I was thinking back to my post last July, Dennis Kneale Recovery in which I remarked that he had declared the bottom was behind us, and it would just take time before it was declared. As you can see, the recession lasted longer the the prior three, and it will take somemore time before we feel that we are in a vibrant recovery. a bit of patience.

Joe

Here is an example of what I had in mind;

Dear Rich,
Some of the money that I left you is in an IRA account. Please understand something about this account. When I left it to you there were no taxes due, but because this IRA was funded with pre-tax money, you owe taxes at your marginal rate as you withdraw it. Fortunately, withdrawals can be made based on your current life expectancy, so you can withdraw this money a little bit at a time over the years and hopefully pay very little in taxes along the way. The way the money is currently invested, even though right for me, may not fit with your investing style or needs. If you wish to reduce the stock portion and keep it all and CDs that choice is yours. You can sell the stock and reinvest the money into CDs or even place it a money-market fund and this transaction will not be taxable. It’s only when you withdraw the money from the IRA that you’ll be required to pay taxes. The required minimum distributions that you must take are just that, minimum numbers, if you need to take a bit more it’s your choice to do that as well. Just keep one thing in mind, if you take out too much money in one year you may jump into a higher tax bracket and pay more tax than is necessary. Lastly, the one thing I ask you not to overlook is to include a new beneficiary should something happen to you. Again this is your decision, a child, a friend, a family member, a charity, the choice is yours.
Use it in good health,

Obviously, you can fine tune this to your own style. The message here is that years of your planning can be undone by one mistake your beneficiary makes. Here’s a way to help avoid that.
Joe

If you are at the point in your investing life where individual stocks are planned for your portfolio (and there are many sucessful investors who have never owned an individual stock) then this book is certainly worth the three or so hours of your time it will take to read.

JOE

1. Make a will
2. Pay off your credit cards
3. Get term life insurance if you have a family to support
4. Fund your 401k to the maximum
5. Fund your IRA to the maximum
6. Buy a house if you want to live in a house and can afford it
7. Put six months worth of expenses in a money-market account
8. Take whatever money is left over and invest 70% in a stock index fund and 30% in a bond fund through any discount broker and never touch it until retirement
9. If any of this confuses you, or you have something special going on (retirement, college planning, tax issues), hire a fee-based financial planner, not one who charges a percentage of your portfolio

I wasn’t planning to make a habit of quoting other author’s advice, but this was too good to overlook. This is from Scott Adams’ book “Dilbert and the Way of the Weasels.” As Scott Adams states, “Everything else you may want to do with your money is a bad idea compared to what’s on my one-page summary. You want an annuity? It’s worse. You want a whole life insurance policy? It’s worse. You want to invest in individual stocks? It’s worse. You want a managed mutual fund instead of an index fund? It’s worse. I could go on, but you get the point.”
I might put a caveat on the 401(k) advice (see my article), but these rules are worth reading and following.

JOE

I recently received a reply from reader Ken I’d like to share:

One does not realize that 1) Employers pay health care costs directly but indirectly; and have insurance companies fight and account for those health care expenses for those companies. My employer uses a Blue Cross plan to minimize its health care costs then pays Blue Cross a fee for that service and a fee for reducing that very same cost. 2) An employer or pool of employers, pays a hospital or health care group or doctors, a predetermined annual amount to preform a guaranteed amount of services for an agreed amount of patients. e.g. The example above. The test may very well have cost $1200, but it may have been part of the agreed upon service that was to be provided by that provider for $1000 as part of the annual fee. The remaining $200 was treated as normal expense and required a co pay. The interesting part to all of this is when a couple both have same but separate health insurance plans to different employers, and because of the birthday rule, the same service is paid different amounts because who covers it first.
Ultimately it all boils down to this: There are always going haves and have-nots; and the haves are always going to be overcharged so they can pay for the have-nots. Doesn’t matter if it’s the present system or Obamacare or Hillarycare. What does matter is the ultimate cost in 1) dollars, 2) cuts in services,3) choice of doctors, 4) choice of care or treatment and 5) use of personal or public money.

In response, regular reader and deep financial thinker, Elle, offered a detailed, well thought response which seemed a shame to leave buried as a comment;

Ken,

1. Employers use health insurers so that employees may benefit from the cost discount attributable to having an enormous number of clients, thus spreading risk. Your use of epithets like Hillarycare and Obamacare are reckless disregard for the clear mathematics of the single payer system. Single payer would do the same as Blue Cross, but given the much larger number of clients and the fact that hospitals and doctors have to work with only one administrator, for less money.

2. When you talk about cuts in services, you seem oblivious to the fact that many health facilities overprescribe services, with no improvement in health outcomes. Why do they overprescribe? Because the doctors at such facilities are not on a straight salary but instead have a financial stake in everything they prescribe. In other words, they work on commission. The models to use are the Mayo Clinics and others, where such a conflict of interest is prohibited, and the docs are paid a straight salary. Before commenting further, you should read Atul Gawande’s June 1 article in the New Yorker on this.

3. Joe, the New York Times for a few years now has been running articles on how not only are doctors’ and hospitals bills’ to the uninsured and under-insured negotiable, but the billing departments actually expect people to call and haggle over the bills. The nominal fee on a bill is monopoly dollars. Plus consumers need to understand that the rate of errors on medical bills is on the order of 50% and typically sizable. It has become such a problem that there is now a profession called “Patient Advocate,” where someone (often a retired nurse or other health care professional) who knows how to decipher what is on the bill. See the article After a Diagnosis, Someone to Help Point the Way, also in the Times. .

People talk about letting the consumer “choose” and so let free market forces work, but the health care system has so much in it that is arcane that the typical patient could not possibly make an informed choice. So it is not a free market when buyers do not have access to needed information.

4. But more of those on the left need to acknowledge that there most certainly are preventive health measures that the “have nots” can implement, at enormous savings to us all. People just need a simple financial incentive structure to practice this preventive medicine. Such preventive medicine translates to national health savings on the order of 30%, from my reading. Google on what the President of Safeway (Steven Burd) did when he gave Safeway employees a health insurance rate structure that resulted in higher premiums for those showing poor habits in the areas of tobacco usage, weight, cholesterol and blood pressure. Safeway health costs went down as its employees started practicing more preventive medicine, more than justifying the financial incentives. See for example Safeway CEO on free-market health care solutions.

5. Never forget that a healthy blue collar and middle class are essential to the success of companies and so your stocks.

Thank you both for your comments, and Elle, you ever feel the urge to send me a guest post, my blog welcomes you.

Joe

1. Allow small businesses to automatically enroll workers in 401(k) plans.
2. Offer an option to receive your tax refund as a saving bond.
3. Allow employees to put payments for unused sick or vacation time into their 401(k) account.
4. IRS and Treasury to offer a guide to inform people how to rollover their accounts when changing employers.

I’m sorry to say, I see nothing here of value. What will put more money in our pockets or help stabilize the financial markets? The third list item only impacts a worker changing jobs, and at time when they are most likely to need the cash. Note – this is not the worker’s 401(k) money, just the pay for unused vacation and /or sick time. I have higher hopes to see changes that will actually have an impact.
Joe

A Money Merge Account agent sent me a link to a You Tube video titled Truth in Lending. The author wanted to illustrate the concept of “front-loaded” interest on a 30 year mortgage. I’ve never seen a post that started with that idea end in anything that made sense, this video was no different. The video itself was well done, nice animation and voice over, but the numbers soon fall apart. I’ll offer two screen shots that show this.

As this slide came up, it seemed innocent enough,unfortunately it ends incorrectly. When working with a financial calculator you need to be very specific. N is not the number of years but number of payments, in the video’s example, 360. PMT, the payment, can be positive or negative depending on the calculator. Excel looks for it to be negative, a classic TI BA-35 calculator, positive. PV is not the equity built, but the present value of the mortgage, starting at the borrowed amount, and of course, ending with a FV (future value) of zero. He then says Compute, but there are two variable missing, %i (the interest rate) as well as FV. So, while I have no idea what his intention was, he now suggest taking I (the interest rate, I suppose) and dividing by Y (years, but why?) to produce a number which is admittedly large but meaningless.

Here, you can see that he author suggests that somehow the interest rate over 15 years is over 24%. But, back to a calculator or spreadsheet, we can see that PV = $200K (original loan) i = .5% (monthly rate or 6%/12) N=360 months (30 years) FV = 0 (after 30 years it’s paid to zero. If we enter these numbers we can comput the missing variable, the payment, which is $1199.10. Then it’s simple to set N to 180 (year 15) and compute the new future value, $142,097.69, as he shows above. On the other hand, we can enter PV =$200K, i = .5%, PMT = $1199.10, N=180 and FV = $142,097.69, and ask to calculate the rate, which of course comes back as .005 or 6% per year. By the way, it’s easy to look at the interest column above and divide say, the 2021 interest into the prior year ending balance and see you get under 6%. A couple hundred video views and no one saw how silly this all was?

As far as front loading is concerned, there’s nothing diabolical in how mortgages are calculated, you owe interest on the principal outstanding at any given time. Since you owe far more in the early years, more of your payment is interest. On this example $200K mortgage, in the first month the interest is $1000, but the principal paid is only $199.10. Pay more if you wish, that’s your decision. But don’t fall for an abomination of bad math. What does this have to do with the Money Merge Account? Only that every time I see numbers abused this badly I’m reminded of my friends at UFirst and the MMA.

Joe

(A right click will open the chart for better viewing) From this chart of the S&P, you can see that from 1980 to 1990 if you simply drew a straight line, and continued that line through 2000, stocks continued on an amazing return path. Note, the graph is semi-log, which means that a straight line represents constant annual growth. So if the S&P grew at exactly the same rate from 1990 to 2000 as the decade prior, the graph would follow the straight line. From 1990-1995 it underperformed a bit, but then accelerated and grew above the trend line I drew. Now, if instead of adjusting the line to a higher growth rate we simply continues to extend it, the S&P would have a present value of 3600, nearly 4 times where we are today. 9 years ago, 3600 was just an extension of a 20 year long trend, now it seems like a lifetime away.

The financial aid process comes with its own acronyms, the first I ran into was FAFSA, (Free Application for Federal Student Aid, only use the Dot Gov site, other sites charge a fee). Next came EFC, the Expected Family Contribution. This chart, generated from the site FinAid is a great start to understanding the process:

This chart is based on parents’ income and assets. You can see that as income rises, the percent expected to be paid toward college rises from about 17% at $40K to over 30% right after $70K income level. Assets are not treated so harshly, rising from 2% to 4% as income increases. Equity in one’s home isn’t counted at all.

On the other hand, 50% of student income is expected to pay for college (ouch!) and 35% of student assets.

Parents’ retirement accounts are not considered in the equation, and a 529 account is considered a parent’s asset, not the student’s.

Before I discuss a few strategies to maximize the aid your child would receive let me observe that the average cost for a private four year school was $25,143 for the 2008-9 school year and the public four year cost averaged $6,585 (it was just announced that these numbers rose by 4.3% for 2009-10). Looking at the chart above you can see that for a public school an income above $60,000 will make aid hard to come by, as an income above $120,000 will support the full cost of private school.

A number of strategies that can make a difference in your EFC:

Fund your 401(k) until it’s max’ed. If you reduce your income from $60,000 to $50,000, you will save $2,350 in the EFC hit as well as $1500 in federal tax for a total $3,850. (See Fairmark to better understand your tax bracket.) After graduation, if you must withdraw the $10,000 you will only be hit with $2,500 in both tax and penalty. (Just making a point, save it till you retire.)

If you are sitting on an investment (non-retirement account) portfolio, and still have a mortgage, pay it in full. $100,000 in assets will be “taxed” at $3,000 per year at the $60,000 income level and $3,200 at higher incomes. If your mortgage is 5%, this translates to over an 8% return on the money each year for the four years of college.

Given the 35% of student assets expected to be used for college, I now understand why so many freshmen are driving expensive cars. Consider, $50,000 in the student’s name will be spent down to $8925 over four years, $41,074 expected to be used for college. In another case of “unintended consequences,” it actually makes sense to go buy a car and blow the money. A better choice would be to take advantage of tax sheltered retirement accounts, 401(k) if the student works a regular job while in high school, Roth IRA if working for a company with no retirement account. The IRA limit is $5000 this year. One can deposit up to 100% of their earned income into an IRA up to that $5000 maximum.

Other advice I’ve run across suggests having your children close together as the aid formula is kind to those with two or more students in college at the same time. If your two children are a year apart, perhaps the older one wants to take a year off before returning to school. These two suggestions are a bit extreme, but will increase your potential aid nonetheless.

Suggest to any helpful friends or relatives who with to help with the cost that they wait until graduation and apply that gift to any loans, but not gift it to the student while in school.

If you are well above the income levels that will qualify you for aid, congratulations, you’ll be paying your student’s way, but if you are in that middle, I hope these strategies help you. For more on this topic, see the article When Saving Means Losing.

Joe