This Life Advice pamphlet about Planning
Financial Security was produced by
the MetLife Consumer Education Center with assistance from the American Association of Individual Investors and the U.S.D.A. Cooperative State Research, Education and Extension Service.
Editorial services provided by Meredith Custom Publishing.
DOES THE IDEA OF PLANNING FOR YOUR FINANCIAL FUTURE SEEM TO COMPLEX OR CONFUSING? Do you think you can't save money because you're barely making ends meet as it is? All excuses, aside, there are two good reasons to seize control of your finances now:
- With today's turbulent economy, you can no longer count on your employer or the government to provide for you new or in the future. You must make your own plans.
- Financial planning is the key to paying for those big ticket itemsbuying your own home or funding a college education for your children.
The sooner you start planning for the future, the sooner you'll reap the rewards. Use this booklet to help you gain control of your own financial destiny.
Establish a Savings Plan
The first step toward financial security is establishing a spending plan. The worksheet below will show you how much money you have coming in and going out. Fill in the monthly dollar amounts for each item below. Then, subtract your total expenditures from your total income.
Monthly Budget Worksheet
Income Expenditures Your Salary ________________ Rent or Mortgage ________________ Spouse's Salary ________________ Utilities (phone, cable, gas, electric) ________________ Bonuses ________________ Insurance (home/health/life/auto) ________________ Commissions ________________ Food ________________ Tips ________________ Clothing ________________ Interest Income ________________ Debt Obligations (alimony/child support/credit card balances) ________________ Rental Income ________________ Medical/Dental Expenses ________________ Social Security Income ________________ Taxes (income/property) ________________ Pension Income ________________ Transportation (car payments, gas, tolls) ________________ Alimony ________________ Personal (toiletries/allowances) ________________ Other ________________ ________________ Gifts (birthdays/holidays/charities) ________________ _____________________ ________________ Recreation (movies/vacations/books) ________________ _____________________ ________________ Other __________________ ________________ Total Income: ________________ Total Expenditures: ________________
This is the amount you currently can afford to save without making any changes in your spending habits. A recommended savings rate is 10% of your take-home pay. If you find that your total is a negative number or is less than you would like to save, you need to find areas where you can cut spending. Begin by recording all your expenditures for one month (cash, check and credit) in a notebook so you know exactly where your money is going. Look for areas where you can cut back. Perhaps you can rent videos rather than going to the movies, cut down on your dry cleaning bill, use coupons at the grocery store, carpool to work or take your lunch rather than eating out.
Once you have determined how much you can save each month, enter this amount on your worksheet as one of your permanent expenditures. Pay yourself first by setting aside your savings when you receive your paycheck, before you have a change to spend the money on anything else. It helps to have savings automatically deducted from your paycheck or checking account. Don't get discouraged if an emergency cuts into your savings. Just get back on track the following month.
How Your Savings Grow
If you can save just $1 a day, that's $365 in a year. If you invest this money at a 4% return, computed daily, here's how it will grow:
Savings With Daily Interest $ 365 One year $ 372 $ 1,825 Five years $ 2,929 $ 3,650 Ten years $ 4,487 $ 10,950 Thirty years $ 21,169
What's Your Goal?
Your first goal should be to save three to six months living expenses as a buffer against emergencies. Fill your personal savings goal for the immediate future:
3 x Total Monthly Expenditures: _____________ 6 x Total Monthly Expenditures: _____________
Keep your financial cushion safely tucked away in an easy-access savings account, short-term certificate of deposit (CD) or money market account. Make sure the bank or financial institution where you keep this money is insured by the Federal Deposit Insurance Corporation (FDIC), which protects the money you have on deposit up to $100,000.
The next step is to decide your short-term and long-term financial goals. Do you want to buy a home? Do you need to save for a child's college education? Are you planning for retirement? Are you saving for a vacation? Write down your goal(s):
Investing Your MoneyOnce you've acquired the basics, you're ready to consider some financial vehicles that will help your money grow over the long term. To increase your spending power, you must look for an investment that will earn enough to outpace the rising cost of living. For example, if a savings account earns 4% interest and the rate of inflation is also 4%, your savings will not increase in value at all. And, if the rate of inflation were to rise, your savings might actually decline in value. Realize, however, that not all investments will make money, and some are very risky.
Assess Your Level of Risk Tolerance
The following questionnaire is designed to help you assess your level of risk tolerance. Questionnaire results can serve as a guide to choosing the investments that complement your financial goals. Discuss the results with your investment representative.
No matter what type of investor you are, it is important to diversify. That means distributing your money across different types of investments so that you're not putting all your eggs in one basket. You may place some of your funds in conservative financial vehicles with a guaranteed rate of return, while putting additional money in aggressive investments that carry more risk but have a possibility of greater returns.
Circle the answer that best describes your response.
Agree Strongly=1pt Agree Somewhat=2pts. Disagree=3pts.
Disagree 1. Preservation of capital is most important to me. 1 2 3 2. I would accept a lower yield on my bond investmants in exchange for the relative safety of government seccurities. 1 2 3 3. Although emerging growth stocks offer high potential return, I would prefer a portfolio of established, high-quality equity securities. 1 2 3 4. I would choose share price stability over higher current return. 1 2 3 5. Portfolio diversification is an important investment consideration. 1 2 3 6. I would accept a lower current yield if I could access my money at any time. 1 2 3 7. I would choose U.S. government bonds versus stocks as my primary long-term investment. 1 2 3 8. I would choose current liquidity over higher, long-term total return. 1 2 3
Score Risk Tolerance Investment Approach 8-12 pts. Lower
- Concerned with capital preservation
- Wish to avoid market's ups and downs
- Liquidity (easily converted into cash)
- Preservation of capital
13-17 pts. Moderate
- Have more available income
- Emphasis on capital appreciation
- Capital appreciation
- Total return
18-24 pts. Higher
- Have both time and money to ride out the market's up and downs
- Seek maximum growth and appreciation
- Maximum capital appreciation
Types of Investments
Here's a quick guide to some of the investment options available to you:
Savings Accounts. Such accounts are a good place to store your emergency funds. They are generally insured by the FDIC up to $100,000 for all deposits at one institution and provide easy access to your money. The chief drawback is that interest rates tend to be low.
Money Market Deposit Accounts. These accounts usually earn slightly higher interest than a savings account but still allow easy access to your money. Some banks and financial institutions require an initial deposit of $1,000 or more and limit the number of withdrawals or transfers you can make during a given period of time.
CDs (Certificates of Deposit). CDs usually earn more interest than a savings account and are a vary low-risk financial vehicle. They are generally insured up to $100,000 by the FDIC for all deposits at one institution. You agree to keep your money on deposit for a fixed period of time. Usually, the longer the term, the higher the interest rate. There may be penalties for early withdrawal.
401(k) Plans. If your employer offers a 401(k) plan, it may be one of the best retirement vehicles available to you. A 401(k) is a retirement savings plan to which you can contribute a certain percentage of your gross income. However, contributions to a 401(k) and certain other qualified deferred compensation arrangements cannot exceed $9,500 indexed periodically for inflation. Typically with a 401(k) plan you have several investment options from which to choose, including stocks, bonds, mutual funds or CDs.
Your employer may contribute matching funds to your 401(k) plan. For example, your employer may match 50% of your contribution for any amount up to 5% of your compensation. That means an additional 50% contribution on the first 5% you contribute to your plan. That's also why 401(k)s are so highly recommended by financial advisors.
Contributions made to a 401(k) should reduce your current income taxes as well. You do defer paying income tax on the contributions you make. Likewise, the earnings in your 401(k) grow tax-deferred until the money is withdrawn. Income tax is due when the money is withdrawn. If you withdraw money before you turn 59-1/2, however, you may also be subject to a 10% IRS penalty. While withdrawals are generally not permitted, certain 401(k) plans may permit withdrawals for "hardship" reasons, such as medical emergencies or college tuition. You do pay income tax on the amount withdrawn, and a 20% mandatory withholding generally is required from the distribution. Moreover, the hardship distribution may also be subject to the 10% IRS penalty.
403(b) Tax Sheltered Annuities (TSAs). Similar to a 401(k) plan, TSAs are retirement plans for nonprofit organizations such as schools, hospitals or social service agencies. These plans allow you to set aside a portion of your pay on a pretax basis and the money invested in a TSA grows free from taxation until such time as you withdraw the money. Withdrawing money from your 403(b) plan before age 59-1/2 is generally prohibited. But there are exceptions. Certain 403(b) plans permit hardship exceptions such as purchase of a primary residence or college tuition. If you qualify for a hardship withdrawal, you will still pay a 10% early withdrawal penalty plus regular taxes. The maximum amount you can contribute to a TSA is determined by how much you make, how long you've worked for your current employer and the amount you contributed in prior years. The general rule is the you can contribute up to $9,500 a year.
Individual Retirement Arrangements (IRAs). IRAs were established to encourage people to save for retirement. Subject to certain limitations, an individual generally may be able to contribute the lesser of $2,000 or 100% of your compensation to an IRA, and the earnings grow tax deferred until you begin withdrawals. Your annual contribution may also be fully or partially deductible, depending on your income level and whether you are covered by another retirement plan. As with 401(k) and 403(b) plans, you may be subject to a 10% IRS penalty for premature withdrawals (generally before the age of 59-1/2), in addition to the income tax. You may have a choice of investment options for your IRA, including stocks, bonds, mutual funds or CDs. Keep in mind that your money must be in an IRA-approved account and that it must be designated as an IRA.
Keogh Plans. Keoghs are retirement plans for people who are self-employed. Usually a maximum of 25% of your net income (or a maximum of $30,000) can be contributed to these plans on a tax-deferred basis. Keoghs are more complicated than an IRA, 401(k) or 403(b), so get tax advice before setting up a plan.
Stocks. When you buy stocks, you acquire shares of a company's assets. If the company does well, you may receive periodic dividends and/or be able to sell your stock at a profit. If the company does poorly, the stock price may fall and you could lose some or all of the money you invested.
Bonds. When you purchase a bond, you are essentially loaning money to a corporation, the U.S. government or a local government for a certain period of time, called a term. The bond certificate promises that the issuing entity will repay you on a specified date with a fixed rate of interest. Bond terms can range from a few months to 30 years.
Bonds are generally considered a safer investment than stocks because bondholders are paid before stockholders if a company becomes insolvent. Independent bond-rating agencies such as Standard & Poor's and Moody's rate the likelihood that any given bond will default. You can find bond ratings in each agency's publications at your local library.
Although there are no penalties for selling a bond before the end of its term, the value of the bond is subject to interest rate fluctuations. If interest rates have risen since you bought your bond, you may have to sell it at less than face value. It is also possible that the bond's yield will turn out to be less than the rate inflation. Some of the bonds available include:
- Savings bonds, Treasury bills (commonly called T-bills) and other securities issued by the U.S. government.
- Zero coupon bonds, which are similar to savings bonds. No periodic payments of interest are made. The bonds are bought at a discount and are worth their face value upon maturity.
- Municipal bonds (munis), which are sold by states, cities and other local governments. They are often tax exempt, which means you will pay no taxes on the interest earned.
- Insured bonds, which are less risky but generally pay lower interest rates because of the protection.
- Convertible bonds, which can be converted into stock.
- High-yield bonds, commonly referred to as junk bonds, which are issued by corporations or governments with low ratings. There are very risky.
Mutual Funds. A mutual fund is generally a professionally managed pool of money from a group of investors. A mutual fund manager invests your funds in securities, including stocks and bonds, money market instruments or some combination and decides the best time to buy and sell. By pooling your resources with other investors in a mutual fund, you can diversify even a small investment over a wide spectrum, which should reduce risk.
There are many types of mutual funds with varying degrees of risk. Most mutual funds charge fees, and you often pay income tax on your profits. Tax rules can be complicated, requiring professional advice.
Annuities. Annuities may be deferred or immediate. Both are financial contracts you make with an insurance company. However, a deferred annuity helps you accumulate money for retirement, while an immediate annuity provides you with a steady stream of retirement income in return for your money.
With a deferred annuity you put money in, and over time it accrues income and interest. The payout occurs at some later date, when you receive a steady stream of payments to supplement your other income. The contributions you make to an non-qualified annuity are not tax-deductible. Contributions to a qualified annuity that is funding an IRA, 401(k), 403(b) or other qualified plan may be before tax or tax deductible. However, taxes on the earnings in the annuity are deferred until you begin receiving payments. Because annuities are generally administered by insurance companies, they can be set up to include life insurance benefits, such as a death benefit to a surviving spouse.
Immediate annuities are usually purchased with one lump sum payment and then begin an immediate payout. You receive payment on a monthly or other regular basis, giving you needed income. You can generally choose to have payouts guaranteed by the issuer for as long as you live or choose form a number of other payment options.
Both deferred and immediate annuities can be either fixed or variable. The issuer of a fixed annuity guarantees a fixed rate of interest (deferred) or a fixed payment (immediate). Although you are protected from any downturn in the market, you won't benefit from any upswings. A variable annuity can earn a flexible rate (deferred) or pay a variable payment (immediate) depending on the performance of the underlying investment options you choose. Variable annuities are designed to accumulate money or provide an income stream that hopefully will rise over time to keep pace with inflation. However, there is some risk involved if the market does poorly during the time your money is invested.
Annuities can be a complicated investment, so discuss then with a qualified financial advisor to make sure you understand all the options and make the smartest decisions for your financial needs.
Your home. Your home may be the largest investment you will make during your lifetime. The market value of your home is determined by such things as its condition, the neighborhood, school districts, square footage of the house and house style.
Other Ways to Protect Your Financial Future
Social Security. You've paid into it most of your life, so don't forget to include it in your financial planning. The income you receive when you turn 65 is based on the average of your 35 highest salary years. You also can collect 80% of your benefit at age 62. If you die, your spouse may be entitled to your benefits. The age at which you can collect full benefits is currently scheduled to increase gradually to 67. You can check the record of your earnings and get a statement of your anticipated benefits by calling Social Security at 800-772-1213.
Life Insurance. Life insurance can protect your loved ones in the event of your death. It's important if you are married and even more important if you have children. There are several types of life insurance:
Term Life insurance pays a fixed amount of money to your beneficiary if you die during the term of the policy. The cost of premiums increases as you get older.
Whole Life insurance is permanent insurance that provides a death benefit that is guaranteed for the insured's life as long as premiums are paid. Participating policies may pay dividends that can increase the policy's cash value but they are not guaranteed.
Universal life insurance is considered a variation of whole life insurance with more flexibility. Within limits, the policy owner determines the amount and frequency of his or her premium payments and is permitted to adjust the policy face amount up or down to reflect changes in his or her needs. As premiums are paid and cash values accumulate, interest is credited to the policy's accumulation fund.
Variable life insurance is similar to universal life in that there is flexibility in connection with premium payments and death benefits. However, with variable life, premium payments are held in separate accounts and the policy owner chooses how the cash value will be invested. Consequently, such a policy's cash value will fluctuate with the performance of the chosen investment portfolios.
Health Insurance. Health coverage protects you in case of sickness or injury. Without it you run the risk of being financially wiped out by just one serious illness or accident. Most people receive subsidized health benefits through their employer, but coverage can also be purchased as an individual.
Disability Insurance. This probably one of the most overlooked forms of insurance for working-age people. Disability coverage replaces a portion of your income when you can't work because of illness or injury. Most policies replace 60% to 80% of your income. (You also may receive income from Social Security for certain disabilities, or from Workers Compensation if you are injured on the job.) If your employer provides a 60% disability policy, you might want to consider a supplemental policy covering 20% of your income.
Long Term Care Insurance. Long Term Care insurance is designed to help pay for nursing home care or home health care expenses. This fast growing type of insurance can protect you and your assets against the high cost of long-term care. Most policies pay benefits when long term care is prescribed by a physician as medically necessary or when someone can no longer physically or mentally take care of basic needs.
Homeowners Insurance. Homeowners coverage protects your financial investment in your home. It provides compensation for damages to your home and its contents, and it may protect you from financial liability if someone is injured on your property. The extent and amount of coverage needed depends on your situation, but if you can afford it, it is wise to insure your home for 100% of its replacement cost.
Auto Insurance. Auto insurance is more than a matter of insuring your vehicle for loss or repairs after an accident. It is a financial safety net that can help you offset the cost of bodily injuries to yourself or others, lost wages due to injury, and law suits brought against you as the result of an accident. Most states require the purchase of basic coverage and then you determine the additional insurance you need.
Estate Planning. Another way to safeguard your family's financial future is through estate planning. Generally, estate planning includes inventorying your assets and making a will or establishing a trust, with an emphasis on minimizing taxes. Estate planning is very complex and subject to changing laws. You may want to seek professional advice.
Do You Need a Financial Advisor?
If you need help with your blueprint for the future, you may want to consult a financial advisor, who can give you advice on everything from budgeting, taxes, retirement and estate planning to investments, insurance and real estate.
Some financial advisors charge you no fee; instead they make a commission on the financial vehicles that they sell you. Other advisors are fee-only, which means they charge you for their services but do not make a commission on what they are selling you. Still other charge a fee for providing the financial plan and may also receive commissions if they sell you any products.
Shop around and talk to several financial advisors. Be sure you feel comfortable with them and can understand their explanations. Ask for their credentials. One credential is a Certified Financial Planner (CFP) designation, which means the planner has taken a series of courses in financial planning, has passed an exam, has at least three years experience and takes continuing education courses each year. Other designations include Chartered Financial Consultant (ChFC), Certified Public Accountant (CPA) and Registered Financial Planner (RFP). Investment advisors and broker/dealers may also be regulated by the state. The Securities and Exchange (SEC) regulates broker/dealer and some investment advisors. Individuals associated with these firms generally must pass certain licensing examinations.
Do You Need a Broker?
If you plan to buy stocks and bonds as part of your investment portfolio, you should know that most must be purchased through a broker. Brokers are licensed professionals who monitor investments and give advice on stock purchases. They charge fees for their serviceseither as a percentage of your portfolio or a fee per transaction. They may also make commissions from some of the investments they sell.
Discount brokerage houses have lower fees. However, they employ salaried brokers who are primarily order takers and do not give investment advice. If you use a discount broker, be sure you are well-informed about stocks and can make your own investment decisions.
If you do decide to use a full service broker, be prepared:
- Shop around for the person who is right for you. Interview three or four brokers.
- Ask each broker about his or her investment strategy and commission schedule.
- Be sure you understand the fees you will pay for opening, maintaining and closing an account.
- Make sure the broker is part of the Securities Investor Protection Corporation (SIPC). The SIPC is a nonprofit corporation that can protect your interests up to $500,000 should your broker become insolvent.
- Call the National Association of Securities Dealers' (NASD) toll-free hotline at 1-800-289-9999. The NASD can tell you if there has been any disciplinary action against a particular brokerage firm or sales representative.
Shop around. Compare the products and fees of various banks, financial planners, brokers and investment houses.
Ask questions. All investments carry some degree of risk, so you should fully understand what you are getting into. Ask for a written explanation of products, operations and fees.
Educate yourself. Spend some time at your local library gathering information. Read investment and financial publications such as the Wall Street Journal, Barron's Investor's Business Daily, Money Smart Money, Forbes and the monthly Standard & Poor's Stock Reports. Moody's Investors Service also has manuals that contain financial information on thousands of companies.
Get advice. A financial advisor, your accountant or tax advisor are all good sources of information to help you understand the choices you are making and what your risks will be. Make sure any salesperson or advisor understands your goals and how much risk you are willing to assume.
Don't buy stocks or other investments pitched to you over the telephone. And never let a salesperson pressure you into acting immediately.
Don't put all your eggs in one basket. Diversificationdistributing your money across different types of investmentsis the key to sound investing.
Never invest in a product you don't full understand.
Finally, reevaluate your financial plan regularly. Also stop and review your plan whenever you marry, divorce, have a child, buy a home or retire.
The Basics of Investing
Gerald Krefetz, Dearborn Financial Publishing $16.95
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PAMPHLETS FROM THE FEDERAL GOVERNMENT
The quarterly Consumer Information Center Catalog lists more than 200 helpful federal publications. For your free copy write Consumer Information Catalog, Pueblo, CO 81009, call 719-948-4000 or find the catalog on the Net- http://www.pueblo.gsa.gov
If you're on the Net, check us out. We're part of MetLife Online (http://www.lifeadvice.com).
And for interesting facts-past, present and future-on topics including medical care costs and utilization, life expectancy and how well we will live in the next millennium, check out Statistical Bulletin, a quarterly publication produced by MetLife, online at http://www.statbull.com.
This pamphlet, as well as any recommeded reading and reference materials mentioned, is for general informational purposes only. It is issued as a public service and is not a substitute for obtaining professional advice from a qualified person, firm or corporation. Consult the appropriate professional advisor for more complete and up-to-the-minute information.
Copyright 1995, 1996 Metropolitan Life Insurance
All Rights Reserved
Schultz PEANUTS Copyright United Feature Syndicate, Inc.
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