wealth
Wealth Tax: Definition, Examples, Pros and Cons
A wealth tax is a type of tax that’s imposed on the net wealth of an individual. This is different from income tax, which is the type of tax you’re likely most used to paying. The U.S. currently doesn’t have … Continue reading →
The post Wealth Tax: Definition, Examples, Pros and Cons appeared first on SmartAsset Blog.
Which Debts Should You Prepay First? A 6-Step Plan
Maya asks:
“Is it better to pay off student loans or a mortgage first? I’m asking for my brother, who took out $80,000 in student loans about 20 years ago and has only paid off about $10,000. He recently bought a home in Southern California and took out a 30-year mortgage that might be as much as $400,000. I don’t know the interest rates he’s paying on these debts. I think he should pay off his student loans first because the total debt is smaller, older, and can’t be discharged in a bankruptcy. What do you think?”
Thanks for your question, Maya! This dilemma is common, especially now that most federal student loans are in automatic forbearance from March 13 to September 30, 2020, due to coronavirus-related economic relief. That means millions of student loan borrowers suddenly have the option to stop making payments without adverse financial consequences, such as hurting their credit or getting charged additional interest or fees.
If you have qualifying student loans and you're dealing with financial hardship due to the pandemic or another challenge, you may be grateful to have your payments suspended. But if your finances are in good shape and you don’t have any dangerous debts, such as high-rate credit cards or loans, you may be wondering what to do with the extra money. Should you send it to your student loans despite the forbearance, to your mortgage, or to some other account?
RELATED: 10 Things Student Loan Borrowers Should Know About Coronavirus Relief
6 Steps to Decide Whether to Pay Off Student Loans or a Mortgage First
Let's take a look at how to prioritize your finances and use your resources wisely during the pandemic. This six-step plan will help you make smart decisions and reach your financial goals as quickly as possible.
1. Check your emergency savings
While many people begin by asking which debt to pay off first, that’s not necessarily the right question. Instead, zoom out and consider your financial life's big picture. An excellent place to start is to review your emergency savings.
If you’ve suffered the loss of a job or business income during the pandemic, you’re probably very familiar with how much or how little savings you have. But if you haven’t thought about your cash reserve lately, it’s time to reevaluate it.
Having emergency money is so important because it keeps you from going into debt in the first place. It keeps you safe during a rough financial patch or if you have a significant unexpected expense, such as a car repair or a medical bill.
How much emergency savings you need is different for everyone. If you’re the sole breadwinner for a large family, you may need a bigger financial cushion than a single person with no dependents and plenty of job opportunities.
If you’re the sole breadwinner for a large family, you may need a bigger financial cushion than a single person with no dependents and plenty of job opportunities.
A good rule of thumb is to accumulate at least 10% of your annual gross income as a cash reserve. For instance, if you earn $50,000, make a goal to maintain at least $5,000 in your emergency fund.
You might use another standard formula based on average monthly living expenses: Add up your essential costs, such as food, housing, insurance, and transportation, and multiply the total by a reasonable period, such as three to six months. For example, if your living expenses are $3,000 a month and you want a three-month reserve, you need a cash cushion of $9,000.
If you have zero savings, start with a small goal, such as saving 1 to 2% of your income each year. Or you could start with a tiny target like $500 or $1,000 and increase it each year until you have a healthy amount of emergency money. In other words, it might take years to build up enough savings, and that’s okay—just get started!
Your financial well-being depends on having cash to meet your living expenses comfortably, not on paying a lender ahead of schedule.
Unless Maya’s brother has enough cash in the bank to sustain him and any dependent family members through a financial crisis that lasts for several months, I wouldn’t recommend paying off student loans or a mortgage early. Your financial well-being depends on having cash to meet your living expenses comfortably, not on paying a lender ahead of schedule.
If you have enough emergency savings to feel secure for your situation, keep reading. Working through the next four steps will help you decide whether to pay down your student loans or mortgage first.
2. Reach your retirement goals
In addition to saving for potential emergencies, it’s critical to save regularly for your retirement before paying down a student loan or mortgage early. So, if Maya’s brother isn’t contributing regularly to meet a retirement goal, that’s the next priority I’d recommend for him.
Consider this: If you invest $500 a month for 35 years and have an average 8% return, you’ll end up with an impressive retirement nest egg of more than $1.2 million! But if you wait until 10 years before retirement to start saving, you’d have to invest over $5,000 a month to have $1 million in the bank. When it comes to your retirement savings, procrastinating can make the difference between scraping by or have a comfortable lifestyle down the road.
When it comes to your retirement savings, procrastinating can make the difference between scraping by or have a comfortable lifestyle down the road.
A good rule of thumb is to invest at least 10% to 15% of your gross income for retirement. For instance, if you earn $50,000, make a goal to contribute at least $5,000 per year to a tax-advantaged retirement account, such as an IRA or a retirement plan at work, such as a 401(k) or 403(b).
For 2020, you can contribute up to $19,500, or $26,000 if you’re over age 50, to a workplace retirement account. Anyone with earned income (even the self-employed) can contribute up to $6,000 (or $7,000 if you’re over 50) to an IRA.
The earlier you make retirement savings a habit, the better. Not only does starting sooner give you more time to contribute money, but it leverages the power of compounding, which allows the growth in your account to earn additional interest. That’s when you’ll see your retirement account value mushroom!
3. Have the right insurance
In addition to building an emergency fund and saving for retirement, an essential part of taking control of your finances is having adequate insurance. Many people get into debt in the first place because they don’t have enough of the right kinds of coverage—or they don’t have any insurance at all.
Without enough insurance, a catastrophic event could wipe out everything you’ve worked so hard to earn.
As your career progresses and your net worth increases, you’ll have more income and assets to protect from unexpected events. Without enough insurance, a catastrophic event could wipe out everything you’ve worked so hard to earn.
Make sure you have enough health insurance to protect yourself and those you love from an illness or accident jeopardizing your financial security. Also, review your auto and home or renters insurance coverage. And by the way, if you rent and don’t have renters insurance, you need it. It’s a bargain for the protection you get; it only costs $185 per year on average.
And if you have family who would be hurt financially if you died, you need life insurance to protect them. If you’re in relatively good health, a term life insurance policy for $500,000 might only cost a couple of hundred dollars per year. You can get free quotes for many different types of insurance using sites like Bankrate.com or Policygenius.com.
If Maya’s brother is missing critical types of insurance for his lifestyle and family situation, getting it should come before paying off a student loan or mortgage early. It’s always a good idea to review your insurance needs with a reputable agent or a financial advisor who can make sure you aren’t exposed to too much financial risk.
4. Set other financial goals
But what about other goals you might have, such as saving for a child’s education, starting a business, or buying a home? These are wonderful if you can afford them once you’ve accounted for your emergency savings, retirement, and insurance needs.
Make a list of your financial dreams, what they cost, and how much you can afford to spend on them each month. If they’re more important to you than paying off student loans or a mortgage early, then you should fund them. But if you’re more determined to become completely debt-free, go for it!
5. Consider your opportunity costs
Once you’ve hit the financial targets we’ve covered so far, and you have money left over, it’s time to consider the opportunity costs of using it to pay off your student loans or mortgage. Your opportunity cost is the potential gain you’d miss if you used your money for another purpose, such as investing it.
A couple of benefits of both student loans and mortgages is that they come with low interest rates and tax deductions, making them relatively inexpensive. That’s why other high-interest debts, such as credit cards, personal loans, and auto loans, should always be paid off first. Those debts cost more in interest and don’t come with any money-saving tax deductions.
Especially in today’s low interest rate environment, it’s possible to get a significantly higher return even with a reasonably conservative investment portfolio.
But many people overlook the ability to invest extra money and get a higher return. For instance, if you pay off the mortgage, you’d receive a 4% guaranteed return. But if you can get 6% on an investment portfolio, you may come out ahead.
Especially in today’s low-interest-rate environment, it’s possible to get a significantly higher return even with a reasonably conservative investment portfolio. The downside of investing extra money, instead of using it to pay down a student loan or mortgage, is that investment returns are not guaranteed.
If you decide an early payoff is right for you, keep reading. We’ll review several factors to help you know which type of loan to focus on first.
6. Compare your student loans and mortgage
Once you have only student loans and a mortgage and you’ve decided to prepay one of them, consider these factors.
The interest rates of your loans. As I mentioned, you may be eligible to claim a mortgage interest tax deduction and a student loan interest deduction. How much savings these deductions give you depends on your income and whether you use Schedule A to itemize deductions on your tax return. If you claim either type of deduction, it could reduce your after-tax interest rate by about 1%. The debt with the highest after-tax interest rate is typically the best one to pay off first.
The amounts you owe. If you owe significantly less on your student loans than your mortgage, eliminating the smaller debt first might feel great. Then you’d only have one debt left to pay off instead of two.
You have an interest-only adjustable-rate mortgage (ARM). With this type of mortgage, you’re only required to pay interest for a period (such as several months or up to several years). Then your monthly payments increase significantly based on market conditions. Even if your ARM interest rate is lower than your student loans, it could go up in the future. You may want to pay it down enough to refinance to a fixed-rate mortgage.
You have a loan cosigner. If you have a family member who cosigned your student loans or a spouse who cosigned your mortgage, they may influence which loan you tackle first. For instance, if eliminating a student loan cosigned by your parents would help improve their credit or overall financial situation, you might prioritize that debt.
You qualify for student loan forgiveness. If you have a federal loan that can be forgiven after a certain period (such as 10 or 20 years), prepaying it means you’ll have less forgiven. Paying more toward your mortgage would save you more.
Being completely debt-free is a terrific goal, but keeping inexpensive debt and investing your excess cash for higher returns can make you wealthier in the end.
As you can see, the decision to eliminate debt and in what order, isn’t clear-cut. Mortgages and student loans are some of the best types of debt to have—they allow you to build wealth by accumulating equity in a home, getting higher-paying jobs, and freeing up income you can save and invest.
In other words, if Maya’s brother uses his excess cash to prepay a low-rate mortgage or a student loan, it may do more harm than good. So, before you rush to prepay these types of debts, make sure there isn’t a better use for your money.
Being completely debt-free is a terrific goal, but keeping inexpensive debt and investing your excess cash for higher returns can make you wealthier in the end. Only you can decide whether paying off a mortgage or student loan is the right financial move for you.
How to Start Investing in the Stock Market
Although investing in the stock market can feel intimidating at first, it could be the key to achieving your financial goals. Short of hitting the lottery or building a thriving business that you can sell, buying securities that increase in value over time is usually the easiest path to wealth. After all, the average savings […]
The post How to Start Investing in the Stock Market appeared first on Good Financial Cents®.
5 Investing Strategies That Can Harm Your Portfolio
If you’re educating yourself on how to invest your money for the first time, books such as Thinking, Fast and Slow, The Little Book of Behavioral Investing, and Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism may already be on your reading list. But you shouldn't stop there. Many investors are surprised to learn that building wealth isn’t based purely on graphs and facts you can learn from books. In fact, psychology plays a huge role in the process. Cognitive psychology shows that the ways we manage our money has a lot to do with fear, excitement, greed, and personal biases.
We often imagine that investors are always rational and make consistent decisions based on new information. However, statistics show that only 20% of individual investors and 30% of institutional investors act rationally. In real life, investors are closer to behavioral finance, which means that they’re influenced by personal beliefs, impulses, and emotions. Even if you did your homework and researched the best investment strategies, emotional behaviors might prevent you from applying them correctly, so it's important to know some of the types of irrational behaviors that can sabotage you.
Five types of irrational behavior that can sabotage your investment portfolio are:
- Overconfidence
- Loss aversion
- Familiarity bias
- Framing
- Anchoring
1. Overconfidence, or the irrational exuberance trap
Studies have shown that people generally believe they are better than average, even when that’s not the case. After a series of successful investments, it's common for investors to assume they have it all figured out. But in reality, it takes years to become an experienced investor, and even the best investors make mistakes.
After the excitement of the first successful investment, it’s easy to become overconfident in your abilities and forget that chance plays a major role in the financial market. One of the most important lessons in investing is that you can never know too much, so no matter what your financial situation is, manage your portfolio prudently.
2. Loss aversion
The more you invest, the more you realize that loss is inevitable. After all, the higher the risk, the higher the reward. But while many investors accept risk in theory, they aren’t ready to deal with loss. This is called loss aversion, and it can prevent you from making a profit. According to researchers, investors experience the pain of a loss twice as strongly as a success, and they’ll do whatever they can to avoid it. As a result, when they notice that an investment is losing them money, whether that investment is a house, stock, or currency, they hold on to it for as long as possible to avoid the sense of finality of the loss. But that can turn out to be a huge mistake and end up losing you more money in the long run.
There are other, more effective ways to limit losses. For example, if you’re trading Forex, you can try copy trading, where live trading results are openly published online, and you can copy the actions of more experienced traders. Or if you’re trading stocks, you can simply set a stop-loss order. This is designed to limit your loss on a security position and make you sell the stock if it drops below a certain value. Of course, there will always be cases when a stock rebounds after an initial drop, but especially as a new trader, it’s wiser to protect your portfolio proactively.
3. Familiarity bias
Although diversification is a surefire way to minimize the risk of loss, gain more return opportunities, and safeguard your portfolio against the volatility of the market, research shows that investors tend to stick to assets they know and are comfortable with. This is called a familiarity bias, and it can be detrimental to your portfolio.
One study has shown that beginner investors in particular stick to domestic stocks, such as large telecom companies or factories in their area, without realizing that these businesses may be sinking. Or even worse, people invest only in their employer’s stock, and when that employer goes out of business, they lose both their job and their profit.
Diversifying can be a bit uncomfortable at first since it means researching stocks out of your comfort zone, but overcoming your familiarity bias is important if you want to protect your portfolio. Don’t put all your eggs in the same basket. Instead, cast a wide net when choosing investments.
4. Framing
The ability to put things into perspective and estimate the impact that events will have in the long run is crucial in trading. However, this ability takes years to develop. When you're new to investing, you’re much more likely to inadvertently practice framing – a cognitive error where you have a narrow-minded approach and evaluate investments in isolation rather than as a cohesive whole.
According to Harry Markowitz’s modern portfolio theory, the assets in your portfolio shouldn’t stand alone. Instead, you should consider how they fit into your general portfolio and, when necessary, readjust the portfolio to reflect the new reality of the market. Cryptocurrency is a perfect example of framing. People who bought Bitcoin in its early days and held onto it are probably very happy, but if they didn’t invest in anything else in the meantime, their portfolio consists entirely of crypto now, and that’s a risky move.
5. Anchoring, or the confirmation trap
The confirmation trap, also known as anchoring or “the house money effect,” occurs when an investor relies relentlessly on a single investment, simply because it worked out well once. Another example of anchoring is when someone takes information from only one source because they were right the first time. But as any experienced investor will tell you, one positive experience is not a guarantee of future success. While learning from the past can sometimes help you understand future numbers, it can also prevent you from making fresh choices based on more relevant insights. To prevent anchoring from limiting your options, always try to view an investment opportunity from different perspectives, stay open-minded, and talk to several consultants before making a decision.
Black homeowners pay $13K more for home loans: study – The Real Deal
Black homeowners pay $13K more for home loans: study The Real Deal
Why is the Homeownership Rate Soaring?
Homeownership makes many positive social contributions, but the most important may be that it is the predominant way families build wealth. And now, numbers are soaring.
The post Why is the Homeownership Rate Soaring? appeared first on Homes.com.
Should You Invest With Friends?
Investing with friends might seem like an intriguing concept. Instead of being the sole decision maker, you can share financial and knowledge-based resources to come up with a compelling investment strategy that serves your collective goals. Investing with friends may also be a way to make a substantial impact in a cause you believe in, […]
The post Should You Invest With Friends? appeared first on SoFi.
How to Include Some Guilt-Free Spending in Your Budget
Here are ways to keep expenses guilt-free to bring joy without breaking the bank and why having some fun money is a wise financial move.
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The post How to Include Some Guilt-Free Spending in Your Budget appeared first on MintLife Blog.
How to Handle a Pay Cut: Budgeting in Uncertain Times
Are you stressed by an income reduction? Try these budgeting tips to survive a pay cut and thrive during this challenging time.
The post How to Handle a Pay Cut: Budgeting in Uncertain Times appeared first on Discover Bank – Banking Topics Blog.