide could still be alive, and counting on having that valid Social Security number. In other words, expiring every one of the 6.5 million numbers (except the 12 still collecting benefits, of course) would solve the problem in one fail swoop. If mistakes were made, it’s highly unlikely that those remaining 112-year olds that slipped through the crack (all 20 or so of them) would overwhelm the system to such a degree that any actual problems would occur.

Of course, that’s not the way the government works. There is no such thing as an “expired” number. It would take an act of Congress (and or a new promulgated rule, I don’t know for sure) to create such a designation. So, the only way to end a number is for it to marked as deceased. But, the SSA can’t just arbitrarily mark people as deceased, there are rules and procedures after all. Which means the only way for a death to be counted is for a hard copy death certificate to be sent, and verified, to the SSA. The vast majority of these people died long ago and no one is out there collecting death certificates for all of these 6.5 million folks, which means their numbers will never be expired.

In true Washington fashion, this is a punch-line news story for now. It will be again in a few years. Eventually, it will either be so ridiculous, or the use of those numbers will become so widespread that someone will actually HAVE to do something. Then, and only then, will anything come of the hand wringing about all those dead people out there with active, valid Social Security Numbers.


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Finance Gourmet on March 16, 2015

Once upon a time, businesses sold you goods and services. You paid once and then used them until they wore out, broke, or no longer served your needs. Then, you went and bought something new. This works pretty good for customers, but can be hard on businesses who have to constantly come up with new ways to sell you something. These days, business has found a better way to consistently fund it’s profit and loss statement, but it may have ruined its customer’s budgets along the way.

Little Subscriptions

When you make your budget for the month, chances are you properly account for those standard monthly bills like electricity, phone, cable, HOA dues, car payments, rent / mortgage, water, heat, and so on. Chances are also good that these payments eat up a fair amount of your budget.

But, are you accounting for all of those little subscriptions out there?

If you try replacing any of those above services, chances they come with different monthly subscriptions. Cutting the cord on your cable company? Netflix, or Hulu Plus are monthly subscriptions. You can also subscribe to Amazon Prime on a monthly basis. If you want to replace your DVR, Tivo wants a subscription fee equal to what Comcast charges to rent it’s DVR.

Lately, it seems like everyone wants to charge you monthly. At first blush, this can seem like a good deal, but these expenses come quick and easy, and can add up to a lot of money along the way. Like music? There are some free services, but if you like your music ad-free and with the ability to skip (or never hear) all the lame songs you want, you’ll need the premium version. Cost $9 per month.

It’s only $9, right?

True, but these days, there are A LOT of things out there wanting to use the subscription model.

I’ve had the Adobe Creative Suite for a long time now. I have version 4. That is no where near the current version, but it still does everything I need it to do, and best of all, it doesn’t cost me any money. If I want to upgrade though, Adobe wants me to SUBSCRIBE to the Adobe Creative Suite. I can get all the Adobe stuff for a whopping $30 per month, or just the photography stuff for $10 per month.

Again, it’s only $10, right?

Of course, I can do the same thing with Microsoft Office. Personal version is $7 per month, or I can install it on up to 5 PCs for $9 per month.

It’s still only $9, right?

The funny thing about the software, is that everyone has added it up and decided it’s a good deal. After all, it works out to the same cost, or even less, if you buy a full install version every time a new upgrade comes out. But, the catch is that most people don’t buy software every time a new upgrade comes out. They wait until they need new features, or their old version breaks down. It’s been years since I’ve paid a penny to Microsoft or Adobe, which is exactly why they want subscriptions.

More Monthly Charges

Software and music aren’t the only places you’ll find this new drive for subscriptions.

There are monthly subscriptions available for legal services, video games (World of Warcraft), online services for calling, sharing, or storing.

I used a Groupon for a massage last month. It was a good enough massage, but the business model of the place is for me to sign up for a monthly massage, even though I don’t usually get a massage every month.

In a lot of ways, these new subscriptions are like those coupons that offer you $1 off when you buy 4. Normally, you’d only buy one box of cereal, but you can save by buying more. I’ve noticed this seldom works out better for me. But, if I would like to increase the rate at which I get massages, I can get one a month for cheaper… I think… maybe…

Budget Those Little Monthly Charges

The most important thing is to make sure that you track and budget all of these monthly charges and make sure you are covering the cost. Seeing what they all add up to each month might also make you reassess the value of that “only $9 per month” charge you signed up for.

Sample Budget of Little Monthly Charges

  • Microsoft Office $9 / mo.
  • Adobe Photography Suite $9 / mo.
  • Spotify $9 / mo.
  • World of Warcraft $15 / mo.
  • Hulu $9 /mo
  • Tivo $15 /mo
  • Massage Place $49 / mo
  • Legal Services Plan $15 / mo
  • Investing Plan $15 / mo. (or percentage of your 401k?)
  • Carwash Subscription $11 / mo

And so on…

The list above runs $156 every month. That’s on top of your regular bills.

The key to getting these subscriptions right is to understand how you use these items and services, not how THEY show you they can be used. If you get your car washed once every 6 weeks, does a cheaper wash every 4 weeks save you money, or just make you wash your car more often?

In my case, buying Adobe on a Black Friday special deal every five or six years is clearly a better deal for ME and paying $10 every month, is clearly a better deal for THEM.

I guess maybe I’ll figure out how to use a different program… and I’ll definitely get my massages somewhere else, without a subscription.


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Finance Gourmet on March 12, 2015

For years, everyone involved in the TV or phone business has boosted their profits using increasingly dishonest tactics, all made legitimate by a few paragraphs of fine print on ever advertisement. For example, the advertised rate doesn’t actually include all of the costs necessary to use the package you are buying. There are plenty of add-on fees, plus modem rental, DVR rental, and so on, which I noticed not long ago when comparing Comcast to CenturyLink here in Denver, one of many articles about cable bill scams I’ve written over the years.

And, then of course, there is the gold standard of trickery, the limited-time offer, where your cable or satellite provider starts by offering you a reasonable competitive rate for a limited time. Then, your rate goes up, automatically, and all those great offers are for “new customers only.”

FTC Claims DirecTV False Advertising

Since all the TV and phone companies use this low-priced trial offer, it was somewhat surprising today to see that the FTC is charging DirectTV with false advertising regarding it’s introductory trial offer of service. Or, as the FTC blog says, “there’s DIRECTV — and then there’s Deceptively Advertised DIRECTV.” – Ouch.

The key to this particular allegation seems to be that the FTC doesn’t believe that DirecTV made it clear enough that even though the trial offer was for one year, that the contract was for TWO YEARS. In other words, you were signing a contract to pay the low price for one year, and the high price for the second year. Cancellation fees were over $400 according to the FTC complaint. Contrast this to Comcast which offers a low one-year rate and a matching one-year contract.

The interesting part here, is that in my experience this IS disclosed somewhere. In fact, when we finally cut the cord from cable earlier this year, one of the issues was the option to bundle DirecTV (or get Dish Network separately) with our CenturyLink internet. I refused to get DirecTV because I saw that I would have to sign a two-year contract and that my rates would be ridiculous during that second year.

In fact, the even more deceptive practice is that CenturyLink’s website explicitly states that you are signing up for a one-year contract. What is not made clear is that this contract duration is only for the CenturyLink part. If you bundle DirecTV, then that part has a two-year contract, even though you are only signing up for one-year with CenturyLink. The only reason I caught that was that I had already investigated DirecTV and wanted to make 100% sure I wasn’t accidentally signing up for a two-year deal with them. Click enough of those little informational buttons, and you eventually get the actual terms of service, and sure enough, there in the contract language it says that you are indeed signing up for two years.

Curiously, I think this is the same practice at Dish Network, the question is, will the FTC be suing Dish Network (a.k.a. Echostar) next, or is there something about the way that Dish displays its fine print that makes it acceptable in the eyes of the FTC? This screenshot is from the Dish website today (3/12/15) and has the same bold print for 12 mo. with the same tiny but you are signing up for 24-months below.

Dish DirecTV Intro Offer Fine Print

DirecTV’s argument will be, as always in these kinds of cases, that it did disclose (and had the customers sign that they got said disclosure) the necessary information and that customers were required to find it, understand it, and live by it, no matter how many didn’t realize they what they were getting into. To win its case, the FTC will have to prove that whatever disclosures the company made were not sufficient.

Of course, none of that will happen. Instead, the company and the FTC will pick an amount of money that is insignificant to the company (other than as a write off on its financial statements) but that sounds impressive to the public to be the fine without the company admitting any wrongdoing. Then, here comes the irony, the company will agree to disclose information better. Exactly, what kind of fine print and buried contract language will be used for that will be up to the company.

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Finance Gourmet on March 5, 2015

Mark Cuban made his fortune (well, his second bigger fortune) during the first tech bubble (some call it the internet bubble) when he sold Broadcast.com to Yahoo for $5.4 billion in stock. The real financial genius of Mark Cuban turned out to be not so much in the founding and selling Broadcast.com, but in quickly and effectively diversifying his investments (including all that Yahoo stock) before the bottom fell out of the internet bubble.

Is 2015 a Tech Bubble?

tech bubble about to popThere have been a lot of people wondering for a few years now if technology is once again in a bubble. You’ve seen the big headlines, of course. Facebook bought Instagram for a billion dollars. Yahoo paid over a billion dollars for Tumblr (even though the company was probably quickly running out of money). These days, having a zero revenue company purchased for a billion dollars is commonplace. The idea is that somehow, someway, those users are worth money, even if the current company has no idea, or even plans, to make any revenue off of them.

In many ways, this is like the stock market bubble that built up in the late 1990s, when any website was considered a good investment candidate for an IPO even when they had zero earnings, and often staggering annual losses. The money will come, somehow, someway, the conventional wisdom said.

The parallels are definitely there.

There is one very big difference between the internet bubble and today’s technology bubble, and according to Mark Cuban this makes this tech bubble worse than the first one.

The difference is that in 90s, companies when PUBLIC, that is sold stock in an IPO for huge money even when they had no profits. It happened over and over again with dozens (hundreds?) of IPOs per year. Analysts that cautioned investors were cast aside, while analysts who said stocks would always go up, where heralded as the real soothsayers of Wall Street.

Today, that isn’t quite what is happening. While some companies are going public without profits, it is a handful of companies each year. Some, like Twitter seemed on the verge of profitability when they went public. Others, like Zynga, went public with profits that couldn’t be sustained. But, there are virtually no companies going public with nothing more than an idea.

To find today’s bubble in technology you have to look at the poorly understood (from the outside at least) world of private investing. In this bubble, there are no publicly traded companies, no shares of stock to buy in your Fidelity or eTrade account. Instead, the investors are the seemingly endless supply of venture capital firms, angel investors, and others who invest in various seed rounds with developing companies. These companies then use that venture capital to fund their operations in order to grow into something big enough to be acquired by Facebook, Yahoo, Google, or Microsoft. The idea of revenues, profit, or even going public is simply not on the radar.

What Mark Cuban thinks makes this bubble worse is that these types of investments have virtually no liquidity. There is simply nowhere to sell your shares of the latest, hot, disruptive, fast-rising company. As such, your investment is locked in, and if this bubble pops. Those investments are going to zero with no way out.

On the other hand, that means, unlike the previous bubble, the damage won’t be as widely spread. These companies in the tech bubble aren’t in anyone’s 401k account, or Roth IRA retirement plans. While there are some smaller investors who have taken advantage of new SEC rules to allow crowdfunding, this is still a far cry from 1999 when nearly everyone’s 401k had a tech fund or stock in it just waiting to blow up.

When this tech bubble pops, it won’t be pleasant, but chances are at least it won’t take everyone else’s investment accounts down with it.

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Finance Gourmet on March 2, 2015

When shopping for a home loan, it can be tough to tell if a certain mortgage rate is good these days. The trick is that all matter of gobbledygook can complicate what you are looking at when shopping for a good mortgage rate. In fact, the mortgage companies and mortgage brokers have made it pretty hard to know exactly what is the best mortgage rate today, or any day.

Lookup Good Mortgage Rates

First, stop worrying about what the “best” mortgage rate is. Chances are that the best interest rate for your mortgage is different from someone else. This is due to differences in credit scores (check your credit scores for free with Credit Karma, or Credit Sesame), differences in home price, and differences in areas. Then, don’t forget that like anything else, the advertised price for a mortgage is only for a specific mortgage in specific circumstances.

One of the few good things to come out of the Great Recession and the near-collapse of the banking system is the Consumer Financial Protection Bureau, or CFPB (who for inexplicably uses lowercase latter for their logo). The CFPB has been building out not only an enforcement division to help protect consumers, but a variety of educational resources as well, so consumers can protect themselves instead.


One such tool is a government check interest rate tool. The benefit of this tool is that it isn’t run by a mortgage company trying to direct your business, or take a commission, or collect your information for some mailing list. While the information is general, this is a perfect place to start to get an idea of what things should look like once you get serious about mortgage shopping online or over the phone.

Is it any good? Well, mortgage companies and banks hate it, so you do the math.

It’s fairly easy to use. Down the right hand side you input your information such as your credit score, your state (where you will be buying the house, not where you are now), how much the house is, and how much down payment you want to make. Then, you can pick term, fixed or adjustable rate, and so on. What you see, is a graph showing you what various lenders are offering for rates based upon the data you enter. Then, as you scroll down you can see what your interest costs will add up to.

cfpb mortgage interest rates website from government

Armed with this information you can see if that mortgage rate being offered is a good interest rate on a mortgage today, or if it is a bad mortgage interest rate. Remember, these are averages and estimates and they depend greatly on what information you enter into the tool. If you enter a 720 credit score, but have a 690 credit score, expect very different results when you go to actually get a mortgage.

Once you know what the going rate is for mortgages, you can shop around. Don’t just take a verbal quote, or a website quote. Ask for a Good Faith Estimate from each lender you are considering. This document has legal requirements and formatting which ensures that you are comparing apples to apples while shopping for your mortgage.

The CFPB mortgage tool is available at consumerfinance.gov.  Make sure you type .gov and not .com which is something else.

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Finance Gourmet on February 24, 2015

Somehow I missed this until today. The Supreme Court is hearing arguments regarding a new(ish) law about 401k plans. Under something called the Employee Retirement Income Security Act (one of the few legislative acts of recent years that doesn’t have a snappy acronym), a company that has a 401k plan has a fiduciary responsibility to employees in the plan. This means that the company must act in the best interest of the employees. As you can imagine, in U.S. courts this gets pretty nebulous, but it does set a standard.

Supreme Court 401k Case

In this particular case, the company, Edison International, has a 401k plan with six mutual funds that charge higher fees than identical options. In other words, the plan administrator, through incompetence, or for other reasons chose the more expensive options for the plan.

supreme court 401k caseUnfortunately, this is very common. Usually, this isn’t the company, or the HR person, deliberately trying to screw over the employees. Instead, what happens is a 401k company comes in and offers up some proposals. It will say something like, you can have a plan with these investments and it will cost this much, or you can have these other mutual fund investments and it will cost this much. The investment options chosen determine the profit of the provider. Only the biggest and most sophisticated employers ever get to setup a plan from scratch and choose fund by fund. In fact, in anything but big employers, the person running the 401k has another “real” job and the 401k is usually something they do on the side. It’s no wonder that many plans have high fees and expenses.

Ironically, the issue the Supreme Court is hearing has nothing to do with the actual investments. Instead, the law has a statue of limitations of six years. The company argues that since these funds have been in the plan longer than six years that they can’t sue over them. The other side argues that since the funds are still in the plan, they don’t count as six years old. So, the Justices will actually be deciding a technicality.

Lower 401k Fees Help Employees

The good news is that no matter what gets decided, lawsuits like this are already moving the bar. Companies will soon demand that the plan providers either certify that they are offering the lowest costs, or even that they indemnify the company if these pre-packaged plans end up being challenged. That means, that 401k providers will just flat out have to offer better plans with better fees.

All of this is good news for 401k plan participants because the expenses in these plans can be absurdly high, especially for smaller employers who can’t get as good of deal on a plan as larger employers can. Reviewing these expenses is a key factor in deciding whether or not you should roll over your 401k plan to a rollover IRA or leave it with your old employer.

Either way, more scrutiny on 401k plan fees, mutual fund fees, and investing fees in general is a good thing for investors all around.


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Finance Gourmet on February 21, 2015

Most professional financial advisors, and most non-professional know-it-alls as well, say that you should keep three to six months worth of expenses in an emergency fund for, well… emergencies.

They aren’t wrong. You never know when life will throw you a curve ball, and when it does, you don’t want a few months of problems to turn into a crushing blow to years of hard financial work and smart decisions. However, the reality is that an emergency fund will never stand up to the worst financial calamities (long-term medical problems). Another reality that causes a lot of people stress is that your emergency fund is designed to be used. Over the course of your life, you fund will likely get drawn down, and then get refilled by more saving.

Emergency Fund versus Reserve Fund

When I was a professional financial advisor in Denver, I stopped calling it an emergency fund when people would find themselves torn about using it when they needed the money for something worthwhile. For example, imagine your son or daughter spent the last several years in the band. During that time, there have been numerous practices, and your child has built up a real love for playing the instrument. Then that day comes where the marching band has a chance to play in Ireland, on St. Patrick’s Day. It’s a dream opportunity.

There will be fundraising, of course, but you still need to come up with $500 for your child’s part of the trip. It isn’t unreasonable to want to be there for what will likely be a huge event in your child’s life. You and your spouse would be looking at a few thousand dollars, plus a little extra because Ireland gets pricier around St. Patrick’s Day. All in, with expenses for the travel, getting your child ready, and having a nice trip, maybe this is a $10,000 expense.

It helps to consider your emergency fund as something more. Calling it a reserve fund, or a cash reserve, is a more accurate way of explaining how and when those funds should be used when the time comes.

For most people, just dropping $10K out of cash flow is difficult. The purpose of your reserve fund, unlike an emergency fund, is for you to take advantage of both OPPORTUNITIES and handle emergencies. This is an important distinction. While a reserve fund isn’t for every night on the town, or every suit or handbag that goes on sale, a unique, expensive opportunity is exactly what such a fund is for.

Never forget that the purpose of all your hard work, and the money earned thereby, is not to check off various financial to-do list items, and it sure as heck isn’t to make a proper net worth spreadsheet. The point of money and work is to live lift. Being responsible is not the same as being stingy or fearful of spending money. When life gives you an opportunity to really live, take it. Enjoy the many wonderful things that friends, family, and places have to offer.

Then, when you get back home, work that budget to get that reserve fund re-built quickly. Then, hope that the next change to tap it is not an emergency, but rather another of life’s many opportunities.

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Finance Gourmet on February 14, 2015

No sooner than had I finished my Digit review, than I saw an ad for another automated savings app on Facebook that takes a different tack for building up your savings automatically with the help of an app and online financial service.

acorns appThis one is called Acorns. Whereas Digit monitors your bank balance and transfers off money its algorithm determines is “extra” into a savings account for you, acorns rounds up the change on every purchase you make and automatically saves that money for you. Another difference is where Digit sends your money off to a savings account somewhere, Acorn, invests your money in a “personalized investment portfolio.”

Is Acorns Legit and Safe?

First up, we’ll want to make sure that Acorns is not a scam. Again, the company is backed by some big name investors, so if it is a scam, some other people got scammed for a lot more money than you ever will.

According to the website, your money is transferred to an SIPC insured account. (SIPC is the investing world’s equivalent of FDIC insured.)

How Acorns Works

Acorns doesn’t work exactly the way you might think it does based upon the headlines and bold print. It’s not that Acorns is a scam, it’s that the actual mechanism it uses to operate doesn’t match up with the concept that is boldly advertised by the company.

This online money service actually has no way to “round up” your purchases. That kind of transaction adjustment can really only be done by the merchant (like when Safeway asks if you want to round up for cancer research), or by the payment processor themselves. Instead, the actual mechanism of Acorns is that you link whatever accounts you want to use for your rounding up and investing, and then the Acorns software keeps track of what you would have rounded up. Then, by linking your checking account, Acorns then makes a transfer of that amount at a later time, once all of your round ups totals at least $5.00.

So Acorns really works like this:

  1. You link your Capital One Rewards credit card to Acorns
  2. You buy lunch for $6.37
  3. Acorns calculates the round up as $0.63
  4. You keep buying stuff, and Acorns keeps adding the amounts up
  5. When you have at least $5.00 of round up, THEN, Acorns transfers $5 from your checking account, no matter where you made the charges originally.

So, if you expect to see each one of your purchases rounded up to the nearest dollar, that won’t happen.

If you expect to see a few cents transferred out of your checking account every time you make a purchase, that won’t happen either.

Instead, depending on how often you make transactions, what you will see is the occasional transfer of $5 from your checking account, a few times every month. There is nothing wrong with this, it just isn’t exactly what you might expect to see.

Currently, Acorns only works as a smartphone app. This makes me nervous security-wise, but with services like Apple Pay, this kind of thing is clearly the future, at least until the first major rip off of people occurs and then the security gets better. However, none of this is Acorns fault. According to their website, they are working on a web app, but it isn’t ready yet.

Acorn Fees

Here is where you want to really be careful with Acorns. The company has done something really great by not having minimum account balances or minimum investments. However, investing your money isn’t free, and Acorn does charge some fees, which they are refreshingly up front about.

First, if your account balance is less than $5,000, you will pay a $1 per month fee. On the one hand, this doesn’t sound like much, but as a percentage, this is actually pretty steep, especially when you first start using the product. For example, if your round ups for the first money total $25, then a $1 fee is 4 percent. But, don’t forget that’s for one month. Annualized, that same fee is something like 48 percent. (That’s not entirely accurate, especially if your account balance is growing, but the point is the same.) Accounts with over $5,000 in them are charged a much more reasonable (actually pretty darn good) fee of 0.25% per year.

It’s too bad you can’t give Acorns $5,000 up front and get the better fee, and THEN start using the product to round up and save your money.

Where Does Acorns Put My Money?

The most interesting thing about Acorns is where it transfers your money to when it scoops out $5 at a time from your checking account.

Instead of putting your money in a savings account, Acorns invests your money in a stock-based investment portfolio. We’ll cover what Acorns investment portfolios look like in the next article, but it is important to understand what this means from a personal finance standpoint.

A service like Digit puts your money in a savings account with no fees. They also pay no interest. On small amounts that you plan to spend anytime in the next three to five years, this is much better than investing your funds in an account like Acorns does where the balance will fluctuate and you will need some time for your earnings to out pace your fees.

However, if you consider Acorns to be money you are setting aside for the long-term, like a kid’s college fund, or even for your retirement, then this is a very intriguing idea. Just don’t forget, your balance will fluctuate with the markets. The stock market is NOT where you put your short-term savings.

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