Today’s (rather long) quote comes to us from the pages of The Ultimate Financial Plan: Balancing Your Money and Life* by Tim Maurer and Jim Stovall in the chapter on annuities:

In the realm of personal finance, no word has been dragged through the mud more times than the A-word—Annuities. Yet annuities survive and even thrive. How they do is not a mystery.

There is not an outcry on the part of consumers demanding annuity products. The reason for the continued vibrancy of annuity sales is that they pay a big honkin’ commission to the selling broker or agent. And, as most of the financial sales tactics exposed in this book, I’m especially qualified to make such a statement, because I have sold them myself. I wasn’t a bad person in those days, conniving to separate people from their hard-earned money for my own selfish benefit. Conversely, every time in years past when I sold an investment product to a client for a commission, I did so thinking it was in their best interest. My recommendations met all the legal requirements of suitability required of a broker, but I acknowledge to you now that in hindsight there is no question my judgment was partly influenced by the amount of money I could make (or not make) on the sale.

And how could it not be? Let’s say you, as a salesperson, had three different products to sell with the following characteristics: one would pay you one percent for every year that the investment continued to be held by the client, one would pay you 5.75 percent up front followed by .25 percent each additional year, and another would pay you 12 percent—all up front. Which one would you be likely to pick, all things being considered equal?…

He goes on to say that the, “…sale of annuities is justified entirely too often because of the massive commissions going ot the broker or agent selling the product.”

I couldn’t agree more. It’s almost like, “Sell first, justify later.”

My belief is that if high cost annuities (variable and the like) were that great for customers, they would have the same payout as a traditional mutual fund.

*Affiliate Link

I don’t know about you but going through files is like taking a walk down memory lane. There were the documents from our first mortgage (1999), medical files from my wife’s three pregnancies, pay stubbs going all the way back to 1998, 401(k) statements going all the way back to the beginning, receipts for big purchases, kids’ report cards, articles and funny stuff I had collected over the years, and lots of other stuff.

I threw out a bunch of stuff away (or shredded it). I kept the stuff I felt was important and filed it away neatly. Some of the financial stuff I put into a spreadsheet. I wish I had done the spreadsheet thing 10 years ago. I think it would have motivated me to better manage our money. I’ve done better the last few years but I’m still not perfect.

Anyway, my advice to all of you who are just starting out in your careers is:

Track your finances. Even if you don’t keep a rigorous budget, at the very least, create a spreadsheet that tracks your earnings, deductions (health insurance and other benefits), 401(K) contributions (and matches) and year-end balances, and your net worth. The act of doing so will force you to take a hard look at your finances and your priorities. Don’t like what you see? Then make changes.

One thing I learned over the weekend was that we aren’t doing as well with our 401(K) as I thought we were. In other words, we contributed a lot more than I thought we did based on the balance we currently have. This shouldn’t really be surprising when you consider the fact that we started contributing in 1997, which means we went through the tech bubble of 2000, 911, and the credit crisis of 2008. That said, our results have been buoyed by consistent contributions. As long as we don’t go through a massive depression, we should be fine over the long run.

Each new year brings with it the opportunity to get a “fresh start.” Among the traditional New Year’s resolutions are to lose weight, get in shape and quit smoking. The following are my suggestions for resolutions for investors.

1. If you don’t have a financial plan, the very first thing you should do is write one and sign it.

2. Make sure you investment plan does not take more risk than you have the ability, willingness or need to take.

3. Make managing the portfolio a year round job, checking for rebalancing and tax loss harvesting opportunities on at least a quarterly basis.

4. If you are working with an advisor who does not provide a fiduciary standard of care, fire him/her and hire one that does.

5. Separate the services of financial advisor, money managers, custodian and trustee.

6. Do not invest in any security that you don’t fully understand all the risks.

7. Avoid all actively managed funds and repeat to yourself “past performance is not a predictor of future performance.”

8. Do not stretch for yield. The main role of the fixed income portion of the portfolio is to reduce portfolio risk to an acceptable level.

9. Ignore all “expert” forecasts, recognizing that they have no value.

10. Do not buy any individual stocks or sector funds, recognizing that has more to do with speculating than investing.

11. Keep a diary of your predictions and review them every year.

12. Adhere to your plan, regardless of what the market does.

13. If you watch CNBC, make sure the mute button is on.

Larry writes a regular blog called Wise Investing for MoneyWatch.

Related books (affiliate links):

• Wise Investing Made Simpler (Second in a series)

• The Only Guide to a Winning Investment Strategy You’ll Ever Need: The Way Smart Money Invests Today

• The Only Guide to a Winning Bond Strategy You’ll Ever Need: The Way Smart Money Preserves Wealth Today

• The Only Guide to Alternative Investments You’ll Ever Need: The Good, the Flawed, the Bad, and the Ugly (Bloomberg)

What Are Financial Goals?

There are many different kinds of financial goals:

• Get out of debt

• Create an emergency fund

• Pay cash for a new (or used) car

• Downpayment on a house

• College fund

• Retirement

The Goal-Setting Process

I’m not a goal-setting expert but I was able to come up with six steps in the goal-setting process:

1. Determine your goal and the amount of money needed to meet the goal.

2. Set a due date for meeting the goal.

3. Decided what investment vehicle that will be used to meet the goal.

4. Calculate the lump sum or periodic payment that will be needed to meet the goal.

5. Track your progress.

6. Reach your goal.

Example

Let’s look at what the process looks like for someone saving up for a downpayment on a house. Let’s say in 5 years you desire a 20% downpayment on a $200,000 house ($40,000).

1. $40,000

2. 5 years (60 months)

3. Since the goal is relatively short-term, the savings will be kept in an interest-bearing savings account. For this exercise, we’ll use an annual interest rate of 1.28%.

4. To determine the lump sum or monthly payment necessary to meet this goal, you can use any number of online calculators, a regular calculator, or you can download this simple Excel Spreadsheet I put together for this post. Because interest rates on savings accounts are so low, the lump sum needed to meet a $40,000 goal in 5 years is really high at $37,500. If you’re going to reach the goal with monthly savings, you’ll need to save $645 per month.

5. For short-term goals, you’ll want to track your performance on a regular basis (monthly or quarterly) and make adjustments as necessary.

6. If all goes to plan, this goal should be met in five years (sooner if interest rates are higher or you can add more to your savings).

If you’ve never set and reached a financial goal, I urge you to give it a try.

Thoughts?

• credit card debt around $15,000. Interest rates of 19% and higher.

• 401(k) balance of $16,000 from a former job. No other retirement savings.

• will not be able to contribute to his 401(k) until next year.

• he has an extra $1,000 per month that he could put towards paying down his credit card debt. (I’m not sure what he’s currently doing with the $1,000.)

Here’s what I told him to do:

1. DO NOT LIQUIDATE THE 401(K)! Why? Because nearly $5,000 would be lost to taxes and a penalty. Not only that, he’d be losing out on the future growth of his 401(k).

2. I would then commit to paying $1,500 (using the $1,000 mentioned above plus current credit card payment amounts) towards paying off the credit card bills. I did some quick math and found that he could have his credit card debt elimated by February of next year:

It’s amazing how quickly interest charges can come down as long as you pay a sizeable amount each month towards the balance.

3. Then, about that time his credit card bills are eliminated, he will be eligible for the 401(k). I would then contribute $1,375 per month to the 401(k), which is the current employee maximum allowed.

4. LEAVE THE CREDIT CARDS ALONE!

The main thing is to have a plan and stick to it.

Have a question:

What reasonable standards should investors use to measure how well or poorly that they are doing?

I’m sure that an answer would include “it depends” but if so, depends on what?

We are about 10% under our 12.31.07 balances and we are pleased but how pleased should we be? There is always someone who well fare better or worse but I’m at a loss as to which reasonable “standards” that I should use to know how I’m doing?

That’s a very good question.

Unfortunately, the appropriate answer is: it depends.

From a general standpoint, your portfolio’s performance should be judged against the appropriate benchmark or benchmarks.

For instance, if you have a portfolio of 50% large-cap stocks and 50% bonds, you would not base your performance on solely on the S&P 500 Index. Rather, you’d base it on a 50/50 split between the S&P 500 Index and the appropriate bond index.

If your portfolio is comprised of large-cap, mid-cap, small-cap, bonds, and real-estate investment trusts, then you need to base the performance on benchmarks for all of those asset classes.

The reason for this is that it’s easy to say, “Wow! We did awesome last year. Our portfolio was up 8%!” The reality could be that a benchmark portfolio might have been up 12%, making your 8% return not so stellar.

Of course, another way to judge your performance is to do what BG suggested in the comments of that post and that is to base your performance on whether or not you’re meeting your future goals. It doesn’t matter how your portfolio is doing if it’s not helping you meet your future goals.

For example…

Let’s say you have a retirement goal of $1,000,000 (purely hypothetical, ignoring inflation). Your retirement is 20 years away and you have $100,000 saved up so far. You are contributing $500 per month into an S&P 500-based fund. You don’t expect your contribution amount to change (again, hypothetical).

Using the RATE function in Excel, I figured that the required rate of return to meet that goal is .78% per month (9.79% annualized). Given that the monthly geometric average total return on the S&P going all the way back to 1926 is .77% (9.64% annualized), you most likely will fall short of your goal by around $25,000.

This leaves you a few choices:

1. You can accept the lower amount at retirement.

2. You can take on more risk by moving into small cap stocks, which have a higher expected return but also are a lot more volatile (more on that in a future post).

3. You can increase your contributions. Based on my numbers, increasing the contribution amount to $540 per month, put’s the expected account value at a little over $1 million.

I realize that we are talking about math based on linear growth, which never happens in the real world. But, it can still be beneficial to have some sort of basis in reality. If your goal is $1 million and you’re investing a certain amount per month, it would be wise to know if you have a shot at meeting your goal.

Thoughts?

Hi!

I’ve been subscribing to AFM for quite some time now and I really appreciate almost all of your blog posts. My room mate just bought a car yesterday and because he has little to no credit (and may have been an easy target) got a 24.99% 6 year loan (his payments are around $380/month making the $13,000 car actually cost close to $30k!). He says he’s going to refinance in a year and hopefully will get a better interest rate after establishing more credit. The salesman said that he could pay extra towards the loan to pay it off early, etc. Let’s say he could afford to pay $480/month, would it be better to pay the extra $100 every month on this higher interest rate, or pay an extra $1200 once he gets on the lower interest rate? I hope my question makes sense! You always do a great job explaining things with your spreadsheets!

Thanks,

R

Your room mate made a really bad decision for a couple of reasons:

1. Running the numbers, I come up with a principal and interest payment of around $350 per month. R says his room mate is paying around $380 per month. This means that the sales guy either talked the room mate into buying insurance or he slipped it in under the radar. Regardless, it’s some expensive insurance that will cost him over $2,100 over the life of the loan. Your friend would be wise to go back into the dealership and DEMAND that they take the insurance off. UPDATE: It was a warranty.

2. He most likely will NOT be able to refinance his loan because the car will depreciate in value very quickly. It’s hard to refinance a loan on an asset that is worth less than what is owed on the loan. Due to the high interest rate on the loan, your friend will be upside down on this loan unless he pays substantially more towards the loan than his payment. That said, given how crappy the financing is, I wouldn’t be surprised to find that this loan has some sort of prepayment penalty.

Your friend would have been smart to have done some homework BEFORE he made such a commitment. It sounds like he made a decision with his heart and ignored his head.

Now, concerning your question:

Let’s say he could afford to pay $480/month, would it be better to pay the extra $100 every month on this higher interest rate, or pay an extra $1200 once he gets on the lower interest rate?

Here is a look at your friend’s car loan amortization summary:

Assuming there’s no prepayment penalty, your friend would be wise to pay as much extra towards this loan as possible. I’m skeptical that he will be allowed to refinance this loan. I ran some numbers and found that if he paid an extra $100 per month towards the principal, he could pay the car off in less than 4 years, saving himself over $5,200 in interest.

I just hope that his decision hasn’t started him down the path of one bad decision after another. Usually people who get upside down on a car, stay that way for A LOOOOOONG time.

Here’s the list along with my thoughts on each point. You can read the original article here:

1. Pay off your nonmortgage debt.

I totally, 100% agree with this. You should have no debt except for a mortgage and possibly a (reasonable) car note.

2. Kick the debt cycle altogether.

I like what the article’s author said here so I’ll just repost it: What good is it to pay off your loans only to take out another one and rack up more debt? An easy way to save for big-ticket items –and avoid going back into debt — is to put money you would have used for monthly debt payments and interest charges into a savings account. For instance, after you make that final $300-a-month student-loan payment, keep making an equal payment to yourself. After one year, you’ll have $3,600 saved. (See “Your 5-minute guide to budgeting” for help allocating your money.)

This is something my wife and I have started doing. We had a 401(k) loan out once and when it paid off, I upped our contribution to close what the loan payment was. The cool thing is that I was actually able to increase our contribution by MORE than the loan payment because 401(k) contributions are payed before tax while 401(k) loan repayments are not. I only wish we would have done this when we payed off our Rendezvous nearly two years ago. We would have nearly $12,000 in a car fund by now had I saved our car note after the car was paid off.

I also use our high-yield savings account (well, it “used” to be high-yield…it’s not so much right now) and pay our property tax into that account so that we have the money available when the tax comes due.

3. Get serious about retirement.

The 30s is when we saw amazing growth in our 401(k) balance. Unfortunately, the market has taken back much of those gains but over the long-run things should be better.

4. Diversify your investments.

We are diversified amoung equities. We don’t have any bonds in our portfolio yet.

5. Continue to learn.

This is one area where I have been lax. I have considered going back to get an accounting degree and becoming a CPA. That’s the degree I probably should have gotten in the first place.

I do at least continue to read books so I’m not completely forsaking educational endeavors.

6. Protect your assets.

As our budget has allowed, I have upped our insurance coverages where I thought it was important. I also upped our deductibles—something that can be done if you have an emergency fund—in order to keep the costs down.

7. Live simply.

I’m thankful that my wife and I live simply. I was looking at our budget the other day and noticed that our mortgage payment, property taxes, and homeowner’s insurance added together are less than 17% of our net income. Yes, we live in an affordable area and make decent money, which makes a huge difference. Lots of people don’t have that advantage. That said, we still made the decision to buy a house that we could afford. It WAS NOT our dreamhouse and it took us EIGHT YEARS before we did any major renovations to the house. And, we STILL don’t have our master suite the way we would like it. Bottom line: unless you make lots of money, you can’t have everything all at once. There’s nothing wrong with waiting until you can afford something.

8. Make your will known.

This is an area my wife and I are going to work on this year. We haven’t done enough in this area.

9. Get a life . . . insurance policy.

Check with your employer to see if they offer life insurance. BE AWARE that if you leave your employer (or are fired), you will most likely lose your life insurance. That’s why it is good to also have an insurance policy that’s not connected to a job. I’d suggest a nice long-term term policy.

10. Be charitable.

My wife and I tithe but could also do better in giving. We do little things like give to the United Way and a couple of religious charities that we agree with but that’s about it. I also am too stingy with my time.

I thought this was a good list. I feel a little better at what my wife and I accomplished in our 30s.

I’m 27 and I can tell you really simply why we are not investing.

1. Since the day we graduated we’ve seen nothing but bad news. Huge tech crash, current crash. We’re not even back to where we were almost 10 years ago.

2. We have huge student loans to pay back.

3. Finally got out of college in 2004, saved as much as possible and am currently underwater…may as well have spent that extra money.

4. There are no solid investment vehicles that are even matching inflation right now.

5. We want to start families soon and need short-term funds, not long-term retirement funds.

6. We don’t really have much trust in our country. Frankly, I don’t think the US is really #1 anymore and our economy will only decline in the long run unless we are willing to tackle education’s inadequacies, stop giving money for oil to countries that hate us, and truly address the issue of consumerism.

We don’t see the market as a stable investment for the near future and would rather sit on cash and then get in either in the US once we balance out or elsewhere if my dollars are still worth anything.

I know firsthand how hard it is to get on your feet after you graduate from college and are just starting out in life. It is tough to think about retirement planning when you’re barely making ends meet. That said, most of those reasons are really nothing but excuses. Let’s look at each one:

1. Since the day we graduated we’ve seen nothing but bad news. Huge tech crash, current crash. We’re not even back to where we were almost 10 years ago.

Tell me one generation that didn’t experience bad news. Bad news is part of life. We go through tough times all the time. It’s nothing new. Use those tough times as buying opportunities since asset prices are typically lower during the bad times than they are during the good times.

2. We have huge student loans to pay back.

Figure out how much you owe and map out a plan to pay them back.

3. Finally got out of college in 2004, saved as much as possible and am currently underwater…may as well have spent that extra money.

Please don’t think this way. Instead, think about it this way: spending that extra money would have only put you further into the hole. It took my wife and I several years to get above water.

4. There are no solid investment vehicles that are even matching inflation right now.

Investments fall in and out of favor. Stocks are suffering right now. However, over the long run, stocks are superior inflation-beaters. Don’t base your long-term projections on short-term performance.

5. We want to start families soon and need short-term funds, not long-term retirement funds.

With proper planning you can have both. It’s extremely important to take advantage of the one thing you have on your side: TIME! Start out by putting a 3-6% of your salary into your 401(k). Once you get used to it, you won’t miss the money.

Saving for retirement when you’re trying to start a family will require some sacrifice. But, it is well worth it. The absolute BEST thing my wife and I did was to start putting money into her 401(k).

6. We don’t really have much trust in our country.

What? The greatest country in the world? Sure, we have problems but this is still a great place to live. Even if you don’t trust our country, what else are you going to do? Go live somewhere else?

Bottom line: it takes patience and sacrifice to get ahead.

I appreciate this reader’s honesty even if I don’t necessarily agree with them.