Ted Benna, who three decades ago seized on an IRS loophole to transform American retirement savings, says he's proud to be "father of the 401k." He also thinks he created a monster.
The plans, which he intended to be as simple for employees as pensions, now offer too many investing options and too many opportunities to make mistakes, he says. "I would blow up the system and restart with something totally different," he told SmartMoney. "Blowing up the existing structures is the only way we can simplify them."
In 1978, when Congress passed the section of IRS code for which the plans are named, lawmakers aimed to limit the scope of cash-deferred plans being offered by some companies, but had no intent to revolutionize retirement. Benna, then the co-owner of the Johnson Companies, a benefits consultancy in suburban Philadelphia, was developing such a plan for a bank client when he happened on the idea that section 401k could allow an entirely new option.
The original 401k plans "could be explained to employees in just a minute," Benna, now 69 and semiretired himself, says. "There were two options, a guaranteed fund and an equity fund," he says. "With the guaranteed investment fund, we'd tell them this is what you will have when you retire. With the equity fund -- which was usually something like the Fidelity Magellan fund -- we'd say, you might have more, but you might have less. Most people would split their contributions 50-50 between the two."
Plans became too complicated
As the plans were embraced by employers and financial institutions, Benna says 401k's were made so complex one needed to be an investing pro to make sense of them. "Now this monster is out of control. We went to three options, then to six, then to seven, then to 15 -- it is far beyond what most participants were able to deal with," Benna says. "And I am not convinced we have added value by getting more complicated."
Better education was supposed to be the solution to intricacies of the plans, Benna says. If employees understood the options, the power of compound interest and dollar-cost averaging, and the advantages of making pretax contributions, it was believed they would do the right thing. "We're throwing tons of money away trying to teach participants how to become skilled investors -- we said, we are going to make people smart and savvy enough to make the right investment decisions, but it just hasn't worked."
Benna blames the newfound complexity on what he says was the small percentage of employees who wanted it. "What triggered this whole mess is that some of the more sophisticated participants were a pain in the butt," he says. "You'd have these troublemaker loudmouths push human resources, and say, 'Why don't we have this "flavor of the month" fund?'" These sophisticated employees are also the ones taking advantage of the education and advice being offered, he says.
Overwhelmed, employees made mistakes
The consequence of all the complexity is twofold, he says. First, employees felt they could be more active investors. "There is too strong a potential for employees to do the worst thing ever, which is moving in the wrong direction, panicking when things are bad and cashing out after they have been battered." Secondly, the current plans induce "a kind of gridlock -- employees get so overwhelmed they do not participate -- they do nothing," he says.
Education didn't work to stop employees from sabotaging their own futures, he contends, but legislation might. "We need a legislative mandate that when you change jobs, the money needs to be retained in a retirement account -- there cannot be an option of 'here's a check, you decide,'" Benna says. He also advocates mandating all employees be auto-enrolled in the plans, and that their contributions be automatically increased one percentage point per year to a maximum of 10% to 15%.
Despite these misgivings, Benna insists the plans are benefiting millions of employees. He gets rankled whenever someone suggests the workforce would be better off had the 401k never been born, noting that the pension system was more fraught that many remember. "I am not anti-defined-benefit plan -- in fact I sold them for decades -- they are great, but only for those who stay with the same company for 20 or 30 years."
By Jeremy Olshan vai SmartMoney.com
http://money.msn.com/retirement-plan/article.aspx?post=eb9632ff-1d35-44ad-bf77-349f8492a081
Thursday, November 24, 2011
Wednesday, November 16, 2011
Failure Is Unlimited
I feel as though I would be remiss if I did not discuss Occupy Wall Street somewhere in this blog, so tag this entry with #OWS.
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| Too bad no one argued that banks were "Too big to bail." |
For the past several years, the phrase "too big to fail" has been a buzzword in these shaky markets. Certain corporations, especially in the banking and insurance industries, have been granted various benefits to keep the company afloat under the guise that they are too important to our economy to risk failing. It mostly started in the fall-out of the Lehman Brothers bankruptcy, and it was deemed a necessary measure to prevent the country from falling into an extensive recession or another "Great Depression."
It has been a controversial phrase in the finance industry since the beginning, mostly because it is a blatant oxymoron. While it has arguably been a success in keeping the economy going, the inherent flaw in the concept is destructive to long-term growth. The dissenting opinion of this tactic is that if large companies are endangered, then their structure is flawed and their collapse will see several new companies emerge from the ashes. Former Federal Reserve Chairman Alan Greenspan simplified it when he said, "if they're too big to fail, they're too big."
The Occupy Wall Street movement has pushed this issue and similar issues to the forefront recently. The(se) protest(s) is (are) mostly against this tactic and other methods to protect the country's wealth, which unfortunately has translated into protecting the country's wealthiest.
The Dow Jones Industrial Average (DJIA) or "The Dow" is comprised of 30 components. By components, we mean corporations or stocks. There are more than 2300 companies actively traded on the New York Stock Exchange. The reason the Dow is cited most often is that its history dates back to May 1896, so it compares today's markets to 100 years of history in a single measure. However, the reality is that while the DJIA is the most cited index, most index funds have far more than 30 stocks in them. Case in point, the Vanguard 500 Index Fund has 500 companies, mirroring the S&P 500. When one of those companies falls from the S&P 500, it is sold from the fund and the new company entering the S&P 500 is purchased. There is a constant "out with the old, in with the new" methodology built into the index fund itself. Likewise, the Vanguard Total Stock Market Index Fund has over 3,000 companies, so the Dow is quite literally 1% of the total stock market.
Unfortunately, the exact demands of OWS have been conceptual and the protests are unclear. Personally, I had a vague idea of the issues central to the movement, but I had to research OWS at length before I could discuss it. Most recently on "Market Watch with Mo Ansari" (an often-cited radio program), there was a guest who opposed "too big to fail" methods and proposed that what our country is facing would be the "lost decades," as opposed to the singular "lost decade" (2000-2010). At the center of his discussion, though, was a pitch for a plan to balance the country's budget in 10 years. He said several other groups tackled the proverbial Rubik's Cube known as the nation's deficit, and his proposal was the only one to wipe it out in 10 years (conversely, the average of most other proposals was 40 years).
Unfortunately, the exact demands of OWS have been conceptual and the protests are unclear. Personally, I had a vague idea of the issues central to the movement, but I had to research OWS at length before I could discuss it. Most recently on "Market Watch with Mo Ansari" (an often-cited radio program), there was a guest who opposed "too big to fail" methods and proposed that what our country is facing would be the "lost decades," as opposed to the singular "lost decade" (2000-2010). At the center of his discussion, though, was a pitch for a plan to balance the country's budget in 10 years. He said several other groups tackled the proverbial Rubik's Cube known as the nation's deficit, and his proposal was the only one to wipe it out in 10 years (conversely, the average of most other proposals was 40 years).
Social Security would continue, he promised, but it would be limited to the population who needed assistance, and the population who did not need the financial assistance would stop receiving the benefits. At that point, I had to wonder: where is the incentive to be a productive member of society? I stopped listening to the guest and started pondering the question for myself. I remembered when my ex-girlfriend told me that she had to pay income tax, and I was genuinely excited for her! She moved out of state and started paying all her bills herself for the first time in her life. On top of that, she was earning enough that she owed taxes at the end of the year. Every single part of that filled me with vicarious joy. She, on the other hand, was not excited.
It seems most conversations about Occupy Wall Street begin and end at this troubling concept.
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| What exactly was the one demand? |
Since the guest on the program mentioned lost decades, it is only appropriate to debunk that misconception as well. If a mutual fund (or individual stock) were trading at $10 today and you invested $1,000, then you would obviously have 100 shares. If the fund (or stock) rose to $17 in five years and then fell to $9 two years later, but then rallied back to $10 three years after that, then it seems as though you would have the same $1,000 again from ten years ago.
Except each year, sometimes each month or each quarter, the fund (or stock) will pay a dividend. For bonds, this is the interest earned on the debt. For stocks, it is a portion of the profit paid out to the owners of the company (stockholders). If you are investing in a tax shelter, such as a 401(k) or IRA, then you are most likely reinvesting dividends. This may not apply to complex portfolios, but the assumption of reinvesting dividends is usually a safe bet.
Therefore, you spent 10 years going between $9 and $17 per share, but your $1,000 investment is substantially higher because, periodically, the fund paid dividends and put money back into itself in the form of more shares. Ten years ago, you had 100 shares trading at $10. Ten years later, you could have 125 shares trading at $10. The investment's earnings would be 0%, but your actual return would be 25%.
However, these "cumulative returns" are often overlooked. While the media is viewing the markets at a 0% return and naming it a lost decade, your wealth has grown 25% in this single investment. The first investment in my Roth IRA was on March 11, 2003, and it went into the Vanguard 500 Index Fund. Lucky for me, that day was the lowest point in the market of the year. I did not invest any more money into that particular fund (future Roth IRA contributions went into other funds) but this investment has given me a bird's eye view of cumulative returns, so trust me when I say it was not lost time for me. The only real "losers" of the Lost Decade were the people sitting on the bench and not getting into the game.
Catchphrases and hooks grab attention. Personally, where my money is and what it is doing is enough to get my attention. And I don't have to outsource that attention to the financial media. "Too big to fail" and "lost decades" are worth discussing, but they should never drive personal investment decisions. Like Mo Ansari often reminds his listeners, you have to invest based on what the markets do, not what they should do. Which is to say, the markets rarely listen to the what financial media says. Follow the market, not the media.
Tuesday, October 25, 2011
How The Rich Get Richer
In recent weeks, there have been a large number of financial articles written to mark the three-year anniversary of the day Lehman Brothers filed for bankruptcy. Calling it "unexpected" news was an understatement for most finance professionals. There were cracks in the armor, and the possibility was discussed heavily on the Friday afternoon heading into that fateful weekend, but most people in finance do not watch the market daily and they are not aware of all the news affecting the industry.
However, everyone took notice on Monday, September 15, 2008, because the Dow closed at 10,900, down 500 points in one day. The peak of the market was in October 2007, so the markets had been on a slow decline for several months already, but this day was different because it was triggered by a specific event, one which truly shook the confidence of the most seasoned investors. Not just investors, the rich investors.
At this point, I should define a couple insensitive terms. The individuals I have classified as the "rich" are by no definition evil or manipulative. Their actions were not greedy and there was no intent to harm others. They are the individuals who have amassed wealth by various means, and one of their top financial goals is maintaining existing assets. I would not even classify them as risk-adverse, but rather very risk-aware. Likewise, the "poor" are by no means living on the streets. In fact, they probably are not living paycheck-to-paycheck either. They are educated individuals who are either uneducated on the finer points of investing or (equally likely) undisciplined on maintaining the finer points they know.
Immediately after Lehman filed for bankruptcy, the markets tumbled and tumbled, and then, they tumbled even further. They turned around eventually, and today the markets are currently at 11,300, just about the same level where these events began. There are thousands of explanations and theories by professionals on how and why the markets reacted the way they did, but in hindsight of three years later, I believe part of it was the quintessential tale by which the rich get richer and the poor get poorer.
The Lehman Brothers was the fourth largest investment bank in the United States at the time of its bankruptcy. At that point, I knew the Lehman Brothers for its bond ratings because they were the most respected in the industry. In fact, I could not even name another bond rating. All I knew was Lehman Brothers. The idea of the Lehman Brothers filing for bankruptcy baffled me immediately. Ignorance was bliss. For those in the know, it frightened them greatly. As a result, they continued to shift their investments from stocks and bonds to money markets, the safest investment option by far.
Personally, I don't remember what the Vanguard Prime Money Market fund was yielding back in September 2008, but I would guess that it was probably a 3% yield. It did not matter though. The fact that investors could protect what they had without incurring further losses was the main attraction. Indeed, those savvy investors acted correctly in their movement.
Speaking again in my defined yet generalized terms, the rich were the first to move their money because they had the most to lose. Perhaps they were the most informed as well, or at least, they had the most informed professionals managing their investments. At the time, I know skeptics of the purported "worst case scenario" dismissed the initial decline as "sour grapes" over the 2008 election in which Barack Obama was elected to replace the "rich"-friendly Bush on a platform of change.
Regardless, the stock markets declined at a rapid pace, falling to 8,775 by the end of the year. Looking back now, I believe that the high net worth investors were protecting their investments at a rapid pace, which pushed the markets down as rapidly. The fourth quarter is often the strongest of the year, so for the markets to fall at least 3,000 points in the fourth quarter worried more than just the rich investors.
As 2009 began, I believe more of the average investors were caught up to speed. Perhaps fueled by the advice of some wealthier neighbors, or more likely, emotionally reacting to their declines, they started to place their own money from stocks to the safer money markets. The markets continued to fall, reaching 6,547 on March 9, 2009. At that point, the markets inexplicably started to turn around. The reasons why it happened at that point remain a mystery for random speculation. And I have my own theory.
In my belief, the rich realized the probability of the markets increasing was much higher than the probability that the markets would continue to fall. Maybe not even "much higher," but simply higher. In fact, we can put it in terms of money, and think through it logically. Those money markets where the rich had placed the bulk of their assets in October were offering less than 1% so stocks would only have to gain 1% to be a more profitable investment. While it's true that the markets could have fallen from 6,500 to 5,000 or lower, that possibility is the nature of the beast. Investors cannot escape risk. But when money markets pay less than 1% interest, there is no incentive to be stock-adverse regardless how risk-aware you are.
The rich understood this shift. However, the poor could not afford to lose more. In my prior scenario, the poor had already lost 60¢ on every invested dollar. Meanwhile, the rich shifted to a stable investment when (or before) their portfolio fell 30%. As things changed, the poor stayed in the money markets to protect what was left but the rich risked losing their 70¢ to gain a little more. In this case, it was a lot more! The markets went from a low of 6,547 in March 2009 back to 10,000 a mere 7 months later. The markets continued to climb, so once again, the rich had $1.07 on every invested dollar while the poor continued to protect the remaining 40¢ of every invested dollar. At the end of this scenario, the rich now have three times as much as the poor for every invested dollar. No greed, no deception, and no malicious intent were involved.
Considering the Vanguard Prime Money Market fund yields 0.03% today (not 3% but 0.03%), there is a strong likelihood that there are many people who are still protecting the 30¢ left from each dollar. When they do venture back into stocks, they will be buying higher than the rich did when they shifted back into stocks. And most likely, their gains will not be as phenomenal as the rise was in those 7 months of 2009.
The key to successful investing is simply to "buy low, sell high," but this cautionary tale epitomizes how investors can innocently "buy high, sell low." To avoid this pitfall, revisit a few of the other entries in this blog, especially the quarterly updates discussing asset allocations and the importance of a periodic rebalance. As luck would have it, I started this blog on February 10, 2009, four weeks before the infamous 6,547 closing.
Monday, October 17, 2011
Making An Asset Calculator
I just created a calculator tool for myself to use to track all my future asset allocations. Therefore, I can determine how much I need to move and where within 5 minutes, such as I did this afternoon before the market closed down 2.15% today. This calculator is a useful tool, because it simplifies the work that you need to do to maintain your asset allocation. If you want to create this calculator for your own use but you are unsure exactly what you're doing (either on Microsoft Excel or with investing in general), then follow these simple steps:
The first row is going to establish the following columns: Fund (Name), Current (Balance), Target (Amount), and Change.
The first column is going to list the funds you own (and want to own) in your portfolio. There may be as few as two funds or as many as 10 funds (keep in mind, sometimes less is more), but list their names down the first column.
In the next column (B), you simply list the balance of each fund. This cell is going to be where you change information each time you visit the calculator in the future. Below the last fund, input the following formula into the cell "=SUM(B2:BX)" with X standing for the cell number of your last fund.
In the next column (C), you are going to input a formula to determine what the target amount in each fund should be based on your asset allocation. If I listed my first fund as the Vanguard Total Stock Index fund in Cell A2, then I would want 25% of my portfolio's balance in this fund. Therefore, I would input this formula into Cell C2: "=$B$X+1*.25" with X+1 standing for the cell number where your formula is for the "=SUM(B2:BX)" balance.
You may need to read that part a couple times before it makes sense, but here is an example to ensure you have done it correct. If you have six funds in your portfolio, then Cell B2 through Cell B7 are going to be where your balance in each of the six funds is listed. Cell B8 is going to be the sum of those cells. On Cell C2, you would want the formula "=$B$8*.25" listed.
In the formula, the .25 designates 25%. For each cell in Column C, you want the formula reflecting each respective fund's target percent. The "=$B$X+1*." portion of the formula will not change. For example, if Column A were listing Total Stock Market Index Fund, Total Bond Market Index Fund, Total International Stock Market Index Fund, and GNMA Bond Fund, and your asset allocation were 75%, 10%, 5%, and 10%, respectively, then your spreadsheet would have "=$B$6*.75" in C2, "=$B$6*.1" in C3, "=$B$6*.05" in C4, and "=$B$6*.1" in C5.
Finally, the last column (D) will simply determine how much money you need to move. Column B represents how much money you have in each fund. Column C represents how much of your current balance you want in each fund. The formula for the first row is "=C2-B2" inputted to D2. If the amount in D2 is positive, you want to move money into that fund. If the amount in D2 is negative, then remove money from that fund.
The first row is going to establish the following columns: Fund (Name), Current (Balance), Target (Amount), and Change.
The first column is going to list the funds you own (and want to own) in your portfolio. There may be as few as two funds or as many as 10 funds (keep in mind, sometimes less is more), but list their names down the first column.
In the next column (B), you simply list the balance of each fund. This cell is going to be where you change information each time you visit the calculator in the future. Below the last fund, input the following formula into the cell "=SUM(B2:BX)" with X standing for the cell number of your last fund.
In the next column (C), you are going to input a formula to determine what the target amount in each fund should be based on your asset allocation. If I listed my first fund as the Vanguard Total Stock Index fund in Cell A2, then I would want 25% of my portfolio's balance in this fund. Therefore, I would input this formula into Cell C2: "=$B$X+1*.25" with X+1 standing for the cell number where your formula is for the "=SUM(B2:BX)" balance.
You may need to read that part a couple times before it makes sense, but here is an example to ensure you have done it correct. If you have six funds in your portfolio, then Cell B2 through Cell B7 are going to be where your balance in each of the six funds is listed. Cell B8 is going to be the sum of those cells. On Cell C2, you would want the formula "=$B$8*.25" listed.
In the formula, the .25 designates 25%. For each cell in Column C, you want the formula reflecting each respective fund's target percent. The "=$B$X+1*." portion of the formula will not change. For example, if Column A were listing Total Stock Market Index Fund, Total Bond Market Index Fund, Total International Stock Market Index Fund, and GNMA Bond Fund, and your asset allocation were 75%, 10%, 5%, and 10%, respectively, then your spreadsheet would have "=$B$6*.75" in C2, "=$B$6*.1" in C3, "=$B$6*.05" in C4, and "=$B$6*.1" in C5.
Finally, the last column (D) will simply determine how much money you need to move. Column B represents how much money you have in each fund. Column C represents how much of your current balance you want in each fund. The formula for the first row is "=C2-B2" inputted to D2. If the amount in D2 is positive, you want to move money into that fund. If the amount in D2 is negative, then remove money from that fund.
Wednesday, September 14, 2011
Manic Money
I used to think chronically poor people were just financially ignorant. Nowadays I am beginning to realize they may be closer to financially depressed. For the past eight years, I have been living (way) below my means. As a result, I was able to quit my job and self-financed a return to school. Although I have money in my name, I have no current income, so living below my means would leave me without basic necessities.
It occurred to me when I was making another cash payment for my house that those payments were starting to feel as though they were getting closer and closer. Most recently, I was tempted to take the $2.02 from my overpayment and buy something entirely frivolous (specifically a candy bar) since it would mean more to me now than it would mean to my mortgage in the long run. I equated the thought immediately with countless tales and occurrences I have heard and seen; all concepts that I never quite understood before that urge.
From this point onward, I may be way off-base. Now I don't plan to drain my portfolio to find out, but it seems to me that coming into money is where most people make missteps, overvaluing the security of the sum, and the inevitable splurging puts them right back where they have always been. In its most extreme form, it's seen as the "curse of the lottery." I once heard the description that money will not change a person, it will just lead them to be more themselves. Honestly, I still don't know what to think about the financial yo-yo, where people catch a break and spend it on themselves before they have to give it to others in the form of payments (usually for items that they have already purchased). All I can do is thank God that I was born to a father who knew otherwise.
In the simplistic words of John "Bradshaw" Layfield in Have More Money Now, "you can have when you have." I believe what the financially depressed are truly under-valuating is how the money that they're turning over to others before they even get their own hands on it is repayment for a pleasure that has already been received (and maybe already forgotten). Whether they are paying off a mortgage or a car loan, all the way down to the more forgettable purchases made on a credit card. There is an innate dissatisfaction when you get something before it has been earned.
Not that I am faulting people who fall into this mindset. At least once, I was one of them.
It occurred to me when I was making another cash payment for my house that those payments were starting to feel as though they were getting closer and closer. Most recently, I was tempted to take the $2.02 from my overpayment and buy something entirely frivolous (specifically a candy bar) since it would mean more to me now than it would mean to my mortgage in the long run. I equated the thought immediately with countless tales and occurrences I have heard and seen; all concepts that I never quite understood before that urge.
From this point onward, I may be way off-base. Now I don't plan to drain my portfolio to find out, but it seems to me that coming into money is where most people make missteps, overvaluing the security of the sum, and the inevitable splurging puts them right back where they have always been. In its most extreme form, it's seen as the "curse of the lottery." I once heard the description that money will not change a person, it will just lead them to be more themselves. Honestly, I still don't know what to think about the financial yo-yo, where people catch a break and spend it on themselves before they have to give it to others in the form of payments (usually for items that they have already purchased). All I can do is thank God that I was born to a father who knew otherwise.
In the simplistic words of John "Bradshaw" Layfield in Have More Money Now, "you can have when you have." I believe what the financially depressed are truly under-valuating is how the money that they're turning over to others before they even get their own hands on it is repayment for a pleasure that has already been received (and maybe already forgotten). Whether they are paying off a mortgage or a car loan, all the way down to the more forgettable purchases made on a credit card. There is an innate dissatisfaction when you get something before it has been earned.
Not that I am faulting people who fall into this mindset. At least once, I was one of them.
Thursday, August 25, 2011
The Hardest Answer
If you have a handsome amount of money built up inside your portfolio, or even just your savings account, then you may find yourself approached with one of the hardest questions to answer financially. When a good friend asks, "is there any way at all you can loan me some money?" If that were the exact phrase of the question, then I strongly advise answering no -- but if the actual question were tied to a specific sum of money (and in cases of sincerity, it usually is), then the request becomes more difficult to decline.
Unfortunately, there is no easy answer in this case, but I can share some of my own experiences and leave the actual response to your own preference since the best answer is neither "yes" nor "no" but rather whatever response enables you both to maintain the friendship comfortably thereafter.
It is no secret that financial strife is often listed as the number one cause of divorces, and I would imagine it is just as damanging to friendships as well. Therefore, my automatic answer is no for the most part. There have been exceptions, however, and there are a few steps to making the request a positive experience. The first is deciding on your own personal maximum, whether it is $1,000 or $100. Ideally, this number should be a direct reflection of your own financial security, but to assume you are financially independent, then this number would be determined by your own feelings of being used or abused (or, more frankly, when you feel as though you are being taken advantage of).
First off, you should donate to charity if you are financially comfortable. Aside from the good it does both for society and for yourself, it is also a good way to protect yourself against scams and other abuse, because it gives you a buffer of (what I call) "forgiveness protection." Whenever I am cheated out of money, I have the ability to reduce my donations by that amount so it does not affect my life at all. Unfortunately, there are people who will understand that mentality and other people who will misunderstand it. If it makes perfect sense to you, then hopefully you are already in practice of it to some degree. If it sounds like flawed logic, then you are probably in the latter half so please don't apply it to your life.
When you loan money to friends, take it from this amount of charitable donations. When your friend pays you back, then the amount goes to charity. Keep in mind that this buffer will not ease your feelings of potential mistreatment, so never give beyond that original amount with which you are comfortable. Ever!
I have given to friends who paid me back and I give the money directly to charity because, for all intents and purposes, my giving it to them was my charitable donation. The first time I loaned a friend a substantial sum of money and she paid me back, I just gave it directly to another charity. It immediately made me feel as though I got twice as much mileage from that charity by loaning it to a friend first (mind you, this logic only prevails if all goes well, so do not bank on that as justification for loaning money to friends).
In another instance, I once loaned a friend money and then I lost my job several months later (about 15 months later). She started paying me back when I was between jobs, so the money came back to me when I needed it most. The money I was getting back then was not money that I would have held in a saving account without loaning it to her. It was money that I would have given away to charity already. Therefore, when I got a new job, I increased my charitable donations to cover that amount as well. In that case, I was my own charity, and the money got thrice as much mileage. But that was an exception, not an expectation.
When you loan money by this philosophy, then this next point should be a no-brainer: never charge interest for a loan! If you need any further evidence of that advice, then refer to Deuteronomy 3:19-20. Sure, banks do it all the time, but that's their business model. Investors do it all the time as their incentive. You are not in the business of profiting off friends. You are in a friendship with a person who is less financially stable than you are. If you give $1,000 and ask for $125/mo. for 10 months, then you have taken $250 more from your friend than they could really afford (extenuating circumstances aside). Potentially, your friend may offer to pay interest on top of the original amount (i.e. paying $100+ for 10 months for borrowing $1,000), but do not use that profit as incentive for giving the loan. Consider it your friend's gratitude for helping out in a time of need. The big difference here is that you are not entitled to the additional interest, so if your friend skimps on that amount, then consider yourself lucky to get the full principle returned.
Finally, the most important aspect of loaning money to friends is to never, ever ask for them to pay you back. Do not loan money you cannot afford to lose, and when you loan out money, do not assume control of when you will get it back. Truthfully, this aspect could be a real deal-breaker in most cases, and it is the reason for my first advice of the standard answer of "no" to most requests. There are ways to create payment plans and other such arrangements in order to stay on track, but they violate the "forgiveness protection" buffer, so you can never be sure. I have loaned money to a friend where we set up a payment plan, and invariably, there was often a reason why the payments had to be delayed. In the interest of full disclosure, it was actually he who insisted on the payment plan. And to my friend's credit, I got all the money back (but I told him to pay me whatever he could when he could, and it took about twice as long as he had originally designed).
Regardless, we are still friends today. And, perhaps surprisingly, he has not asked to borrow money since the loan was repaid. And that is the surest sign that I made the decision in that situation.
There are times when loaning money to a close friend is the best thing to do. But don't cloud your judgment with the best case scenario or swerve your expectations when you weigh the decision. Your friend's sincerity will not increase the likelihood of full repayment. It could just as easily end the friendship.
Unfortunately, there is no easy answer in this case, but I can share some of my own experiences and leave the actual response to your own preference since the best answer is neither "yes" nor "no" but rather whatever response enables you both to maintain the friendship comfortably thereafter.
It is no secret that financial strife is often listed as the number one cause of divorces, and I would imagine it is just as damanging to friendships as well. Therefore, my automatic answer is no for the most part. There have been exceptions, however, and there are a few steps to making the request a positive experience. The first is deciding on your own personal maximum, whether it is $1,000 or $100. Ideally, this number should be a direct reflection of your own financial security, but to assume you are financially independent, then this number would be determined by your own feelings of being used or abused (or, more frankly, when you feel as though you are being taken advantage of).
First off, you should donate to charity if you are financially comfortable. Aside from the good it does both for society and for yourself, it is also a good way to protect yourself against scams and other abuse, because it gives you a buffer of (what I call) "forgiveness protection." Whenever I am cheated out of money, I have the ability to reduce my donations by that amount so it does not affect my life at all. Unfortunately, there are people who will understand that mentality and other people who will misunderstand it. If it makes perfect sense to you, then hopefully you are already in practice of it to some degree. If it sounds like flawed logic, then you are probably in the latter half so please don't apply it to your life.
When you loan money to friends, take it from this amount of charitable donations. When your friend pays you back, then the amount goes to charity. Keep in mind that this buffer will not ease your feelings of potential mistreatment, so never give beyond that original amount with which you are comfortable. Ever!
I have given to friends who paid me back and I give the money directly to charity because, for all intents and purposes, my giving it to them was my charitable donation. The first time I loaned a friend a substantial sum of money and she paid me back, I just gave it directly to another charity. It immediately made me feel as though I got twice as much mileage from that charity by loaning it to a friend first (mind you, this logic only prevails if all goes well, so do not bank on that as justification for loaning money to friends).
In another instance, I once loaned a friend money and then I lost my job several months later (about 15 months later). She started paying me back when I was between jobs, so the money came back to me when I needed it most. The money I was getting back then was not money that I would have held in a saving account without loaning it to her. It was money that I would have given away to charity already. Therefore, when I got a new job, I increased my charitable donations to cover that amount as well. In that case, I was my own charity, and the money got thrice as much mileage. But that was an exception, not an expectation.
When you loan money by this philosophy, then this next point should be a no-brainer: never charge interest for a loan! If you need any further evidence of that advice, then refer to Deuteronomy 3:19-20. Sure, banks do it all the time, but that's their business model. Investors do it all the time as their incentive. You are not in the business of profiting off friends. You are in a friendship with a person who is less financially stable than you are. If you give $1,000 and ask for $125/mo. for 10 months, then you have taken $250 more from your friend than they could really afford (extenuating circumstances aside). Potentially, your friend may offer to pay interest on top of the original amount (i.e. paying $100+ for 10 months for borrowing $1,000), but do not use that profit as incentive for giving the loan. Consider it your friend's gratitude for helping out in a time of need. The big difference here is that you are not entitled to the additional interest, so if your friend skimps on that amount, then consider yourself lucky to get the full principle returned.
Finally, the most important aspect of loaning money to friends is to never, ever ask for them to pay you back. Do not loan money you cannot afford to lose, and when you loan out money, do not assume control of when you will get it back. Truthfully, this aspect could be a real deal-breaker in most cases, and it is the reason for my first advice of the standard answer of "no" to most requests. There are ways to create payment plans and other such arrangements in order to stay on track, but they violate the "forgiveness protection" buffer, so you can never be sure. I have loaned money to a friend where we set up a payment plan, and invariably, there was often a reason why the payments had to be delayed. In the interest of full disclosure, it was actually he who insisted on the payment plan. And to my friend's credit, I got all the money back (but I told him to pay me whatever he could when he could, and it took about twice as long as he had originally designed).
Regardless, we are still friends today. And, perhaps surprisingly, he has not asked to borrow money since the loan was repaid. And that is the surest sign that I made the decision in that situation.
There are times when loaning money to a close friend is the best thing to do. But don't cloud your judgment with the best case scenario or swerve your expectations when you weigh the decision. Your friend's sincerity will not increase the likelihood of full repayment. It could just as easily end the friendship.
Wednesday, August 10, 2011
Mid-3Q Update
Today is August, 10, 2011, which is the day I should have rebalanced my portfolio. However, if you recall from my last "Full Motley" entry, I started by noting how quickly the trigger date had arrived. Well, I was a full month ahead of schedule! The most interesting part is that if I had waited the month, then I would have made my adjustments today as the market closed around 10,700, instead of the 12,600 mark where it was a month ago. I also would not have ceased my contributions into my Roth IRA, which was the right move to make in my opinion for my daily finances.
Most likely, I will move a portion of bonds from my Roth IRA to the stocks during this valley. Also, I will have an unrelated entry later this month (that is, unrelated to my personal portfolio and the markets in general), but for now, let's continue tracking the Dow's third-quarter freefall....
No rest for investors: Dow plunges 520
http://money.cnn.com/2011/08/10/markets/markets_newyork/index.htm?iid=Lead
NEW YORK (CNNMoney) -- After a one-day respite, U.S. stocks plunged sharply yet again Wednesday as investors were confronted with mounting fears about Europe's ongoing debt crisis, this time in France.
The Dow Jones industrial average lost 520 points, or 4.6%, to 10,720. The index ended the day near session lows.
The S&P 500 fell 52 points, or 4.4%, to 1,121; and the Nasdaq composite lost 101 points, or 4.1%, to 2,381.
Stocks were led lower by the financial sector. On Wednesday afternoon CEO of embattled Bank of America Brian Moynihan tried to reassure investors that conditions at the bank and in the country are much better than they were four years ago when the financial crisis hit. The comments were made during a call hosted by investor Bruce Berkowitz of Fairholme Capital Management.
But the comments were not enough. Shares of the Dow component plunged 11% on the day. BofA has fallen nearly 50% so far this year.
Other names in the financial sector were hit just as hard. Shares of Citigroup, Goldman Sachs and Morgan Stanley dropped about 10%. Shares of Wells Fargo, UBS and JPMorgan Chase were down around 7%.
Along with BofA's problems, investors remain worried about the Europe's ongoing sovereign debt crisis.
Ever since Standard & Poor's stripped the U.S. of its AAA credit rating on Friday, fears have been building that rating agencies may also downgrade AAA-rated nations in Europe, since they are also struggling with massive debt problems.
On Wednesday, shares of French bank Societe Generale tumbled 15% on the Paris stock exchange amid speculation that France, Europe's second-largest economy after Germany, may be first to face a rating cut.
European banking shares also fell sharply. Deutsche Bank's stock dropped 12% while Spanish bank Banco Santandedr dropped 9.5%.
Most likely, I will move a portion of bonds from my Roth IRA to the stocks during this valley. Also, I will have an unrelated entry later this month (that is, unrelated to my personal portfolio and the markets in general), but for now, let's continue tracking the Dow's third-quarter freefall....
No rest for investors: Dow plunges 520
http://money.cnn.com/2011/08/10/markets/markets_newyork/index.htm?iid=Lead
NEW YORK (CNNMoney) -- After a one-day respite, U.S. stocks plunged sharply yet again Wednesday as investors were confronted with mounting fears about Europe's ongoing debt crisis, this time in France.
The Dow Jones industrial average lost 520 points, or 4.6%, to 10,720. The index ended the day near session lows.
The S&P 500 fell 52 points, or 4.4%, to 1,121; and the Nasdaq composite lost 101 points, or 4.1%, to 2,381.
Stocks were led lower by the financial sector. On Wednesday afternoon CEO of embattled Bank of America Brian Moynihan tried to reassure investors that conditions at the bank and in the country are much better than they were four years ago when the financial crisis hit. The comments were made during a call hosted by investor Bruce Berkowitz of Fairholme Capital Management.
But the comments were not enough. Shares of the Dow component plunged 11% on the day. BofA has fallen nearly 50% so far this year.
Other names in the financial sector were hit just as hard. Shares of Citigroup, Goldman Sachs and Morgan Stanley dropped about 10%. Shares of Wells Fargo, UBS and JPMorgan Chase were down around 7%.
Along with BofA's problems, investors remain worried about the Europe's ongoing sovereign debt crisis.
Ever since Standard & Poor's stripped the U.S. of its AAA credit rating on Friday, fears have been building that rating agencies may also downgrade AAA-rated nations in Europe, since they are also struggling with massive debt problems.
On Wednesday, shares of French bank Societe Generale tumbled 15% on the Paris stock exchange amid speculation that France, Europe's second-largest economy after Germany, may be first to face a rating cut.
European banking shares also fell sharply. Deutsche Bank's stock dropped 12% while Spanish bank Banco Santandedr dropped 9.5%.
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