By Kate Ashford, Carolyn Bigda, George Mannes, Walter ...

[Pages:41]RULES TO GROW RICH (Edited)

By Kate Ashford, Carolyn Bigda, George Mannes, Walter Updegrave and Penelope Wang Money Magazine, November 2006

Tough financial questions come your way all the time. How much do I need to save? Should I refinance my mortgage? It sure would be nice to have an easy guide on hand for those moments. Now you do.

PLANNING

1. If you're not saving 10% of your salary, you aren't saving enough. The earlier you start saving, the less you'll need to set aside every year to meet your goals. That's because you allow your money more time to grow -- the gains on your invested savings will build on the prior year's gains. That's the power of compounding, and it's the best way to accumulate wealth. Saving at least 10% of your annual salary for retirement is recommended, but the older you start saving, the more you'll need to save. If you start at 50, you may need to put away 30% a year and still postpone retirement by a few years.

2. Keep three months' worth of living expenses in a bank savings account or a high-yield moneymarket fund for emergencies. If you have kids or rely on one income, make it six months'. An emergency fund is a hassle to build, but you'll be glad you did next time your transmission sputters or your boss hands you a pink slip. Besides curbing spending where you can and setting aside a small amount of your pay every two weeks, there are several ways to build your cash cushion. Some sources to draw on: (1) A bonus or financial gift from a relative; (2) Money you get back from a flexible spending account, a transportation reimbursement account or an insurance claim. (3) An extra paycheck. If you're paid every two weeks, you'll get 26 paychecks a year. So in some months you'll get three instead of two. If your fixed monthly expenses don't change, you might be able to set aside one paycheck a year.

3. Aim to accumulate enough money to pay for a third of your kids' college costs. You can borrow the rest or use some of your income to help out when your child is in college. Most parents have trouble saving enough for their retirement. But they still want to help their children pay for college. In the struggle to feed your 401(k) and your child's 529, the 401(k) should win out. That's because there are no scholarships for retirement and your children have a lot of funding options, including financial aid, loans and a job. They also can go to an excellent, but less expensive school. And when they're in college, if you have some extra cash after contributing to your retirement accounts, you can help them pay some of their expenses with it.

4. You need enough life insurance to replace at least five years of your salary ? as much as 10 years if you have several young children or significant debts. Life insurance lets surviving family members maintain something close to the standard of living they enjoyed prior to you or your spouse's death. Stay-at-home spouses also should have life insurance, since they do all sorts of things that you would need to pay someone else to do in their absence. There are two types of policies: Cash-value: These cover you for your entire life and includes an investment component. Term: These cover you for a specific period of time and provide a death benefit only. For most people the choice is a no-brainer - the premiums on a term policy are much lower.

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5. When you buy insurance, choose the highest deductible you can afford. It's the easiest way to lower your premium. It's the open secret of the insurance game: File a claim, your premiums go up. For that reason, it's in your interest ? as much as possible ? to shoulder small damages out of pocket. For home insurance, raising your deductible from $500 to $1,000 could save you 25% on premiums, according to the Insurance Information Institute

6. The best way to improve your credit score is to pay bills on time and to borrow no more than 30% of your available credit. It also helps to pay off debt rather than moving it around because the ratio of your credit card balance to your credit limit is key. Say you owe a total of $2,000 on four credit cards, each of which has a $2,000 limit. Your total credit limit is $8,000, of which your total balance ($2,000) accounts for 25%. If you transfer all your balances to two cards and cancel the other two, your total credit limit is reduced to $4,000, and your $2,000 balance now accounts for 50% of that limit. Also, don't open new accounts when applying for a loan if possible.

INVESTING

7. All else being equal, the best place to invest is a 401(k). Once you've earned the full company match, max out a Roth IRA. Still have money to invest? Put more in your 401(k) or a traditional IRA. One of the keys to saving for the long run is keeping as much money as possible shielded from taxes. A 401(k) gives you that and more: You also get an immediate tax break, because contributions come out of your paycheck before taxes are withheld. And there's the possibility of a matching contribution from your employer ? that's free money. The federal limit on annual contributions has been increasing gradually, and is $15,000 in 2006. If you're 50 or older, you may contribute an additional $5,000. With a Roth IRA, you get no immediate tax break, but withdrawals in retirement will be tax-free. You can make at least a partial contribution to a Roth if your modified adjusted gross income is less than $110,000, if you're single, or less than $160,000, if you're married and filing jointly.

8. To figure out what percentage of your money should be in stocks, subtract your age from 120. Since 1926, stocks have returned an annual average of 10.5 percent, long-term government bonds returned 5.1 percent, and "cash," measured by Treasury bills and other short-term investments, has returned just 3.1 percent. In other words, if you're investing for the long-term, stocks are the place to be. But in the short term, the stock market can be downright dangerous, with much more severe drops than the bond market has. That's where this rule comes in - the younger you are, the more time you have to recover from stock-market crashes. As you get older, you should gradually move money out of stocks and into bonds.

9. Invest no more than 10% of your portfolio in your company stock - or any single company's stock, for that matter. In a bear market, it's tough to find a safe-haven ? a lot of the stocks in your portfolio will be sinking too. But don't compound the risk by holding too much in any one stock. The most recent dramatic example of just how serious this "specific-stock" risk can be is Enron, which imploded after its executives allegedly engaged in various acts of malfeasance. But a company with perfectly honest management might fall on hard times too. And if it's your employer's stock, you're in an even worse position ? not only will your portfolio be decimated, but your job could be at risk.

10. The most you should pay in annual fees for a mutual fund is 1% for a large-company stock fund, 1.3% for any other type of stock fund and 0.6% for a U.S. bond fund. Running a mutual fund isn't free ? companies have to pay for research, managers' salaries, and so on. Those costs are borne by the investors in the funds and get deducted from returns. A percentage point here and there may not sound like much, but a fund manager needs to pick a lot of great stocks to make up for those costs.

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11. Aim to build a retirement nest egg that is 25 times the annual investment income you need. So if you want $40,000 a year to supplement Social Security and a pension, you must save $1 million. This rule is based on the amount that you can safely withdraw from your nest egg in retirement. The single most effective thing you can do to ensure that your money will last is to start out with a low withdrawal rate of 4 percent, then raise that amount annually to compensate for a cost-of-living increase or inflation. The reason is that if a bear market hits early in retirement, an enormous loss can put such a big dent in the portfolio that it won't be able to recover in time to benefit when the market rebounds.

12. If you don't understand how an investment works, don't buy it. There is no shortage of investment products out there. In addition to stocks and bonds, there are exotic hedge funds and insurance products. Fortunately, you don't have to try and make sense out of them. In fact, you can construct a sensible portfolio with just two index mutual funds ? one stock and one bond. To reach your goals, you don't need to shoot for spectacular returns. Individual investors can outpace the market with moderately above-average returns in good times, as long as they don't lose too much money in bad times.

HOME AND MORTGAGE

13. It's worth refinancing your mortgage when you can cut your interest rate by at least one point. There are transaction costs and fees involved in any refinancing that must be either paid out of pocket or added to the mortgage principal. Some of those costs can be considerable. Title insurance can easily run into four figures and broker fees can be expensive as well. Like many things in life, timing is everything here. Is your job likely to relocate soon? Will you need a bigger house in the next couple of years? Unless you're planning to stay in the home for a while, the benefits of a lower monthly bill may not be worth the additional expenses that refinancing generates.

14. Spend no more than 2? times your income on a home. For a down payment, it's best to come up with at least 20%. Many buyers in recent years have stretched the limits of affordability, and have bypassed the traditional 20% down model. But make a smaller down payment, and most lenders will require you to have private mortgage insurance (PMI), which adds a minimum 0.5% of the loan amount to your mortgage payments, about $1,000 more a year on a $200,000 principal.

15. Your total housing payments should not exceed 28% of your gross income. Total debt payments should come in under 36%. These guidelines include payment on all loans, such as school and auto loans and credit card debt. Also remember to take into account other home-related expenses to judge a house's affordability. Property and school taxes, home insurance and energy costs and requirements can vary considerably around the nation. Try to estimate future maintenance costs and work them into your budget. Some homes, especially older ones, may require more regular upkeep than homes built with more modern materials. Roofs, siding and heating, cooling, plumbing, and electric services may have to be replaced within a few years of purchase.

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KENT FAMILY FINANCES

FACTS Ken and Kendra Kent have been married twelve years and have twin 4-year-old sons. Kendra earns $78,000 as a Walmart assistant manager and Ken is a stay-at-home dad. They give you the information on the next page about their finances.

PROBLEMS

1. Using the information in item (1) on h/o 5, determine which accounts are assets and liabilities and prepare a balance sheet in proper form as of April 30, 2007. The solution is on h/o 6.

2. Prepare an income statement for May, considering the following: (a) The payroll deductions are all expenses except the 401(k) contribution. The contribution reduces her net pay and cash and increases her 401(k) account balance by $100. One asset is increased and another asset is reduced by the same amount. As discussed on casebook page 5 below the income statement, these are balancing entries on the balance sheet; neither is an income nor an expense.

(b) All May expenditures are expenses except the principal payments on the loans and the $1,000 investment in the mutual fund. The loan payments reduce an asset (cash) and liabilities (the loan balances). The mutual fund investment reduces one asset (cash) and increases another asset (mutual fund investment). These are also balancing entries on the balance sheet and are not expenses.

The solution is on h/o 6.

3. Prepare a Balance Sheet as of May 31, 2007. All of the ending balances are in the facts except net worth. The following items affected net worth during the month: (a) net income for the month as shown on the income statement; (b) the increase in value of the mutual fund investment (not counting their additional investment). The solution is on h/o 7.

Additional Information Kendra read the income statement and balance sheets and could not determine what accounted for their increase in net worth. Accountants typically include a reconciliation of net worth in the financial statements so the reader of the statements can readily see the factors that increased (or decreased) net worth during the year. A Reconciliation appears below the Balance Sheet on h/o 7.

Kendra also asked why their cash balance increased less than their monthly income. She wants to know how the family spent their cash. The Cash Flow Statement on h/o 7 provides this information to her. We will discuss it in class.

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(1) Assets and Liabilities (FMV) (in alphabetical order)

401(k) retirement account car loan, current portion car loan, remaining balance checking account condominium credit card balance IRA account mortgage loan, current portion mortgage loan, remaining balance mutual fund net worth savings account Toyota

4/30/07

$12,500 317

12,018 4,000

235,000 3,178

42,000 1,449

172,666 22,000

150,872 10,000 15,000

5/31/07

$12,600 317

11,771 4,164

235,000 2,600

42,000 1,449

172,480 23,700 ?? 10,000 15,000

(2) May Income

Kendra's salary is $6,500 per month; the following amounts were deducted from her May paycheck:

FICA (6.2% of her salary) medicare tax (1.45% of her salary) Federal income tax withheld Illinois income tax withheld health insurance premium 401(k) contribution

total withheld

$ 403 94

500 195 105 100 1,397

(3) May Expenditures

car maintenance and gas clothing entertainment groceries miscellaneous utilities and telephone mortgage payment:

principal payment interest real estate tax

car payment: principal payment interest

mutual fund investment total expenditures

$186 863 517

1,566

246 70

316

$172 111 147 422 252 375

1,566

316 1,000 3,981

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FINANCIAL STATEMENTS

Assets

Current Assets Checking Account Savings Account Mutual Fund

Total Current Assets

Other Assets IRA 401(k) 2003 Toyota Condominium

Total Assets

KENT FAMILY BALANCE SHEET as of April 30, 2007

Liabilities and Net Worth

$ 4,000 10,000 22,000 36,000

Current Liabilities Credit Card Car Loan, current portion Mortgage Loan, current portion

Total Current Liabilities

$3,178 317

1,449 4,944

42,000 12,500 15,000 235,000

Other Liabilities Car Loan balance Mortgage Loan balance

Total Liabilities

12,018 172,666

189,628

$340,500

Net Worth

150,872

Total Liabilities and Net Worth $340,500

KENT FAMILY INCOME STATEMENT

For the month of May 2007 Revenues

Salary

$6,500

Expenses

Car Maintenance and Gas Clothing Entertainment Federal Withholding Tax FICA tax Groceries Health Insurance Illinois Income Tax Interest on Car Loan Interest on Mortgage Loan Medicare Tax Miscellaneous Real Estate Tax Utilities and Telephone

Total Expenses Surplus (Net Income)

$172 111 147 500 403 422 105 195 70 863 94 252 517 375

4,226

(4,226) $2,274

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KENT FAMILY BALANCE SHEET as of May 31, 2007

Assets

Liabilities and Net Worth

Current Assets Checking Account Savings Account Mutual Fund

Total Current Assets

$ 4,164 10,000 23,700 37,864

Current Liabilities Credit Card Car Loan, current portion Mortgage Loan, current portion

Total Current Liabilities

$ 2,600 317

1,449 4,366

Other Assets IRA 401(k) 2003 Toyota Condominium

42,000 12,600 15,000 235,000

Other Liabilities Car Loan balance Mortgage Loan balance

Total Liabilities

11,771 172,480

188,617

Net Worth

153,847

Total Assets

$342,464

Total Liabilities and Net Worth $342,464

KENT FAMILY RECONCILIATION OF NET WORTH for the month of May 2007

Additions to Net Worth May surplus Mutual fund appreciation Total Additions

$ 2,274 700

2,974

Reductions in Net Worth Increase in net worth

Add Net Worth on April 30, 2007 Equals Net Worth on May 31, 2007

0 2,974

150,872 $153,846

KENT FAMILY CASH FLOW STATEMENT for the month of May 2007

Sources of Cash May Surplus

$ 2,274

Uses of Cash

For Debt Payments Car Loan Principal Payment Mortgage Loan Principal Payment Reduction of Credit Card Balance

Cash Used for Debt Payments

$ 246 186 578

1,010

(1,010)

For Investments Investment in Mutual Fund 401(k) contribution

Cash Used for Investments Increase in Cash

1,000 100

1,100

(1,100) $164

Add Cash on April 30, 2007 Equals Cash on May 31, 2007

4,000 $4,164

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TECHNICAL ANALYSIS

The following statement about technical analysis and the chart at the bottom of the page appears in An Introduction to Technical Analysis at I will discuss the chart briefly in class.

Technical analysts consider the market to be 80% psychological and 20% logical. Fundamental analysts consider the market to be 20% psychological and 80% logical. Psychological or logical may be open for debate, but there is no questioning the current price of a security. After all, it is available for all to see and nobody doubts its legitimacy. The price set by the market reflects the sum knowledge of all participants, and we are not dealing with lightweights here. These participants have considered (discounted) everything under the sun and settled on a price to buy or sell. These are the forces of supply and demand at work. By examining price action to determine which force is prevailing, technical analysis focuses directly on the bottom line: What is the price? Where has it been? Where is it going?

Even though there are some universal principles and rules that can be applied, it must be remembered that technical analysis is more an art form than a science. As an art form, it is subject to interpretation. However, it is also flexible in its approach and each investor should use only that which suits his or her style. Developing a style takes time, effort and dedication, but the rewards can be significant.

? resistance (horizontal line) ? support (horizontal line)

1 Do not look at this material unless you are curious; it is highly technical, even for an introduction. To get to the introduction, click Overview in the Chart School Table of Contents, then click Technical Analysis under "More Articles for New Chartists."

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