A Guide To Owning or Renting Your Home

A Guide To Owning or Renting Your Home

Owning versus renting your home is a longstanding and often passionate debate. The reasons for owning or renting differ according to financial calculations and your personal preferences.

Factors To Consider

If you seek to own a home, do you prefer stability, building equity, control over home and its responsibilities, and tax benefits? Will you enjoy a sense of pride in ownership? On the other hand, does flexibility and freedom appeal to you, not having to deal with the home’s repair and maintenance, freeing you to use savings to make investments, and not have to worry about declining home values?

I understand the allure of owning your home as I have had with our primary home. We continue to hold a second home which we may one day make our primary spot. I grew up in the Bronx in an apartment building for affordable housing. As a result, my family paid a relatively low stabilized rent. Owning our home as inspired by the American Dream was out of my family’s budget.

My husband, Craig, is a real estate attorney dealing with residential and commercial transactions. When I went to law school, I was fascinated by the real estate field and became an investor in commercial properties for a time.

Before we review the advantages and disadvantages of owning and renting your home, let’s address critical factors to consider in making this critical decision.

Housing Market Trends

When it is the right time for you to buy or rent, it may be worthwhile to be aware of the overall housing market, that is, home prices, interest rates, and mortgage rates in particular. US homeownership had grown from 45.6% in 1920 to 66.2% in 2000. Homeownership rates peaked in 2004 at 69.2% (in both April and October of that year), then retreating to 65.8% in 2020.

Generational Gap In Buying Homes

According to a 2019 Zillow report, the average age of the typical first-time homebuyer in the US is 34 years old. Since the Great Recession, millennials were initially slow to purchase their home as they grapple with high student debt and slower wage growth. However, millennials’ average mortgage debt in 3Q 2020 is $237,349, just below $247,567 held by Gen X according to Experian data.

A major consideration in timing a purchase is the level of mortgage rates. Generally, mortgage rates rise during periods of strong economic growth and decline during weak or recessionary periods. Mortgage rates have been historically low, with current rates for 30 years, the fixed rate at 3.564%, and 15 years the fixed rate at 2.615%.

By pursuing a home purchase, make sure your finances are in order. That means being debt-free and establishing or expanding your emergency fund. When we review the financial costs, you’ll better understand the need to have a solid financial condition.

Substantial Financial Differences Between Homebuying And Renting

Financial costs differ between purchasing a home and renting. Homebuyers’ substantial costs can be divided into one-time payments upfront and at the closing. Purchasers face required one-time upfront and closing costs in addition to the ongoing or recurring expenses.

The process of buying a home through closing may be overwhelming, but each step is well defined.

Upfront And Closing Costs

Homebuyers are usually surprised by the number of required payments to those professionals (home inspector, bank attorney, title closer, appraiser, broker, attorney) who are assisting in their purchase. There are also other costs associated with securing the mortgage and protecting the lenders, as they will effectively own 80% of your home. You will pay mortgage application fees, points, and origination.

Upfront Costs

 

Earnest Money

Earnest money can range from 1%-3% up to 10% of the home price, depending on the locale. This money is a consideration for the mutual acceptance of a deal with the seller. As a credit, this amount reduces the purchase price at the closing. If you default before the closing, the earnest money can be the measure of liquidated damages to the seller.

Home Inspection

A qualified inspector will need to inspect the home for damages.  An inspection can help you decide on a house to buy, but before you put money down. The fee amounts vary based on the type of home, square footage, and locale. It is an essential cost as you may find structural damage or disclose other issues can reduce the price you are willing to pay.

Appraisal fees

These fees are for an independent certified appraiser’s report. The report is essential to protect the bank’s  collateral exposure. They are paid directly to the bank after inspection but before the closing and in conjunction with the mortgage loan agreement.

Escrow Accounts

The escrow account is for the bank’s benefit and the attorney’s.

The attorney escrow account holds your down payment for the house. The bank’s escrow covers prepayments for property taxes on the homeowner’s behalf for up to six months. Additionally, the buyer will be paying a full year’s homeowners insurance premiums upfront and one-twelfth of the premium into escrow. Some borrowers,  if applicable, pay private mortgage insurance (PMI) premiums. PMI is required if the buyer is making a down payment of less than 20% of the home price preferred by the lender.

Closing Costs

The final part of your purchase involves several closing costs associated with formalizing the mortgage processing and concluding the transaction between buyer and seller. They include charges for the loan application, processing, and underwriting. The latter may amount to about 1% of the loan. So if you are borrowing $300,000, you will pay $3,000.

You will be paying for a title search and other title-related costs to ensure you are purchasing a home with “good title” free of fraud and any liens for unpaid taxes, etc. The title company collects a premium and receives recording fees.

You will also be paying an attorney for closing your deal and representing you as the buyer in most states. The attorney’s fee ranges from $750-$3,000 depending on the deal’s complexity and your locale.

Recurring or Ongoing Costs

Your ongoing monthly costs of buying a home are your mortgage payments, utilities, garbage, property taxes, and homeowner insurance. These are predictable or fixed costs.

If you are buying a house (rather than an apartment), maintenance, repair, painting, and appliances may vary depending on the house’s condition and age. The costs are often difficult to estimate and may depend on your DIY abilities. You will also have other expenses for lawn care and snow removal, which differ based on your geographic location.

Costs of Renting Your Home

Upfront costs are far less. Landlords usually require 1-2 months for a security deposit at the time of the lease signing. Some landlords will increase additional security or fees for any pets you have for potential damage to their property.

The landlord may require an application fee for administrative costs and a possible broker fee unless the landlord pays this. There may be a move-in fee depending on the type of home you are renting.

Recurring Rental Costs

Tenants are responsible for monthly rent, all utilities, and renters insurance. While the homeowner has homeowners insurance, that doesn’t cover your personal property, including your furniture, clothing, electronics, computers, jewelry, and anything of value to you or liability insurance. The landlord will require you to purchase renters insurance.

Landlords are required to provide you with at least 30-day notice in most states with an increase in the rent unless stated as part of a multi-year lease.

What Is Your Financial Situation?

Before going house-hunting, if you plan to make a purchase, it is a good idea to check your credit report for any errors or issues. You need to be aware of any errors that you should correct. You should know your credit score and what amount of mortgage you can afford. There are steps you can take to raise your credit score.

By the way, your credit report matters to your landlord also. A poor credit report could be a thumbs down on your ability to rent. If your credit score is fair, it may mean providing your landlord with more security. However, a poor credit score has far more of a negative impact on your ability to borrow.

MyFICO’s loan calculator is handy for estimating your APR, monthly loan payment, and total interest paid. For example, using a $300,000 loan your payments for 30 years and 15-year mortgages as of April 9, 2021, based upon your FICO score will be:

30 Year Mortgage

Credit Score                APR             Monthly Payment        Total Interest Paid

760-850                      2.764%                  $1,227                    $141,702

700-759                      2.986%                  $1,263                    $154,517

680-699                      3.163%                  $1,291                    $164,881

660-679                      3.377%                  $1,327                    $177,583

640-659                      3.807%                  $1,399                    $203,664

620-639                      4.353%                  $1,494                    $237,826

 

15 Year Mortgage

Credit Score                APR             Monthly Payment        Total Interest Paid

760-850                      2.107%                  $1,945                    $50,162

700-759                      2.329%                  $1,976                    $55,736

680-699                      2.506%                  $2,001                    $60,219

660-679                      2.72%                   $2,093                    $65,685

640-659                      3.15%                   $2,093                    $76,822

620-639                      3.696%                 $2,174                    $91,255

 

A Few Observations

Irrespective of your FICO Score, the lower the credit score, the higher your APR, monthly mortgage payment, and total interest paid.

Financial Implications For 30 Year versus 15 Year Mortgage

When comparing the different loan maturities on a $300,000 loan:

  • The APR will be higher for the 30-year mortgage than 15 years, all else being the same.
  • The monthly mortgage payments will be significantly higher for the 15-year mortgage, given the shorter period. If you can afford to pay the higher monthly amount, you are better off with the 15-year mortgage because you pay less in total interest.
  •  Assuming you have a 720 credit score, the total home price, including total interest paid and down payment will be lower with a 15-year mortgage loan.
  • The 30-year mortgage is much higher because you are paying interest on your loan longer, so the total home price or principal is $375,000 plus $154,517 equals $529,517.
  • If you opt for a 15 year mortgage, your total home price or principal  is $375,000 ($300,000 loan + $75,000 down payment of 20%) + $55,776 in total interest equals $430,776 for principal and interest.

Advantages Of Buying Your Home

 

1. Building Equity

Paying your mortgage over time will result in building some equity in your home. You should be aware that your initial payments are predominantly for interest on your loan, especially if you have a 30-year mortgage and equity builds relatively slowly.

On the other hand, you will undoubtedly be owning your home much more quickly with a 15-year mortgage. A mortgage amortization calculator helps compare the principal and interest portions for the 15 and 30-year mortgages. Assume your loan begins in April 2021.

The comparison reveals that more than half of your first monthly payment goes to the principal than interest with the 15-year mortgage. However, only about a third of your payment goes to the principal with 30 years. The amount between principal and interest reaches parity until the year 2032, and equity rises slowly after that until the year 2050, when you satisfy the 30-year loan.

2. Your Home As An Appreciable Asset

Depending on your time frame, US new home median prices reflect appreciable growth. Median new home prices have risen from $17,200 in 1963 to $212,300 in 2011 according to the US Census of Housing. That is a 5.38% compounded annual growth rate. However, adjusted for inflation, the growth rate is 1.8%. On the other hand, inflation-adjusted monthly rent grew from $568 in 1960 to $934 in 2010, according to Apartment List Rentonomics. This 68% hike in rent is well ahead of the 18% rise in household income during the same period.

Your investment in your primary home essentially keeps pace with inflation rather than generating strong investment returns. When calculating returns you need to factor in the interest costs to the total price. That said, you are living in your home and hopefully enjoying a high quality of living which can be priceless for many.

There have broader differences in select markets across the US that exhibit stronger appreciation due to higher population growth, demand, and other factors.

Housing Bubble

The US housing bubble was particularly troubling for homeowners in the mid-2000s. Housing prices peaked in early 2006, then leveled off until record drops of 18% as reported by the S& P Case-Shiller index in October 2008.

While this drop was exceptional, it still provides a warning sign for those interested in purchasing their homes as loss in home values is real. However, some markets have recovered from the Great Recession and recent housing price trends seem more favorable.

3. HELOC As A Source of Funding

Once you have built some amount of equity and have paid your mortgage on time, you may be able to set up a home equity line of credit or HELOC. You can often get a loan more quickly and at lower rates because you are using your home equity as collateral. Part of these funds could go to building a new kitchen or expanding the house.

The HELOC, if not maxed out, can positively help your credit score. This is because the HELOC has increased the available amount of credit, lowering your utilization rate and improving your financial situation. Credit utilization accounts for 30% of your credit score. HELOC increases debt, so make sure you pay this loan on time and in full. To avoid a hit to your credit score, don’t close the HELOC unless you are too tempted to use the money or about to close on the house, as it will then lower the available credit.

4. Possibility of Rental Income

When you live in your primary residence, you don’t often think about renting out your property. However, your family may relocate for your firm for a couple of years, or your kids are moving out, and you want to travel more. You may decide to rent out your home or list it with Airbnb.

5. Stability In Owning Your Home

It is wonderful to raise your kids in one home, become part of the neighborhood and community. There is a certain calm feeling of not searching for a place to live and pack and unpack boxes. (Having just moved to a new home, I can share that I will be thrilled when our family settles in our home and the last box is gone.)

6. Tax Benefits After The Tax Law Changes

The 2017 tax law did impact some of the tax deductions enjoyed by homeowners. If you itemize your deductions on a joint filing, you still claim mortgage interest payments up to a $750,000 face value loan. Qualified loans include your mortgage, home equity loans, and HELOCs. This tax change is a reduction from $1,000,000 before the recent tax law. You can no longer deduct interest associated with home equity debt unless buying or improving your home.

Deductions for state and local taxes (known as the SALT deduction) and property taxes are capped at $10,000. This amount may be appropriate in Ohio but not in high-tax states like New York or California. This is a reduction from unrestricted amounts previously deducted. You can still deduct the proportionate interest associated with your apartment building’s mortgage if it is a co-operative.

Homestead Exemption

Certain states, like Florida, offer exemptions if you meet specific requirements. This exemption may protect a surviving spouse when the homestead spouse dies. A homestead exemption is a law that protects the value of a home from property taxes and creditors. Depending on the state, a property tax can get an exemption in the range of $25,000-$75,000 of a home’s assessed value from property taxes.

7. You Have Freedom To Do What You Want

Are you creative? Your home can be a good option for you. There may be some conformity required, but your wallet limits design and remodeling. You can do gardening and grow vegetables. Owning your pets is more manageable in your home. Your children can listen to loud music with fewer rules of noise after hours. Peace of mind can be precious for you and your family.

8. Sense of Pride In Ownership

For those who have rented for a long time. owning your home feels like an accomplishment. The land is a natural resource, and there is a good feeling of knowing you own the land where you walk and live.

Ask any refugee that has had their home taken away from them what a house meant to them. My mom was a refugee when she came to the US, having lost her family. Her home was taken away illegally and violently. While owning a home eluded her, she always considered owning a home away to wealth.

Disadvantages of Owning A Home

 

1. High Costs To Own

We addressed the one-time and recurring costs a homeowner has to realize, but it bears repeating. In particular, there are unforeseen events that require homeowners to do planning ahead of the purchase. Having an ample emergency fund is essential for all, but homeowners need to expand that fund to avoid borrowing unnecessarily.

Consider the age of the home and its condition when factoring in maintenance and repairs. Are you handy? We are not, and so we rely on a plethora of plumbers, electricians, and those who can help us around the house with shower breaking and leaky pipes. I keep wanting to spend time watching YouTube to pick up some tips but I am always afraid of starting a fire.

Our teens are handier but not always available given their schoolwork, friends, sports, video games, and sleeping late.

It may be worthwhile to watch the 1986 movie The Money Pit with Tom Hanks and Shelley Long. It left an indelible memory of what not to do with your house.

2. Lack of Flexibility

If you are adventurous, you may feel stuck in the same house and environment, especially as your friends may pick up and leave to try life in another place or country. You may want to sell your home and retire to another locale, but the local economy is weak.

We had next-door neighbors who experienced that predicament. They lived in Connecticut and had bought a house in Florida. The market had been terrible for the better part of a decade. They had to stay put in the colder climate they planned to avoid in their later years. They finally sold last year.

3. Your Home Has An Opportunity Cost

A home is usually the most significant asset you own. The mortgage, maintenance, repairs, and property taxes require a lot of capital that may be better invest in a diverse investment portfolio. Many people believe that when they sell their house, they will use the money for retirement. That is true, but there is no guarantee that you will be able to sell your property quickly or not be facing declining values.

Too much concentration on one asset is hazardous. You need to have investments in other assets but saving to invest in other vehicles is difficult when so much capital is in real estate.

One way to avoid this difficulty is don’t buy a house too big for you. The amount of space homeowners have been buying has dramatically increased since 1973. Specifically, median size homes have recently expanded to 2,467 square feet, up to 1,000 square feet. During that time, the average living space per person in the household has nearly doubled to 971 from 505. Do we need all that space and then have to furnish it too?

Advantages of Renting

 

1. Rental Costs Are Less

The lease agreement with the landlord provides your financial responsibilities, which are essentially predictable: monthly rent payments, utilities, lawn care, garbage disposal, and snow removal if applicable. There is a minimum of upfront fees. Finding an apartment may be harder in specific markets and more expensive based on demand.

2. Benefits of Ownership Without The Property Taxes

You may be fortunate to get the best of what property taxes pay for without having to pay these costs when you rent. Families are always willing to pay more money for a house to be located in a nice place with a great school district. Higher home prices and property taxes may put buying a home out of your range.

Our Recent Move To A Rental House

By renting, you can access the town’s beauty, infrastructures like transportation, town pool, and schools. These attributes are a big reason why we moved to a small town (from a big city)  to a house rental (from an owned apartment) and switched our kids from a private school to one of the best public schools in the state, if not the country.

Our son joined the football team, and our daughter is considering other sports not readily available at her previous school. It was a difficult decision, especially for me, having grown up in the city. Although it is early, it feels promising.

Renting may also help you get familiar with the area before purchasing and allow you to get your financials in order.

3. Free Of Maintenance And Repairs

Your landlord has primary responsibility for the care of the property. It is up to you to inform your landlord of the need for maintenance and care. For those not handy or not wanting to spend the money to fix things, renting can be ideal.  Usually, the landlord wants to use their folks (e.g., painters, electricians) for respective issues in the home.

4. Flexibility To Leave

At the end of the lease, you can leave the premises. Many people decide to move around and explore different areas or look for other jobs. You aren’t tied down, and as long as you make payments through the end of the lease, you are good to go. It is challenging to leave your own home as quickly as a tenant can.

Disadvantages of Renting

 

1. Higher Rent Or Sells Property

Your landlord can raise your rent with proper notice or sell the property. Renting has increased faster than household income has since 1960. Apartment List Rentonomics points out that inflation-adjusted rent rose 64% from $568 per month in 1960 to $934 in 2010, while household income grew only 18%.

Many homeowners turn to rent if they are unable to sell their property due to a poor market. Once the market turns, they may ultimately sell the home you are renting.

Markets vary, but in specific markets, there are fewer homes to rent.

2. No Equity Buildup or Tax Benefits

It is common for people to say that renting is throwing money away. Of course, this is not true as you are paying for the living space for some time. You have the freedom to find the best affordable apartment you can to live in an area you prefer.

You are not getting equity or tax benefits from your rent, but you are getting several advantages. You can divert your savings into other assets.

3. A Bad Landlord

It would be a drag if you rent an apartment from a bad landlord, but the good news it is not permanent. Before you rent, check out Yelp to see if there any red flags to know about your landlord. People are always willing to share their bad stories.

I recall some horrifying stories that painted their landlord as a reincarnation of Jack Torrance, played by Jack Nicholson in The Shining. Torrance was the caretaker at an isolated hotel.

If you are having trouble with your landlord, who is not providing services promised in the lease, there are legal actions to take.

4. No Upside From A Strong Housing Market

As a renter, you do not get the benefit of improving house values. It may feel bad when your friends are experiencing some growth in their home value, while you may be getting a notice from your landlord that they are getting ready to sell or raise the rent.

 

Final Thoughts

Hopefully, this guide provided you with good information to decide between buying or renting your home. Frankly, you can look at the calculations related to mortgage costs, building equity, home prices, square footage, but in the end, the choice is a personal one for you and your family.

If there is one point I would like to make, consider how your preferences line up with your long-term financial goals. Make sure that if you find your dream house, it is doesn’t break the bank. You don’t want to be too overladen with debt.  Remain disciplined in your spending and make saving a priority.

 

Thank you for reading! If you rent or own your home, would you kindly share your experiences with us? We always like to hear how you decided which shed light on a home decision.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

How To Make Better Money Tradeoffs

How To Make Better Money Tradeoffs

“There are no solutions; there are only trade-offs.”

Thomas Sowell

There are tradeoffs in most aspects of our lives. We have a plethora of choices and cannot do everything we want to do. For every choice we make, opportunity costs requiring us to forego benefits for the option not selected. Opportunity costs are the loss of potential gains from other alternatives when making a choice.

Tradeoffs between time and money differ significantly based on age and lifestyle based on our unique set of values. With less time like Boomers as an older generation, you might place more importance on time while young people may favor money. That is not always the case.  Based on this global survey, those in the 20s and 30s tend to lean more time than money, valuing experiences over possessions than boomers, as seen in this infographic.

Each of us has to decide based on our characteristics and circumstances. Typical examples of trade-offs between time and money as we ponder our individual decisions, we:

  • Opt for a job requiring a long commute for a pay hike.
  • Have one income with mom or dad staying at home with the kids.
  • Go to a movie instead of working on an assignment due the next day.
  • Job security with the government or seeking a wealth opportunity with long hours and traveling.
  • Attend a community college initially, then transfer to a four-year college.
  • Work at home to spend more time with family.

Sure, we can try multitasking or combine activities when we face conflicting demands on us. However, there is often a price to pay when poor execution results.

Make Diligent Choices

Instead, we may inform ourselves by making diligent choices. How conscious are we when we make these decisions? For some decisions, make complex financial calculations as needed. On the other hand, there are times when we may not even be aware of having made a choice. Time, money, productivity, and health may act as alternative constraints, reflected in your priorities.

Time is a precious finite resource we often waste. Even if we have unlimited capital available, we just don’t have the time to spend it fruitfully. We want to enjoy our lives to the fullest, with health on our side. Without taking care of ourselves, time is short, and no amount of money may cure our illness. Since we have longer life expectancies, we need to support ourselves by fulfilling well thought out financial plans.

Typical Tradeoffs We Face:

 

Your Home: Buy or Rent

Owning versus renting your home is among the most common tradeoffs involving personal preferences, age factors, and your financial situation. Our family has rented and owned our home. After many years of ownership, we are renting a home in a lovely town, taking advantage of a great public school system.

If you seek to own a home, do you prefer stability, building equity, control over the home, and its responsibilities and tax benefits? Will you enjoy a sense of pride in ownership? These benefits come at a high cost based on a 20% down payment and mortgage loans for 80% of the home’s principal price, with interest rates strongly determined by your credit scores. The opportunity cost of owning your home may prevent you from saving for retirement and making other investments. Your home will not likely appreciate more than inflation.

The term of your loan can vary based on 15 years versus 30-year mortgages–another trade-off. The longer the loan, the lower your monthly payments. However, the 30-year mortgage raises your total costs compared to the 15-year loan.

Financial Implications For 30 Year versus 15 Year Mortgage

When comparing the different loan maturities on a $300,000 loan:

  • The APR will be higher for the 30-year mortgage than a 15 year one, all else being the same.
  • The monthly mortgage payments will be significantly higher for the 15-year mortgage, given the shorter period. If you can afford to pay the higher monthly amount, you are better off with the 15-year mortgage because you pay less in total interest.
  •  Assuming you have a 720 credit score, the total home price, including total interest paid and down payment, will be lower with a 15-year mortgage loan.
  • The 30-year mortgage is much higher because you are paying interest on your loan longer, so the total home price or principal is $375,000 plus $189,622, equalling $564,620.
  • If you opt for a 15 year mortgage, your total home price or principal  is $375,000 ($300,000 loan + $75,000 down payment of 20%) + $76,012 in total interest equals $451,012 for principal and interest.

On the other hand, renting provides flexibility and freedom. Your rent is usually more affordable than home costs, not having to deal with the home’s repair and maintenance, freeing you to use savings to make investments, and not have to worry about potential declining home values. The downside of renting your home has restrictions to do what you want to make your place more livable. Your landlord could decide to sell the property and require you to move. There is always the risk of having a bad landlord whose actions force you to pick up and leave.

My Take

The necessity of the tradeoffs of owning your home versus renting considers the tug between time and money differences.  When buying your home, you are making a long term commitment to the neighborhood, greater responsibilities in maintaining the property, insurance, and keeping up with monthly payments for some length of time. Alternatively, renting is usually a shorter-term commitment that may require future moves but with less responsibility and costs.

For families who want to control their home, buying is the way to go, especially if you can handle the shorter mortgage terms so you can pay off your debt sooner. Understand your long term goals for your family and financial priorities for your money. Don’t take on too big a house that you can’t afford. Renting is a great choice, especially if you don’t want the headaches of your own home. We compare advantages and disadvantages in our guide to owning and renting your home here.

A Car: Buy, Lease or Borrow

If owning your home is seen as the American dream, our culture has long embraced car ownership as a faithful supplement to our lifestyle. When seeking a car, you have a few alternatives. Do you want a new or used car, preferably certified pre-owned? Are you buying or leasing this car? If you are getting this car for personal rather than business use, the tradeoffs between buying the car with a loan or a lease are relatively straight forward. Assume you are getting a new car in a low-interest-rate environment and similar credit scores whether you are buying or leasing. About 30% of those getting a new car is leasing.

The Advantages And Disadvantages Of Leasing A Car:

There are lower upfront costs requiring a security deposit and usually the first month’s payment. Payments for registration and taxes are needed for leasing and buying the car. When leasing, you will make lower monthly payments for the lease term. Your credit score influences the amount, favoring those with very good to excellent scores.

The manufacturer’s warranty covers most if the leased car’s repairs.

Depending on your term, you are getting the latest technology available in safety, entertainment, and comfort. Those who lease can get a new car every 2-3 years.

There are mileage limits on the car though you may be able to negotiate a bit.

You don’t own the car at the end of your lease. Gap insurance is an optional add-on car insurance covering the difference between the amount owed on a vehicle and its actual cash value in the unforeseen event it is totaled or stolen. When returning the leased car, you may have to pay for excessive maintenance, wear and tear costs.

End of lease costs can be a bit shocking when returning the car. When we finished our lease recently, we were quite surprised at some of the hidden fees discussed when we initiated the lease. We incurred costs close to $1,000 to the lessor to reimburse them for taxes to the local municipality. These fees were relatively new to us, causing dismay. This lease was likely our final one.

Advantages and Disadvantages Of Buying A Car:

Higher upfront costs, including down payment and trade-in, if you have another car. Of course, the more the upfronts costs, the lower your monthly expenses.

Owning presents higher monthly costs than leasing, depending on term length. According to ValuePenguin, the national average of US auto loans is 4.37% in 60 months, though in recent years, buyers have increasingly extended their loan terms to 72 months, with 84 months gaining popularity. The longer the loan, the higher the total interest you are adding to the car’s cost. Experian has reported that new car buyers with the highest credit scores have average loans of 63 months versus those with the lowest scores taking out loans of 72 months.

As you own the car, there are no restrictions on mileage or what tires you want. While you can resell your vehicle, keep in mind that it is a depreciable asset that loses value in the early years and is impacted by mileage long term.

My Take:

The tradeoff on buying or leasing a car is similar to owning or renting your home. A third option to buying or leasing a new car is buying a certified used car. Depending on its age and mileage, it may have remaining time left on the manufacturer’s warranty. After purchasing and leasing cars for years, we recently chose this third option. We paid cash for a 4-year-old certified Subaru as a second car, given its strong reputation for longevity. We are tremendously happy with it.

Spending vs. Saving

This tradeoff’s concern is that it ignores the need to temper spending in favor of saving money. If you spend more than you earn, you either will be withdrawing from your savings and investment accounts or, worse, borrowing to pay for your purchases. On the other hand, if you spend less than you earn, you can better afford your living costs and enjoy life. Having money left over to build an emergency fund, save for retirement, and make investments provides you with more options over the long term.

Adopt an attitude that allows you to enjoy life but not be so costly that you can’t afford your bills. Avoid lifestyle inflation, which comes about when your earnings rise, and you increase your spending. The more you can delay spending and reduce impulse buying, the better your financial health. Many experiences are free, healthy, and worthwhile pursuits. Make room in your budget for a solid emergency fund, pay off your debts to manageable levels, and save for retirement.

Emergency Fund Vs. Debt Payoffs

You should be put savings aside for an emergency fund to cover at least six months of essential living costs. This habit will eliminate the stress of the unknown and reduce your need to abuse your credit card. Many people lack $1,000 in savings to pay for unforeseen costs like a job loss, an emergency surgery for a favored pet, or a damaged car. Having to pay for these costs often leads to higher debt, especially credit card debt with higher interest costs. Set small savings amounts aside earmarked specifically for an ample emergency fund and invest this money in a readily accessible liquid account.

Paralleling these savings, you need to pay your monthly student loans and your credit card bills. If you can’t pay your credit card balances in full, reduce your spending. It is easier said than done. However, committing to keeping debt at a manageable level is critical.

Saving For College Or Retirement: A Tough Choice

When faced with helping your children with their college funding or tapping your retirement money, it becomes a tough choice you don’t have to make. If you are in your 50s or more, you should not touch your retirement account. True, you want to avoid burdening your kids with student loans early in their lives. The average student loan is $31,172, a significant amount of debt to carry. However, they have the benefit of a longer-term horizon than you.

As a young couple, your earnings are rising through your 20s, 30s, and beyond. To avoid having to make a difficult choice, later on, save, and invest now. These are the years you should make your money work for your future. It may mean spending less now, so you have more money to address critical areas of your lives later consciously. These involve essential trade-offs.

Don’t ignore what you can do now to provide plenty of benefits to you and your family long term. Handling money allocation into key baskets for college funding, retirement, and investments early will improve your financial outlook.

Save For College Early Using A 529 Savings Plan

When you expect a child, put aside some money into a 529 Savings Plan or other plans you can read about here. You get tax benefits using pretax money invested in several options based on your preferences. The more money you can put into these funds, the greater likelihood of lower borrowing in your children’s college years. Most states have their plans and have a lot of investment choices. Prioritize saving early in your child’s life so that you don’t have to borrow from your retirement funds.

Retirement Savings In Your 20s

You should begin to save for retirement as soon as you enter the workforce, if not before. Most employers offer 401K retirement plans that make it easy to fund your account through your paychecks. Automating these payments is simple though it may require an opt-in process. Setting this up at work is among the first things you should do when you start your first job.

Many employers will contribute to your retirement account based on a pre-determined match formula. For example, if you save a targeted percentage of 6% of your paycheck to your company-sponsored retirement plan, they may add 50% of that amount or an additional 3% of the money to your account. Separately, you should also set up an IRA or a Roth IRA and focus on contributing up to the maximum amount allowed.

Saving for retirement in your 20s allows you to have a sizable nest egg with compounding returns when you are ready to move to the next stage of life. On the other hand, catching up to saving for retirement in your 50s, while possible, is very difficult. It may mean working longer or tapering down your lifestyle in your later years. The risk you have of waiting too long to accumulate retirement money is that of losing your job in your 50s or if, for health reasons, you no longer can work.

Facing these tradeoffs head-on and early in life create a lot of flexibility and freedom in your later years. Make your money and time work for you as productively as possible. It is easier to sacrifice some choices for the more significant wallet needed later on. Long term comfort in retirement is a worthwhile aim.

Final Thoughts

Making tradeoffs that consider time and money may be intuitive or involve financial calculations balanced with your financial priorities. Addressing many major decisions early in life may provide you with financial flexibility and the freedom to choose an array of lifestyle options. The more you delay thinking about your choices, the harder the trade-offs you have to make. Your 20s and 30s are golden times to tackle savings as your earnings rise. Avoid finding more things to spend on that don’t positively add to your comforts.

Thank you for reading! Please visit us at The Cents of Money to see other such posts and subscribe to our weekly newsletter.

What kind of tradeoffs have you been facing? Did your choices involve your lifestyle or career? We would love to hear from you!

 

 

 

 

 

 

How Safe Are Your Bank And Financial Accounts?

How Safe Are Your Bank And Financial Accounts?

The coronavirus has weakened our financial markets and our economy as social distancing has slowed economic activity. With high unemployment and tweaked growth, we have been in a recession. Many people are hurting. Unfortunately, there are many who like to take advantage of those who distracted by losing jobs, keeping businesses afloat, and worrying over the tragic virus. 

Are You Financially Safe?

Are your bank and financial accounts safe during this time? Yes, it is to a great extent. However, it is essential to know if your funds are secure. That varies by product and how it is offered. Which accounts are insured and from what potential risks?  We will review the different financial accounts you have. You also need to consider the safety of your bank. The last recession-plagued banks either were acquired by larger banks or collapsed. More than 450 banks failed across the US during 2007-2012 according to the FDIC.

We will discuss your financial accounts at banks, credit unions, and at your brokerage firm. Our stocks and bonds carry more risk than bank accounts. Recognize that fraud may rise due to swift economic changes. We have some recommendations below to better protect yourself. But first, a little background on where we are today given the havoc caused by the coronavirus.

The Federal Reserve’s Emergency Measures

The Fed has taken massive emergency measures not seen since the Great Recession, which we address here. Chair Jerome Powell deserves credit for aggressively providing liquidity to lenders and our financial system swiftly. We need to see these actions.

Thus far, Powell and his troops have reduced their benchmark fed funds rates to near zero. They lowered the Fed’s discount rate used for those banks that couldn’t borrow from peer banks. The Fed will lend to those banks as the banker of last resort.

As part of their program, they have purchased considerable amounts of government and mortgage securities and will do more. They have adopted similar quantitative easing levels used during the last recession. Also, they reduced the reserve requirement ratio to zero from the standard 10% level. A lower reserve requirement means that banks can increase the lending of their deposits in their vaults. Banks are being encouraged to lend 100% (from 90% regularly) of their capital to businesses and consumers in need.

There will likely be more liquidity sources from the US government, Small Business Administration, and the private sector as the Biden Administration takes over. There is a movement to provide increased financial support.  Check your local websites for more information

From Economic Stability To Economic And Financial Market Volatility

Today, banks are more robust than during the last recession. However, credit pressures are now rising, and cash is needed by many. That is especially true for small companies, their employees, and households who don’t receive paid sick leave. Fear of the virus spreading has required us to change how we interact, shop, and dine. Social distancing has become the new norm.

After a long economic recovery and a bull market, we are now moving into an environment reminiscent of the severe recession of 2007-2009. Then, failures of financial institutions caused bank customers to try to liquidate deposits. The Fed is trying to avert a credit crunch.

Fraud often rises in this environment. As a result, use available security features to protect ourselves from gaps related to new digital technologies. As consumers, we need to know what risks exist. We provide some recommendations.

Another question you may ask: how safe is your bank? Bankrate reviews and rates various banks. Banks with $1 billion in assets are typically more vulnerable in weak markets we have now. Check this list for your bank from time to time to make sure they are not troubled.

Financial Crisis Left Some Bad Memories

Market liquidity failure caused the Great Recession. Rumors and false news were always around. I remember watching Citigroup shares dropped to $0.97 per share in March 2009. Investors lost confidence and feared that more than Lehman would collapse. The market value of Citigroup fell below $6 billion from $277 billion in late 2006. People were standing in lines around the block at a New York City midtown Citibank location to withdraw their money. No one wants to revisit that scenario.

According to the Federal Deposit Insurance Corporation (FDIC), more than 450 banks failed from 2007-2012. Most of those that collapsed were smaller banks. While we are not facing such a scenario today, it is worth knowing what kind of protections are available for our financial accounts.

FDIC Insurance For Deposits At Banks And Thrifts

The FDIC insures deposits in banks and thrifts of up to $250,000 per depositor ($500,000 for joint accounts), per insured bank for each account. To check if the FDIC covers your accounts, you can check their estimator.

Most banks fall under the FDIC insurance mandate. State banks may have insurance coverage if they are members of the Federal Reserve. So are state-chartered banks that are not members. There are very few state banks that do not have FDIC insurance. You can check here.

What Accounts Qualify For FDIC Protection

You have coverage for deposits in accounts for savings, checking, negotiable order of withdrawal (NOW), money market deposit account or MMDA (but not money market mutual funds), time accounts like a certificate of deposit (CD), cashier’s check, or money order.

To maximize coverage, you can open accounts at different financial institutions and for other accounts. However, different branches do not count as a separate bank. If you are holding money in qualified accounts, like savings or money market securities, you may have coverage for retirement accounts, specifically for traditional IRA and Roth IRA. However, keeping your retirement savings in money market accounts are not a good way to build a nest egg.

What Is Not Covered

FDIC does not insure bonds, stocks, Treasury securities, mutual funds, annuities, municipal securities, life insurance policies, safe deposit boxes, or their contents or any investments. These financial products are protected separately by the Securities Investor Protection Corporation (SIPC). We will discuss this below.

What The FDIC Does Not Protect But Other Federal Laws Do

The FDIC does not protect bank customers from losses associated with bank robberies or thefts, including identity theft, fraud, or privacy.

While identity theft, fraud, or privacy is not protected by the FDIC,  report any occurrences to the Federal Trade Commission (FTC) as soon as you discover them. If your credit, ATM, or debit card is lost or stolen, federal law limits your liability for unauthorized charges. Report it immediately.

Data breaches have become more common in recent years. In this guide, we discuss what you should do if these fraudulent transactions hurt you.

The Electronic Fund Transfers Act (EFTA)

Consumer risks rise with the increase of instant electronic payments. The Electronic Fund Transfer Act (EFTA), also known as Regulation E, protects consumers when using electronic means to manage their finances. This federal law covers transactions that use computers, phones, or magnetic strips to authorize a financial institution to credit or debit a customer’s account.

Electronic payments often take the place of traditional paper checks. More consumers are banking online. While people still use paper checks, fintech adoption is expanding. Specifically, peer-to-peer payment (P2P) providers are enabling instant transfers via mobile apps like bank-sponsored Zelle and Paypal’s Venmo.

Fintech Platforms Are Convenient But Need To Be More Secure

These products were likely not anticipated by EFTA. As a result, they may have raised consumer risks without enhanced protection against data security and privacy breaches. However, providers are strengthening their products.

Statista estimates a total 2019 transaction value of $4.1 trillion in digital payments, with an average transaction value of $1,102 per person. However, an S&P Global Market Intelligence Fintech late 2018 survey reports consumers avoiding these mobile apps cite security as a significant concern.

Consumers should be responsible when using these P2P platforms. Peer-to-peer products are convenient for sending money quickly to those we owe money. Just make sure you are sending it to the right party. P2P users should double-check the relevant address, number, or username of the person they are trying to send money to. We can make mistakes, or worse, be defrauded.

Consumer Reports (CR) reviewed peer-to-peer payment providers comparing their safety features. They called for the EFTA to extend protections for unauthorized transactions when potential fraud may occur. 

NCUA Protect Credit Unions 

Credit unions are financial institutions like banks. They are member-owned financial cooperatives. Members, usually union workers, control these entities. They are nonprofit organizations, offering savings accounts and loans like a bank.

However, the National Credit Union Administration Insurance Fund (NCUAIF), not the FDIC,  insures credit union members’ accounts with $250,000 in coverage for their single ownership accounts. They cover the same type of accounts as FDIC but refer to accounts as “shares or share drafts” for savings and checking accounts.

If you go over the federal limit of $250,000, you can ask your bank or credit union if they offer private deposit insurance for more coverage.

 You can find an estimate of whether your share is covered, check here.

SIPC Provides More Limited Safekeeping For Investors

SIPC provides coverage for investment assets held in a brokerage, limited to the custody function. They only protect customers of member broker-dealers if the firm fails financially. The Custody Rule is to safeguard client funds or securities against the possibility of being lost, harmed, or misused.

Coverage is up to $500,000 for all investment accounts at the same institution, including a maximum of $250,000 held in cash.

No Coverage For Market Losses

SIPC does not provide blanket coverage. Market risk is not covered, meaning investors’ losses from the declining security values are uninsured. Investors assume all losses.  It’s part of the higher risks (and rewards) of investing in stocks and bonds. The latter securities are subject to more market fluctuation than risk-free and liquid cash and cash-equivalents insured by FDIC.

Instead, SIPC’s coverage protects unauthorized trading in customer accounts for stocks, bonds, treasuries, CDs, mutual funds, including money market mutual funds. They do not protect commodity futures.

Retail investors, including young investors and traders, increased participation to 20% of the market trades by mid-2020, up from 10% in 2019. Attracted to the rising stock prices, inexperienced investors may ultimately lose money if they are not fully aware of the risks. Retail stock trading app Robinhood, a SIPC member, has ramped up a young customer base in recent years. Like all brokerage firms, they need to make their customers aware of the risks they assume.

Where FINRA Comes In

The Financial Industry Regulatory Authority or FINRA is a self-regulating nonprofit organization overseen by the Securities Exchange Commission (SEC). While SIPC does protect market losses, consider filing a dispute against the broker if they bought securities that were unsuitable for your portfolio. FINRA resolves disputes between investors and brokers through arbitration and mediation.

If the broker sells worthless securities to a customer, the customer will file a complaint with FINRA, not SIPC.  FINRA is responsible for monitoring the broker-dealer industry. They oversee that qualified and licensed brokers remain so. Securities sold to investors must be suitable based on that individual’s needs and risks adequately disclosed. For example, selling high-risk securities to retirees is not generally appropriate.

For a time, I was an active FINRA arbitrator, hearing alleged injured investors and their brokers after stocks fell during the severe recession. Many investors lost a lot of money in fanciful mortgage lenders like Countrywide.

How Can We Better Protect Ourselves From Fraud

 Mandated consumer protections for our financial accounts only go so far. We need to have a healthy dose of skepticism and take our own precautions. Digital technologies are growing faster, providing us with more capabilities and convenience. Compliance gaps exist among incumbents (like Wells Fargo) and fintech companies.

Here are our recommendations to protect thyself:

 

1. Be Alert To Imposters And Phishing Emails

According to the FTC, scammers are sometimes posing as someone you can trust, such as a family member, government official, or charity. Never send money or give out personal information in response to an unexpected request.

2. Safely Dispose Of Your Personal Information

Use a paper shredder or wipe your computer’s hard drive. Find ways to delete all your information from your smartphone and remove your SIM card. To be honest, I keep all my old electronic devices.

3. Don’t Use Public WiFi

In the recent past, I always used Starbucks’s wifi, literally living at my local place when studying for the bar (to practice law). Now, we encourage our kids to use public wifi rather than drive up our data bill. No more! We find it easy to connect to public wifi because there isn’t authentication that is beneficial for hackers.

4. Don’t Believe Your caller ID 

It is effortless for scammers to use fake names and numbers. I have picked up my house phone because I recognized my own cell number. I hung up that baby so fast that I almost broke my phone. My house phone is on borrowed time.

5. Consider How You Pay

While credit cards have significant fraud protection when detected, wiring money does not. According to the FTC, wiring money is among the worse methods you can use to send money. If you are using Western Union or MoneyGram,  be aware that you can’t get your money back.

When I worked on a case for the court, an elderly woman who was losing her mental capacity was literally giving away a large portion of her significant net worth through MoneyGrams. She had a constant caller asking her to meet him in mysterious places in her neighborhood. Her family was unaware of her declining capacity or her constant money wiring until they found huge withdrawals.

When using Venmo, Zelle, or Apple Pay, make sure you are sending money to the correct party. Check the recipient’s address and contact info.

6. Keep Your Passwords Private

Young people tend to overshare everything including their smartphones, and often will provide friends their passwords. Change passwords often and use strong passwords. For those who worry about forgetting a password, use a password manager.

7. Don’t Carry Your Social Security Number In Your Wallet 

I am preaching the obvious but don’t carry any private information containing your social security number. That number is your identification and on many different kinds of documents, such as credit card applications, bank applications, or your health plan. You never want to lose your identity to others.

8. Review Your Credit Report For Possible Issues

The three nationwide credit reporting companies–Equifax, Experian, and TransUnion–are required to provide you with a free copy of your credit report at your request, once every 12 months. You can also visit annualcreditreport.com for your free report. The FTC does not recommend that you use other websites for free reports.

9. Monitor Your Personal Statements

Review all your statements when you get them and call vendors when you spot a mistake. Check your deposit balances daily. Sign up for text alerts with your bank.

10 Don’t Open Suspicious Emails

When you get mail with a bank name, scrutinize it carefully. Don’t open links from someone you don’t know or appear to be suspicious. Your bank will text if they see unusual spending or call you.

For more on how to protect your privacy, see here. If your child has their own bank account or credit card, they need to take precautions as well.

Final Thoughts

Our financial assets are important to us. We need to make sure our accounts are safe from outside factors and take our own precautions. Our bank accounts are insured by the FDIC. To a lesser degree, so are our investment accounts by SIPC. As we do more banking online and use P2P platforms, we need to be aware of increased risks and take precautions.

Technology is a wonder given its convenience. Banks (and businesses overall) have increased data privacy and security. For the most part, our accounts are generally safe. Most importantly, I hope you and your families stay healthy.

Thank you for reading!

How are you fairing in this crazy world? What precautions have you taken that work well? We would like to hear from you.

 

Best Personal Finance Tips You Should Know

Best Personal Finance Tips You Should Know

This time of year is always a good time and place to see where you stand regarding your financial goals. Build and strengthen financial habits to achieve financial success. Use these personal finance tips as a checklist to become more financially organized at the beginning of the year. No matter what your situation is, your financial success doesn’t happen without work. Careful planning, often with professional guidance, requires that you look at a wide range of your finances and how you handle money.

We cover major tenets of personal finance and relevant tips you should know to have better financial health and success.

Evaluate Your Monthly Budget

Track your monthly income and expenses. Break your expenses into fixed or non-discretionary expenses and variable or discretionary expenses by category on an excel spreadsheet. Think of your budget as your household’s income statement. Your budget will help you to control your spending.

Use the 50/20/30 budget rule as a rule of thumb. Essentially, you are allocating your after-tax income into three budget buckets:

  • 50% of your spending are for your needs, notably housing, utilities, groceries, car payments and other needed fixed or non-discretionary expenses.
  • 20% for savings that can be used for paying down debt, emergency fund, and  investing or combination.
  • 30% are for your wants, that is discretionary or flexible spending for entertainment, vacations, and shopping. This what is left after your allocations are made for priorities, notably needs and savings.

Adopt a disciplined strategy as early as possible when you have fewer items to track. Use budget apps readily available or create your own excel spreadsheet.

Update Your Net Worth

Keep track of your net worth which is your household balance sheet. To calculate net worth, add all of your assets that you own less all liabilities that you owe. When you are young, you may have more liabilities because you are just starting out and may have college loans. However, over time, through accumulation of assets that grow at rates faster than your debt, you should have amassed comfortable net worth.

Net worth is an important benchmark to compare against your short and long term financial goals. Are you where you want to be in your 20s, 30s, 40s and thereafter? The fastest way to build wealth is through good financial habits that require saving, spending less, managing debt wisely and investing.

Build An Emergency Fund

Save for emergencies in a separate account that is readily available money. A common mistake made is not saving money for unexpected events like losing a job, pet surgery or a flood in your basement. Plan for 6 months of essential living costs to take care of rent, mortgage, uitlities, credit card bills and any other fixed monthly costs. Make sure your emegency fund is liquid in either cash or cash-equivalent (also known as money market) securities.

This fund should be used for emergency purposes not necessarily your wants for a high priced vacation. If you like to travel a lot, it may be worthwhile to have a separate vacation fund to set aside for those purposes.

Make Savings Your Mantra

Spend less than you earn so that something is left over to put in savings. Part of your savings should be allocated to investing. Growing your money in investment accounts is your best path to a comfortable financial life and to achieve wealth. Alternatively, spending more than you earn will result in more debt.

Automate your finances from your direct deposit paycheck so that some portion goes into your emergency fund, 529 college savings and retirement savings. Even with automation, review your amounts periodically. It is easy to set up withdrawals from your earnings and forget about it. However, you may be able to afford higher amounts than what you set up initially and can sock some more money away now.

College Savings Planning Should Be Started Early

Set up a 529 college savings fund as soon your newborn arrives. There are several ways to save for college besides a 529 plan like a Coverdell Education Savings Accounts and UTMA. Saving for college early gives you a headstart in growing funds through the power of compounding  while enjoying deferred tax benefits. Virtually all states have their own plan though you are not limited to your home state. There are a variety of funds to choose from including target date funds.

Retirement Savings And Earn Company Match

Save for retirement as early as possible. By setting money aside early you benefit from compound growth, that is, interest on interest. You may defer tax payments or reduce tax costs long term. Learn how your employer-sponsored 401 K plan works with respect to matching contributions which can be quite valuable. A company 401 K match may be a certain percentage like 6% of your salary with the firm matching dollar for dollar (or 100% which is generous) or something less of the amount you saved.

These contributions are like “free money” so don’t leave these dollars on the table. Open up a Roth IRA account to complement your 401 K retirement plan. You want to max out these amounts. Invest this money in a variety of investment choices offered by the plan.

Don’t delay savings for your 529 plan or retirement plan because of you are overwhelmed by the various options. Opt-in to a plan. You can make changes later on.

Health Care Savings Accounts

Find out if you have a flexible savings account (FSA) or a health savings account (HSA) available through your employer. Both plans can help you purchase qualified healthcare costs through pre-tax earnings contributions. The HSA is available either through your employer or if you are self-employed. You cannot have both plans.

The FSA plan sets lower contribution limits than HSA, and if you don’t use it by year-end, you forfeit what’s left in the account. The employer controls the FSA, while the individual controls the HSA.

The HSA plan has higher contributions, covers a broad range of medical expenses, and is more flexible. Unlike the FSA, it does not have a “use or lose” feature. Instead, if you don’t spend the remaining amount that year, it rolls over. The HSA is portable, so if you leave your company,  you can bring the account. You can earn interest on your HSA like any savings account. However, if you use those funds on unqualified items you will pay a penalty, and, if you are below 65 years, you may need to pay taxes as well.. 

Managing Debt Wisely

Pay your bills on time and in full so that your balances are not being charged interest. When you pay only the minimum amount required by the credit card companies, you are paying far more in interest for what you charged on your card. Give your cards a rest until you can pay it all every month.

Use shorter borrowing periods for car, student loans and home loans to lessen the interest amount.The shorter the time frame on your car,  home mortgage or student loans, the lower your total respective cost will be  Yes, you are paying more per month but over a shorter period of time. Perhaps you can increase your down payment.

Know your respective interest rates, fees, penalty rates and terms on all borrowings: mortgage, car, student loans, and credit cards. When interest rates decline as they did in 2019, refinance your rates.

Use Credit Cards With Care

Credit cards provide an essential convenience and help us to build our creditworthiness. However, if you only pay the minimum on those balances, you are incurring high interest rates on what you owe. This is when compound interest becomes your enemy, and you are paying interest on interest. Keep your balances as close to zero as possible.

Use cash more when possible. It can be a motivator to spend less and help us negotiate lower prices when bargaining. You feel the burn instantly as to seeing it on your monthly bill.

When using payment provider services like Venmo and Zelle, know the differences in your liabilities. Credit card holders are usually liable up to $50 for unauthorized charges if you report your card as stolen. User protections for P2P vary so check carefully for coverage.

When working on debt payoffs, eliminate debt with highest interest rate first. I understand the psychological benefits of the snowball method and if it that is an effective motivator for you, go for it.

Avoid payday loans should go without saying. however, if this is your only choice, work with a financial counselor as soon as you can.

Control Your Spending

Comparison shop for everything you buy or sign up for: groceries, clothes, cars, homes, applicances, and services such as financial advisors,  insurance, banks ,credit cards. Be as informed as possible about points, rewards and cash-back offerings that encourage more spending than necessary.

Negotiate when and wherever possible. This goes for shopping and the interest rates on loans. However, learn to negotiate for higher compensation as well.  Opportunties are sometimes waiting for you to be more proactive in the bargaining process.

Know your wants versus needs. You don’t need everything to survive. Many items we say we need are really wants we desire like a long vacation or luxurious clothes.

Don’t go grocery shopping without a detailed list. This was a game-changer for us when my husband would come home with loads of unnecessary items all the time. Use per-unit pricing to compare items. Find coupons online.

Window shop with friends and buy when alone.

Be aware of numerous biases playing with your decision making.

When car shopping, buy certified pre-owned cars which have been completely inspected, repaired and may have original factory warranties remaining on its life. Do your oil changes and maintenance check ups as required.

Building And Managing Your Credit

Review your credit report periodically. It is available for free from AnnualCreditReport.com on an annual basis. You can also get one free report every 12 months to review your credit reports from each of the credit bureaus: Equifax, Experian and TransUnion. Then you can review your report more often especially when there are issues.

If and when you find errors, have the issues corrected as quickly as possible. Here’s how you do it.

Your creditworthiness is essential for more than just borrowing. Your prospective employer, landlord, utility provider and potentially significant other may want to know how you handle money too. By the way, background inquiries are usually soft inquiries that do not affect your score. However, hard inquiries happen when you are signing up for a new credit card or trying to refinance your mortgage loan  and will negatively  impact your score.

Know how the five key categories impacts your credit score. Your FICO scores are based on the following percentages:

  • Payment History – 35%
  • Credit Utilization – 30%
  • Length of Credit History – 15%
  • Credit Mix – 10%
  • New Credit – 10%

 

Your Child As Authorized User

Parents can help their children build up their credit by authorizing them as users on their cards. Think carefully about your own credit score. If it is low, it may actually hurt their score and defeat the purpose of being on your card. Know your child’s age and maturity, their ability to be responsible and setting up spending limits. There are virtually no age limits so it is up to parents to decide when their child is ready to have access to a credit card.

Yes, it is worthwhile for kids to get a credit boost. However, make sure you are not exposing them to fraud or identity theft, one of the downsides of children having a credit card. You will need to monitor their credit report along with yours.

Before getting them a credit card, talk to your children about money, spending and saving as a means to convey the need for good financial habits. The card is for their needs, not for paying for their friends’ needs and wants.

Raise Your Credit Score

The better the credit score, the lower your borrowing rate and the better on getting credit card deals regarding rewards and cash back. There are a variety of ways to raise your credit score or avoid inadvertently lowering it.

Don’t close any credit card accounts as this will ding your score. Instead, put these cards in a safe place like a drawer and don’t use them.

Keep your credit utilization rate well below 30% of total available credit. It may be beneficial for you to open an home equity line of credit(HELOC). If you have equity in your home you can take out a line of credit up to that value. This will expand your available credit, improving your utilization rate.

Certain programs are becoming popular that may help you boost your score for free or a low monthly amount. For example,Experian Boost, launched in late 2018 counts on time household payments for services such as telephone utilities tpwards your score. RentTrack And Rental Kharma report on time rent payments to credit bureaus.

If you have poor credit or in need of building up your credit, apply for a secured credit card as a means of boosting your creditworthiness. Become an authorized user on a close family member’s card for a period of time.

Applying To College

Fill out FAFSA, Period

If you are seeking funds for college, there is no downside to filling out the FAFSA (Free Application For Federal Student Aid) form other than your time spent. The form is necessary for federal loans, grants, work study programs and merit based scholarships. Don’t lose these opportunities by bypassing FAFSA. Federal loans tend to have better loan rates than private loans.

Be aware of your respective terms, grace periods, due dates and repayment options. Automate where possible so you don’t miss any payments. Try to target paying back your loans in a shorter time frame than the standard 10 year terms especially if you get bonuses or are getting nice raises.

Consider community or two year colleges which can be cost effective, for those who wish to work while going to school or want an interim step.

Save Money In College

When in college, look for ways to save and make money. College students tend to be better budgeters and track spending based on having less money to spend. As students living in a close environment, you are sharing similar tight money circumstances over the four years at school. College students eat ramen noodles, take public transportation and enjoy more experiences.

Keeping up with the Jones comes later on, after you get your first job and start making money. Try to remember your frugal days at college. Resist lifestyle inflation by having  good financial habits.

Understand Your Company Benefits Plan

Whether you are working at your first job or at the same firm for years, review your company benefits package. What may not have been of interest to a 20 plus year old, may be desirable now. Companies are increasingly adding to their compensation plans that can be customized for your life stage. Among the standard benefits plans are retirement plans, health care insurance, tuition reimbursement, insurance, flexible spending accounts (FSAs) or health savings accounts, paid vacation, sick time, medical or family leave.

You may need to add more coverage to parts of your benefits offerings such as life insurance. Typically, companies provide you with a starter package which will likely not be enough protection for a growing family. Company plans vary and may be a good reason to choose between two competing offers.

How To Start Investing Early

You can only reduce spending and save so much. Learning how to invest is the best way to outpace inflation, save money for college tuition and retirement, and accumulate wealth. According to a Gallup poll in 2019, 55% of Americans own stocks either individually, in mutual funds or in retirement accounts. This rate is below pre- 2008 recession levels of 62%.

Inflation refers to increases in prices resulting in reduced purchasing value of money. As prices go up say 2%, your money will get less units than it did in prior periods. Through  investing in stocks, you can better maintain your purchasing power. Stocks  tend to generate better returns (based on higher risks) than other securities, outrunning inflation. Stocks grow at a compound growth rate of 9% over the long term (over 90 years), though 2019 has been a banner year with S&P index, including dividends,  registering one of best gains since the 1990’s at roughly 30%.

Stock Market Games

Playing a simulated stock market game is a great way to learn how to invest and get familar with relevant terminology without losing real money. There are a number of free games  available and easy to set up that mirror realistic trading and investing with friends, family or on your own. Many of these sites have tutorials, videos and articles to educate you on the basics and provide strategic tips.

Start Investing With Small Amounts

Put small amounts  like $25-$50 per month into your investment account that you can afford to lose. That is, don’t invest your rent money. Starting small is a good way to get started as you gain a better understanding and confidence. Many large online brokers have lowered or eliminated commissions and initial minimum amounts designed to encourage small investors. Be aware that there may be management fees on your balances.

Buy Exchange Traded Funds or ETFs  which do not have minimum requirements, are available at low fees and provide you with diversification. Most mutual funds require a minimum initial investment between $500-$3000 and higher. For beginner investors, that may be a steep amount. You have many choices of ETFs and low cost index funds. Start with Vanguard’s offerings.

Some Investing Basics

When you begin buying stocks, have a long term outlook. Although commissions are reduced, you can realize better returns with long term investing (over a year or more) rather than trading. There are tax benefits when holding a stock more than one year by way of capital gains and capital losses.

Have some discipline strategies in place for when you should sell or exit a position. If you have a stock that is up 20%-25%, it is a good idea to sell a portion of your gains. A useful rule is “bulls make money, bears make money and pigs get slaughtered.” That is, don’t get too greedy.

Another good rule when investing in stocks, courtesy of Investor’s Business Daily (a great resource!) is to always sell a stock if falls 7%-8% below what you paid for it. The premise of this principle is that by selling at that level you are capping your downside potential. It has worked well for me. On the other hand, another strategy investors use is to buy small portions of stock initially and then buy opportunistically at lower prices to reduce cost basis of your stock.

I consider that all investors, including beginners, should have a basic knowledge about the Federal Reserve and their impact on interest rates, money supply and financial markets. We a have a primer on the Fed for those who want some insights.

Compound Growth And CAGR

One of the most important terms in finance to understand is compound growth. It can work against you when you are referring to a long term debt such as a fixed mortgage when you are paying interest on interest which increases your loan. Here, when investing, it can work in your favor when you are referring to the growth rate of your investment in your portfolio. Keep in mind, while stocks have above average returns, they have down years which can be sharp like during the 2008 recession.

The most accurate way to calculate returns is the compound annual growth rate or CAGR which smooths out returns over a longer period of time. Investors like to compare CAGR S&P 500 index (commonly referred to as “the market”) to their savings account or to that of a specific mutual fund or to their portfolio. This how investors can see how they are doing relative to the market. The formula for the compound annual growth is here. Thankfully, there are CAGR calculators to use.

If you are investing without a financial adviser, you need to do research. There are a lot of publicly available resources available to learn about the company and its businesses, its industry and its risks. You need to understand trends in the market. Expect stocks to be volatile and they may bounce back quickly after a fall in the market. BLOG POST

Diversification And Asset Allocation

Diversification of your stock holdings is important. Don’t put all your money in one stock or one sector of the industry. That is a recipe for greater losses. The best way to achieve diversification is through buying ETFs or low cost index funds which contain baskets of different securities. You want to minimize your risk as best as possible based on your own tolerance.

Not only do you want to have different stocks in your portfolio, you should aim to have different types of investments. This can include money markets, Treasury, municipal and corporate bonds, foreign securities and real estate. You can use ETFs and mutual funds to gain diversification within each asset class. Asset allocation is a means of diversifying these different investments. How you allocate your assets is based on your preference, age and lifestyle. Use a financial advisor or planner to talk through your planning and goals.

How To Choose A Financial Advisor

Meet with a financial planner or advisor to review your financial goals periodically and discuss how to achieve them. A financial planner does much more than selling you securities. Look for someone with a CFP designation. However, that should not be your only criteria. You should feel comfortable with this person and/or team.They should understand your household’s financial situation, lifestyle and your plans regarding children and college, career, retirement, insurance needs and estate planning. Here is how to choose a financial advisor.

Protect Your Family Financially

We love our families. Take proper steps to financially protect them. Providing financial security–besides making a good income, saving, paying off debt and investing– requires protective measures like buying essential insurance coverage and estate planning.

Insurance Coverage Is Essential

Your employer may provide you with some types of insurance as part of your benefits, including life, health and disability but often it is not enough. As your family grows you need to make sure you are adequately covered to take care of your family’s essential living costs and their future plans, including college. There are 8 types of insurance that you need to have proper coverage: auto, homeowners, renters, life,  disability, health, long term care, and  umbrella insurance.

Estate Planning

Prepare for the worst for your family’s sake. There are a number of steps to take for estate planning. Create a will and/or trust according to your wishes. You also need advanced medical directives and a living will as essential documents for your loved ones and health care providers.  Most people resist dealing with estate planning as a difficult topic. However, not dealing with it may leave your loved ones in a confused state during their time of grief. Think of estate planning as a plan of action that you are taking for your family.

Review And Update Your Designated Beneficiaries

An effective and efficient way to distribute our assets is by designating our beneficiaries outside the will through our bank accounts, insurance policies and such. Many of our assets are nonprobate property. As such, they are transferable to survivors by contract immediately upon death rather than under a will.

The advantages of contract transfer over the distribution of assets by a will are less time, cost and more privacy. Transfers to loved ones by a will could take 6 months-1 year if probate is not required. If contested in court, the distribution could take longer. Even worse, your will would be made public through court documents. At a minimum, be aware of the need to have designated beneficiaries for all assets. Review and update your beneficiaries based on life events such as having a new child or other necessary changes.

Invest In Yourself

Education does not end at the schoolhouse door. Embrace learning so you can master skills that are valuable to you. Read more and acquire knowledge so that you are competitive at work, have wider and diverse social circles and can teach others. Avoid procrastination which can be costly and cause unnecessary mistakes. Use time as the precious resource it is so that you may live everyday to its fullest.

Final Thoughts

To achieve financial success in life you need to have a game plan combined with good financial habits. Measure how you are doing with a review of your budget and net worth. They are key documents that help pinpoint where there may be some improvements needed. Financial planning should be discussed among family members. Calculate certain financial ratios, benchmarking your financial health. These ratios are tools designed to evaluate financial strength. As a companion to this article, see our post: 18 Financial Ratios You Should Know.

We hope this has been helpful to you. Thank you for reading and share it if you found it as valuable. Let us know what your thoughts are! Wishing you much prosperity and health in the coming year!

 

 

 

 

 

Valuable Financial Terms You Need To Know During The Pandemic

Valuable Financial Terms You Need To Know During The Pandemic

Ever want to know financial terms, but you were afraid to ask? During the pandemic, a lot of words are cropping up that may be hard to understand. In middle school, I was challenged by vocabulary, as my scores showed. As a result, I carried a dictionary to school when I was in college or graduate school. The coronavirus has been enough of a hardship to overcome. Explaining these key terms you need to know is one job I can handle to navigate these waters better.

See our article on Wall Street and investing jargon here.

17 Financial Terms To Know:

1. Bailouts

A bailout provides financial liquidity to people, companies, or countries on the verge of bankruptcy. Being strapped for cash due to losing your job or a drop in revenues create hardships and the need for immediate help. This financial assistance can take many forms and from different entities. Recipients may get cash, loans, bonds, or stock purchases. The Federal Reserve and the US Treasury have provided significant liquidity. Congress passed the CARES Act containing a stimulus package. There will be more aid in 2021, given the severity of this downturn.

Bailouts were controversial for banks and other financial institutions during the 2008-2009 Great Recession. The current bailout recipients have varied based on the coronavirus’s broad impact. Bailouts, or allocations of money, have gone to large corporations like airlines.  Like New York, several states have significant needs because of denser populations but, haven’t yet received the money. Hence, “Blue State Bailouts.” This is an unfortunate term. Asking for financial assistance to fund essential public employees sounds like a necessity.

2. Bear Market Rally

A bear market rally occurs during a bear market (I know, duh) when there are increases of at least 10%  in prices of stocks, bonds, or indexes. Our latest bear market began for the Dow Jones Industrial Average on March 11th, followed by the next day’s S& P 500 index. The market continued to drop to its lowest level on March 23, 2020. From that trough, stocks rallied through 2020 and up 16.3% for the year.. That is the epitome of a bear market rally.

3. Bear Market And Bull Market

We had been in a bull market for so long that a bear market had become increasingly inevitable. A bull or bear market rises or falls 20% or more. The “bear” market term came from the early 18th century.  Daniel Defoe said: “Thus every dissembler, every false friend, every secret cheat, every bear-skin jobber, has a cloven foot. The bear market was first popularized by a huge market crash known as The South Sea Bubble of 1720.

There is more to the history of the origination of bulls and bears here. Envision these animals’ movement: bears swipe their paws downward while bull horns rise.

4. Black Swans

A black swan event is an event that comes as a surprise (can be negative or positive) that has a significant effect impact of potentially ground shifting magnitude. The term is an ancient saying that relied on black swans not existing in contrast to the more common white swans. However, Dutch explorers were reportedly the first to see black swans in Western Australia in the late 1600s. The rareness of black swans became a metaphor for unpredictability.

Nassim Nicholas Taleb wrote of its theory in his book, “The Black Swan: The Impact of the Highly Improbable.” He argued black swan events have three characteristics:

  • Unpredictable;
  • Massive impact; and,
  • After the fact, an explanation is concocted that makes the event appear less random.

Some examples of black swan events are the rise of the personal computer, the Internet, September 11, 2001, World War I, and the 2008-2009 financial crisis.

Black swans are usually labeled after the event has passed. However, many pundits have immediately referred to the coronavirus-related pandemic as a black swan event. However, it is not clear it is so. Did you know there are white swans and gray swans beside the black version to reflect differences in predictability?  Geary Sikich elaborated on these other swans providing the guidance we share here.

White Swans

White swans differ in using the three principal characteristics used for black swans but reflect:

  • Highly certain events;
  • Carrying an impact that can be estimated; and
  • Later, the focus shifts to errors in judgment or some other human form of causation.

Gray Swans

On the other hand, a gray swan is a highly improbable event that fits black and white swans. Using the same three characteristics, the event is:

  • Highly probable;
  • Its impact can quickly cascade; and
  • Like the white swan, the focus shifts to errors in judgment or some other human form of causation.

 The Pandemic Is Probably A White Swan

Calling COVID-19 a black, gray, or white swan event may be premature. Were this virus and its effects foreseeable before its arrival? Taleb believes so. He believes the coronavirus pandemic is a white swan event because it was predictable. As a co-author in this January 2020 paper, Taleb issued a warning to prevent the worldwide coronavirus spread virus in Wuhan, China.

There were plans to prevent such a pandemic back in 2017. Recently, it became more known that Obama officials briefed Trump’s team to go through a hypothetical virus pandemic scenario. At this gathering of both teams, members considered the possibility of shortages of ventilators. The goal was to model such a scenario similar to the coronavirus we have now. Those who were there assumed the virus would appear in Asia before making its way to the US. These meetings should have been a valuable exercise. Instead, according to mixed reports, there were few accomplishments at these sessions.

5. Business Interruption Insurance

Many businesses buy interruption insurance to cover losses from lower revenues, fixed costs, or temporary relocation of operations. Typical commercial leases require this coverage. Insurance usually covers losses such as fire, natural disasters (e.g., Hurricane Katrina or Sandy), or potentially a virus pandemic. An important question is whether the insurance policy explicitly addresses viruses as a possible event.

It would be highly unusual for a virus to be specifically named. On the other hand, businesses with the SARS outbreak in the early 2000s may have adjusted their contracts to delineate viruses as a potential risk. The 2011 tsunami in Japan is another monumental example that interrupted businesses. So were those businesses covered then? I would be willing to bet that insurance companies will be scrutinizing all their contracts. They will attempt to decline coverage for this current crisis.

6. Deferred Interest

Deferred interest comes into play when interest has accrued, but there is a delay in the payment period. Typically, borrowers pay interest charges monthly. In some cases, lenders may agree to defer the interest. You will usually remain responsible for this accrued interest. Eventually, you will pay this interest. However, there are exceptions to this. The CARES Act allowed deferral interest on most federal student loans, with accrued interest beginning September 30, 2020.

Related Post: A Letter To College Students During The Pandemic

7. Economic Stimulus

Stimulus actions can be taken by the Federal Reserve (the Fed)  or by the US Treasury to help the economy. The Fed can implement measures through its stimulative monetary policy. Similarly, the Treasury’s fiscal policy can budget for stimulus packages with Congress. During the Great Recession, the Fed took aggressive action such as quantitative easing (QE) to provide our financial system liquidity. Quantitative easing is a fed tool used to aggressively purchase government (and other) securities from commercial banks. The Fed is essentially providing funds to the banks, encouraging them to use this money to increase lending.

The CARES Act was a $2.2 trillion package rolled out in 2020. More financial funding will be forthcoming to those unemployed and small businesses. Stimulus checks or economic impact payments will be directly deposited in recipients’ bank accounts or sent by check.

8. Emotional Contagion

Emotional contagion resulted from the coronavirus spreading to a significant global population. This phenomenon occurs when these individuals’ emotions and behaviors spread to other people. The round-the-clock news cycle and social media produce viral images continually showing quiet streets, people wearing masks, and ads providing instructions on washing your hands. The rise of anxiety, depression, and fear further amplify our vulnerable feelings. These are examples of emotional contagion.

9. Flight To Quality Or Safety

When markets become volatile and stocks decline, investors seek quality and safety from other securities. Turbulence happened in March 2020 as our stock market moved from a bull to a bear market in weeks. At times there may be several factors that converge on the markets, which add substantial risk. These issues could be rising interest rates, a slowing economy, and reduced earnings estimates for the upcoming quarters.

In declining markets, investors tend to rotate out of specific sectors like tech growth stocks and flock to safer stocks with above-average yields. They may even move out of the equity markets and put money into Treasury securities. In 2009, as the housing sector weakened, leading up to the Great Recession, buyers sought refuge in Treasury securities. Our markets will likely remain volatile, reflecting headline risk.  As the knowledge of our substantial unemployment sinks in, investors may take that flight again.

10. Forbearance

When a borrower has difficulty making loan payments, they may ask their lender for forbearance. Lenders may agree to a forbearance request rather than seeing the borrower(s) heading into bankruptcy, where recovery gets tougher. The Fed has urged lenders to be “responsive to the needs of low- and -moderate-income individuals, small businesses, and small farms affected by COVID-19 consistent with safe and sound banking practices.”

Our CARES Act addresses federal student loans that are in forbearance. Forbearance occurs when payments pause without interest accruing until a specific date.

11. Force Majeure

Force majeure is a French term often interchangeable with Acts of God. The coronavirus pandemic has certainly impacted businesses around the world. Many companies have found it difficult-to-impossible to maintain full operations and fulfill contractual obligations. Force majeure is a fairly common clause found in contracts. How it applies may be specific to the contract. An attorney may need to raise appropriate questions. They may ask if the coronavirus qualifies as a force majeure event and was performance impossible? How foreseeable was the risk of COVID-19  (see Black Swan above)? Firms usually have business interruption coverage ( see above) as well.

12. Furloughs Have Become More Common

We hear companies announce furloughs plans often. Companies continue to look for ways to reduce their costs as lower consumer demand has resulted.  Generally, furloughs are mandatory time off from work without pay. Furloughs or releases are not layoffs as employees retain their jobs, benefits, and any employee rights. Temporary layoffs are furloughs so long as employees expect to return to work at the end of the period. Many industries use releases when they see reduced demand either seasonally, a cyclical downturn, a union strike, or an emergency such as COVID-19. It could be for a fixed term of two weeks or longer or a particular day, such as all Fridays in the summer.

A furloughed employee typically expects that they will return to work. They retain their jobs and return at a specific time or a condition that ends their release time. That could mean the strike is over or demand for services or products has returned. When the employees are out of work, they retain some of their benefits, notably health or life insurance. Furloughs are not usually COBRA qualifying events, but it is always best to check with your respective employer.

What About Retirement Benefits?

Retirement benefits may pause for employees on leave. Workers typically make contributions to their 401K employer-sponsored plan via their paychecks. However, if they aren’t making money, they are probably not making contributions. Neither will their employers make match contributions during furlough periods. On the other hand, employees may seek part-time employment or new jobs altogether. Depending on how long the leave, this can slow growth in your retirement accounts.

13. Initial Jobless Claims For Unemployment Insurance

Average weekly initial jobless claims reflect the number of people filing for unemployment insurance for that week. It is a leading indicator that predicts future economic activity. In past months, the claims have been staying stubbornly high. The latest US Labor Department reported close to one million new signups for unemployment.

High unemployment rates rise during recessions. It peaked at 10% during the Great Recession. During the Great Depression, unemployment reached a rate of 24.9% in 1933. That said, we never have zero unemployment as companies move their businesses around, close unproductive firms causing frictional job losses for some employees.

Claims for unemployment insurance will remain high for the foreseeable future. Make sure to take advantage of these benefits. The US Department of Labor lists eligibility requirements on its website. We explain here, but you do need to check your respective state’s instructions. Look for the individual state standard in which you worked using CareerOneStop, which provides each states’ rules.

Unemployment Benefits Eligibility

You are eligible for benefits if you are unemployed through no fault of your own. Typically, you cannot file if you were fired or let go for “gross misconduct.” Please note that you should apply in any case because the firm must prove gross misconduct in most cases through a lawsuit. Relaxation of rules has been common during the coronavirus timeframe.

Federal/State Efforts

While there is federal guidance for eligibility, each state has its minimum requirements that a candidate for unemployment insurance benefits must satisfy. Each state varies regarding minimum time worked and wages. States pay the unemployment benefits to the claimant typically for 26 weeks. As a result of the CARES Act, the relief package provides an additional $600 per week in unemployment paid by the federal government until July 31st. This is in addition to the extended 39 weeks of state unemployment payments. 

The federal government provided this kind of financial support during the Great Recession as well. They extended the unemployment insurance period to the standard 26 weeks given by states for a record total of 99 weeks.

Related Post: Why Unemployment Matters

14. Lockdown or Stay-In-Place

The notion of a lockdown always sounds ominous when used for potential terrorism at schools, offices, or airports. Currently, lockdowns or stay-in-place orders have been used as an emergency protocol to encourage people to stay at home. Lockdowns prevented the spread of the coronavirus to an extent.

Beginning in China, then expanding into the largest global lockdown ever, it has brought the global economy to its knees. Some countries have been gradually lifting their respective lockdowns. The US has introduced phased guidelines for states to emerge from the lockdown though no state is fully open as of yet.

15. Margin Calls

Don’t do it! Sorry, that was a reflex reaction I have to that term. When buying shares in a company, you may use some of your own money and borrow the rest from your broker. Margin calls are an extension of credit, with the securities acting as collateral. When the company’s shares decline in price, your broker will ask you to put up more money towards the borrowed amount or to sell the shares. The broker uses margin to protect themselves from losses on loan to you. Both the Fed and FINRA set industry rules for investing in the market. Your broker usually sets the minimum margin requirement. They could be stricter than federal guidelines.

Margin buying offers higher profits and higher risk through the added leverage. By paying only a small portion of the total amount, investors amplify their purchasing power. However, when financial markets are volatile, brokers make margin calls. These calls boost the losses suffered as well. Margin interest rates for Charles Schwab are effectively around 8% on small debt amounts, declining to 6.575% for debit balances under $500,000. The higher the amount borrowed, the greater the risk. Given these risks, I have always avoided using margin to buy stocks.

16. Price Gouging

Many people have been experiencing price gouging as shortages increase. Certain products such as paper goods, sanitizers, masks, and  PPE (personal protective equipment) necessities have been in low supply. Price gouging occurs when a seller increases goods, services, or commodities in response to unusual demand due to lack of supply. Gouging is when prices elevate to unreasonable or unfair levels. As the virus affects worsened, there were reports of people hoarding some of these products and selling them at absurd prices. Besides being morally wrong, price gouging is illegal according to respective state statutes in effect.

17. Recession: Are We There Yet?

All this talk about an economic downturn requires some clarity. Are we already in a recession? A recession has at least two sequential quarters of negative economic growth measured by GDP (gross domestic product). We are technically in a recession with requisite economic indicators of weak growth and unemployment. Of course, we are in a recession with roughly 11 million people unemployed. Consumer demand is lacking, and with high initial unemployment claims still at high levels. Depressions are far more severe than recessions and last far longer. The Great Depression lasted ten years.

The current recession is not the typical kind caused by cyclical demand shrinking. This downturn is associated with a coronavirus pandemic, requiring lockdowns and changes in consumer behavior. While our economic downturn began in response to a health crisis, it has impacted supply (e.g., shortages) for what we need or reduced demand as we have remained home. If not working remotely or are essential, a significant portion of our workers may be out of jobs through furloughs or layoffs.

Final Thoughts

Financial terms related to the pandemic have been expanding our lexicon. Knowing these terms are useful to know when you participate in the market or need to understand your insurance situation. Many of us never heard of coronavirus before the pandemic. Now many of us have a working knowledge of medical technologies involved in vaccines and their development. I hope this list helps. Thank you for reading! Sign up today for your weekly newsletter!

We have a number of related investing posts you may have an interest in:

Guide For Investing Beginners

Diversifying Your Portfolio

How Stock Markets Games Can Teach Investing

 

Property and Casualty Insurance – A Complete Guide For 2021

Property and Casualty Insurance – A Complete Guide For 2021

Protection against loss is critical for everything you do, including running your own business or earning money from a side hustle. The primary tool for mitigating business risks, such as those described by Your Money Geek, is property and casualty insurance.

There are many insurance policies within the property and casualty insurance realm, each with its own vocabulary. Understanding the different types of property and casualty insurance can limit the number of many causes of catastrophic financial loss. In particular, you will want to know which ones apply to your business or side hustle.

This post will talk about the most important types of property and casualty insurance for small businesses and side hustles. These coverages include business owners (with key components – auto, liability, and property), professional liability, workers’ compensation, and fidelity and surety bonds. I’ll highlight the coverage provided by each type of business insurance. Also, I’ll touch on some factors to consider as you decide whether to buy them.

Businessowners Insurance

Some small businesses buy a package policy, called a business owners policy (BOP), to cover their vehicle, liability, and property exposures. It is similar to the combination of personal auto and homeowners insurance policies. Businesses that don’t need all three types of insurance coverage can buy insurance policies separately. The separate policies are commercial auto (covers all vehicle types), general liability, and property. The package policy is usually less expensive than the three separate policies, as long as you need all three coverages.

The limit of liability determines the maximum amount the insurer will pay for a covered liability claim. Also, one or more deductibles determine the insured’s amount before the insurer starts paying for physical damage claims. Separate deductibles can apply to each of the comprehensive and collision portions of vehicle coverage and claims related to physical damage to any buildings and/or contents covered by the policy.

Vehicles

The vehicle coverage is the same whether bought in a BOP or a separate commercial auto policy. It protects against anything for which the business owner becomes legally liable related to vehicles’ operation covered on the policy. That is, if an insured driver is in an accident, liability insurance will usually cover the costs to third parties. These costs can include injuries or damage to their property.

The insured has the option also to purchase physical damage coverage. This insurance can cover damage to the insured’s vehicles either from an accident (collision coverage) or other perils, such as theft and fire (comprehensive coverage). The vehicle coverages for commercial vehicles are very similar to those in a personal auto policy, which I cover in detail here.

If you use your personal vehicle for your side hustle or business, you must buy commercial auto coverage. Personal auto policies generally exclude coverage for:

  • Employees during the course of employment.
  • While used as a public or livery conveyance, ownership or operation of a vehicle, such as Uber or Lyft.
  • The insured, when employed or otherwise engaged in any business.

Almost all claims made against your personal auto insurance will be denied if your vehicle was being used for a side hustle or business.

Premiums for auto insurance vary based on the number and types of vehicles insured; the coverages, limits, and deductibles purchased; characteristics of the drivers; where the vehicle is driven; and the distances driven, among other factors.

Liability

Businesses usually face one or more of four types of liability – vehicle (discussed above), premises and operations, products, and professional. Premises and operations and product liability are parts of both general liability policies and BOPs. Professional liability is a separate policy, so I’ve covered it below.

Premises and Operations

Premises and operations coverage (which I’ll call Prem/Ops) provides insurance for things related to your business location or operations. It covers injuries to third parties (not employees) or damage to their property.

Slips and falls by customers at business locations are the most common types of Prem/Ops claims. For example, if someone is injured at your business location, in your parking lot, or as the result of your operations, your business may be liable for their medical expenses and/or lost wages.

If your customers come to your place of business, you’ll want to consider premises and operations coverage. Most homeowners policies exclude coverage for claims related to a business. As such, it is important to check your homeowner’s policy if you do business out of your home to avoid gaps in coverage.

The premium for Prem/Ops coverage depends on your business’s nature, the number of types of locations, and the limit of liability you purchase, among other factors.

Products Liability

Product liability coverage provides insurance for damages related to your product. These damages include third parties (not employees) who are injured or their property when damaged. For example, medical device manufacturers’ product liability insurance protects the company against claims that their products are defective and cause injury or illness to patients.

On a much smaller scale, burns from McDonald’s coffee that was allegedly too hot are also insured under products liability coverage. If you make a product that could injure someone or damage their property, you’ll want to consider product liability coverage.

Premiums for product liability coverage depend on the type of products sold, the number of sales, and the limit of liability you purchase, among other factors.

Property

Property insurance protects your property, including buildings and their contents. You can also purchase insurance for just the contents if you don’t own the building. Property coverage protects against a long list of perils, including fire, hurricane, tornado, vandalism, and theft. In many places, you must purchase earthquake or flood coverage separately. Any intentional damage or damage from acts of war, arson, and sometimes riot is usually not covered. Read your policy to make sure you understand what is covered and what isn’t.

When you buy property coverage, you estimate the values of your buildings and contents. Insurers can often reduce the amount of any claim recovery, even for partial damage, if you underestimate your property’s value. As such, it is important to determine the value of your buildings and contents fairly.

Property insurance for businesses always includes business interruption coverage. Under this coverage, the insurer pays for lost profits and some overhead expenses when a covered peril has damaged your property. The insurer also covers expenses related to a temporary location where you operate your business while your building is being replaced or repaired.

Business interruption insurance applies only when your business is interrupted due to a peril covered under the buildings and contents coverage. For example, a pandemic is rarely a covered peril for buildings and contents because it doesn’t damage either one. In that case, there is no insurance coverage if your business is shut down from a pandemic.

Premiums for property coverage depend on the values, types, and ages of insured buildings, the value and types of insured contents, where the property is located, and the deductible you have selected, among other factors.

Umbrella

An umbrella policy allows you to increase the limits of liability on all your liability policies at once. An umbrella policy can provide coverage for vehicles, Prem/Ops, and products liability. The limits on the underlying policies must meet certain minimum requirements. An umbrella policy usually protects you against liability claims not covered by the underlying policies, such as libel and slander. The concepts underlying umbrella policies that protect businesses are similar to the concepts that underlie personal umbrella policies.

Umbrella premiums depend on all the characteristics of the underlying policies and the limit and deductible on the umbrella policy.

Professional Liability

Professional liability insurance protects you against claims that you have caused someone an economic loss by making a mistake when providing professional services. For example, if you are providing bookkeeping services, a client might sue you if you prepared tax returns incorrectly, leading to a client’s financial loss. If you are providing legal services, errors could include everything from missing a court deadline to providing incorrect advice. A professional liability policy usually covers all these errors unless intentionally made.

If your business provides advice or professional services to clients, you will usually want to purchase a professional liability policy. Professional liability covers services just as products liability insurance covers things your business manufactures.

Professional liability premiums depend on the type of services provided, annual revenue, and the limit of liability selected.

Workers’ Compensation

Workers’ compensation insurance (often called workers comp) protects you against the cost of injuries and illnesses to employees during their employment. Almost every US state requires you to provide workers comp for employees, as long as you have at least the minimum number of employees. That minimum number of employees is usually around four. Some states, such as California and Colorado, require you to provide coverage even if you have only one employee.

Workers comp reimburses employees for a state-mandated portion of lost wages and medical costs. Employees covered by workers’ comp cannot sue for covered injuries and illnesses except in minimal situations.

Premiums for workers comp depend on the number of employees and their wages, the state in which they work, and the type of work performed by each employee.

Surety & Fidelity Bonds

Some businesses need to buy surety or fidelity bonds as part of their operations. Most surety bonds provide guarantees to third parties (the obligees) that you (the principal) will perform certain actions. By comparison, fidelity bonds protect an employer against the fraudulent or dishonest actions of its employees.

Surety Bonds

One of the most common surety bonds is a construction bond. If your business is a construction company, it might promise to build a structure for a buyer. The buyer will likely pay your business for some of its services in advance. In that case, the buyer wants a guarantee that you will complete the structure.

You can buy a construction bond from an insurer for the buyer’s benefit (the obligee). If you fail to complete the structure, the insurer will either pay the buyer for the cost of completing the structure or will hire a contractor directly to complete it.

Other commercial surety bonds cover signature guarantees for notaries and remediation costs for mining or drilling operations. Surety bond requirements vary widely by state. I found the “What Bond Do I Need?” section of this website quite interesting.

Fidelity Bonds

Most fidelity bonds insure property, money, or securities owned by customers to which employees have access. For example, a fidelity bond usually covers the embezzlement of deposits by an employee for services or products not yet provided. Similarly, a fidelity bond can insure against misappropriation of pension assets or real estate escrow funds. A fidelity bond can also provide protection if an employee takes something while at a client’s business or home.

Bonds

Most side hustles and tiny businesses don’t require fidelity or surety bonds. Nonetheless, they are essential components of a company’s risk management plan if it has any of these types of exposures. The face amount of the bond, the type of coverage provided, and the insured’s history and financial condition determine the cost of surety and fidelity bonds.

Other Types of Property and Casualty Insurance

There are several other types of property and casualty insurance that a small business might need.

  • Crime Insurance – Property insurance and fidelity bonds don’t cover all theft losses. If you sell a product, you might need to look into purchasing crime insurance.
  • Cyber Insurance – Cyber insurance can cover your operations if a cyber-attack disrupts them. It also can protect you if your confidential business and/or your customers’ or employees’ personal information is stolen electronically. If your business has any of these exposures, you will want to investigate the various types of cyber coverage.
  • Directors’ and Officers’ Liability Insurance (D&O) – D&O insurance covers economic losses incurred by third parties that result from significant decisions made by directors or officers. Publicly-traded companies or companies with more than one owner often buy D&O insurance. If you are not the sole owner of your business, you might want to evaluate the need for D&O insurance.

Where to Buy Property and Casualty Insurance

Buying property and casualty insurance for a business are similar to buying it for your personal exposures.

  • Some insurers, such as Progressive (just an example – in no way do I intend to endorse Progressive as I know nothing about its premium, coverage, or service), allow you to purchase insurance for your business online.
  • Other insurers, such as Liberty Mutual (again, just an example), are direct writers. You talk directly to an employee of a direct writer when buying insurance.
  • Insurance brokers and agents provide access to all other insurers. They usually have access to a wide range of insurers. Small businesses, especially those without unique exposures, can work with an agent to acquire insurance. You may need to work with a broker if you have a large business or need unique expertise.

If you are new to buying insurance for your business or your business has unique exposures, I suggest a direct writer, insurance broker, or insurance agent. Purchasing insurance online, especially if you are an informed buyer, can often, but not always, save you money. The lower premium reflects insurers’ lower expenses as it doesn’t have to pay commissions or sales force expenses.

Final Thoughts

This is a guide for protection against loss for your business or side hustle. There are many insurance policies within the property and casualty realm. Household insurance policies that cover health, life, car, and other types can be found here.

This article originally appeared on Your Money Geek and has been republished with permission.

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