Legacy and Estate Planning for High Net Worth People

iStock_000001826742SmallDo you have a high net worth? When you add up the value of all of your real estate, investments and life insurance, if is it in the millions, then this article might be for you.

I always find it helpful to first look at some of the origins and developments of a subject. Estate planning is one of those areas that have changed quite a bit.  It used to serve only the ultra wealthy ($100 of millions), who used to be a very small percent of the population.  Looking back a few centuries, in England and America, there were not many very wealthy people. Small cottage industry styles of business and agriculture employed most people. There were a few large industry magnates, large land owners, and people from or connected to royalty. Wealth and power was controlled by the few wealthy people, governments, and politicians. During those eras, most people had few assets to worry about after they died.

With industrialization and the growth of democracy, capitalism, entrepreneurism, and higher education, an unprecedented amount of wealth was generated in the hands of private citizens–everyday common people. We have really seen quite a bit of acceleration in this trend for individuals to become wealthy through hard work, free enterprise, and investing. This has been especially true since WWII, and it has accelerated with technology, as evidenced by Internet, leisure and sports industries.  The demographics of our country have changed along with this. Today there are more millionaires than ever before as a result of favorable stock market returns, real estate appreciation, accumulations in IRAs and 401(k)s, and larger family incomes. In addition, the largest transfer of wealth ever seen—estimated to be in the tens of trillions of dollars—is due to occur over the next 30 years. Other than wills, more involved estate planning used to be only for the very rich, who could afford and justify paying a lawyer. Now moderately successful people can easily amass wealth of more than several million dollars. When you add up the value of homes, stock portfolios and retirement funds, it is easy to see how it is possible.

Not only has the distribution of wealth changed, but so has the practice of estate planning. For many people, the focus on estate planning used to be to minimize estate tax. For example, within the last 20 years, the Federal Estate Tax started levying taxes on estates as small as $500,000 to $1,000,000 at rates of around 35%, increasing the taxes to more than 50% for the largest estates. Today’s exclusion amount (not subject to estate transfer tax) is more than $5 million. This doubles for married couples; therefore, unless someone’s net worth is currently over $10 million, or it will be at life expectancy, the prime goal of estate planning isn’t any longer estate tax minimization or avoidance.

If estate tax avoidance isn’t the main goal, then what is? Estate planning will always deal with taking care of family and dependents, and dealing with the complexities of transferring business, real estate, privacy and creditor protection, probate cost avoidance, and charitable planning. However, wealthy people are taking a more active role in their estate plans, wanting to be stewards over their wealth, making sure family members don’t just inherit large amounts of money, but that they inherit in a fashion that rewards maturity. In addition, with many people with large charitable interests, charitable plans are playing a much bigger role in the overall estate plan. People leaving money don’t want to be remembered as the old rich guy or gal, but as successful people that contributed to others’ success and health, and to society’s overall benefit long after they die. The want good stewardship while they are alive, and they want to have some control from the grave. Thus the term Legacy Planning communicates the new paradigm versus estate planning.

Legacy Planning Today:  What is a legacy?  A legacy is what you want to be known for today and after you are gone, and what continues to live on.  Someone might say: “This again is a negative, planning for when I am dead!”  This could not be farther from the truth.  You create your legacy by how you manage your financial affairs and how you live your life now. How do you create a positive living legacy?  You probably already do it; you create it by demonstrating your beliefs and values:

  •  By how you give
  •  With your family and friends
  •  In the leadership roles where you serve
  •  Through your current or future career pursuits
  •  In the positive contributions you make to the world
  •  In how you transfer your positive values and beliefs to others
  •  In how you live every aspect of your life
  •  In how you give gift money to family and charity, both today and after you are deceased

Creating a legacy plan is so much more than estate planning.  It involves creating plans centered on the things you value most, the beliefs you hold, and the people you love; in addition, it focuses on passing many of your beliefs and values to successive generations. It is a journey of rediscovery that many people go through when they hit mid-life, perhaps an exciting new chapter in your life.  It is focused on your goals, needs and concerns instead of the consequences of not planning. Legacy planning is not focused on all of the intricacies and complexities of estate planning.  That is why, for the purpose of this article,  the finer details of estate taxes, features and benefits of specific trusts, methods of transferring businesses, and techniques to minimize taxes have not been discussed. Legacy planning starts with what you want, and not with the legal pieces. High net worth people today want a plan that will do many things:

  • Teach and transfer values to the next generation
  • Continue to give them control today
  • Be flexible to change
  • Address personal passions
  • Help satisfy philanthropic concerns
  • Provide for financial, emotional, professional, and legal needs of surviving spouses and children
  • Maximize and control wealth for a long life span
  • Gift to family members while they are alive, so that wealth can be can transferred in a way that helps rather than hinders them
  • Transfer business (possibly to a family member) in a tax- and cost-effective way
  • Assure privacy, creditor protection, and ongoing professional management

The Cost of Not Planning. There are some very practical reasons why people should plan too. If you don’t plan, you must be aware that you or your family will face many consequences of your failure to plan:

  •  You or your estate will over-pay taxes, both income and estate, as well as ongoing legal costs
  •  Assets will not pass equitably or as you intended
  •  Your business transfers may be very messy
  •  You will miss out on taking advantage of money- and tax-savings devices, because they will be lost if  not done within a certain time period
  •  Your kids may fight over money
  •  Attorney fees will be much higher than necessary
  •  Your favorite charities will not receive what you intended them to get
  •  Children may inherit money in a way that might spoil them

Summary: Legacy planning is a process to put into action with your financial and legal advisers. Many legal, accounting and financial firms go the extra step by providing coaching, self exploration, and even individual and family workshops. The planning process is an opportunity to dream new dreams. The planning profession is privileged to witness and assist clients through this process of transforming the completion of previous successes into exciting new and satisfying ventures.

Preparing for Meeting with an Attorney for Estate Planning

Most people don’t have a will or trust, or if they do, it may be out of date. Make it a goal this autumn to get your affairs in order. This article will help you prepare for meeting with your attorney for estate planning. When you meet they will ask you all sorts of questions, and will ask for a lot of information. The longer you take of their time, the more costly the process will be. Therefore, the more prepared you are, the higher level of service and care you will receive. This is because you won’t have to spend a ton of time talking about the basics. You will have gotten some of that out of the way by studying this, and by gathering some information.

Here are the various steps to build an estate plan for you and your family:

Step 1: Create a Written Financial Plan

Acquire a financial plan. Having a plan gives you the road map to help you figure out your present and future financial condition. People don’t plan to fail—they fail to plan. The process of creating a financial plan enables you to understand and establish your goals for you and your family. Your financial plan will also serve as a compass, giving you proper direction for commencing the estate-planning process.

Step 2: Understand Basic Estate Planning Concepts

The following is a partial list and brief explanations of the concepts you may need to understand as you prepare to plan your estate.

  • A will provides for distribution of property you owned at the time of your death in any manner you choose, subject to state limitations, and assets that didn’t have a beneficiary (which means the estate is the beneficiary) and the will and probate process will sort that out.
  • A guardian is someone you name in your will to care for your children in case something happens to both parents.
  • Trusts are created to hold, own, and control property. They can also help your survivors avoid some parts and expenses of probate court. They can also provide creditor protection and privacy.
  • A Living Will and Health Care Power of Attorney help if you become unable to make medical decisions for yourself.
  • A Durable Power of Attorney grants legal authority to a trusted person to handle your finances and property if you become incapacitated and unable to handle your own affairs.
  • Asset Transfers to Children require special handling—your estate plan should name a guardian if the children are minors or it should provide for a trust to manage money your children may inherit from you.
  • Estate Taxes and Income Taxes may be deducted from your estate if it’s large. Talk to your attorney about charitable planning, gifting, trusts, and irrevocable life insurance trusts.
  • Funeral Expenses are best paid by cash and not funeral prepayment plans; pre-arrangement is okay though.
  • A Letter of Instruction is a document that you create to explain your wishes; be sure to include your plans for your organs and your burial or cremation.
  • Business and Farm plans are important; if you own them; your estate plan should address the complexities specific to these situations
  • Document Organization and Storage is important for locating important documents when they are needed. Locate all important documents and review them.
  • Life Insurance instantly provides significant amounts of cash to help provide for your dependents, pay off debt, and pay estate taxes. Your financial plans should include a life insurance review.

Step 3: Make a Checklist of Concerns

Check any of the following that may apply to your situation. If you are unsure about a particular item, check it anyway so your attorney may address it.

  • Charitable wishes
  • Distributing assets to your heirs or disinheriting
  • Medicaid impoverishment issues (tread carefully in this area)
  • Protection for: Minimizing estate and income taxes, heirs losing inheritance, avoiding probate process and expense, heirs spendthrift tendencies, creditor protection, greed of heirs, children, business or Farm plans
  • Common issues: Guardians of minors, keeping plans private (out of public record), children of previous marriage and current marriage, minimizing costly estate expenses, designate recipients of specific assets, grandchildren inheriting, avoid family quarrels over the estate, special needs child, property in other states or countries and disability planning

Step 4: Outline Your Wishes

Outline your wishes prior to the meeting with the attorney. It is important that your estate planning documents clearly reflect your intentions. This will prevent misunderstandings.

  1. Think through scenarios of how your property will pass if: You predecease your spouse or your spouse predeceases you. Children predecease you or you and your spouse die at the same time. Determine who you want to be the guardian of your minor children and what age you would prefer property to be available to your children with and without restrictions.
  2. Designate your preferred recipients for any specific assets.
  3. List charitable organizations you want to include in your estate plan and the amount you wish to give or the asset(s) you wish to donate.
  4. Ask your attorney to explain all of your options and the issues that may apply to your situation.

Step 5: Assemble Information for the Attorney pdf link

Step 6: Change Ownership and Beneficiary Arrangements: Ownership and Beneficiaries should be reviewed as the final step of estate planning to coordinate with your plan. This may be the most neglected part of the estate planning process. Make necessary changes to property ownership (e.g., homes, life insurance, investments) and beneficiaries (e.g., life insurance, annuities, pensions, IRAs and transfer-on-death accounts) to coordinate with estate plans.

Summary - Estate and Legacy planning is a process. Engage trusted legal, financial, and tax advisers to help you complete the process from the initial design, document drafting and implementation to reviewing your plans from time to time, You, your loved ones, and your business and charitable concerns will be glad that you did.

Important Homeowners and Umbrella Insurance Facts

New home construction

Homeowner’s & Umbrella Ins.

Property and Casualty insurance protects the things we own, such as our cars, homes, and businesses. It also protects areas with gaps in coverage such as professional and personal liability. This article will explore many of the major issues about homeowners and umbrella insurance. It will touch on some other insurance you should be aware of and provide tips to save you money so that you can intelligently review your insurance coverage.

Property and Casualty insurance can vary greatly between companies who provide it and from state to state. This information is offered as a general overview to help you become more educated about your choices. Seek the advice from a trusted professional insurance agent.

Important Insurance Tips

  • Coverage limits: Discuss with your agent the recommended insurance amounts for all the various categories pertinent to your situation.
  • Price Comparisons: Shop around. This is a simple suggestion, but it can save you several hundred dollars per year. Since prices vary, get at least three quotes: from the Internet, from independent insurance agents, and from captive insurance agents. The captive agents can sell products only from their respective companies.
  • Documents. Keep the documents from your previous insurance companies in case you are sued after you switch your coverage.
  • Group your insurances. Buy your homeowners, auto, business and umbrella insurance from the same insurer, if possible. Many insurers give multi-policy discounts.
  • Maintain good credit. This is important because it may help cut your insurance costs. Some insurers are increasingly using credit information (although not without controversy) to underwrite insurance policies.
  • Don’t let price be the only factor. If comparing quotes, pay attention to coverage amounts. Many prefer to use a local agent whom they can talk to in person, someone they trust to give insurance advice. Ask friends for recommendations, and contact your state insurance department to find out whether it provides information on consumer complaints. Choose an agent or representative who listens and takes the time to answer your questions
  • Use Well Rated Insurance Companies: Choose companies that are financially stable. They should be able to tell you their rating from companies like A.M., Best, and Standard & Poor’s.
  • Read your policy. At least review the main declaration page, which describes your personal coverage. Read or at least scan your insurance policy, for you may be surprised what is and isn’t covered. This makes you more aware of things to be careful about and how to file a claim. You might discover that you are insured for things you didn’t realize were covered. This is good to know if something happens.
  • Review your coverage regularly and always read any updates that you receive in the mail. Sometimes your coverage is only slightly modified. e.g., when laws change. At other times you might be facing a more significant change.

Home Insurance. Your single biggest asset is most likely your home and its contents. If you suffer a loss to your home, it substantially affects your net worth. To protect this asset, ensure that you have homeowners, condominium or renters insurance. Your homeowner’s policy also covers you for certain types of liability and may extend coverage to your belongings away from home.

Common Homeowner’s Insurance Coverage:

  • Dwelling Protection covers your actual house for a variety of different losses, such as fire, wind, hail, and vandalism.
  • Other Structure Protection is important too, since it extends coverage to other improvements to your property separate from your home, e.g., detached garage, fence, or shed.
  • Personal Property Protection protects the stuff in your home, for some of the same risks mentioned for dwelling protection, but it also protects against theft.
  • Loss of use pays for your housing expenses if you are unable to occupy your house while it is being repaired, e.g., following a fire.
  • Bodily Injury Liability and medical payments covers injuries sustained by anyone who is injured on your property; it also covers some lawsuits of guests, which can help save you from the financial responsibility of paying an attorney to defend you or from paying medical bills if you are found at fault.

Coverage and Cost Reduction Tips

  • Risk prone areas. Do you live in an area that is prone to floods, hurricanes or earthquakes? If so, consider that most policies do not cover damage from floods or earthquakes. Contact your insurance agent for riders to cover these risks.
  • Important riders. Ask your insurance agent about important riders that you should consider, such as ones for basements, sewage backup or sump pump failure.
  • Replacement Cost. Make sure your policy covers “replacement cost” on contents and structure, to insure that your contents and building are replaced or fixed at today’s inflated costs, and not at a depreciated value.
  • Inflation protection on the structure. Inflation may cause the cost of repair to be greater than an amount normally covered. Ask your agent for information.
  • Renters Insurance. If you are a renter, be sure to acquire insurance for your possessions and for liability.
  • Condominium Insurance. If you own a condominium, the condo association should provide coverage for the structure; however, ask your agent for loss assessment and coverage for improvements that you make.
  • Be a good insurance risk. Try to keep your claims low by placing fire extinguishers in strategic locations in your home. Install sprinkler, smoke, fire and theft alarm systems if feasible. Keep your home and land maintained and free of debris. From time to time your homeowner’s policy company may send people inspect your home. One of the things they look for is the condition of your home to make sure you have maintained the property. Good upkeep contributes to fewer losses on average.
  • Personal Property Description. Create (and keep current) a written or video inventory of your home’s contents, so that if you have a loss you can provide this information to your insurance company. An easy way to do this is to shoot a video of the entire contents of your home and to save the file on the cloud, e.g., in Drop Box.
  • Engrave your larger possessions, or use theft ID or tracking technology.
  • Limits on certain types of property. Your policy may limit the coverage for such things as guns, sporting equipment, cameras, computers, items used for business, jewelry, antiques, stamps, coins, and other collectibles. Consider increasing your limits on these categories, or buy ‘riders’ for specific items. Keep appraisals, insurance policies, home contents inventory, photos, and records in a secondary location, such as in a bank safe deposit box.
  • Discounts for fire and security systems may apply to your policy.

Business Insurance. Being self-employed can be risky enough, and without proper insurance protection, your risks increase. Having your business threatened by a casualty loss could threaten your ability to earn a profit and to stay in business. We live in a very litigious society, and when you own a business you face an increased risk of legal action. Business insurance is a very specialized area of insurance, and many small businesses and professionals have gaps in coverage. Consult with a good business insurance agent regarding your needs. Coverage can vary greatly depending on your type of business or profession.

Personal Umbrella Liability Insurance. Umbrella insurance is probably one of the least understood property and casualty insurance policies, so most people don’t obtain it.

Umbrella insurance is actually very simple. It is designed to provide added liability protection above and beyond the limits on other insurance policies such as auto and homeowners. Umbrella insurance provides coverage when certain limits of those policies are exhausted.

Automobile and homeowners’ policies should contain liability coverage. Liability insurance pays expenses for such things as an injured person’s medical bills and lost wages. It may also cover the cost of a legal defense. Medical expenses and legal fees can easily exceed the liability limits on other insurance policies.

A personal liability umbrella insurance policy provides that extra layer of liability coverage, usually for a low premium. Consider purchasing at least $1 million of coverage (usually for around $10 a month). Discuss the appropriate amount of coverage and costs with your auto and homeowners’ insurance agent.

Umbrella liability policies may also provide coverage in other areas, such as personal injury (including libel and slander), defamation of character, and protection for volunteers to a nonprofit.

Summary. Property and casualty insurance is not exciting, but it is vital in our society. It is a necessary budgetary expense, and it is important to your overall financial condition. 

Important Auto Insurance Facts



Auto Insurance Tips

Property and Casualty insurance protects the things we own, such as our cars, homes, and businesses. It also protects areas with gaps in coverage such as professional and personal liability. This article will explore many of the major coverage and savings issues about automobile insurance so that you can intelligently review your insurance coverage.

Auto insurance can vary greatly between companies who provide it and from state to state. This information is offered as a general overview to help you become more educated about your choices. Seek the advice of a trusted professional insurance agent.

Important Auto Insurance Issues

  1. Coverage limits: Discuss with your agent the recommended insurance amounts for all the various categories pertinent to your situation.
  2. Price Comparisons: Shop around. This is a simple suggestion, but it can save you several hundred dollars per year. Since prices vary, get at least three quotes: from the Internet, from independent insurance agents, and from captive insurance agents. The captive agents can sell products only from their respective companies.
  3. Documents. Keep the documents from your previous insurance companies in case you are sued after you switch your coverage.
  4. Group your insurances. Buy your homeowners, auto, business and umbrella insurance from the same insurer, if possible. Many insurers give multi-policy discounts.
  5. Maintain good credit. This is important because it may help cut your insurance costs. Some insurers are increasingly using credit information (although not without controversy) to underwrite insurance policies.
  6. Don’t let price be the only factor. If comparing quotes, pay attention to coverage amounts. Many prefer to use a local agent whom they can talk to in person, someone they trust to give insurance advice. Ask friends for recommendations, and contact your state insurance department to find out whether it provides information on consumer complaints. Choose an agent or representative who listens and takes the time to answer your questions
  7. Use Well Rated Insurance Companies: Choose companies that are financially stable. They should be able to tell you their rating from companies like A.M., Best, and Standard & Poor’s.
  8. Read your policy. At least review the main declaration page, which describes your personal coverage. Read or at least scan your insurance policy, for you may be surprised what is and isn’t covered. This makes you more aware of things to be careful about and how to file a claim. You might discover that you are insured for things you didn’t realize were covered. This is good to know if something happens.
  9. Review your coverage regularly and always read any updates that you receive in the mail. Sometimes your coverage is only slightly modified. e.g., when laws change. At other times you might be facing a more significant change.

Automobile Insurance Coverage Tips

  • If you owe more on your car than it is worth, check for gap insurance.
  • Be sure to cover your car for its intended use, such as business, pleasure, commuting to work (check the actual mileage to work and give the correct number of miles to your agent), youthful drivers, etc.
  • Diminished Value Compensation covers loss of market value your car may incur as a result of a serious accident. Ask your carrier if it offers Diminished Value before you buy a policy.
  • Make sure your present liability coverage is higher than the minimum required by law. Consider your coverage amount in relation to your income and net worth. Let your insurance agent know your financial circumstances to help you evaluate the correct amount for you.

 Money Saving Tips on Auto Insurance

  • Before you buy a new or used car, check with your insurance agent for insurance costs. Some cars (sports cars, for example) may be much more costly to insure than others. Stay within your insurance budget.
  • Use higher deductibles to reduce your premium if you have sufficient funds in savings.
  • Reduce coverage on older cars that have little to no value.
  • Look into group insurance discounts from your employer, professional associations, business and alumni groups, and military associations.
  • Buy a low-profile car. Cost of insurance is determined in part by the type of vehicle you drive. Some are favorites for thieves or are more expensive to repair. Check with your insurance carrier for suggestions.
  • Review your declaration page to make sure that your car is ‘rated’ appropriately. Every vehicle is rated by certain types (e.g., 2-door or 4-door) and high performance models. These things can make a difference if your car is assigned to the wrong type by mistake.
  • The greatest way to reduce your insurance costs is to keep free of accidents and tickets. Drive conservatively, don’t take chances, avoid distractions and multitasking, and keep your emotions under control when you are behind the wheel, and you will have fewer tickets and accidents. Be a defensive driver. Driving is not a competitive event that you have to “win.” Safe driving is a matter of life and death. Don’t be super conservative either. Going too slowly, not keeping up with traffic, or staying in the left lane on the freeway may actually increase aggressive driving among other drivers.

Other Possible Automobile Insurance Discounts

  • No Accidents
  • No Moving Violations
  • Driver Training and Defensive Courses
  • Anti-Theft Devices
  • Low Annual Mileage
  • Air Bags
  • Anti-Lock Brakes
  • Daytime Running Lights
  • Student Drivers with Good Grades
  • Students living away from home
  • Long-Time Customer
  • Storing car in a garage
  • Driving monitor device

Typical Auto Insurance Coverage:

  • Liability Coverage protects your financial situation by helping to pay the for the damage you cause to someone else’s car or body; it is usually required by state law.
  • Comprehensive Coverage pays for damages other than collision damage. Some of them may include theft, vandalism, fire, falling objects, weather-related events, animals, and glass breakage.
  • Collision Coverage is to help pay for repairs or replacement of your vehicle after an accident.
  • Underinsured or Uninsured Motorist Coverage helps to protect you if you’re involved in an accident caused by someone who had no insurance, or if the damages were more than the coverage allowed.
  • Medical Payments Coverage is for some of the medical costs if the insured or passengers (or other drivers of your car, depending on the state) are injured in an accident.
  • Personal Injury Protection (also called PIP), which is available only in some states, can help you pay for medical expenses and some other personal expenses from a covered loss.
  • Optional coverage can include many things, but the most common ones are reimbursement for towing costs and car rentals related to covered claims.

Summary. Property and casualty insurance is not exciting, but it is vital in our society. It is a necessary budgetary expense and it is important to your overall comprehensive financial plan. Driving provides a great feeling of freedom—just ask any teenager. With freedom comes huge responsibility for your car, yourself, passengers, other drivers, and surrounding property. Auto insurance helps insure your ability to cover the expense of potential damages or injuries to people and property. Driving in a car is probably the most risky activity we engage in when we consider all of the variables, such as habits of drivers, weather, traffic, stress and mechanics, and performance of the car itself. Therefore, you are always at risk of something happening unexpectedly. Our automobiles are also one of the most expensive items we own and are subject to a whole host of potential damages or vandalism. Because of the risks involved, auto insurance is one of the most expensive parts of your insurance budget.

Understanding Investment Types and Accounts

bucketOne thing that confuses a lot of investors are the various types of Investment Accounts. This article will help people identify and distinguish between them, whether they are retirement (qualified) and non-qualified accounts, in addition to IRAs and college education accounts. This article will help you understand the difference between them, what they are designed for, and how to prioritize them.

Many people are confused by all of the naming of accounts like IRAs, 401(k)s, 529s, and non-qualified accounts. Sometimes they refer to them incorrectly as investments, but they really aren’t. The confusion is best cleared up by obtaining a financial plan. When you fill out a financial planning questionnaire, you are forced to identify and figure them out, and how they might be focused on your future goals.  This too helps people to choose what investment accounts or ‘buckets’ are best for you.

Asset Classifications vs. Accounts: Asset Classifications indicates the investments that you invest your money into. The Account or ‘bucket’ is the holding label of your investment. The ‘bucket’’ label is important, because it may provide certain ownership or tax status; therefore, it is important for you to understand the difference.

Asset Classifications

  1. Cash or Cash Equivalents: Savings Accounts, Certificates of Deposit (CD), Money Market Accounts
  2. Bonds are essentially a loan between an investor and the entity, such as a corporation or a government. They can be issued for a short period of time, intermediate term, or long-term. In addition, they can be very safe or risky, depending upon the financial strength of the borrower/entity. Some bonds issued by municipalities, may have certain tax advantages, and are called municipal bonds.
  3. Stocks are essentially an equity investment in a corporation. They can be issued by a company in your country (Domestic) or another country (Foreign). In addition, the stock can be in a small company (Small Cap), medium size (Mid Cap), or large company (Large
  4. Tangibles are things like precious Metals, coins, real estate, or any collectible tangible property that has value.

Buckets or Accounts are the way your assets are titled or held. Just about any asset listed above can be invested and put into one of these asset ‘buckets:’

  1. College Education Accounts: These are accounts designated as 529s, Pre-paid tuition and College Savings Plans. These are similar in some ways to qualified accounts, in that the IRS provides some tax advantages.
  2. Minor Accounts: Minors (age 18 in most states) don’t have legal right to enter into business arrangements and sign contracts. However, to be able to invest for them, accounts can be set up in their name, giving them future rights of the money, while restricting others from having some control over it. These accounts, depending upon the state, are either Uniform Gift to Minors (UGMA) or Unified Transfer to Minors Act (UTMA) accounts.
  3. Non-Qualified or regular investment, means almost all other investments, and can be any type of account this is not one of the above two types of accounts. They usually don’t have a special tax advantages like the qualified accounts, but that is not to say they have some tax advantages over other investments (please consult your tax or investment adviser for full information).
  4. Qualified Accounts  means the account is ‘tax-qualified,’ or possesses some special income tax advantages usually aimed at retirement. The Internal Revenue Service or IRS, provides some kind of tax benefit to the person or entity contributing into it. There may be a tax deduction to the company or individual for investments into a Qualified account or bucket. In addition the interest or growth may be without current income taxes being taken out of it (like other accounts might be subject to), until the money is used at retirement.
  5. Annuities are a little of strange, therefore they are a little hard to classify between accounts and assets. For the purpose of this discussion, they are a type of account. However, what makes them confusing, is that they can either be a non-qualified (see above) annuity with some tax advantages similar to qualified that we will cover next, or they can be qualified, and carry with them the extra tax advantageous of qualified accounts.


    • Company plans: Retirement or Pension Plan (or Defined Benefit plan), or 401(k), Profit Sharing, Keogh, or SEP (Defined Contribution Plan)
    • Individual plans: Individual Retirement Arrangement or IRA, and Roth IRA arrangements
    • Not for profit plans: 403(b) and 457 plans

Asset Classification and Account Buckets

Now that you understand the difference between asset classification and account buckets, you are ready to get the next basic concept: placing your investment asset into an account. This part really confuses many people, but this is how it works. You can virtually (which means in many cases) place any of the above investment Asset types, into any type of Account Bucket. For example, you can invest or place stocks and bonds in your IRA, UGMA, College education or non-qualified Account Bucket. Each Account Bucket has specific rules and taxation, that your advisor can tell you about.

Identifying what bucket to invest in first, second, and so on depends on various factors, the overriding ones of which are those based on your financial plan. If you have a financial plan, you will know which areas that additional funding is needed, and you can allocate your investment ‘buckets’ accordingly. Here are some examples of how Assets and Accounts work together:

  1. Emergency Cash Reserves. These assets need to be liquid, quickly and easily accessible without risk that value may go down, in case money is needed for a car or house repair. Reserves allow for emergencies and unexpected expenses without jeopardizing cash flow, increasing risks, and taking money from accounts that are being set aside for things like college or retirement. Therefore, most people put their emergency cash reserve in a non-qualified account. Secondly, they often place some of their investments in cash equivalents in their non-qualified account, for emergencies.
  2. Saving for specific goals, such as a new car or the down payment on a home   There are many things that require fairly large sums of money all at once, such as buying new appliances or taking a vacation. In order to ensure that you have the money you need when you need it—without borrowing it or affecting other goals, it is important to save money regularly toward these planned expenses. Therefore, you wouldn’t use college or qualified accounts for these kind of purchases. Just like in the first example, you would use a non-qualified account for saving for specific goals, most of the time.  If the need for money is in a few months or years, your investment adviser would typically recommend that you place/invest in cash equivalents or short-term bonds into these accounts. If the purchase isn’t going to be for many years, your investment advisor may recommend other long-term investments for your non-qualified account.
  3. Retirement/Financial Independence. Most financial advisers recommend that you fully maximize the amount you are able to put into pension plans and IRAs prior to investing in other Account Buckets.’ These retirement plan accounts usually provide very good income tax advantages. Your investment advisor will recommend various Assets for these accounts.
  4. College Education. Most financial advisers recommend that college education savings priorities should fall behind retirement goals. Your adviser may recommend that you place money intended for college in a 529, UGMA or UTMA Account Bucket. Your adviser will then choose appropriate assets to invest in, depending upon the level of risk you are willing to take, and when the money is needed- the same criteria they will use for all of your accounts (the above are just examples)

 Summary of Investments into Asset ‘Buckets.’

  • Emergency Reserves: Using non-qualified account bucket
  • Vacation Home and future car purchase: Non-qualified bucket usually
  • College: Non-qualified and education buckets like 529, UGMA/UTMA
  • Retirement: Qualified bucket (Pension, 401(k), IRA, and Annuity) & non-qualified bucket
  • Specific Goals: Non-qualified bucket usually

Summary. It is important for every investor to understand the different types of investment Assets and Account Buckets, so that they are not confusing them as the same thing, as many people do.

Fundamentals of Investing

iStock_000011625011SmallInvestment management seems to be hard to understand, but it doesn’t have to be. We will examine the three different investment management methods, as well as risk and asset classes. We will also discuss practical steps to begin constructing your investment portfolio.

Investment Management has sometimes been defined as: Managing assets and resources in relationship to your personal and financial goals, in order to most efficiently accomplish desired results.

One objective of any financial plan is to determine the right mix of investment method and asset types and accounts for you.

The Three Investment Methods: Every investment decision uses one or more of the following, and every investor should be aware of how they work:

  1. Asset Allocation: Investing in Asset Classes matched to client risk, reward and goals. Investors utilizing this method believe that diversification in various assets classes provides the most favorable investment results.
  2. Security Selection: Buying and Selling of an individual’s securities–usually stocks and bonds, but the securities can be other types. Stock (or other) pickers believe that through careful analysis of individual securities, market conditions, and economics provides the best investment returns.
  3. Market Timing: Buying and selling of securities for a particular season, often short-term, compared to buy-and-hold strategies many asset allocators or security pickers employ. Market timers look for industry, company and economic trends, and they believe this is the best way to invest.

Security Selection is deciding which stock or bond to purchase or sell. This gets the most attention in the media because it is interesting. Business news shows like to highlight stock pickers from Wall Street who talk about up-and-coming companies.

In order to be a good stock picker, you must make a careful evaluation of which stock to purchase. The goal, of course, is to purchase low and sell high. In order to make good decisions, you need a lot of information about all stocks. Security selection is challenging because of the large number of stocks that are available for purchase. Secondly, it is difficult to find accurate, up-to-the-minute information about companies, and the information becomes quickly outdated. In addition, a lot of knowledge and experience are required to be able to process and interpret the information. Investment skill requires understanding and knowledge of economics, demographics, accounting, corporations, industries, and countries, to name a few.

Great stock pickers are hard to find; however, if you do your research you will find the minority of stock pickers who have consistently beaten their respective indexes. Stock pickers can be stockbrokers who sell stock. Or they may be private money managers who usually have a staff of research people who pick stocks for clients. Investors are required to give them a minimum amount of money to invest. Mutual fund companies employ a large staff of expert researchers and analysts to help them pick securities.

Market Timing is seeing where a market or security currently is, and then betting where it may be going, and when. To break-even or win at market timing, accuracy of over 60% of the time is required to cover the losses caused by mistakes of the other 40%. It is not 50/50 because of commissions, taxes, and other transaction costs associated with trading securities. You have to be right in all four decisions: what to buy, when to buy it, what to sell, and when to sell it. A mistake in any of these may eliminate the gains in the other three. Very few market timers have shown a consistent track record of being correct more than they are incorrect. Some market timers use Options. Options are purchased contracts to buy or sell an investment at a particular price, to profit from what is usually a short-term movement (up or down in value) of the underlying security.

Asset Allocation is mainly based on the famous and comprehensive study by Gary P. Brinson, Brian D. Singer, and Gilbert L. Beebower in 1991.* They found that over 91% of long-term portfolio performance is derived from the decisions made regarding asset allocation, and not market timing or security selection.

You don’t hear that much about asset allocation in the media, since it is boring and it doesn’t make exciting news. In addition, it is sure to draw a yawn at a cocktail party as compared to a hot new stock you may have heard about.

Asset allocation means that money in a portfolio gets divided up between the different asset classes. Most investments can be categorized into one of four asset classes: stocks, bonds, tangibles (things you can touch), and cash. There are dozens of asset classes in the U.S., and most also have mirror images in the foreign markets.

An asset allocation should be tailor-designed for each investor based on the comfort level of risk and volatility, the rate of return hoped for and the individual goals.

Most financial planning application have some sort of Investment Discovery Questionnaire. After completing the questionnaire, you will discover which of the five most commonly used investment risk tolerance categories corresponds to your input. Your investment adviser could refer to this and surely utilize his/her own questionnaire to help you arrive at the risk tolerance and asset allocation that is best suited to you.

Risk. In every aspect of life, we are faced with varying degrees of unknown outcomes. These uncertainties in life are sometimes referred to as areas of risk. In particular, financial matters are commonly described as either safe or risky or somewhere between the two extremes.

It is important to recognize that the term risk can refer to more than simply the loss of your money. Some of the different examples of these risk areas are described below.

  • Loss of Principal. Imagine that you have $10,000 invested in a stock. The stock declines in value to $5,000, and you sell the stock. Then you have suffered a loss of principal. On the other hand, if you do NOT sell the stock while the value is down, and the stock recovers to $10,000, then you have not suffered a loss. Time and diversification are keys to mitigating this type of loss.
  • Loss of Purchasing Power. If you own a $10,000 certificate of deposit earning 5% interest, you will receive $500 per year interest. Since the account is insured by the FDIC, and the interest is guaranteed for a set timeframe, this may seem like a safe investment. If we experience inflation at the rate of 3% per year, the purchasing power of the $500 income will be reduced after the first year to $485, and after 10 years to $372. The purchasing power of the $10,000 after 10 years will be reduced to $7,441. This loss is a permanent one with no chance for recovery unless our economy goes into a protracted deflationary cycle.
  • Tax Loss. With the same $10,000 as above, and assuming you are in the 25% tax bracket, the $500 interest would be reduced to $375 after taxes. After 10 years, the $500 interest after taxes and inflation would provide purchasing power of only $277.
  • Liquidity. If you place all or most of your financial assets into non-liquid assets (such as real estate, mortgages or notes, small business interests or even tax-deferred retirement accounts with severe early withdrawal penalties), you may find that you no longer have control of your financial future. If your personal financial affairs take a turn for the worse because of a disability, loss of employment, death in the family or any other unforeseen event and you cannot readily reposition your assets to meet your new needs, then you are exposed to the risk of not being in control of your financial wellbeing.

Although there are other types of risk that could be considered, the above examples illustrate that it is important to properly plan and balance your financial assets so that all possibilities are considered.

Asset Classifications Types

  • Cash or Cash Equivalents: Savings Accounts, Certificates of Deposit (CD), Money Market Accounts
  • Bonds are essentially a loan between an investor and the entity, such as a corporation or a government. They can be issued for a short term intermediate term, or long-term. In addition, they can be very safe or risky, depending upon the financial strength of the borrower/entity. Some bonds issued by municipalities may have certain tax advantages, and they are called municipal bonds.
  • Stocks are essentially an equity investment in a corporation. They can be issued by a company in your country (Domestic) or in another country (Foreign). In addition, the stock can be in a small company (Small Cap), medium size company, (Mid Cap), or large company (Large Cap).
  • Tangibles are things such as precious metals, coins, real estate, or any collectible tangible property that has value.

Index Investing. Because of the popularity of index funds, any discussion about investing should include them. Index Mutual Funds are those Mutual Funds that invest only in the securities that are in the index. For example, the Standard and Poors 500 Index Funds offered by many mutual fund companies invest in only those 500 companies represented in the index. The research has clearly established that investing in Index Mutual Funds will outperform most stock pickers’ and mutual fund managers’ choices. Does this mean that you should only invest in Index Funds? Some very smart people have concluded this; however, consider:

  • Some mutual fund managers have consistently out-performed their respective indexes.
  • Some mutual fund managers have consistently out-performed their indexes or have performed nearly as well, but they have invested in securities that have less risk and volatility than those in the index.
  • Investing in a portfolio of mutual funds may provide more diversification.

Summary. The following are simple steps to begin implementation of an investment plan that is suitable for you. First, you should decide which investment method you prefer: Asset Allocation, Stock Picking, or Market Timing. If you are doing asset allocation, follow these steps to begin the process:

  • Complete a financial plan to determine your goals and asset allocation.
  • Decide if you want to use index funds or investments selected by an investment adviser.
  • Find an investment adviser if you decide to use one.
  • After careful consideration and discussion, choose your philosophy of investing: Security Selection, Market Timing, or Asset Allocation.
  • If you work with an investment professional, ask about the methods used to determine your portfolio.
  • Some advisers use an Investment Policy Statement (IPS), for every client. Your individual IPS will outline
    1. Investment Selection Process: Policy, methodology, and systems for selecting investments.
    2. Investment Performance: They may or may not be able to provide this for you. It depends on how they construct portfolios and how the security regulatory agencies permit reporting.
    3. Reallocate investments into the funds chosen according to your asset allocation and investment policy statement. Evaluate tax exposure to changes prior to re-allocation.
    4. If you have funds in an employer-provided retirement plan, reallocate current balances and future contributions into those funds that fit your asset allocation. Obtain performance information from the retirement plan provider and discuss with your investment adviser.
  • If you have retirement funds left at a previous employer, open up an IRA account and roll over those assets into it. Invest those assets according to your asset allocation.
  • Review your investments quarterly. Your investment adviser should provide you with up-to-date information about:
    1. Overall performance.
    2. How your performance relates to the adviser’s respective index.
    3. Underlying fund information.
    4. Current asset allocation balances compared to your prescribed asset allocation.

*Gary Brinson, Brian Singer, & Gilbert Beebower “Determinants of Portfolio Performance: An Update,” Financial Analysts Journal, June ‘91

The Problem With Debt and How to Escape It

Erase Debt - Green Button

Eliminating all (non-mortgage) debt should be one of your top financial goals: A lot of debt spells disaster for most people’s financial plans, and it should be avoided at all costs. These are the top 8 reasons why having a lot of debt can be harmful: 

  1. Debt works against wealth building: High interest loan payments enrich lenders at the expense of the borrower: lenders get wealthy, but you don’t.
  2. Debt adds to stress: People with a lot of debt have much more stress compared to those who don’t; they are unhappier and they enjoy life less with debt.
  3. Debt subtracts from life’s enjoyment: If you’re making a lot of debt payments, your disposable income will be limited, and you will have less money to save or to use for having fun.
  4. People with a lot of debt worry more: High debt people live a stressful paycheck-to-paycheck existence, never knowing if they will have enough money each month to cover their bills.
  5. Increased financial difficulty: Debt is the number one reason people state for having financial problems.
  6. Less prepared for emergencies: Big borrowers don’t have emergency cash, and things such as big car repair costs or health care bills increase debt and stress.
  7. Spend more: Most people who carry large credit card balances are less frugal, and they are less careful comparison shoppers.
  8. Earn less: Financial stress is the number one reason employees perform poorly at work, leading to lower incomes.

How to get out of debt: Eliminating debt should be deliberate, and it should be tackled with enthusiasm so that you can quickly break the spending and credit habit. These are the top 9 ways to get out of debt:

  1. Accumulate $1,000 in savings for total emergencies, for things such as major car repairs or trips to the emergency room (not for ordering pizza). This allows you to avoid using credit cards when an unplanned expense pops up.
  2. Snowball your debt. With this technique you first pay only the minimum payment on each debt account. Then take all of your disposable income and add it either to the highest interest account or to the lowest balance loan for the feeling of success when accounts are repaid 100%. When one debt is eliminated, your monthly debt payment shouldn’t decrease, but you should use the payment from the paid-off debt toward the next unpaid debt on the list, continuing this method until all debts are repaid. eFinPLAN has a debt acceleration tool to help you get out of debt.
  3. Create a budget, track spending, and reduce spending on entertainment, eating out, vacations, and groceries.
  4. Get a second job, because a second income can go a long way to helping you pay down your debt. Devote 100% of your new income toward debt reduction.
  5. Freelance if you have a marketable skill, and use the income you derive to pay off debt as quickly as possible.
  6. Downsize by purchasing a smaller, less-expensive home and car if you can do so without spending cash today or incurring more cost over the long-term.
  7. Temporarily stop 401(k) contributions and direct 100% of the redirected funds to paying off debt.
  8. Sell stuff. Start by cleaning house and selling items. Use the cash from the sales to repay debt. You might miss some of your favorite things, but when you are debt-free you can easily buy them in a few months, if you still want them, by using your previous payments that used to go to debt.
  9. Consumer Counseling Agencies: If you are so deep in debt that you can’t even make minimum payments, start by trying Dave Ramsey’s pro rata debt repayment plan. Some people have success with special companies designed to help with repayment. I only occasionally favor agencies that can negotiate terms with lenders and establish repayment plans for a very small fee. However, I am not in favor of credit negotiation firms that charge healthy fees to negotiate a lower payoff. There has been some fraud in this industry. Therefore, research agencies extensively, know all the pro’s and con’s before signing, and look for several industry accreditations. Using these agencies is often considered a last-ditch effort to avoid bankruptcy.

Summary: Having a lot of debt is one of the top major obstacles to financial success. Commit to getting out of debt and you will improve the quality of your life!

This is the 2nd article in a 3-part series on debt. Please read all of these article to be a better user of it, and for ways to avoid and escape it.

  1. A Basic Review of Debt
  2. The Reasons and Costs of Over-borrowing
  3. The Problem with Debt and How to Get Out of It

The Reasons and Costs of Over-Borrowing

ball and chaing

debt ignorance leads to poverty

The concept of debt management is especially important today as Americans are saving less and are further in debt than at any other time in our history. Why do people over-borrow and what is the ultimate cost?

Reasons for Growing Debt Level. Americans owe more and are saving less than at any other time in modern history. This slumped some during the great recession, but it has recently been reported to be on the rise again. Why do Americans borrow so much?

  • Lack of Knowledge: Some people were never taught–or never learned on their own–money management skills and principles of borrowing.
  • Delayed Gratification: Most people have no patience; they want to borrow to purchase things that they can’t yet afford instead of saving for them. This trait is new to the last 30 years, and never in history have people been so accustomed to constant debt usage.
  • Loss of Employment: Many people have lost their jobs, and it may take them time to replace their income or they may be hired at a lower pay than they were previously earning.
  • Health Bills: The cost of health insurance and health care has increasingly consumed a larger percentage of people’s budgets.
  • Student Loans: Many people come out of college not just with huge student loan debt, but also with credit card debt.
  • Inflation: It has been reported that inflation on average has been low (3%); however, recent increases in health care, gasoline, and food costs, as well as suburban real estate taxes, have taken a heavy toll on the middle class.
  • Wages have stagnated for many people in the middle class over the past 15 years and often have not increased to keep pace with inflation.
  • Inflexibility to Change Lifestyle: Instead of cutting back, some middle-income people save less, use up savings, and borrow more so that they don’t have to change their lifestyles.
  • No Plan: Most people do not have an overall financial plan, including goals for savings and spending. An eFinPLAN financial plan will help you plan for your future financial goals.

The True Costs of Borrowing. The costs of borrowing are both psychological and economical. Having too much debt is a burden that squeezes family finances and increases stress. The economical costs are provided below. Think of debt as an investment. Does it make sense to borrow money, pay interest to someone else (who is profiting from you) and buy an asset that has lower value at the end of term? Or would it make more sense to save money in the bank (who loans it to someone else, giving you part of the profit by way of interest), or buy part of a company that is appreciating in value (which in essence is what stocks are)? The answers to this are obvious.

Down Pmt
Loan Amt
Home       200,000          20,000       180,000     6%              30       1,079
Auto        25,000            5,000         20,000     8%                5          406
Cons. Credit        10,000            2,000           8,000   12%                3          266
Credit Card        10,000                   0         10,000   12%              22          250


Interest Paid
Total Cost
Property Value at Term
Gain or Loss at Term
Home        208,509     408,509                5%          864,388       455,879
Auto            4,332       29,332             -15%            11,093       -18,239
Cons. Credit            1,566       11,566             -15%              4,437         -7,129
Credit Card            6,513       16,513             -15%                 280       -16,233

When people borrow, sometimes what is most important is the monthly payment; however, they often don’t consider the overall financial impact. If you master proper use of borrowing, you will end up being much better off than other people who have incomes similar to yours.

Tips to avoid over-borrowing: The following are excellent recommendations regarding debt and borrowing:

  • Credit Cards: Get rid of most of your credit cards and pay off balances monthly. If you carry a balance, switch to a card with a lower interest rate for new purchases and transferred amounts.
  • Automobile: Avoid large automobile loans; purchase used cars with money you saved. If you must borrow, keep a car for 10 years.
  • Automobile Leasing: Do not use leasing 98% of the time, but if you do, don’t use it to obtain a car that costs more than you could afford if you purchased it. For example, if you could afford the purchase payment on a $25,000 car, don’t lease a $40,000 one. Look for lease “deals.” Nearly all manufacturers offer no-down-payment lease plans from time to time with very low payments in order to lower their inventory or to avoid layoffs. These lease plans can be the preferred automobile solution, but only for few people who are great negotiators. Just remember that you will have to obtain another car at the end of the lease
  • Furniture, Department Store, and Appliance: These loans often have the highest interest rates (after the 90-days same as cash); if at all possible, do not take out these types of loans.
  • Home Loans: We have enjoyed historically low interest rates that have allowed the purchase of very large homes. The preferred decision should be to buy a lower-cost home and to save and invest more. Instead, people have purchased homes at the very far edge of the bank’s approval amount. The larger the home, the more it costs to insure, furnish, maintain, and heat/cool. In addition, the real estate taxes are usually considerably more.
  • Home Equity Loans: These can be attractive for the purchase of automobiles, home improvement and business financing, because the interest can be deductible (consult a tax adviser). However, as with all loans, consider your overall financial plan.
  • Debt consolidation loans: Home Equity Loans are often marketed to consolidate credit cards and purchase depreciating goods. These are attractive because of probable tax-deductible interest and potentially lower payments. However, many people use the lower payment to go out and buy/borrow more, and then later consolidate again. This never-ending cycle increases debt and eats away at the equity in the home from appreciation.
  • If in college and you don’t have a college savings account, avoid borrowing for the total cost by working part-time, applying for grants and scholarships, going to a lower-cost community college the first couple of years; but whatever you do, don’t live on student loans. I’ve known people to incur hundreds of thousands of dollars in debt. It makes more sense to take a little longer and work your way through.

This is the 2nd article in a 3-part series on debt. Please read all of these article to be a better user of it, and for ways to avoid and escape it.

  1. A Basic Review of Debt
  2. The Reasons and Costs of Over-borrowing
  3. The Problem with Debt and How to Get Out of It

A Basic Review of Debt

The concept of debt management is especially important today as Americans are saving less and are further in debt than at any other time in our history. Let us explore what debt is, when it is good and bad, how to get out from under its bondage, and what the consumer should be aware of. 

Loans Defined–An arrangement in which a lender lends money to a borrower and the borrower agrees to repay the money, usually along with interest, at some future time. If $10,000 is borrowed at 8% for four years, will have a monthly payment of $244.13. The interest cost is $1,178. Therefor total cost is $11,178, and when you receive the loan, your net worth automatically goes down by that amount.

Type                             Tax Deductible Interest?     Appreciating Asset?        Okay or Bad?

  • Home loan, or mortgage           Yes (usually)                               Yes                                  Okay with moderation

Home loans are considered okay debt because an appreciating asset has been purchased, mortgage loan interest is deductible, and some feel that is the only way home ownership can be obtained. No debt is wonderful, so even with home loans it should be used with moderation.

  • Home Equity or 2nd Mortgage   Yes (usually)                               Yes                                 Okay with moderation

Home equity loans are considered okay, because they may be deductible; except when they are used to purchase depreciating assets (furniture, swimming pool, vacation). Many people during the great recession spent their home equity foolishly, and when they ran into financial difficulty, they had little home equity because of massive loans and depreciating values.

  • Margin Loan (on investment)      Yes (sometimes)                          Maybe                          Risky, extreme caution

Margin loans are secured by an investment portfolio to purchase additional investments. Some wealthy people do this.

  • Consumer loan                         No                                              No                                       Bad

Consumer debt are loans used to purchase items that rapidly decrease in value, such as furniture, appliances, and automobiles

  • Credit Cards                             No                                              No                                       Bad

Credit cards if not paid off each month can lead to serious debt problems. Credit cards psychologically encourage over-spending for many people

  • Business loans                         Yes (sometimes)                        Yes hopefully                      Okay sometimes

Business loans are usually a term loan to invest in your business to increase its value and income.

Types of Loans: Basic

  • Term Loans are debt loan with a fixed maturity and an amortization schedule. These types of loans are usually used for autos and homes.
  • Lines of Credit  are extended by a lender to a borrower, usually without a fixed maturity. These types of loans are credit cards, home equity loans, and business loans
  • Secured Loans produce debt with some form of collateral securing the loan, such as a home.

This is the 2nd article in a 3-part series on debt. Please read all of these article to be a better user of it, and for ways to avoid and escape it.

  1. A Basic Review of Debt
  2. The Reasons and Costs of Over-borrowing
  3. The Problem with Debt and How to Get Out of It

How to Buy a Car and Avoid Lemons

Lemon Car

Besides the purchase of a home, automobiles are the second most significant purchase that consumers make. The wrong car buying decision can cost you thousands of dollars. Here are some tips for buying the right car for you so that the purchase doesn’t interfere with your accomplishing your other financial goals.

Have you heard the jokes about Land Rovers? This is one of my favorites: They say 90% of all Land Rovers manufactured are still on the road. The other 10% have reached their destination. There is truth in this joke. I know of some people who have iffy personal finances, and their Land Rover repairs literally put them in poverty. Unless they do a little research, low to moderate income people should never buy a Land Rover. If they only checked J.D. Powers 2014 Vehicle Dependability Study they would see that Land Rover ranks 3 from the bottom, just ahead of Dodge and Mini out of 31 car manufacturers (in the 2013 Initial Quality study, it ranks 18th, which is a little better).

These are the 6 steps you should take when considering your next car purchase:

Step 1: Review Your Financial Plan.  Before you even think about the purchase of a car, you should look at your entire financial picture, your comprehensive financial plan. The purchase of a car affects not only the amount of money you currently have in savings and any investments you may use to buy the car, but also any differences in payments (such as maintenance, gas, insurance and repairs) that will affect your budget each month and possibly for years to come. Of all your purchases, cars rank second to homes in their affect on your ability to reach your other financial goals.

Start by looking at your financial plan. If you don’t have a financial plan, consider an eFinPLAN financial plan. The decision to purchase a car should not be made in a vacuum. It should take into consideration all of your financial goals and responsibilities. When you purchase a car, you should understand how it will affect your other priorities. If, over time, the car will cost you less than you can afford, then you will be able to get out of debt sooner and perhaps retire sooner than you planned. Proper planning regarding the purchase of a car might mean the difference between being able to afford a vacation or staying home. A poor choice would be to buy a car beyond your means and use a charge card for vacation expenses.

As with all financial decisions, the decision to buy a car should be a component of the overall written plan that you have made for your future. When you do a budget, you will be able to see your gross and net income, and then you can estimate how much you have left over to invest. Most people skip this step when they buy a car, and they don’t even know if they can afford to buy one. I know, because they ask me to counsel them after they purchase the car and discover that they can’t afford it. If it is repossessed, then their credit rating tanks. People with bad credit ratings are taken advantage of all the time at local used car lots, with high payments resulting from high interest rates and car prices much higher than the Kelly Blue Book estimate.

Step 2: Examine Financial Aspects of Car Purchases                     

  • Insurance: Compare how much you are paying for insurance for your current car versus a new one. Discuss the cost to insure potential cars with your insurance agent before purchasing.
  • Fuel: Evaluate how much your fuel budget will be for the new car. Remember, the EPA average miles per gallon for cars prior to 2008 (when they revised the calculation method) are off by approximately 15–20%. Some car makers have been penalized for false estimates on their published window stickers, and we blogged about it in 2012 and tweeted about it in 2014.
  • Hybrids: Gas and electric cars as well as full electric save you a lot of money in gas, so take this into consideration in your budgeting. However, the extra technology makes the cost of the car cost about 20% higher. They might have a tax savings offsetting the additional costs, but remember to account for this additional cost in your plan.
  • Car Payments: Consider the cost of monthly car payments and calculate how much the new payment will reduce the amount of money you have to save or invest, to reduce debt or to be applied toward other priorities in your financial plan. You can easily calculate monthly payments by using free payment calculators available on the internet, such as those at DinkyTown.com.
  • Regular Maintenance: Estimated costs should be available from new car dealers for each model and each year of ownership. However, ask if they have extra expensive tires.
  • Repairs: If you are buying a used car, use the Internet to research approximate costs for repairs for each year you plan to own the car. The repair and parts industries keep this data, and a good repair facility should be able to help you estimate the cost after they inspect the vehicle.
  • Duration of car ownership: Make sure your plans include the length of time you will keep the car. This should help you avoid making rash decisions about new car purchases. For instance, your plan may involve buying a new car when your child is in middle school, paying it off during high school years, being free of car payments during college years, and perhaps purchasing a new car to keep during your retirement.

Once you have all of this data, update your eFinPLAN financial plan. You can use the ‘what-if’ scenarios to see how a car or any other major purchase will affect your overall financial plan both now and in the future. Don’t forget to make changes to your financial plan after purchasing a car.

Step 3: Select an Auto Type that Meets your Specific Needs. In step two you determined the monthly amount you can afford for insurance, gas, maintenance and repair, and how this purchase will affect your overall financial plan. The next step is to decide what type of car you should purchase. This is where most people slip up and make a bad decision. They have a general idea of the car that they want, and they go to the dealer, with little or no research, and buy a car. When the car purchase is emotional, and it often is, bad decisions can happen. They may be impossible to reverse and may affect your overall finances for years to come.

What do you want in a vehicle? Consider the following:

  • Safety: Is safety a key concern, such as collision or airbags and size of the vehicle?
  • Cargo capacity: Do you need a large trunk or cargo space?
  • Interior space: Are you a large person, or do you have a large family?
  • Miles-per-gallon: Do you want a high mileage or hybrid car to cut down on vehicle emissions, or to save on gas?
  • Domestic or foreign: Do you prefer a domestic manufacturer? If not, is it important whether the manufacturer is European or Asian?
  • Luxury level: Do you prefer regular or luxury? Are those preferences for car interior, exterior, or both?
  • Four-wheel drive: Do you live in an area where the roads and weather make having a four-wheel drive vehicle beneficial?
  • Business: Are you in business where the type of car you drive makes a difference? For example, realtors often find it important to have a nice large upscale car to take clients around in.
  • Car people: Are you a car/truck guy or gal, and just love driving a particular brand or type of car? I am asking this question as a man who receives a phone call from my wife each month when the current issue of ‘Car and Driver’ is delivered. I understand the thrill of driving a great car and the agony of driving a rust bucket. If you are a car nut like me, and you have a limited budget, you may be more vulnerable to making a mistake. You may need to read this article several times to put financial planning issues above your emotions.
  • SUVs: Some consumers purchase an SUV without fully educating themselves about possible additional costs. These vehicles are extremely popular because of perceived prestige, and they provide safety, great visibility, cargo capacity, and comfort. However, cars sometimes surpass the crash test standards of SUVs, and SUVs are more difficult to maneuver in emergencies because of their high center of gravity (which sometimes results in rollover crashes). SUVs can cause more severe injuries to others driving sedans. These luxury vehicles are more costly to buy, to operate (gas and maintenance), and to insure; yet poor people buy used high mileage SUVs all the time. Make sure that you do your research before buying.
  • Environment: Many people buy hybrids and electric cars because they are good for the environment. However, that may not always be the case. Consider that electric cars probably get their energy from fossil fuel powered electric plants. Also, the process of making high-tech batteries can be hard on their environment. Interesting article at this link.
  • Size: So what do you need and want–a sedan (size and number of doors), station wagon or hatchback (great for young people with who move a lot), van, truck, or SUV (they come in many sizes)? If you a sports buyer or if you buy a specific brand due to image or past satisfaction, you will probably skip thinking about many of these things when you purchase, but it may cost you.

Now that you have reviewed your financial plan, thought through the financial aspects of a car purchase and your specific needs without emotion, you are ready to identify the car that will best meet your needs.

Step 4: Identifying Potential Vehicle Choices. Steps number 2 and 3 should help you narrow the type of car that you will own in terms of price range, vehicle type, and domestic versus foreign nameplate. Now you are ready to select the best vehicle in terms of the following factors:

  • Description: Compile a description based on Step 3.
  • Price: Narrow your search based on your optimal price range (Steps 1 & 2).
  • Research: Gather research information. Use the internet, car magazines (such as Car and Driver [the library usually has back issues; pay special attention to the comparison article to similar car types in a certain price range]), trips to dealerships, and some of the links in this article.
  • Cost of Ownership: Now that you have your list narrowed down to 2–4 types of vehicles, you probably want to compare the costs of ownership. Obtain the following information:
    • Routine Maintenance
    • Gas mileage estimate
    • Repair estimates
    • Cost to insure
  • Hybrid Vehicles: Many car buyers choose hybrid vehicles to save money on gas or to emit fewer toxins into the environment. If your decision is based on gas mileage, make sure that you do the math calculations. Hybrids usually cost more than similar cars or SUVs and may take 50,000 to 100,000 miles for the gasoline savings to surpass the additional price of the car.
  • Safety: Last and surely not least, examine the safety ratings for each type of car. It’s important to consider:
    • Brakes: Compare the distance it takes to stop from 60 miles per hour. The difference in stopping distance can range dozens of feet—which can make all the difference in an emergency stopping situation. Also look for anti-lock brakes.
    • Crash ratings: Look up the vehicle crash rating on the NHTSA website.
    • Safety features: Look for other safety features, such as passive restraint and airbag systems.
    • Handling: This is important to know, because the better a car is at handling and communicating to the driver what is happening between the tires and the road (feedback), the better the car’s ability to assist with accident avoidance and poor weather. Car magazines usually provide this type of information.
  • Test Drive: Aol reports that 1 in 6 people don’t test drive a car before buying it. You may want to drive it a few times, to get a true idea of how it feels. Your list should now be narrowed down to a few vehicles. Go take them for a test drive, but before you do, go to step number 5. Remember, having done all this research you will know more about the car than 75% of car salespeople. You will be better able to spot exaggerated claims about the car the salesperson might make (this happens every time I talk to an automobile salesperson).

Step 5: New or Used? Cars depreciate pretty quickly, so it makes a lot of sense to buy a good used car instead of a new car. This is especially true if the car has low mileage and can be purchased from someone you trust, such as a friend or a family member, or from a “certified used car” program. However, be careful of the latter since they may charge a premium for the certification.

Before you begin to look for your dream car, you should do your research (e.g., with Kelley Blue Book) to find the approximate fair price range. Also consider using services like Experian and Carfax to research the title on your car to see if has been in a flood or an accident.

Avoid the extra add-on charges, such as gap insurance (your insurance agent should provide this), rust proofing, and extra warranties. These are usually a bad deal at best, if not simply a rip-off.

Now that you have the price range and have narrowed down the type of car you’re looking for, go to two or three dealers for each car and negotiate your lowest price. I once spent an entire Saturday afternoon driving back and forth between dealerships on opposite ends of town relaying the latest deal from one salesperson to the other. I spent a Saturday, but I ended up with a great car at a great price from the furthest dealership. I used the service department from the closer one.

If you are purchasing a used car, always have the car inspected by an excellent mechanic.

I have known too many people that were lured to sexy used European automobiles but were not ready for the larger regular maintenance and repair bills that may come with them. Unless you can afford the higher expense, stay away from buying high mileage European cars. Asian and some American used vehicles will generally give you fewer headaches.

There are two other very good articles on this website to read before making a decision; “Used car cautions,” and “How to buy a good used car for less than $5,000.”

Step 6: How to Pay for It? Cash, Financing and Leasing. If after you have you have reviewed your financial plan and have determined that you have sufficient reserves to purchase a car with money you have in savings or investments, you now have a choice to make: use your money or someone else’s.  If you can borrow against your home, chances are you can deduct the interest.  If this is the case, the net cost to borrow may be less than what your investments are earning. This assumes that your investments’ rate of return is very good and your income tax rate is medium to high.  However many people are more comfortable owning things outright, regardless of the financial advantages. Be very careful. Many people use their home’s equity and never pay it back in full.

If you decide to finance the car, know your financing options before buying. Talk to your bank or credit union, and look on the Internet for options. Read the fine print.

Most financial advisers probably advise against leasing; however, I think leasing deserves a second look but only in certain very rare instances. This is when manufacturers offer extremely low lease plans from time to time, with little or no money down. These are very attractive.  Do not be swayed by flashy advertisements. Read the fine print and make sure you know the details, such as mileage charges and down payments. Before signing, compare the actual costs for the next two leases, or to lease then buy it out. Do not use leasing to purchase a car that you normally could not afford.

For example, let’s say someone earning $50,000 can afford a payment on a $20,000 car ($522 for 48 months at 8%). However, a car manufacturer might offer a no-money-down lease on a nice mid-size car with a great warranty for $199 per month for 36 months. The lease would be a better overall deal for short-term cash flow. However, the purchaser would never have equity and would need to continue making car payments of some kind after the lease expires. For a single person who always wants to have a safer newer car (let’s call him or her “Pat”), this might be okay. But let’s say Pat sees an advertisement to lease a 3-series BMW for $359 per month with $2,500 down. Pat would certainly enjoy having a beautiful car and might be able to afford the down-payment and make the monthly lease payments. In the long run, though, could Pat afford to purchase the $35,000 car? Probably not. Now Pat has spent $2,500 from savings for a down-payment, and the insurance premiums are higher.

For calculating whether it is better to borrow or lease, and to determine whether borrowing from a home equity loan is advantageous, there are easy to use calculators in the “Auto Calculators” section of dinkytown.com.

Other sources of Information. The Federal Trade Commission website provides a lot of useful information about the car buying process in general. Consumer Reports (consumerreports.org/cro/index.htm) provides good data about dependability ratings, but you have to pay for it. (Our local library has free online search and view capability, so check with yours.) If you are buying a new car, check the Internet for used car inspection checklists.


How to buy a great used car? Planning to buy a low-cost used car? If so, read How to Buy a Good Used Car for Less than $5,000, this helpful still gets a lot of web-traffic.

Used cars to avoid: Many people spend more on repairs than they do for the car itself. Read Used Car Cautions for a list of used cars to avoid.

Summary. You work hard for your money, and although this process is work, it’s worth your time and energy to make educated automobile purchase decisions in line with your financial plan. In the long run, you’ll be glad that you did, since your overall financial health will be affected by these decisions. Making a wise decision will give you greater satisfaction every time you get behind the wheel.

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