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Three Steps to an Iron-Clad Protection Plan

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“No one knows the day or the hour…”

Unfortunately, that phrase is so true.  We here in the O.G. house, along with the whole FFA crew, join those across the world in thinking about (dare I say ‘praying for’) those impacted by the terrorism in Boston, the terrible storms in the Midwest, and the explosion in Texas.  The phrase “when it rains, it pours” comes to mind.

These recent events have encouraged me–nay, they’ve compelled me, to write another bit about protection planning.  There are three crucial pieces to a well-designed protection plan and collectively, they are the single most important part of your overall financial plan.  I don’t care what funds you use, what your company 401(k) match is, or even how many pre-IPO shares of Google you own – without an adequate protection plan in place, you have nothing.

Are you worried about your protection strategy? Here are three steps to an iron-clad protection plan.

 

Step 1:  Forget the 6 months notion – head right to 12 months of cash

 

Many financial professionals suggest three to six months worth of expenses in a cash reserve position.  That’s baloney.  If you were sick or injured, would you want to be counting backwards from 90 until you run out of money?  I didn’t think so.  Skip three months and six and head right to 12 months of lifestyle-sustaining cash reserve, especially if you work for yourself or in an unstable industry…and what industry ISN’T unstable these days?  This will take some work to figure out, because it’s not just your annual salary, but rather what you need to sustain your lifestyle for the next 12 months.  We’ve discussed saving in a Roth IRA as a dual-purpose account HERE if that suits you better.

Why do you need so much in cash?

First of all, what exactly is “so much” anyway?  Obviously, “so much” is a relative and personal term – I have one client who “only” has $90,000 in his savings.  That’s on top of the “nearly empty” checking account with $55,000 in it.  Oh, and he spends $60,000 a year  – 100% covered by his pension.  Cash is king.  It allows you to negotiate (doctors have different “cash” prices – as do other businesses) and is easily accessible.  The last thing you want in an emergency is to be floating credit card balances while your insurance company decides how and when they’re going to pay.  Get emergency cash now.  Make a plan and do it.

 

Step 2:  Buy disability insurance beyond what your company provides

 

This is an increased cost, no doubt, but who among us could live on less than 50% of your current income?  I know things around here would get a little tight, for sure!  Remember what I said a few minutes ago about “lifestyle-sustaining” income?  If something tragic happens, should that mean that your kids can’t play soccer anymore?  What about dance class?  If you’re no longer able to work for the rest of your life, do you think you should continue to build up a retirement nest-egg?  Disability coverage only usually pays until age 65!  Then what will you do?

It’s usually best to find your own outside coverage in addition to what your employer provides.  Group coverage will be 100% taxable when you receive it.  Coverage paid for entirely by you is 100% tax-free.

Take this example:

Let’s say you make $80,000 a year as an electrical engineer.  You have group disability of 60% that kicks in after you’ve exhausted all your vacation and sick time.  Sixty-percent of $80,000 is $48,000, right?  Now, let’s subtract 25% for taxes, so that leaves you with $36,000, or roughly $3,000 a month.  You were making $5,000 a month after tax.  Can you today cut two grand out of your household budget?  No?  I didn’t think so.  Everyone’s cost may be different, but let’s say a disability policy that pays you $2,000/mo DI costs $150/mo.  That’s $1,800 a year…is it worth it?  Let’s put it another way:  Your boss says, “Hey Jimmy, we’re going to cut your salary from $80,000 to $78,200 from now on, but if you even get sick or can’t work ‘cause you’re too hurt, you’ll get all your pay until you retire.”  What would you think? I think you’d take that plan.

Go, right now, do not pass go, do not collect $200, go now and acquire an disability application.  Fill said application out and send in the first month’s premium.  Do it now.

 

Step 3:  Buy a gazillion dollars of life insurance.

 

I won’t spend a ton of time on this – we’ve discussed this many times before….but whatever you think you need for life insurance, double it…then double it again.  Too many people buy only a minimal amount of life insurance. If people rely on you for money now or in the near future, go online to a life insurance wholesale shop (if you can’t think of any, in the US, google “buy life insurance”…there are a lot of interesting blogs about life insurance. If you are based in UK, then I recommend reading this blog for latest news and updates related to life insurance.) and purchase a policy.  Twenty or thirty years should do it and the policy had better have lots of zeros (at least 6) and a number bigger than 1 at the beginning.  Does that sound like too much coverage? If you ask any financial planner who’s had a client die–who’s had the unfortunate task of delivering a life insurance check to a widow or survivor–they all know that the survivor nearly always says the same thing: “Is that it?  How am I supposed to make it on that?”

If you want to get technical, read this to figure out how much you’ll need.

I hate that these evil and terribly tragic things happen.  I, in no way shape or form, can justify them or even begin to make sense of them.  In the days and weeks ahead, we’ll hear from the culprits and it still won’t make sense.  What I do know is this:  We cannot ever predict the future.  We can only have a plan on the shelf to execute once tomorrow is here.

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We Gave Frugal the Finger

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Let’s get philosophical before I tell you how I’m about to blow $4,000 on things people may think are “trivial.” What’s the purpose of money?

As some of you know, the Men’s NCAA Basketball Championship is winding up right now.  Last weekend, the top 8 teams played to whittle the field down to only the top 4.  (Various copyrights prevent us from actually calling the top 4 teams what they truly are – and the “ultimate four” doesn’t quite have the same ring-J).  For those that watch or follow college basketball, there are four great teams left – one of whom I’ve followed since birth and still watch religiously. They haven’t been this far in a long, long, time and may not make it again for a long, long time.

As my wife and I were watching the glorious victory of our favorite team I had (what I thought at the time was) a brilliant idea: let’s go watch the semi-final games!

 

Planning a Last Minute Trip

 

So we talked about it Sunday night and began looking at ticket prices – holy sticker shock batman!  Apparently, we weren’t the only two people thinking about these games!  Total ticket cost for three games of basketball: $1,500.

Now, we have to find a hotel – again sticker shock – there goes another $1,500.  We decided to drive, to save some costs (also gives us some flexibility), but after food and gas our total cost is probably around $4,000 or so.

Some would call this quick, unplanned, and certainly unbudgeted for trip, excessive or irresponsible – I call it freedom.  My job before this was to build a reserve…and I did. What’s your reserve for? Emergencies and opportunities. If I have a cash reserve of $30,000 or $26,000 once this is over, is it really that big of a difference?  I don’t think so.

 

Money’s purpose isn’t to buy things – it’s to have experiences.

 

This is a question I rarely am asked in client meetings, but try to ask to clients as much as possible:  What’s the purpose of money?  Is it goal attainment or is to make your life better?  Perhaps it’s to make another persons life better, or maybe even to help a whole bunch of people, say through an endowment or something similar.

I think it’s much simpler than that.  Money equals happiness.  Happiness is freedom.  Freedom to do what you please with whom you please when you please.  I’m not talking about being pompous, flashy, or flamboyant, but rather just having the ultimate freedom to do whatever you want.

…and after this, I’ll have the obligation to my freedom to build my reserve back up so (hopefully) I can do this again next year!

 

When Is It Time to Call in the Professional?

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A serious question here…without an answer. Does anyone have the mathematical equation?

Over the last few weeks, my garage door opener has been acting up.  Door goes up…won’t come down.  Goes up half way…won’t open at all.  In my expert “garage door opener” opinion, I decide it’s probably the opener. I’ve used the door before, so I’m pretty sure this is a no brainer.
I drove down to Home Depot, purchased the latest-and-greatest Genie model and began screwing it together.  Never mind that I know nothing about the difference between a “screw drive” and “chain drive” opener. I figured I could get this thing done easily.  Since I had installed my previous garage door opener, I though, “Hey, I can do this!”

After six hours of tinkering, I was ready for the test run:  Hit the button…drum roll please…and viola!  It opened!

Press the button again…it’s going down, down, aaannndddd….stopped.  Half way down.  Six hours of work (or rather six hours of not working) and it’s still as broken as it was before I began on this project.

 

Advice From a Friend: Call the Professional

 

A friend happened to stop by and while we were playing around with it, suggested I call a professional.  I had been convinced I could do this without help!  I really wanted to be able to do it right!  But, alas, I finally had to wave the white flag and admit: I have no clue what I’m doing.  So I sheepishly make the call.  The door guy came by right away and strode like John Wayne into my garage. You should’ve seen his face and head shake as he saw each and every tool I owned spread across the garage floor helter-skelter.

I began to explain the problem, what it would and wouldn’t do, blah, blah, and he’s not even listening.  He grabbed the door, shook it, lifted it, and it slammed down.

Without even asking if I would stop talking he cut me off and said, “The spring is broken.  Gonna be $289 plus $35 per ½ hour labor.  Oh, and your garage door opener is broken.  That’s another $450, but that includes labor…and it’s the best opener on the market.  We take check or credit card and I can be out of here in under an hour.  OK?”

 

What’s the Cost of Pride?

 

I now know the cost of my pride:

$250 for the “new” but now broken garage door opener,

$450 for the new one I now have to buy.

Oh, and here’s the best part:  The old one hadn’t even been broken.

I can only laugh at the irony:  I plead with people every day to outsource their crucial financial decisions to a professional: and sometimes I can’t even take my own advice.

 

When’s the Right Time?

 

Is a broken garage door the right thing to call a pro over? When is it time to call in experts?  What’s the ultimate cost?  In my case I would have saved the cost of the two new openers and just replaced the spring for $289.  But our financial lives are much more complex, aren’t they?

The truth is, a lot of people can do their own simple financial planning and investment work, but statistically, most don’t.  Sometimes we hire professionals to do work because we don’t want to do it (mowing the lawn, house cleaning, etc.) and other times we hire a pro because we don’t know how (taxes, mortgages, etc.) and then there are times we need to hire a pro so we don’t screw it up (garage door openers).  Don’t let pride get in the way of accomplishing the goal:  a fee or commission is a small price to pay for goal attainment.

…but I still think I would have been happier if I’d been able to fix the door myself.

When do you call in the pros? When do you DIY?

PPI Claims: Go it alone or Get Help?

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You cannot turn on the TV or pick up a newspaper lately without being bombarded by people telling us to claim back PPI. Many of them do not however, take the time to explain exactly what PPI is, why it has affected so many of us or why it is important that we try and claim it back.

What is PPI?

Payment Protection Insurance (PPI) is a type of insurance provided by money lenders when you take out a loan, credit card or mortgage. Its purpose is to provide financial cover should you become ill, injured, unemployed or redundant. Should you be unlucky enough to fall victim to one of these circumstances, PPI should be able to meet the remaining payments you owe your lender until you can return to work.

Why Is PPI a Bad Thing?

Given that its function is to protect us, it may seem odd that the press is branding PPI as a bad thing. The fact is; it is not a bad thing if the recipient has asked for PPI. The reason for all the outcry is that in many cases, the individual borrowing money was not made awarethat they were purchasing PPI or the terms of the agreement were unfair or poorly explained. In a time where most people have to be keeping a tight rein on their spending;millions of people having splashed out hundreds – or even thousands – of pounds on unwanted PPI suddenly makes all the fuss seem justified.

Who Can Claim?

Various companies have emerged to try and help people claim back miss-sold PPI. In their efforts, they have outlined exactly what PPI is and who is entitled to try and claim it back. Generally, situations where people can claim back PPI include:

  • Customers who were not made aware that they were paying PPI.
  • PPI policies that were not utilised.
  • Cases where PPI was made compulsory.
  • PPI policies that ignored existing health issues.
  • Policies that did not provide cover for the unemployed.
  • Cases where the PPI cover did not last for the entire length of the loan.

Should I get Help?

With so many organisations offering helpto claim back PPI, you may ask what exactly it is that they do. If youopt to have someone help, you often just need to fill out a claims form with basic info about yourself and then sit back and wait. At most you may have to sign a pre-prepared form they send or speak briefly to one of their advisors on the phone but you will not have to contact your bank or lender personally and can let the claims company do all the leg work. Being experts and knowing all the correct protocol, your chances of a successful claim are arguably greater but most of these companies offer a ‘no win, no fee’ payment system where if they cannot get your money back, you do not have to pay them a penny.

Can I do it myself?

People who decide to make claims often automatically assume they need to use a claims company but it is possible to do it alone. When the whole point of the PPI scandal is that consumers have paid out money they did not want to; some would argue that paying out more money to try and get other money back seems somewhat backwards. With some wanting as much as 30% of your settlement from a successful claim; boycotting the middleman and making the claim yourself is definitely a viable option.

You would need to dig out your paperwork and check the details of your policy to see if you qualify, then contact your lender directly, via phone or letter, requesting a refund. If your bank rejects you, the next step involves contacting an ombudsmen; the official, free service for resolving financial disputes.

Going it alone is without doubt the more time consuming of the two options but allows the greatest monetary reward upon victory but whichever route you decide to take, PPI is considered one of the nastiest hidden charges to hit the public in recent times and making a claim is definitely worth it.

It’s Time to Stop Acting Like an Ostrich

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Sometimes I read reports and try to wring a few statistics out of them for use in client presentations or marketing events.  Each year, the EBRI does a survey The Retirement Confidence Survey, and while I’ve heard of this report, I’ve never sat down and read it.  Today’s post is me recanting some of these numbers and percentages – unbelievable numbers and percentages – which really makes my head spin.

Did you know…

  • 46% of all workers have saved less than $10,000 for retirement;
  • Of those age 55 and older, 36% have less than $10,000 saved;
  • Only 12% of surveyed workers have over $250,000 saved;

Is it really possible that people actually think this is acceptable?  Give me a break – over one third of workers over age 55 have saved less than $10,000.  This is insane.

What do you do if you’re part of that group?  Get off your butt and do something about it.  I know it can seem like “it’s too late,” but there’s no time like the present.  You may have to tear the bandaid off, cut out cable, dining out, sell the cars and the fancy china, but doing nothing isn’t a plan either.  Get real.

Did you know…

  • 53% of workers have never done a calculation to determine how much they need for retirement;
  • 45% of people “guess” at how much money they’ll need
  • 18% did their own calculation

I feel like the guys from ESPN Monday Night Football…”C’mon, man!”  This isn’t even hard work!  All you need is a calculator and a few minutes!  “But, O.G., I don’t know how to do pressent value / future value calculations on my calculator…”  Well, I guess you should just throw your hands up in the air then, because either you’re born with the ability to use a HP 12C or your not.

Or…you can Google “Retirement Calculator” and see what happens.

45% of people guess.  I love that.

Did you know…

  • 30% of all workers think a retirement balance of $250,000 is adequate for a lifestyle-sustaining income in retirement;
  • Only 14% of 55 and older workers think that number is over $1 million;

Two-hundred and fifty thousand dollars is what the average retiree will spend…on healthcare costs during retirement.  Not including all the other expenses!  Quiz question: At what age will the second death occur, statistically, for a couple, age 65, who retires today?

92.

That means today’s retirees have a 30 year retirement ahead of them – that’s about how long they’ve been working – and somehow $250,000 is enough?

Financial advisors preach the “4% rule” which simply states that you have a high likelihood of success if, when you retire, you withdrawal 4% of the balance of your account in year 1, and then increase that with inflation each year thereafter.

One million dollars equates to a $40,000 distribution this year.  But we forgot something…inflation between now and when you retire.  If you’re 40 years old, a simple 3% inflation rate devalues the $40,000 by nearly half by the time you retire.

For what it’s worth $1 million isn’t even close for most people.

Did you know…

  • 23% of workers have engaged a professional advisor to help them plan;
  • less than 1/3 of those people followed the advice from the advisor;

Let me get this straight: Most people don’t do the calculation to determine how much they need to save where to save it or even what their goal is.  Thankfully, some people (a whopping 23%) have engaged a professional – but then don’t follow his or her advice.

This is simply astounding.  If you’re not going to sit down and do it yourself, then for cryin’ out loud hire someone to help… and just do whatever they tell you to do! I know that there are rotten pros out there…but doing something is a hell of a lot better than sitting around hoping things will get better.

We can’t just bury our heads in the sand and assume things will work out.

For more information on this report by the EBRI, please visit their website.  They have all sorts of data and research available, but this is simply the most amazing thing they do.

Making the Most of your Pension when Retiring Overseas

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Have you ever thought about retiring overseas? It is a dream for many to enjoy their golden years under a sunnier climate, in a cheaper country, or closer to family (in the case of foreign workers). Before you take the plunge and pack your bags, you should think about several aspects of your overseas retirement.

Retiring overseas, things to consider

Where will you retire? The list of heavenly destinations is long, but what country suits you most? Will you speak the language or be willing to learn? Make a list of your priorities, such as proximity to an airport, a supermarket, a library, the need for a car, and so on. What are your non negotiable? How far off the beaten paths do you want to live? You may be looking for some sun but can you bear real heat for months at a time? How about immigration or banking?

You can find lots of expat forums to inquire about the cost of living, renting or buying a place, healthcare, food, domestic help and other expenses. Remember to consider the time difference with the UK if you want to keep in touch by phone on a regular basis, as well as the cost of a flight if you would like to come back once in a while.

The cost of local products can be very low overseas compared to the UK, while other things like internet service, imported foods, healthcare… could be higher. You need to determine the overall budget to make sure it fits your pension allowance.  Once you take into account the cost of flights, some European countries may actually end up cheaper than places like Turkey or Egypt.

Talking to a few people who already live there can be enlightening, as they will have an in-depth knowledge of the area, something that is difficult to get if you visit for a week while on holiday. Ask about the seasons, the political situation, the health system… and how expats blend into the local community.

Local expats are also a good source to tell you where to get a first flat or house, the neighborhoods to avoid and the price you should expect to pay. Having a temporary home for the first few months allows you to search for the perfect place without stress. You could ship your belongings, generally with a tax exemption if you are a resident in your new country, or just bring the minimum with you and furnish your new place locally.

A few UK credit cards will let you withdraw money abroad without a commission, apply for one of those before you leave so you can get money while you set up a bank account in your new country.

The next step to consider is how to get the best value of your pension pot.

Transferring your pension abroad with a QROPS

QROPS means Qualifying Recognised Overseas Pension Scheme. It is a pension scheme approved by HM Revenue and Customs, that allows you to transfer your pension benefits overseas without any penalty. For this you need to decide to retire abroad, in a country of the UE or any other country that has a double taxation agreement with the UK, like Thailand, the USA or Zimbabwe. You can receive part of your pension as a lump sum, but 70% of the nest egg need to be invested to produce a lifetime allowance. To be worth the move, you would need a pension nest egg of over £25,000.

Qrops information is available online, to make sure you get the most of your UK pension. This is a popular scheme for expats since your pension pot will not be taxed under UK law, but in your country of residence. There are also no lifetime allowance caps or age limit to purchase an annuity. Your UK pension scheme administrator will take care of the transfer and make sure it complies with HMRC requirements. This scheme does not apply to your state pension.

 

Have you ever considered retiring abroad? Which country has your preference?

 

 

 

Rethink Your To-Do List: Throw Out Your Problem Tasks

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Your life is too short to work on tasks you aren’t good at or don’t like. Remove unnecessary tasks and I’ll bet you’re happier AND have more money.

Recently, I was reading an article from Edmunds, Stop Changing Your Oil, where its author, Phillip Reed, contends that the vast majority of people mindlessly change their oil every 3,000 miles – and not because it’s needed. Today’s cars can drive further, sometimes twice as far, between oil changes – but because we’ve been conditioned and trained by our parents, grandparents, peers, and service mechanics for years to do so, we change it more quickly than necessary.  Reed suggests that not only is this a waste of money and oil (replacing good oil before it’s ‘used up’ is bad for the environment) but it is part of a much larger ‘plot’ (my word not his) between the oil industry and consumers to up-sell and cross sell us into thousands of needless expenditures over our car’s lifetime.  Interesting read, to be sure.

 

Stop wasting time

 

But this made me think: What are some other things in our lives that we should stop doing?  Or maybe stop doing so frequently?  I’ve written many times about my thoughts on the purpose of money; money can and should be used to provide for oneself later in life, but needlessly sacrificing pleasurable things today so that my great-great-grandkids can inherit sixty-four million dollars is ridiculous.  So, in my life there are things I don’t do, not because I can’t, but because I can trade an hour of my time working in the yard for an hour prospecting for new clients or perfecting my putting stroke – both things I like doing immensely more than weeding the garden, fixing the power or mowing my grass.  And I’m perfectly comfortable with that exchange.

Part of my goal when giving something up is to exchange that freed up time with something else that provides me increased marginal utility (my economic professors are smiling ear-to-ear).  Notice how I didn’t say, “provides me with more money” or “more free time,” but rather increased utility.  To me, that can be any number of things: spending time with family and friends, watching a great basketball game, playing golf, acquiring a new client, marketing, or maybe even just reading a good book.  But, if I can eliminate something that I’m not terribly good at or like to do with something I do like to do or am good at doing – I’ve increased my utility.

Said another way, utility = happiness.

 

Remove the “Junk”

 

Eliminating things from one’s life becomes a liberating experience and frankly, it doesn’t have to be anything as big as changing a job or selling a couple kids (although the thought has crossed my mind).  It can be as simple as cleaning out a closet or even organizing that dreaded kitchen junk drawer.  Ask anyone who’s started selling stuff on eBay and you’ll likely find that they found the experience quite addictive – cleaning up or eliminating things from one’s life is addicting and you cannot wait to find something else to clean up.  Just last week, I asked my team whether there was one particular client who we should fire – just so we’d remove that headache from our lives.

The same can be said for reducing the frequency of useless or draining activities.  In the Edmund’s article, Reed doesn’t say we shouldn’t ever get our oil changed or car serviced, but rather reduce the frequency of doing those activities.  Ask yourself the question: What things should you reduce?  In the money/finance world that could be something like frequency of dining out or dare I even say, trading in your stock account!  Maybe I’ll write an article titled: Stop Trading in Your Stock Account.  Nah, that’ll never pass the review board.

Take a second, oh dearest reader, and ponder this question:  What’s the one thing you could eliminate in your life right this second that would measurably increase your utility?  The logical follow-up to that is: What would your life be like, if you did it…today?

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Dow Reaches All-Time High: Is Now The Time To Invest?

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This article could be consider “Part 2” of the article I posted a few weeks ago, Is It Time for the Market to Crash

Write it down: March 5, 2013 the Dow reached it’s all-time high at a close of 14,253.77. Remember the last “all-time” high?  It was in 2007, October to be exact.  The bear market low of 2009?  That was almost exactly four years ago, March 6, 2009.  So the question becomes: Is now the right or wrong time to invest?

First, let’s take a look at where we are.  The markets are up over 100% since the Great Recession, but why?  Isn’t the economy still in shambles here and overseas?  Job growth is anemic, currency and debt issues abound, right?

True.  All true.  But stocks aren’t priced based on what the currency markets are or aren’t doing.  They’re not priced based on the trade balance between Argentina and Botswana.  They’re priced based on expectation of future earnings.  It’s that simple.

Or it’s not.

 

The Case For Now IS The Right Time To Invest

 

There are of course, other factors – for example, stocks have been (and probably will continue to be for a while) a better overall value than bonds and other fixed income securities like CDs.  Interest rates continue to be low and investors are generally tired of their paltry 0.50% interest on their cash in the banks.  Just this week I had a conversation with a client who has $50,000 in cash reserves, earning a whopping 0.75% dividend at his local bank.  Those factors also drive stock prices higher.

We should ask this question: How are the largest companies of the U.S. and the world doing?  Some other questions that will lead you to a rosy future: Look at free cash flow (that’s at an all time high) corporate balance sheets (exceptionally flush with cash) company stock buy-backs (trending higher) dividend payouts (and the ever increasing rate of those payouts).

That mutual fund of yours? Based on these numbers, it appears we’re headed higher.

 

The Case For Now ISN’T The Right Time To Invest

 

That doesn’t mean there won’t be major pullbacks.  A few weeks ago, I talked about having a “It’s time for the market to crash” kit ready to go.  Investors are piling money into the market again after sitting on the sidelines while things looked lousy, and that’s not a good sign.

Just because you’re planning for a pullback doesn’t mean you can’t also be planning for the next leg up.  As I talked about then, planning is important, but plans are not. (So said the wise Winston Churchill…just a few years before I wrote it here).

 

My Overall Take

 

When I evaluate the strength of earnings potential of the greatest companies here and abroad I see great things ahead.  That doesn’t mean there won’t be market swings.  It doesn’t mean there won’t be a pullback of some kind.  But when I look to the future, I see a world that continues to get bigger, faster, and stronger, and I’d rather own the companies that are leading the charge.

So yes, now’s the time to invest.  But so was yesterday and the day before and so it will be tomorrow.  As long as you believe in the future and think tomorrow will be better than today, it’s always a good time to invest. Don’t stop your investment plan because of CNBC hype or Wall Street Journal headlines.

…but, if I’m wrong – and Lord knows I probably will be more times than not – I’ve still got a back up plan on the shelf ready to execute at a moments notice, and you should, too.

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How To Increase Your Yield Through Microloans

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Sometimes it takes a little creativity to reach your destination.

The world economy continues to slowly gain traction but many cash investors aren’t seeing that translate to increased yield in their short and mid-term cash investments.  According to Bankrate.com, the average yield for a $10,000 money market investment was a paltry 0.52%.  That’s a whopping $52 per year, excluding any fees or costs, and definitely excluding inflation.  Last year, the Social Security Administration increased retiree benefits by 1.7% to offset increasing costs.  Based on that inflation adjustment, investors are losing purchasing power each and every year by doing what at first glance appears to be the right thing: investing in a reliable money market account.

Imagine an investment that guarantees you’re going to lose money – that’s what a traditional cash reserve is doing today. That’s why so many bloggers lately question the need for an emergency fund at all. Don’t fall into that trap.

Microloans: A Primer

Microloans are very small loans made to borrowers who typically lack collateral to support the loan.  Sometimes, microloans are also made to those who don’t have steady employment or even verifiable credit.   There are two well-known microloan organizations – serving a completely different market. The most well known peer-to-peer lender is Prosper.com.  They have over 1.6 million customers and have funded over $400 million in loans to their members.  Prosper.com helps connect borrowers who have reasonable credit with lenders who are trying to earn a higher return on their money.  The other micro-lending site is Kiva.  They primarily help people and families across the world to “create opportunity and alleviate poverty.”  Between the two, Kiva seems altruistic, whereas Prosper seems more capitalistic.

How To Earn Money

While both Kiva and Prosper offer the opportunity to lend money to whomever you wish (and for whatever purpose you wish), Prosper created a system to help those who want to use Prosper as an investing tool.  On their website, they breakdown all the financial metrics for the different types of loan ratings.  Prosper also provides advice on how to create a “diversified” portfolio of microloans.  (Diversification is important when investing in loans – some are going to default!)

Returns on these investments are beyond enticing – Prosper’s best members, those they rate AA – have an average credit score of 808 (well above the national average).  Those AA loans have a historical loss rate of 1.70% – but have an average return of 5.50%!  That’s leaps and bounds above our Money Market rate listed above.  The lowest rated Prosper members (credit score 683) have a 14% loss rate and a 13.29% average return.  A well-diversified portfolio of Prosper loans could make an attractive portfolio.

It’s Not All Roses

This may seem like a great “fire-and-forget mission” and in some ways it is, but there are some things you’ll need to recognize before you invest in microloans at a place like Prosper.  First, the loans are three years long, and there’s no way to get your money back early if you truly need it.  Secondly, you will experience some defaults.  As I mentioned above, even the highest rated consumers still default.  You need to realize you’re becoming the bank!  Prosper recognizes that their traditional model doesn’t suit everyone, so they have created their Prosper Trade Notes program, but even that comes with it’s own long list of pros and cons.

Sum It Up

If you have some extra cash reserves – money that you know you aren’t going to use for at least three years – Prosper.com could be a viable solution to increase your yield.  If you want to loan money for a more altruistic purpose, consider Kiva.  Both of them serve a specific purpose, but Prosper has a greater chance to provide a consistent income stream for the investor.

Photo: Philip Taylor PT

Is It Time for the Market to Crash?

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Every once in a while, I like to shake the Magic 8 Ball to see what might happen next.  Recently, I’ve been getting a lot of “Reply Hazy.  Try Again” and “Cannot Predict Now.”  This is very frustrating, since I’m supposedly a ‘professional.’ I’ve taken those answers to mean that I need to do a bit more research on my own.

On a complete side note: You now can just use the internet to “shake” the Magic 8 Ball: http://8ball.tridelphia.net/  Too funny.

Whenever we trend up to either a new high, all-time high, or a cyclic high, I start to get a little antsy…almost like the sensation right before you go over the big hill on the new rollercoaster.  Unfortunately, that analogy works too well.  It seems like whenever we go higher – whenever you start hearing Jim Cramer, etc. telling us all to BUY BUY BUY – a big pullback happens.  Let’s look at where we are today:

This is a Year-to-date chart of the S&P 500.  Up, up, and up some more. (Up 5.35% YTD)

Here’s a chart for the 1-year S&P 500 (Up 10.37%)

And another 5-year chart (Up 11.29% – which also includes the 2008 recession)

And finally, a 10 year chart – up an astonishing 77.14%

Since March 13, 2009, the S&P 500 is up over 119%!  This is wonderful!

But it makes me pause.

As I look through history, and it’s the only guide we have, it seems like every 5-7 years something comes along and knocks the wind out of our sails.  It’s 2013, five years ago was 2008.  Before that was 2000-2002.  Before that was the LTCM mess is 1998.  Then the recession in 1991.  Black Monday in 1987.  Are we on the verge of another recession?  Worse maybe?  A depression?

If you listen to the news, or better yet, the commercials on satellite radio, the answer is an unequivocal “yes!” (I’m talking to you, Mr. “Critical Warning number 6”  guy).

So, what do all the recessions, depressions, declines, flash-crashes, etc. have in common?  The market has always rebounded from them all.  Each an every one.  Ask your grandparents what they thought of investing in stocks in 1940.  Or your parents and grandparents about investing in the 70s.  They’d all say the same thing…”This time is different.”

This time isn’t different.  Today’s apocalypse du-jour is tomorrow’s back page story.

You might think, then, that I must be all smiles all the time and a traditional buy-and-hold forever type of investor.  I’m not.  But neither am I chicken little.  At times like these – when the market’s doubled in just inside 4 years – you must plan for dark days ahead.  If you do, and you make logical, fact-based plans today, when the markets turn tumultuous, you can just pull out the plan you made when you were level headed.

 

Here’s what might be in your “Time for the Market to Crash” plan:

 

1.  A profit maximization strategy.  If you’re like some investors, you’ve continued to buy your bi-weekly allotment of 401(k) funds and Roth IRA stocks over the past several years.  That has served you well. It’s time to make sure you have a profit strategy in place.  If you own individual stocks, set a stop-loss price on your positions.  If you have mutual funds, set a day every two weeks or so to review the price.  Write down at what price you’ll sell to lock in some profits.  In my business we try to aim for a trailing 10% stop loss.  For example, if I bought GE at $7, and today it’s at $23, my stop-loss might be at $20.  I’ll continue to adjust that upward as the stock moves higher.

2.  A cash accumulation plan.  Investors who were well prepared for 2008 weren’t prepared by selling all their positions in 2007, but rather they had accumulated a large cash position so that when GE was trading at $6 a share and Warren Buffet plunked down $5 billion, they could do the same.  Since the market’s near an all-time high, it may be time to start directing some of your monthly savings into a pure cash position – ready to strike when the fire sale happens.  Whenever it happens.

3.  A plan for choppy markets.  What happens if the market doesn’t do anything, a la 2011?  Can you still make money?  You sure can.  Consider investing in options, high dividend paying stocks and bonds, as well as investments that profit from volatility.

4.  A plan to educate yourself.  It amazes me how many people I see and talk to each and every day who are completely OK with being an idiot.  You don’t have to go get a master’s degree in actuarial sciences, but it doesn’t hurt to read a little (unbiased) commentary about stocks, investing, the markets, and the history of all those things.  Being prepared for the next “event” whatever it is, means more than just having money set aside in the right places.  It means having a prepared mind as well.

No one knows what’s going to happen tomorrow in the market.  Anyone who says they have even the faintest idea are fooling themselves.  But, that doesn’t mean you should just throw in the towel and bury your head in the sand.  Winston Churchill once said, “Plans are of little importance, but planning is essential”

Make sure you take time this weekend to do a little planning.  Your investment portfolio will thank you later.

All charts from Big Charts