Financial Planning Stuff You Need to Know

Obama will inherit twin economic crises. The immediate financial crisis and recession and a longer-term crisis (Medicare, Social Security, Infrastructure)

What should you expect?

In the next year:

• Obama’s tax plan will likely be passed by congress meaning a tax cut for most Americans earning less than $200,000/year and a tax increase for those earning more than $250,000. There will possibly be a capital gains tax rate increase for these taxpayers as well.

• Some sort of fiscal stimulus plan although more focused on infrastructure rebuilding vs. checking sent directly to taxpayers.

• A re-evaluation of the current economic rescue plan and an expansion of the plan to other industries and to some homeowners facing foreclosure.

Over the next few years:

• Some type of health care plan that would be similar to the one in Massachusetts which requires everyone to buy health insurance if their employer doesn’t provide it. It will likely offer a Medicare-type like option for people who could not afford to purchase private insurance.

• Possible changes in Medicare and Social Security, more likely Medicare which is in more trouble. Expect Medicare to be allowed to negotiate prices for prescription drugs (which it cannot do by law now) and higher premiums. The very complicated Medicare+Choice options are likely to stay.

• A tougher economic climate (not due to Obama) but due to our country’s desire to live on borrowed money. Eventually living off newly borrowed money becomes unsustainable, especially if we use that money for current consumption (flat screen TVs, cars, etc.) vs. investments that increase our long-term wealth (education, bridges, etc.)

What should you do?

• Save more. Long-term returns on stocks will average in the single digits as they did from 1966-1982. Although you cannot control what returns you get in the market you can control how much money you save. Plus if I am wrong, you can retire that much earlier.

• If you earn more than $250,000 and can shift your income into 2008 from 2009, or possibly 2010 into 2009, then doing so will reduce your tax bill.

• If you earn more than $250,000 and have capital gains that you are thinking about realizing, do it now. Capital gains tax rates will be higher for you in the future.

Major economic transformations are always difficult, and usually lead to major political transformations (as happened yesterday). If Obama can navigate the political and economic waters he could set the nation on the course to a much better future.

We are facing some difficult economic times. I’m challenging you to figure out how to live on 30% less income than you have if you had to.

What are your top priorities and what would you cut? What is really necessary? Should you have a decline in your income due to a job loss, reduced business income, or for a medical reason it’s much easier to cope with the change if you have already figured out how you would adjust your spending.

Check out the November, 2008 issue of Kiplinger’s to see how people have dealt with a reduction in income.

The world economy is having its worst financial crisis in decades. The stock market has dropped by over 30% from its peak. Several major banks have failed. Many people are worried.

At times like this having a long-term plan is more important than ever. If you don’t you are likely to be swept up by the emotions of the moment and make decisions that will hurt you in the long-run. Making decisions under stress causes us to go into “fight or flight mode.” When we are in this mode, all of our higher reasoning ability is shut down in order to make sure we can escape from the imminent danger. Unfortunately for our brains a financial crisis is not the same as being chased by a tiger and responding to it instinctively vs. using our higher reasoning ability often leads to a poor long-term outcome.

Below is a logically true statement that goes against emotional sentiment:

• What ever happens in the future now is a better time to buy stocks than in Oct 2007.

The statement is true because on average stocks are more than 30% cheaper than they were in Oct 2007. Even if the market declines more someone who buys today will be better off than someone who bought in Oct 2007.

However, stocks were selling like the proverbial hotcakes in 2007 and now it’s hard to give them away. Why?

Our emotions tell us that the recent past always predicts the future, even though intellectually we know that is incorrect. In 2007 with the market reaching new highs we felt that it could only go up, and now with the financial crisis we feel it can only go down.

Having a long-term plan allows you to weather the financial and emotional storms and make better decisions for your future. Not having a plan could allow you succumb to emotions and make investment decisions on the “Sell-Low, Buy-High” philosophy which never works.

Changes are coming that will affect most Americans who will seek to borrow money in the future. Here are some of my predictions: (Note some of these changes have already occurred).

1. You will need a substantial down payment to purchase a home. Yup, we essentially back to the 20% down payment requirement of the past.
2. It will be harder to qualify for a mortgage. To get the best rates a FICO score of over 760 will likely be necessary.
3. It will be harder to get a home equity line of credit and the loan-to-value ratio of the credit line will be lower than in the past
4. It will be harder to get an auto loan unless you have great credit.
5. Fewer auto lease deals will be available (We’re already seeing that with domestic makes).
6. It will be harder to get credit cards and credit lines will be lower.You will see fewer credit card offers in the mail.

In essence the days of living on borrowed money are over. For those of you who are working with me, most of you have already made that transition and are ahead of the game. For the rest of you it’s coming if it hasn’t already.

Yes, all good things must come to an end.  The days of high-yield savings accounts offering 5% or even 6% with no minimum balances are over.

This is what some of my favorites are paying:

Emigrant Direct: 3.6% down from 5.05% www.emigrantdirect.com

ING Direct: 3.4% down from 5% www.ingdirect.com

Shore Bank: 4.15% down from 5%  www.sbk.com

According to www.Bankrate.com the highest online savings account is now paying for an account with a $1 minimum balance is 4.10% at E*trade Bank and Ameritrust Bank in Cleveland. I guess they don’t know about ShoreBank here in Chicago.

Despite the lower interest rates the accounts are still a good deal for your short term savings.  They still pay more than 10 times the .25%-.35% interest that traditional savings accounts at some of the larger banks in Chicago pay.

That difference can add up. If you had $10,000 in an internet savings account at Shore Bank you would earn approx $415/year in interest.  If you had it at a bank that paid 0.25% per year you would earn approx. $25/year.  Is it worth $390/year to spend 20 minutes setting up your online high-yield savings account?

Everyone is worried about identity theft.  In a few states anyone is allowed to put a Free on their credit.  This means that no one can open a new credit account in your name (not even you).  It also prevents the sale of your credit information.  This would stop a lot of identity theft in its tracks! In order to remove the freeze you would need to contact the three credit bureaus.  In other states including Illinois you can only freeze your credit if you are a victim of identity theft.  For most people who are not applying for credit frequently this would be a great benefit and much more effective than the costly credit monitoring services that the credit bureaus sell.

Why is the benefit not available to all consumers?  You guessed it:  MONEY! The credit bureaus make a lot of money selling YOUR credit information to whoever wants to buy it.  A credit freeze would prevent this from happening and cost them money.  In weighing the costs and benefits there is clearly a great benefit to everyone if we could significantly reduce identity theft. However, the forces opposed to it are concentrated and have money to contribute to protect their interests even at the cost of the public at large.

If you would like to see the ability to freeze your credit report extended to everyone, contact your state representatives. To find yours click on this link http://www.elections.state.il.us/DistrictLocator/SelectSearchType.aspx. If we all put pressure on our representatives they will do the right thing.

Many people I speak with feel their finances are in good shape when they are actually on the road to some serious financial issues. Below are some things that many people consider “Normal” but could indicate the start of financial troubles:

1. You carry credit card debt month to month — Carrying credit card debt means that you have spent more than you earned and did not have any emergency reserves.

1. When thinking about major purchases you focus on the monthly payment vs. the total cost. Car dealers love buyers like you!  They can almost always come up with an acceptable payment for you by stretching out your payment period to 7 or even 8 years while charging you a very high rate of interest!  Or there may be another “gotcha” like a balloon payment at the end of the loan.

1. You don’t have a reasonable idea of what you spend every month. People who don’t have an idea of what they are spending are often spending more than they are taking in and slowing going into debt. They would prefer not to think about the issue and put off the day of reckoning as long as possible

1. You don’t pay yourself first. The most successful savers I’ve met have always made themselves their top financial priority.  The first money they earn goes into savings/investing.  What is left over is what they have to live on.  These savers realized that by sacrificing some immediately gratification today, they will be able to provide for their future.  They also pass along great financial discipline to their children, who learn most of their financial management skills by watching what their parents do (not what they say).

If you see yourself doing any of these “Normal” things take a good look at your finances.  It’s much better to nip an emerging problem in the bud, than to dig yourself in a big hole that will be difficult to get out of.