While discussing the difference between saving and investing, it was suggested that “risk” influenced where the money was “stored”.  So, let’s explore what risk is.
Simply stated, when talking about investing, risk means that the asset could lose value … that it would not be sufficient to pay what it is needed for.  But, simple never really tells the whole story, does it?  For this reason, let’s take a little deeper look at the kinds of risk that an investor has to face.
•        Credit Risk – also known as default risk, this is the possibility that someone to whom money has been loaned will not be able to repay the debt as promised.  This risk is most common when someone has purchased bonds.  Example:  you have loaned money to a friend.  When the day on which the loan was to be repaid, your friend tells you that he/she does not have the money and cannot repay you as promised.
•        Interest Rate Risk – this is another risk faced by someone who has purchased a bond.  It is the risk that the lender has tied up his or her money in a loan paying a low interest rate and, when interest rates rise, the lender will not have that cash available to lend at the higher, more profitable, interest rate.  Example:  you have loaned money to someone at 5% interest.  This was all the money you had available to loan.  Now, someone else approaches you and states that, if you will loan them money, they will pay you 6% interest.  Since this would be a profitable business deal, you would like to make the loan.  However, you have not yet been repaid by the first borrower so you are unable to make the more profitable loan.
•        Market Risk – this risk can be faced by someone who has either invested in stocks or bonds.  It is the risk that you will not be able to sell something for at least as much as much as you bought it for; or, the item cannot be sold at a profit.  Example:  you bought an asset for $5,000 and, now, no one will pay you more than $4,000 for that same item.
•       Liquidity Risk – this risk can affect anyone who buys any asset; stocks, bonds, real estate, any asset.  This is the risk that your asset cannot be turned into cash when cash is needed.  Example:  ten years ago, you purchased trading cards that you hoped would go up in value.  Today, you find out that these cards are no longer considered valuable and no one will buy them from you.
•       Inflation Risk – this may be one of the most insidious risks people face because it means that money won’t buy as much in the future as it buys now.  Example:  imagine that you had a $100 bill ten years ago.  Because you knew that you would need it and could not afford to lose it, you had it sealed in a can and buried it in the back yard.  You clearly marked the point where it was buried and guarded it to ensure that no one dug it up and stole it from you.  To understand the impact of inflation risk, ask yourself how many bags of groceries you could have purchased with that $100 bill ten years ago; then, ask how many sacks you could fill with that same bill if you took it to the store today.
Clearly, there are different kinds of risk and there are steps that can be taken to protect yourself against those risks.  Managing risk is a topic that we will explore in another article.

Saving vs Investment

In all of the financial counseling sessions I’ve conducted; and, in all of the personal finances classes I’ve taught, the subject of saving inevitably comes up.  While discussing the importance of “saving for a rainy day”, one class participant asked me to explain the difference between saving and investing for the future.

Both involve deferred consumption … not spending money today so that it is available for use at some unspecified time in the future.  So, what does differentiate one from the other?  I believe that the distinction is found in two things … where the money is kept and the amount of time that is expected to elapse before the money will be used.


Let’s talk about time as it relates to where we keep our money.  Saving usually implies that the money will be needed in a relatively short period of time; for example, saving money for a new refrigerator or for a new set of tires for the car.  Both examples imply that the money will be needed relatively soon, possibly within the next year or so.  Since the money will be needed soon, it must be kept where it can be accessed quickly and easily; it must be a liquid asset.  Since it will be needed soon, the saver cannot take risks that might lead to less money being available than will be needed; the asset cannot be subject to possible depreciation.  For these reasons, some assets are far more suitable for savings than other assets.

Cash is certainly an asset that can be kept in a variety of locations.  It can be kept in grandma’s old sugar bowl or under the mattress.  Unfortunately, these carry the risk that the funds may be stolen since neither location is secure; and, sadly, there is no way these funds can grow since they earn no interest.

Suitable places to keep savings include savings accounts, money market funds, and certificates of deposit (CD’s) at their local bank or credit union.  All three are low risk; i.e., the value of the account cannot go down.  All three pay interest with CD’s paying a somewhat higher interest rate in return for the depositor’s promise to leave the money untouched for a specific period of time.  All three are designed for the short-term storage of money.  This is why they are good for saving.


Investing, by its nature, carries risk … the chance that the value of the asset might decrease … risk that there may not be enough money when it is needed.  There are many kinds of risk which will be discussed in another article.  For now, suffice it to say that the risk of loss makes many investments unsuitable for short-term financial needs.

Investments such as stocks, bonds, mutual funds, real estate, and real estate investment trusts (aka REIT’s) are much better suited to long-term financial goals.

Planning For Retirement – Part 5 … 403(b)’s

As we saw in Part 4, a 401(k) plan allows people who work for large companies to reduce their taxable income by having money deducted from each paycheck and invested in a retirement plan.  That’s all well and good if you work for a “for profit” company, right?  But, what if you work for a 501(c)(3) non-profit organization; or, you work for a non-profit hospital; or, a church; or, you work in the public school system?  Good news … there’s a plan designed specifically for YOU!

Known as a 403(b) plan or a Tax Sheltered Annuity (TSA), this plan functions much like a 401(k) or an IRA.

  • Like a 401(k), the 403(b) plan reduces the amount of money on which you will pay federal income taxes.  You will, however, still be required to pay social security and medicare taxes on this income.
  • Depending on your adjusted gross income, you may be eligible for a $1,000 ($2,000 if filing jointly) Retirement Savings Contribution Tax Credit when you contribute to a 403(b) or 401(k) plan.
  • Like money in a 401(k) or IRA, you will not pay taxes on your contributions or the growth and earnings on those contributions until you withdraw the money from the plan.
  • The maximum contribution to a 403(b) plan is $17,000 in 2012; and, if you are age 50 or older, you can contribute an additional $5,500 under the “catch-up” provision.
  • Because this plan provides a tax-sheltered environment in which your investments grow, you will be subjected to the same taxation and penalties if money is withdrawn from the plan prior to age 591/2; and, just like the IRA and 401(k) plans, you must begin taking annual minimum distributions from the plan at age 701/2.
  • Just like a 401(k), you cannot establish your own 403(b) plan.  These plans must be established by your employer.

While these plans are often referred to as Tax Sheltered Annuities (TSA’s), you have options regarding where and how the money can be invested.

  • As the name implies, money can be invested in an annuity or variable annuity contract issued by an insurance company.
  • Alternatively, the money can be invested in a custodial account made up of mutual funds.  This is known as a 403(b)7 plan.
  • Churches can establish retirement income accounts under section 403(b)9.

Contributions that you make into your 403(b) plan are always yours although you may be subject to a surrender charge if you terminate an annuity contract within a specified number of years after it was issued.  If your employer makes any matching contributions, they may be subject to a vesting schedule similar to the vesting schedules in a 401(k).

403(b) plans offer yet another great way for qualifying workers to plan for retirement through the use of payroll deductions.  If you work for a 501(c)3 non-profit agency, church, hospital, or in the public school system, check out this great plan … someday, you’ll be very glad to have the extra retirement income that these plans can provide.

Planning For Retirement – Part 4 … 401(k)’s

In Part 1 of this series, we briefly discussed how retirement planning had changed from the days when Joe went to work for The Big Company.  Back then, the company provided a pension plan that paid Joe a retirement income based on how many years he’d worked for the company and how much he made while he worked there.  Today, his grandson, Joe3 works for a company that offers a 401(k) plan rather than a pension.  But, how does the 401(k) work?

A 401(k) plan has much in common with an IRA.  Like an IRA, the 401(k) allows Joe3 to reduce his taxable income by contributing money into the plan.  Joe3 directs his employer to deduct a specific amount of money from each paycheck.  These untaxed funds are invested in accordance with instructions that Joe3 provided when he authorized the deductions.  The growth of the investments is not taxed until such time as Joe3 takes money out of the account.

Because this is intended to serve as his retirement plan, Joe3 is expected to leave the money in the account until he is at least 591/2 years old.  If he withdraws money from the account before that age, he will pay ordinary income taxes on the money withdrawn; and, he will pay a 10% penalty for the premature withdrawal.

One of the real advantages of the 401(k) plan is the ability to contribute far more to the plan than is permitted for an IRA.  While the maximum contribution to the IRA in 2012 is $5,000, an individual can contribute up to $17,000 into the 401(k).

Another advantage is that this plan allows an individual to reduce his or her taxable income regardless of annual income.

Moreover, because the 401(k) plan entails regular, consistent, investments, the individual is able to take advantage of the concept of “Dollar Cost Averaging”.  Dollar Cost Averaging simply means that the purchaser buys more shares when prices are low and fewer shares when prices are high.  Consider this example.  Joe3 has decided to invest $100 each month in stock issued by the XYZ Company.

Month Price Per Share Total Shares Purchased
January $10.00 10
February $5.00 20
March $20.00 5
Total $300.00 35

As can be seen, Joe3 has invested a total of $300.  If he decided that he wanted to sell all of his shared in the XYZ Company, how much would he have to sell them for in order to make money; $5, $10, $20, or something else?  If we divide his $300 investment by the 35 shares he owns, we can see that he paid an average of $8.57 per share; thus, he’ll make money if he sells the entire investment for more than $8.57 per share.  Of course, this does not include any fees that he may have to pay when selling the shares.

Now, let’s extend this concept into Joe3’s 401(k) program.  If Joe earns $500 per week and directs his employer to deduct 10% ($50) from each check and place that money into his 401(k).  When prices are high for Joe3’s chosen investment, he will buy fewer shares at the high price.  When prices are low for Joe3’s investment of choice, he’ll get more shares.  At his retirement, Joe3 will have amassed a significant retirement account that he can convert into a regular monthly income to support him in his golden years.

One final potential advantage should be recognized here.  Some companies provide some type of matching contribution to an employee’s 401(k) contribution.  Joe3’s company contributes $0.50 (fifty cents) for every dollar that Joe3 puts into his 401(k).  This represents an immediate 50% return on his investment so longs as Joe3 remains with the company long enough to “vest” that matching contribution.

Companies have a choice in vesting schedules; specifically, that matching contribution becomes the employee’s money when one of two schedules has been met.

  • “Cliff Vesting” – the entire matching contribution becomes the employee’s property after 2 years of employment.
  • “Stair-Step Vesting” – the matching contribution becomes the employee’s money in increments; i.e.,
    • 20% of the matching contribution belongs to the employee after 2 years of employment;
    • 40% of the matching contribution belongs to the employee after 3 years of employment;
    • 60% of the matching contribution belongs to the employee after 4 years of employment;
    • 80% of the matching contribution belongs to the employee after 5 years of employment; and,
    • 100% after 6 years of employment.

Some employers measure the beginning of the vesting period from the initial date of employment while others measure it from the date on which the matching contribution was made by the company.  Of course, the employee’s contributions to the plan always belong to the employee and cannot be taken away (which is not to say that the value is always the same … the value can increase or decrease based on the performance of the investment that the employee has chosen).

Just like the IRA, Joe3 must begin withdrawing money from his 401(k) by the time he turns 701/2.  Failure to make the minimum annual withdrawals will result in the assessment of tax penalties.

401(k) plans offer employees a great way to plan for retirement through the use of payroll deductions (if you don’t see the money, you don’t miss the money) and growth within a tax sheltered environment.  If your employer offers this type of retirement plan, check it out … someday you’ll be very glad you took advantage of the opportunity to plan for your future retired life.

NEXT UP … 403(b)

Planning For Retirement – Part 2 … Individual Retirement Accounts (IRA’s)

Basic Information

The creation of Individual Retirement Accounts was included in the Employment Retirement Income Security Act (ERISA) of 1974.  This law empowered individuals to create their own retirement program by contributing money (at that time, the maximum contribution was $1,500) into a special account that would grow on a tax-deferred basis; and, the contribution to this account would reduce the individual’s taxable income for the year in which it was made.  Tax-deferred growth was, and continues to be, one of the greatest advantages offered by an IRA.

Originally, these plans were restricted; meaning, only those people who did not have any type of employer sponsored retirement plan could participate.  But, over the past 37 years, numerous changes have been made to the IRA.  Today’s IRA can be used by any individual; but, there are qualifications that determine how the plan can be used to reduce taxable income.  To see how the plan works, we’ll examine several different scenarios.

Janice works for an employer that provides no retirement plan of any sort to its employees.  Because Janice has no access to a qualified retirement plan, she can contribute up to $5,000 to her IRA and her full contribution can be deducted from her taxable income.  Thus, if Janice makes $40,000 this year and she contributes the maximum amount into her IRA, she will immediately reduce her taxable income to $35,000.

Todd has a qualified retirement plan available to him through his employer.  Because he is eligible to participate in this plan, Todd has some restrictions on tax deductibility of his IRA contributions.  If Todd’s modified adjusted gross income (MAGI) is less than $58,000, any contributions he makes into an IRA will be fully deductible.  If his MAGI is over $68,000, his contributions will not be deductible.  If MAGI is between these two amounts, his contributions will only be partially deductible.

Loren is 60 years old.  Because he is over 50 years of age, the law allows him to contribute up to an additional $1,000 to his IRA under what is referred to as the “catch-up” provision.  The deductibility of this additional contribution is subject to the same standards as both Janice and Todd.

The limits to modified adjusted gross income for married couples are higher; and, the availability of a qualified retirement plan to both or either person will impact the deductibility of the contributions.

The Advantage of Tax-Deferred Growth

Let’s assume that Josh invests $5,000 into his IRA every year, beginning at age 35.  After 30 years, Josh is age 65 and has made a total investment of $150,000.  We’ll also assume that he earns the same 8% return on his investments every year.  Finally, we’ll acknowledge that Josh is in the 25% marginal tax bracket.  Let’s see how his money would grow.

Total Contribution IRA Value Non-IRA Value
$150,000 611,729.34 $314,256.29

Now, let’s assume that, at age 65, Josh takes all of the money from his account in one lump sum.  How will taxes impact his retirement?

Total Contribution IRA Value Non-IRA Value
$150,000 611,729.34 $314,256.29
Taxes Owed on Withdrawn Amount $152,932.34 0
Total Spendable Funds $458,797.01 $314,256.29

Obviously, I think that we will agree that Josh is better off with the after-tax value of his IRA than he would have been had his account been subject to taxation for the entire 30 year period!  You can use a number of different financial calculators that are available on-line to see the advantages of tax deferral in your own specific circumstances.

Withdrawal of Money

As shown above, funds in an IRA are subject to federal income tax when withdrawn from the account at or after age 65.  But, if those funds are withdrawn before age 65, the proceeds are not only subject to income taxation, a 10% penalty will also be collected for a “pre-mature” withdrawal!  While there are some circumstances under which the 10% penalty will be waived, clearly, these accounts are intended to be left untouched until retirement.

Next up … ROTH-IRA’s

Planning For Retirement … the ultimate level of unemployment – Part 1

Long ago and far away, in a time and place where cars sported lots of chrome and fins, the head of household (we’ll call him Joe) got out of bed each morning and went to work at The Big Company, Inc.

Joe started working at The Big Company right out of school and it was understood that he would work there for his entire career.  When he retired, The Big Company’s pension plan would send Joe and his wife a pension check each month that would allow them to enjoy their golden years with some degree of comfort.  The Big Company accepted the responsibility for investing the right amount of money each year to ensure that Joe’s retirement (along with the retirement of all of Joe’s fellow workers) would be safe and secure.  Joe could count on that pension check arriving like clockwork each month and he could never outlive that income.  That’s just the way things worked “back then”.

Today, Joe’s grandson (affectionately called Joe3 by family members faces a much different employment future.  The Big Company (TBC) no longer offers its employees a pension plan.  Instead, TBC invites its employees to contribute money into a Qualified Retirement Plan.

This Qualified Retirement Plan allows TBC to deduct money out of Joe3’s paycheck each week.  Joe3 decides how much will be taken from the check and how that money will be invested.  While TBC makes sure that there are many options for Joe3 to choose from, Joe3 is responsible for selecting his investments and monitoring them from month to month and year to year to make certain that he sufficient money to fund his own retirement.  If he plans well and the investments perform well, Joe3’s retirement should be safe and secure.  If he fails to put enough money into the plan; or, if the investments don’t perform as well as he had hoped and he has too little to retire on … oh well, that’s Joe3’s problem and TBC has no responsibility or culpability for the shortfall.

Since it’s Joe3’s responsibility to make sure he has enough money when he retires, we’re going to take a look at the different plans that Joe3 can choose from; the opportunities that those plans offer and the limitations that are included in those plans.  In Part 2, we’ll look at one of the most prevalent Qualified Retirement Plans … IRA’s

Will That Be Debit or Credit?

The news that several major banks are planning to charge consumers a monthly fee for using debit cards appears to be an attempt to drive consumers to a greater use of credit cards.  Why?

  • First, new regulations have taken effect that limit the fees that these banks can collect from merchants whenever a consumer uses a debit card.  It does not appear that these same limitations will apply to the use of credit cards.
  • Second, consumers have been making a conscious effort to pay down credit card balances and to voluntarily limit their use of credit.  Lower balances mean less interest can be collected by the banks, further cutting into their profits.  If the banks can drive credit card balances up again, interest receipts should increase and profits should rise.
  • Third, many banks are already charging consumers fees for the privilege of carrying one or more of the bank’s credit cards in their wallets.  The fee may be called a monthly or annual service fee; a membership fee (one must wonder what the consumer is a member of); or any one of a number of other euphemisms for a cardholder fee.  Increased use of credit cards is likely to lead to new accounts being opened and an increase in fees that can be collected by the banks.

If you are one of the many consumers who has resolved to reduce your debt and live within your means, stay firm in your commitment to living in a personal cash economy.  It may be hard to break the credit habit; but, your family’s financial well-being hangs in the balance.

Saving Money at the Grocery Store – part 3

Teaching financial management classes gives me an opportunity to share money saving ideas with many different people; and, as different as all of the people are, they often ask the same question, “Where do you find all of these great deals?”  There is no one answer.  In fact, these bargains are found in many different places.  Here are just few suggestions.

  • Grocery store flyers – every week, the local paper contains an insert that includes the advertisements from the various supermarkets in the area.  These flyers contain not only announcements of sales; but, they also frequently print recipes that use the products that are on sales.
  • Mail – since not everyone subscribes to the local paper, the grocery stores also have the flyers delivered every home along with the mail on the day after the flyers are delivered in the newspaper.
  • Internet – each of the major grocers in my area also publish their advertising flyers on line.  To find them, just do a web search for [store name] weekly circular.  Additionally, there are many websites that offer coupons at no charge.  A few that I, and others, have found helpful are …





If you have other websites where you regularly obtain coupons, please submit them so that they can be shared with others.

Saving Money at the Grocery Store – part 2

My friend Carol proudly declared herself to be Coupon Clipping Royalty and claimed the title, “Queen of the Coupon Clippers”.  Two questions immediately come to mind when people start talking about coupons.

  1. Can you really save enough money to make taking time to clip them worthwhile?
  2. Where do you find all of these “great” savings?

Let’s take the first of these  questions.

Yes, you really can save enough money to make it worth the time it takes to clip the coupons!  Think of it this way … what is the value of your time? 

If you spent 30 minutes clipping coupons and saved just $10 on your grocery shopping expedition, you’d have the equivalent earning of $20 per hour!  Aren’t you worth that kind of money?

If you spent just 30 minutes reviewing the grocery store advertising circulars to see what kinds of sales you could take advantage of before planning your menus for the week, how much could you save?  To find out, I performed a brief experiment.

I picked up the grocery store flyer for a nearby supermarket and created seven dinner menus using only “buy-one-get-one” items.  I tracked the amount of time it took to complete this exercise here are the results:

  • 2 chuck roasts – one weighed 2.88 pounds while the other weighed 2.82 pounds.  At $4.99/lb., I got 5.70 pounds of beef for $14.37.  The first one was cut into bite sized pieces and cooked with vegetables to make a beef stew for Monday’s Dinner.  The second one was used to make pot roast for Sunday Dinner.  Total spent:  $14.37  Total Saved:  $14.07
  • 2 bags of frozen, boneless/skinless chicken breasts.  Each bag contains a total of 40 ounces of chicken; or, 8 pieces, each weighing approximately 5 ounces.  Four pieces were cut into small pieces and turned into sweet and sour chicken for Tuesday’s Dinner.  Another 4 pieces were baked with some rice, matchstick carrots, and broccoli along with a can of cream of chicken soup to make a casserole for Thursday’s dinner.  Total Spent:  $10.99.  Total Saved $10.99; and, I have the second bag of chicken breasts in the freezer for use next week.
  • 2 packages of center cut pork chops.  The first package weighed 1.29 pounds and was baked for Wednesday’s Dinner.  The second package weighed 1.22 pounds was cut into bite sized pieces and simmered in a plum sauce and served with rice (also buy-one-get-one) for Friday’s dinner.  Total spent on the pork:  $6.05.  Total Saved on the pork $5.72Total spent for rice:  $2.99 for a 3 pound bag.  Total saved $2.99, and, I have enough rice left in the pantry for several more meals.
  • 2 jars of pasta sauce (each 24 ounces) and 2 packages of spaghetti (each 1 pound).  One package of spaghetti and one jar of sauce were cooked for Saturday’s dinner.  The remaining package and jar are in the pantry for use next week.  Total spent for both pasta and sauce:  $5.08  Total saved:  $5.08.
  • 2 frozen pepperoni pizzas.  One was baked for dinner on Saturday night and the other is in the freezer for use next week.  Total spent:  $6.99.  Total saved $6.99

Total savings:  $45.84

Time spent:  20 minutes

Per hour “wage” equivalent:  $137.52

I would dare say that most of us, if offered a job that paid $137 per hour, would leap at that opportunity.  This “job” is yours for the taking.  All you have to do is block out a little time to plan the menus and shop the flyers to find the bargains.  You’ll eat well; and, you’ll save money, too!

Coming next:  Where do you find all of those “great” savings?

How can I save money at the grocery store?

Recently, my good friend and client Carol asked me to review her family’s budget with her to determine if there were any opportunities she was missing for saving money and getting the most value for every dollar she spends.

While going through the budget, I noticed that she was spending far less at the grocery store than she had in the past.  I asked her how she had managed to cut her grocery bill while prices seem to keep going up nearly every day.  She shared her strategy with me … here it is.

  • Every Sunday, she sits down and plans her menu for each meal for the week.  Once the menu is set …
  • She creates a shopping list that lists out everything that is needed to put those meals on the table.  She then …
  • Takes the list to the pantry and crosses off those items that she already has.  With the list pared down to the items that she must buy, she …
  • Becomes the “Queen of the Coupon Clippers”.  Finally,
  • Carol goes to the store with her shopping list; and, if an item that looks good is not on the list, she does not buy it.  She sticks with her plan.

Sounds easy, doesn’t it?  Planning ahead helps avoid impulse buying.  It also ensures that all of the required ingredients are on hand when it’s time to make dinner.  Planning also helps save money!

It’s certainly well worth trying … it just might help you get more for every grocery dollar that you spend!