Читать книгу The Handy Investing Answer Book - Paul A Tucci - Страница 13
ОглавлениеWhat is “saving”?
Saving, or savings, has many definitions in the English-speaking world. But most definitions describe saving as the act of putting aside money, after all consumption expenditures, for future use. Some experts add to the definition that savings may be more liquid and accessible than investments, which may not be immediately accessible.
What influences my ability to save?
Among many variables, the most basic influence is your preference, belief, and ultimately your decision to do without or abstain from present expenditures in order to have the ability to use this money at some time in the future. You should understand or have a goal in mind, and then make adjustments in current expenditures in order to meet your goals.
Why should I save my money?
Many people save money in order to attain certain goals. Some of the most widely accepted reasons to save money include: having extra money in order to invest regularly; accumulating money in case of an emergency (usually three to six months of living expenses in the form of cash); deferring on paying taxes by using before-tax income and employer matching funds (in an IRA, 401(k) or other retirement account); putting away money in order to purchase a principal residence; saving for vacations, to purchase cars, or unexpected medical expenses; and to fund your current or future educational expenses. Before you begin investing, you should have your emergency funds set aside, and should exclude these sums from what you will ultimately use for your investments.
What are some strategies to help me save money?
It is important to understand that the act of setting aside just a tiny amount of money on a regular basis quickly multiplies. If you save only one dollar per day over the course of a year, with even a fraction paid in interest to you, it will result in helping you achieve some of your financial goals. But it is not necessarily the amount that you ultimately save. It is having the financial discipline to stick to your plan of accumulating money that guarantees your success over time.
What are some other strategies to assist us in saving money?
Some of the best strategies employed to assist us in saving money include: knowing where you are in terms of our income/expenses and net worth today, and creating a goal with a time frame of where you wish to be. Caring about saving even small amounts gives you the practice and trains you to have the discipline to save and care about larger amounts. The very act of keeping track of our spending will cause many people to begin to see how they can cut their expenses, by not purchasing on impulse, comparison shopping for lower prices, decreasing the usage of credit/debit cards, and creating and sticking to a monthly or weekly expense budget.
Why should I get in the habit of paying myself first?
In light of everything written above, it is important to create the behavior of paying yourself first. This means setting aside money from your normal weekly or monthly expenses that you use only for your savings and investments. Even if it is a small amount, it is important to set this money aside first so that it is not redirected to meet other expenses.
What is a “cash cushion”?
A cash cushion is a special savings that you may cover three months to one year of your expenses. The amount you need to accumulate depends on knowing your current expenses. The amount you need to save is also dependent on your ability to find another job should you abruptly change employers, which may be several months, or even years. So it is good to plan accordingly.
Don’t have all your money tied up in bonds and stocks; keep some in cash for emergencies so that you have it available for unexpected investment opportunities.
Why else should I have a portion of my portfolio in cash?
Many experts believe that holding a certain percentage of your portfolio in cash has many benefits for investors. Although it is important always to have a certain amount of cash on hand for emergencies or unplanned expenses, you should also have cash on hand to acquire investments when the opportunity arrives, so you do not have to sell other successful, longer-term positions—and pay the capital gains taxes—in order to purchase more investments. You can simply use cash. Other experts believe in holding a certain percentage of your portfolio in cash as a way to preserve your capital in a down market. Cash also increases value over time during periods of deflation. When purchasing a house or other real estate investment property, using cash to increase your down payment may enable you to obtain better terms on your loan and to make a more attractive offer for the property.
Why else is cash important to my portfolio as an individual investor?
According to experts at The Wall Street Journal, cash plays a very important role for all of our portfolios at different stages in our financial lives. First and foremost, by preserving capital and insulating it from the downward trend of a market, you have more money available to invest later. There is also a big opportunity cost that must be considered when you think of selling off investments—instead of using cash—in order to acquire new investments. By selling prematurely, you may not realize the gains you wished to make, and may actually incur losses. Many experts believe that if you need cash to make big-ticket purchases such as cars or houses, it is better to hold this money in the form of cash than to invest the money and have to sell the investment after poor performance, or at a loss, after a relatively short period of time. One expert cited the fact that many central banks have priced cash at levels approaching zero (percent interest), creating volatility in the prices of other investment vehicles. So it is best to have a strategy for the proper allocation of cash within your portfolio.
How can I get out of debt?
The most important step to getting out of debt is to understand what behaviors or circumstances caused the debt to begin with, and then focus first on changing those behaviors. This means that if you have incurred a lot of credit card debt because of undisciplined spending habits, you must immediately attack the root cause of the debt in order to reduce it. If you incurred a debt because you obtained a mortgage for more house than you can afford, you must find a way to sell the house without incurring a loss, and purchase a smaller, more affordable house.
What is the second most important step to getting out of debt?
The second step is to save this money you used to pay off loans and credit cards, and to pay special attention not to take on any more debt going forward. In other words, take the money you used to pay for your monthly credit card bill or car loan, and put it directly into a savings account, spending nothing on your credit card going forward. And remember to pay yourself first.
Is there any priority I should consider when paying down debt?
Yes. You should first pay off your highest interest loans or credit obligations. Credit cards are usually a high-interest rate credit obligation. So you must pay as much of your credit card balance, plus the interest on the balance, each month until the balance reaches zero. If you plan it out, and pay a certain amount each month, without taking on any new debt, you will see a light at the end of the tunnel. Pay a consistent amount each month, as much as you can afford. If you feel you can pay off more, because of a wage hike or pay increase at work, use that extra cash to reduce your debt.
What is the average percentage of a typical American’s gross income that is used for mortgage and consumer debt payments each month?
According to the Federal Reserve, Americans spend about 11.89% of their monthly gross income on mortgage and consumer debt payments. Homeowners (those who specifically purchased homes with mortgages) spend about 15.27% of their monthly gross income.
Why is debt management important to an investor?
There are many reasons why managing your debt is an important component of investing. All debts carry some sort of obligation and fee associated with the use of the money. In addition to the principal that needs to be repaid by a certain date, so do all fees and interest on the debt. In order to repay this debt, money that would normally be invested from your current earnings must be redirected to pay off this debt. So you lose both the current earnings and the potential to earn more on this money if it were to be invested.
What is the hidden cost of debt to an individual investor?
The hidden cost of debt to the individual investor is the opportunity cost or lost opportunity of using money that could have been invested earning some return, in order to pay off debt and interest charges.
What are some warning signs that my debt may be a problem?
According to the U.S. Department of the Treasury, many signs that help evaluate the health of a financial institution are relevant to individuals as well. Among these warning signs are failure to file taxes and other financial statements in a timely fashion; slowing or decrease in one’s income over time; deterioration of our available cash; decline in our assets as percentage of our total assets (e.g., the value of our principal residence and its equity declines); our debt increases; and keeping poor financial records (not knowing our current financial situation).
What is a front-end ratio?
A front-end ratio is calculated by dividing your total monthly housing cost by your gross monthly income.
What is a back-end ratio?
A back-end ratio is calculated by dividing your total monthly housing cost plus all other debts by your monthly gross income.
Why are front- and back-end ratios important?
Front- and back-end ratios are important because they indicate to lenders and creditors how much debt you can afford.
Why use a debt-to-income ratio?
In order to prevent people from buying a house they may not be able to afford, lenders will establish how much debt you can handle, and use this as one factor to determine your loan amount.
How much debt can I afford?
The amount of debt you can afford depends roughly on your front-end and back-end ratios, or debt-to-income ratio. Although the use of the ratios differs from lender to lender, on average your front-end ratio should never exceed 28%, and your back-end ratio should never exceed 36%.
What if my debt-to-income ratios are higher than average, and a lender still will give me a loan?
Just because a lender qualifies you for a loan, that does not mean you should take it. The lender may not care about your long-term financial success. Having a worse than average debt-to-income ratio means trouble on the horizon if not corrected, and should signal action on your part to reduce the debt.
What is “debt consolidation”?
Debt consolidation is the act of taking out a loan in order to pay off several others. Assume that you have credit card debt carrying interest rates as high as 20%, and you have a home mortgage (with some equity in your house) with an interest rate of 5% for 30 years. In a consolidation, you take out a home equity loan (which charges a smaller interest rate) for the value of your high-interest credit card debt, and then make payments on your equity loan until the debt is repaid.
What is a “debt consolidator”?
A debt consolidator provides a service wherein he looks at a client’s debt situation and creates a strategy designed to pay off the debt, in exchange for a fee.
What is the trouble with debt consolidators?
According to many experts, the main trouble with the debt consolidation industry is that it is a largely unregulated business, and many companies that promise unsuspecting families assistance end up taking fees and leaving town. They may promise to work with banks to arrange for your loans, and in the end may take what little money you have.
Be careful whom you choose to assist you with debt consolidation. The industry is barely regulated by the government, and you might get an unscrupulous “debt consolidator” who will leave you high and dry.
How do I check the credibility of a debt consolidation company?
It is important to check with your state’s attorney general’s office, as well as the Better Business Bureau, before seeking the assistance of a debt consolidator. You may also search online to see if there have been any negative comments or stories written about the company. Check with the company’s references to see if the company is legitimate. Also, contact the local chamber of commerce in the city in which the company is located to see if there are any complaints about it. If you sense any time pressure from a pushy debt consolidation representative, find another company. This is a sign that the business may not be legitimate.
How might I locate the name of a legitimate debt consolidator?
To find the name of a legitimate debt consolidation company, many experts suggest you visit the National Foundation for Credit Counseling website to identify registered members. After selecting a credit counselor, you may then meet to identify a reputable debt consolidator, if it is recommended as a strategy.
If I have a much lower interest rate for my old credit card debt, by using the equity I have in my home, what else could be wrong with debt consolidation?
After you consolidate all of your debts into one loan, it may be amortized over many years. Because the debt is now spread out over a long period of time, if you make the minimum payments each month, you may pay much more in interest to retire the debt.
What steps can I take to minimize my credit card and other debts?
According to experts at the Federal Trade Commission (FTC), the first step to liberating yourself from credit card debt is to get a realistic picture of your income and your expenses. You may divide your expenses into two categories: fixed expenses, meaning those expenses that don’t really change from month to month, such as rent or mortgages; and variable expenses, items that may change from time to time, such as utilities, food, and entertainment. If you have received notices from creditors, you should contact them directly and ask to arrange for a way to reduce your monthly payment to a reasonable level. Stop using your credit cards so that you may begin to improve your financial picture. The FTC notes that your debt can be secured or unsecured. When debt is secured, ownership is not conveyed until all payments are made, such as your house or car. If you stop making payments, you may lose that asset. When debt is unsecured, it is granted with no ties to any particular asset, such as credit cards, signature loans, and medical bills. But most lenders are willing to work with you to create a more reasonable payment plan, so you should speak with your creditor when you have a problem. Creditors—especially credit card companies—may change the terms of your agreement and reduce your annual percentage rate to a more reasonable level.
How does credit card debt affect older Americans?
According to a recent report by the AARP (formerly American Association of Retired Persons), older Americans (those over age 50) carry more credit card debt than younger Americans. Half of these older Americans carry some medical-related bills on their credit cards, especially prescription bills and dental expenses. Forty-nine percent of older Americans reported that car repairs also contributed to their credit card debt; 38% stated that home repairs contributed to their overall credit card debt; 34% rely on using credit cards to pay for basic living expenses such as rent/mortgage payments, food, and utilities, because they lack the cash in their checking and savings accounts to pay for them; 25% of older Americans say that a loss of employment contributed to their credit card debt; 18% drew upon retirement funds to pay down debt; and 23% got into debt in order to help other family members.
How much total debt should I have?
To be safe financially, the monthly payments on all your debt should be less than 36% of your monthly gross income.
What steps can I take to increase my available funds so that I may invest?
The most important step to increasing your funds available for investing is to understand your true financial picture by taking into account your income from all sources, your complete debt picture (including all loans, credit cards, and other obligations), understanding your daily or monthly expenses, paying special attention to areas where you can eliminate or reduce these expenses, and directing this money to investments that earn a return.
When is taking on debt a good idea?
Increasing your debt may be beneficial if the loaned capital is put to good use, as in purchasing real property (that may be valuable or increase in value over time), by obtaining an educational loan that may increase your earning power in the future, and by using a home equity loan to improve your home to increase its resale value at some future time. Additionally, if you take on low-interest debt for such valuable activities, you free up your cash reserves to do other things such as investing. In the case of mortgage loans, the interest you pay on that loan is deductible against your reported income when you file your tax return each year.
What are the next steps to increase my available funds so that I may invest?
You should pay off all higher-interest rate debts first, since those debts use so much of your income. You should stop using credit cards in favor of cash, and be sure to pay off the balance of what you used on a credit card in full each month, so that you do not take on any more debt. And never pay only the minimum amount that credit cards request, as this will keep you in the debt cycle for a very long time.
How can I calculate how much credit card debt I can afford?
The easiest answer to this is zero. Credit cards should not be used as a way to finance purchasing anything, because the interest rate and finance charges are too high ever to justify it. If you were to use a card to buy an expensive TV, it will end up costing you twice the original price if you use a credit card and pay the monthly minimum payment and “finance” the purchase. Credit cards should only be used to make purchases for an amount you can pay off entirely each month.
How long does it take to resolve a credit card issue?
According to a survey by Javelin Strategy & Research, the average time to resolve a credit card fraud issue dropped 30% to 21 hours.
What are the best credit cards?
According to a 2010 J.D. Power survey of card holders, the best cards in terms of overall customer satisfaction are: American Express, Discover, U.S. Bank, Wells Fargo, Chase, Barclaycard, Bank of America, Capital One, Citi, and HSBC.
If I have a balance of only $1,000 on my credit card, with a 15% interest rate, and I only make the minimum payment of $15 each month, how long will it take me to pay off the balance, and how much will it really cost me in the end?
By paying only the minimum due on a credit card balance in the example above, it would take about 12 years to pay it off, and end up costing you more than $2,000.
What are the first steps to eliminate credit card debt?
The first step to eliminate credit card debt is to destroy your card. This will prevent you from adding further debt onto the card.
What are additional steps that I can take?.
The next step is to analyze how much you can afford to pay each month, and make it a priority to pay both the monthly payment and a part of the balance each month so that you may reduce the balance that is accruing interest and fees as fast as possible. Never believe that you can get out of debt by paying the minimum monthly payment on your credit card.
What is the average amount of credit card debt for a typical American family?
Approximately $15,788.
How many credit cards exist in the United States?
There are 609.8 million cards being used in the United States.
What is the average number of cards owned by each person?
The average number of cards that people carry is 3.5.
How many credit cards should I have?
You probably should have not more than two cards, in case you absolutely need to use one, and have one as a backup in case your primary card does not work.
When in deep credit card debt, the first step to take is to cut your cards so you won’t use them anymore.
Why use credit cards?
Credit cards give you access to cash immediately so that you may pay for many different expenses, from food to utility bills, without having to carry large amounts of cash. Consumers only have to write one check each month to cover many monthly expenses. Some credit cards allow consumers to earn points for using the card, which are later redeemable for products or services.
What is the first rule of using credit cards?
Do not use a credit card unless you can pay off the balance in full each month.
Why pay off the balance each month?
You want to pay off your balance each month to avoid paying interest on your balance, which can be exorbitant, depending on your credit history and interest rate calculation.
What does my credit history have to do with my credit card interest rate?
Card issuers look at your credit history to see what kind of risk you might be to them, what chance you will default, and how much debt you can handle. Depending on this, the card issuers decide on an interest rate that will cover the costs of defaulting accounts, fraud, and profit, and this number is the rate that they then charge the consumer.
So if I have a great credit rating, I might get a card with better terms?
Yes, if you are less of a credit risk, have a higher steady income, and own other assets, you will likely be approved for a lower-interest-rate credit card.
What is a “mortgage”?
A mortgage is the amount of money loaned from a bank for the agreed-upon price of a house that is financed by the bank in the form of a loan to the buyer, less down payment and closing costs at the closing of the transaction.
What about interest rates and their effect on housing prices?
The higher the interest rate for a mortgage, the more the demand for mortgages is suppressed, since buying a house becomes more unaffordable to many potential buyers. As interest rates or the price of money decreases, the more demand there is from buyers, and this makes prices more buoyant over time.
How low are today’s mortgage interest rates?
Interest rates on loans for houses are lower than nearly any time in the past 50 years. They may go even lower before we see a bottom in the interest rates for mortgage loans.
Why are there fewer potential buyers for houses today?
There are fewer potential buyers for houses because many fear employment loss, an inability to obtain a loan, an inability to manage current expenses, and expectations that prices will further decline. Potential buyers would rather wait out a decline in price than jump in now. Sellers are holding out for the best price because they need to pay off their mortgages, and pull as much value from their house as possible in order to buy another house.
While mortgage rates have risen slightly in 2014, they are still around 4.5% for a 30-year fixed mortgage, which is a great deal for investors and home buyers.
What does the term “underwater on a mortgage” mean?
When you are “underwater on a mortgage,” you cannot sell your current home because you owe more on the balance of your home mortgage than you can make when you sell the house today.
How does increasing my down payment help protect me from going “underwater”?
Increasing your down payment provides some protection to you because if you put more money down to purchase the house, you owe less money on the mortgage in the future, and when it is time to sell, you will be able to sell at the market price with less risk of owing more than the house is worth.
What tax advantages does home ownership provide?
One of the great benefits of home ownership is the tax-shielding aspect of having a mortgage. Essentially, the government allows you to deduct, or not count, the amount of mortgage interest against your income that you pay in one year. Another sizable advantage—and one of the principal benefits of home ownership—is that up to a certain capital gain ($500,000 for a married couple), you do not have to pay taxes on the gain in the value of your house. If you itemize deductions, you may also deduct your property taxes when you file your income tax returns.
What is the general rule for obtaining a home loan?
The general rule is that a good borrower can afford monthly payments—including principal, interest, insurance, and taxes—equal to 25% of his gross income. Some experts believe that you can have a debt income ratio as high as 28% to cover your mortgage, insurance, and taxes. You should also have a total debt income ratio (of all of your debts plus the mortgage payment) of less than 36% if you wish to qualify for a mortgage.
What is “mortgage fraud”?
Mortgage fraud involves a crime committed in order to secure or grant a mortgage, falling into two categories: misrepresenting information on a mortgage application (59% of all cases), and appraisal-related misrepresentation (33% of all cases).
Which states lead the nation in mortgage-related fraud?
According to a report issued by the Mortgage Asset Research Institute, Florida, New York, California, Arizona, and Michigan lead the nation in mortgage fraud.
What percentage of buyers ultimately pay cash to purchase an existing house?
In 2010, more than 25% of all existing houses sold were purchased by cash buyers, who didn’t need or want to obtain a mortgage.
Why do mortgage companies, banks, and finance companies require homeowner’s insurance?
Mortgage companies, banks, and finance companies require homeowner’s insurance because they technically own your home, and want to be sure they get paid for the mortgage loan plus interest, even in the event the house burns down. The insurance will cover the costs to replace the house, and ultimately the homeowner will be able to continue to pay the mortgage or sell the house.
What types of mortgages are available to consumers for a home purchase?
There are many types of mortgages available to consumers to purchase a home, depending on your financial situation, including fixed-rate mortgages, FHA loans, interest-only loans, and adjustable-rate mortgages.
What is a fixed-rate mortgage?
A fixed-rate mortgage has a fixed interest rate for the period of the loan, and allows you to pay off the loan over a period of time. Such amortization periods can be 10 years, 15 years, 20 years, 30 years, and even 40 to 50 years.
What is the distinction between the different loan periods?
The shorter the period of the loan, the higher the monthly payments, and the less interest you have to pay over time, since you are borrowing and using the money over a shorter period of time.
What is an “FHA mortgage”?
The Federal Housing Administration, which provides mortgage insurance through FHA-approved lenders, is the largest insurer of residential mortgages in the world. Depending on the state in which you live, the amount you can borrow for a mortgage may differ.
Who uses FHA mortgages?
FHA mortgages are used by first-time homeowners because they require a smaller down payment than conventional mortgages.
How long must I pay for mortgage insurance with an FHA loan?
FHA loans require the borrower to pay for the insurance for five years, or until the loan-to-value ratio reaches 78%, whichever is longer.
What is a loan-to-value ratio?
A loan-to-value ratio is the loan amount divided by the house’s selling price.
What is “mortgage insurance”?
Mortgage insurance protects lenders from losses if a mortgage is not paid in full. Depending on the amount of your down payment to purchase a home, you may be required to obtain mortgage insurance until you have paid off enough of the loan, minimizing the risk of defaulting on the loan.
The Federal Housing Administration (FHA) is the largest insurer of mortgages in the world and a great resource for first-time home buyers.
What is an interest-only loan?
It is a loan that allows a person to pay, for a period of time, only the interest on a loan. At the end of this period, the borrower must make a balloon payment of the value of the entire loan, or refinance the loan into a conventional loan.
What is an adjustable-rate mortgage (ARM)?
An ARM offers a fixed-rate of interest for a short period of time, usually three, five, or seven years. At that point, the interest rate may change up or down, depending upon the index to which the interest rate is tied. These loans also have limits as to how high the rate can change in a year, and in the life of the loan. The borrower may continue paying the loan at this variable or adjustable-rate, or may refinance the loan to a fixed-rate conventional mortgage.
What are the steps involved to get a mortgage?
The first step is to order your credit report, to discover if it contains any errors and/or inaccuracies. The bank will also order its own copy of the credit report to initiate your loan. The credit report will be used by the loan officers to determine whether you are a good candidate for a loan, as well as how large a loan you can obtain. Next, it is important to have a clear picture of all your debts—the amounts of the balances, and the monthly payments. You should also have your most recent pay stub, showing your current income, and the last two to three years of your IRS W-2 forms, because as your income will be used to determine your eligibility. You should also have your most recent bank statements and investment account statements, showing your most recent balances. At this point, you should also know how much money you will use in cash toward a down payment on the loan.
Does it matter to lenders how large a down payment I will require?
The larger your down payment for a house, the more favorably your lender will consider your mortgage application, and the better your terms will be. You will also benefit from paying less interest over the life of the loan.
Should I pay down my debts before I apply for a mortgage?
If at all possible, in order to reduce your normal monthly expenses, it is a good idea to try to reduce your debt load, as it will help you secure a mortgage. You also benefit by eliminating high-interest rate debts before taking on a relatively lower-interest rate mortgage.
How should I choose a lender?
You should choose a lender by comparing the interest rates, the amount of money required for a down payment, and any fees or points associated with the loan. You may also want to inquire how long it will take to process your loan. Always speak with several different lenders, and beware of lenders offering comparatively low interest rates, as they may just be “teaser rates” designed to get you to come in and speak with them. You should meet with lenders after you have learned as much as possible about their current rates and practices, as well as fees, so that you will know who is giving you the best deal.
What are “points”, or loan origination fees?
Lenders charge points for mortgages, including fixed-fee mortgages. One point represents 1% of the loan amount. Not all lenders charge points for loans, so shop around to find the lowest fees.
Getting preapproved for a home loan will give you extra bargaining power when bidding on a house. Sellers are more inclined to agree to an offer if they know a lender has thoroughly checked your credit and financial stability.
Should I sell my house before getting a loan for my next home purchase?
Your chances of obtaining a mortgage will be far better if you sell your current house, because your income may not support the payment of two mortgages. Also, sellers look more favorably on offers without house sale contingencies.
What does it mean to be “preapproved” for a loan?
When someone is preapproved, the lender has already investigated his creditworthiness, and has established that he can borrow up to a certain amount from the lender. A home-buyer often receives preapproval before making an offer on a house, in order to make his offer more attractive to a seller.
Why is it important to be preapproved for a loan?
When comparing offers to buy a home, a house seller would prefer to consider an offer from someone who has a letter from a lender stating that he is already approved to borrow the amount of the sale price of the house over someone who makes the purchase contingent upon getting a mortgage or financing.
What does it mean to be “prequalified” for a loan?
Prequalification for a loan means the bank or mortgage company has looked at the borrower’s income and debt to determine the approximate amount of the loan. It does not mean the borrower has been approved for a loan.
Can adding just a few hundred dollars to my mortgage payment help to reduce my debt?
Yes. You can choose to add an additional sum to your normal monthly mortgage payment to pay down your loan principal. The effect can shave several years off your mortgage, and save you thousands of dollars in interest payments, depending on your loan size, your interest rate, and how many months you have remaining on your mortgage.
How many homes are in foreclosure in the United States?
According to experts at Realtytrac.com, as of March 2014 there are 483,224 bank-owned homes in the United States, with 51% still occupied by the former owner or tenant. This is down from a peak of about one million homes in 2010.
The real estate bubble that precipitated the U.S. recession of 2007–2009 resulted in widespread home foreclosures. Even today, home ownership in the United States is at a low not matched since 1960.
How many people risk home foreclosure?
in 2010, 1.7 million homeowners were notified that they were at risk of defaulting on their loan because of missed payments. This means one in 78 homeowners was at risk.
How many U.S. homes received foreclosure filings in 2010?
According to RealtyTrac, more than 3.8 million foreclosure filings—including default notices, scheduled auctions, and bank repossessions—were reported on a record 2.87 million U.S. properties in 2010.
How long does it take for a home to be foreclosed?
Within 15 months after you stop paying your mortgage, your home reverts to the lender.
What states have the highest rate of foreclosure?
Nevada, Arizona, Florida, California, Utah, Georgia, Michigan, Idaho, Illinois, and Colorado have the highest rates of foreclosure.
What does the foreclosure rate mean for American home ownership?
The foreclosure rate means that home ownership most likely will fall to its lowest level since 1960, when 61.9% of American families owned their own homes, and perhaps even lower over the next few years.
What is a “home equity loan”?
A home equity loan, or second mortgage, is a loan financed by a bank that allows a homeowner to receive a lump sum cash payment for the value of the equity he has accrued in his house, or leverage the accrued equity of his principal residence. After you have been living in your house for some time, assuming that real estate prices have been increasing, you begin to build equity in your house. Banks allow you to borrow from them this value, or equity, in the form of a line of credit that can be paid off over time at the prevailing interest rate when you secure the loan. Many people use this loan to make necessary improvements on their home, which may increase the home’s value. As the house appreciates in value from the time of purchase, and the value of this asset changes over time, the house’s equity is the value of the house (according to the lender) minus the value of any previous loans or mortgages on the property. This value can be loaned back to the owner, to make improvements to the property, consolidate debt, or pay other expenses. You may borrow a certain percentage of this equity. You must pay fees and closing costs, and must pay off this loan, including interest, according to the terms set forth by the lender. Typical terms to pay off home equity loans range from five to 15 years. The full amount of the loan must be repaid if the house is sold before this term expires. The AARP reports that 16% of Americans age 50+ used their home equity to pay down credit card debt.
How does a lender know the value of a house, if it is not for sale?
In order to compute the house’s worth, lenders use a variety of data points, including recent sales of nearby property, property records, deeds, mortgage records, and current appraisals.
What is a “home equity line of credit” (HELOC)?
A home equity line of credit is similar to a home equity loan, except the lender gives you the opportunity to use all or part of the credit over a certain period of time. Lenders may offer initial low interest rates, and may attach conditions as to when the credit line is to be paid back or closed, so it is important to understand the fine print on a HELOC. The interest rate may also be fixed or variable, depending on the terms established by the lender, allowing a homeowner to access as much of the credit as he requires.
Why are home equity loans desirable to homeowners?
Home equity loans are desirable because they allow a homeowner the chance to access the equity that he has accrued in his house, rather than waiting until he sells it to realize these gains. Typically these loans carry a much lower interest rate than other types of loans or lines of credit, such as credit cards. If the loan is used to make capital improvements to the secured property, it may actually improve the value of the property. A home equity loan is sometimes used by someone who wishes to consolidate his credit card debt in favor of obtaining a lower-interest-rate home equity loan, and pay off expensive credit card balances without incurring exceptionally high credit card interest rates and other associated fees. The interest on home equity loans may also be deductible against your adjusted gross income, so please check with your tax adviser for the most current rules when filing your tax return. Many lenders offer online calculators to help a user understand how large a loan he can obtain. If you have a steady income, and control over your living expenses, a home equity line may be a good option to help solve a financial need.
Why can a home equity loan be dangerous for homeowners?
There are many reasons why obtaining a home equity loan can be troublesome for homeowners. The equity that a homeowner gains as the value of his house increases over time can be loaned back to the homeowner, and paid back over time with interest. Most experts agree that it is inadvisable to obtain a home equity loan, especially when house prices are falling. If the value of your local real estate market plummets after you obtain a loan, you could be “underwater” on the mortgage, a very dangerous financial situation in which to find yourself. Obtaining a home equity loan may not solve the initial financial problem that led you to obtain the loan in the first place. You need to control expenses and improve income. A home equity loan may also artificially create a sense of higher income, which is dangerous if you cannot control expenses. And obtaining such loans or lines of credit may help perpetuate poor spending patterns, especially if you use the credit unwisely.
What is the downside of using a home equity loan?
Some people use home equity loans to buy cars and clothes, fund vacations, or purchase second homes. This may lead to major financial problems in the future, if not correctly managed. Often home equity loans are given to people with terms that allow them to pay only the interest on their line of credit each month. This means the borrower never pays off the principal of the loan, and could end up paying a notable amount of money in interest payments. This is often written in the fine print of the loan documents, and is concealed from borrowers to make the loans appear more attractive.
Is it easy to get a home equity loan?
It is easy to get a home equity loan if you have owned your home for many years, and have a good credit history. An equity line may be obtained as soon as the bank can schedule an appraisal of your home to determine its present value. Assuming you have no other loans on the property, you can usually obtain a home equity loan in a matter of days or weeks.
What are other considerations or requirements to obtain a home equity loan?
The borrower should have a good debt-to-income ratio, and is normally required to make minimum monthly payments on the loan.
How do I determine the market price of a house?
The market price of a house is derived from the recent sale price of comparable houses (comparables or “comps”) found within a specific radius of the house, the quality of the house, the neighborhood, and the market demand for the house at that price.
What is a “home equity conversion mortgage”?
A home equity conversion mortgage is another name for a reverse mortgage.
If you have owned your home for a number of years and have a good credit rating, it can be fairly simple to get a home equity loan.
What is a “reverse mortgage”?
A reverse mortgage is a financial product for people aged 62 and older with significant home equity. The homeowner may be able to pull out this equity in the form of a mortgage, whereby the bank actually pays the homeowner a lump sum, monthly checks, or a line of credit for the amount of equity the homeowner wishes to receive. There are significant fees in order to do this, usually 10% of the home’s value. It allows a retiree to pull out equity in his home without having to incur a home equity loan, allowing him to receive additional income. The reverse mortgage is then paid off when the home is finally sold. The reverse mortgage also incurs interest fees, which are paid back when the home is sold.
What are the requirements to obtain a reverse mortgage?
To obtain a reverse mortgage, you must be at least 62 years old, must own your home (meaning you have either no mortgage on your home or a very small balance due), and must live in the home.
How much equity may a homeowner pull out in a reverse mortgage?
The amount a homeowner may pull out in equity in a reverse mortgage depends on the age of the youngest borrower/owner of the home, the current interest rate, the current appraised value of the home, and any mortgage insurance the lender may be required to purchase.
Why are reverse mortgages controversial?
Reverse mortgages are controversial because many lenders target an older, less informed market of potential clients who may not be aware of the many risks of removing equity from their homes. The fees are very large, compared with other forms of loans, and there is a risk that home prices may not increase, therefore making it very difficult for the loans to be repaid. There are no strict income requirements to obtain this type of loan.
When must the homeowner pay back a reverse mortgage?
The homeowner must pay back a reverse mortgage when an owner sells the home, moves out of the home for 12 consecutive months, or fails to pay the property taxes or property insurance on the home.
What is an alternative strategy to using or obtaining a reverse mortgage?
Many retirees choose to downsize their lives and sell their principal residence in order to monetize their home equity, and subsequently pay cash using this equity to purchase a smaller home. This strategy contributes more to sustaining your wealth than pulling equity from the house in the form of a home equity or reverse mortgage.
How do I rebuild my credit history after filing for bankruptcy?
In order to rebuild your credit history after a bankruptcy, try to establish a line of credit in small amounts, and pay off these amounts every month. Decide never to spend more on your credit cards than you can afford to pay off entirely each month. If your issue was overspending, learn how to create and live within a budget. If your issue was large medical expenses for you and/or your family, consider getting a job that offers more affordable or subsidized medical insurance at better rates. If your issue is not having adequate savings to survive economic downturns, work hard to save six months to one year of expenses, and do not touch these savings, no matter what happens.
What is the best order of priority to pay off credit card debt?
You should make a list of all your credit card debts, and determine the interest rate on each of these obligations and each monthly payment. Give highest priority to the credit card debt that carries the highest interest rate and highest monthly payment. Give higher priority to debts with no tax advantages, such as credit cards, than to debts such as mortgages, as there are tax advantages to having the mortgage.
How many U.S. households have credit cards?
There are 54 million households with credit cards in the United States today.
How much credit card debt exists in the United States?
Roughly $866 billion in credit card debt in the United States exists today.
What is the average amount of credit card debt for U.S. card holders?
The average card holder has $15,788 in credit card debt. This could be debt related to anything from everyday purchases of food and gas to clothes, large household items such as TVs or washing machines, to monthly utility bills.
What percentage of card holders are more than 60 days delinquent on their credit cards?
Nearly 4.27% of all card holders are more than 60 days past due on their credit card payments.
About 54 million households in the United States have credit cards, and the average person has 3 to 4 cards.
What is the difference between a debit card and a credit card?
A credit card allows you to borrow money from a card issuer in exchange for paying the provider of the goods or service in full. You must pay off the balance of the purchase in full, plus any interest or fees charged during the statement balance period. A debit card deducts money immediately from an account (usually a checking or savings account at a bank), and therefore incurs no interest payments. The bank then sends you a monthly statement that shows all transactions cleared for the month on the debit card.
What does “living within your means” mean?
Living within your means is defined as the amount of income you take in, less your taxes, is the same as the amount of money you need in order to live.
What does the phrase “living beneath your means” mean?
Living beneath your means is defined as the amount of income that you take in, less your taxes, is less than the amount of money you need to live.
Why is budgeting so important to create wealth and financial success?
If you are good at managing your expenses—spending less than what you bring in—you will find money left over each month, which can be directed to savings or investing. Living beneath your means is one of the most important keys to financial success.
What must I do in order to live beneath my means?
The answer to this is found within your attitudes about money and material goods, and your ability to postpone or do without certain items now, in expectation of getting some future payback as a result of your frugality. For example, you must decide that having a stress-free financial life—by driving a paid-for, ten-year-old car—actually feels better than the stress created by having to pay off a $20,000 loan to finance a brand new car.
Why create an expense budget?
You can create an expense budget so you may attain or reach some financial goal in the future, whether to save a certain amount of money for a future purchase, such as a house down payment, educational expense, a vacation, or a large appliance, or to pay down debt.
How important is it to have a goal in mind when I decide to create an expense budget?
It is very important to have a goal in mind when you create an expense budget. Visualizing the goal makes it much easier to check your progress toward that goal, and measure your progress, whether positive or negative. Having the end prize in mind—whether an amount, or an actual physical item you would like to purchase—makes the goal more tangible and, in the end, more easily attainable.
What is a “budget”?
A budget is the established limit of the amount of expected expenses during a defined future period.
Setting up a family budget is an important step in keeping expenses under control and staying out of debt.
What is “zero-based” budgeting?
Zero-based budgeting is a method by which one accounts for the spending of every dollar of income from all sources. If any one category must be revised upward, another must be revised downward so the effect is zero on the total amount that is spent during the budgeting period. This way, your expenses can never exceed your income, if you stick to your budget.
What are some steps in using a budget?
The steps in using a budget are Goal Setting, Budgeting, Analysis, Monitoring Actual Expenses, Improving the Budget, and Adjusting Behavior.
What are some typical family budget categories?
Food (groceries, restaurants); Housing (mortgage/rent, property taxes, insurance, utilities, repairs); Clothing; Transportation (public, fuel, insurance, lease payments, car loan, rental); Health Care (including insurance premiums, co-pays, deductibles, prescriptions); Entertainment; Personal Care; Education; Communications (land line, cell phone, Internet, cable); Computers/Technology; Income Taxes; Pensions/401(k); After-Tax Investments/Savings; Charity; Life Insurance; Lawn Care; Credit Card Debt; Other Loan Payments; Hair/Salon; and Travel.
What are some steps to establishing the right goals for investing?
At the onset, you should be able to articulate the reason why you are investing in the first place. The reason for this is that by illuminating each reason, you can see why you are investing, and each activity’s time horizon. Perhaps your goal is retirement savings, so that you accumulate enough capital to fund your living expenses during your retirement years. Depending on your age at the time you invest, this goal could be long term. Perhaps you wish to invest your money to fund educational expenses that you may need in a few years. This reason to invest may have a short- or medium-term time horizon, and would require different strategies and risks. It is good to have a clear expectation in terms of what returns you would like to see, perhaps on an annual basis. You must decide what percent return you wish to obtain, and what you are willing to lose during this term. As in all complex projects, it is good to divide your goals into attainable subgoals. You should begin investing in choices that you understand, and that match your competency. You also need to have a clear understanding as to how much time you should spend managing your investing activity, as some investment choices may require you to spend more time researching, reading, and deciding than others.
What is another important step in setting my financial goals?
You should understand that to be successful at investing, you must have a clear picture of where you are today, a snapshot of your financial picture. This analysis is not difficult to perform, but it does require some time. If you know where you are today, then you have a value with which to compare your investing strategies and to measure how they contribute or detract from your goals and objectives.
Why should I invest regularly?
Investing regularly teaches you the discipline and commitment necessary to achieve your financial goals. It also directs money that may have been used for unnecessary expenses into investments that help you achieve your long-term financial goals.
How do I create a goal?
You may create a goal around nearly anything that you can imagine. It is very important that you focus on attainable goals that are easily manageable.
Must I have personal financial software in order to be successful at managing my financial goals?
No. Your money can easily be managed on anything from the back of a napkin to an Excel spreadsheet. What you must focus on is to adopting behaviors that will allow you to begin to accumulate wealth, keep your spending in check, and be sensitive to your financial goals. Software merely helps you keep track of most of your sources of spending and saving in one place, and imports data automatically from your banks and investment accounts, saving you time that would be spent doing everything on paper.
What do I do if my investing goals conflict?
Sometimes investing goals conflict. You may want to save to purchase a house, and simultaneously save to help fund your children’s education. You will always have choices, and it is a personal decision to fund one choice over another. But one thing is certain: If you cut expenses and increase your income, you will be better able to fund more goals than if you do not.
Why should my goals be easily manageable?
As you make these life changes, you will want to see results and reward yourself many times, in order to reinforce the changes in behavior and attitudes that financial success requires.
What are some examples of financial goals?
Some financial goals might be: reduce debt by 20%; save 10% of what I earn; save $20,000 to pay for a house down payment, reduce my credit card debt to $1,000.00, save $10,000 per year for my children’s education; and reduce my heating expenses by 25%.
What are some basic steps that I can design in order to attain my personal financial goals?
There are several steps we all should take in order to be successful at creating and reaching our financial goals. We should begin by thinking of and assessing our attitudes toward money, and focus on what thoughts or attitudes seem to be blocking our ability to attain our financial goals. Many of these concepts started at an early age, by observing how our parents and other significant players in our lives dealt with financial issues. All the beliefs and attitudes about money that are blocking us can easily be changed. We should begin to read and learn about personal finance by using information that is available to us, such as by searching the Internet, reading magazines on personal finance, paying attention to the business and financial section of the newspaper, and watching personal financial shows on TV and online.
It may seem a bit intimidating at first, but after a while, the information begins to make sense. You begin to see how small economic changes affect variables such as today’s stock price, but not next year’s stock price. You begin to see which economic variables affect each other, why the price of oil is so critical to the economy, or the effect of the interest rate in a capital such as Tokyo or London. You should assess your financial picture and have a truthful and open view of where you are in terms of your income and expenses. You should seize every opportunity to improve your income. You should look at your expenses and discover the overages. You should see if you have at least six months of emergency funds set aside—in case of a job change or other life event—so that you can easily ride through it. And you must consider paying yourself a certain percentage of your income each pay period first, never touching these funds unless they are to support some financial goal, such as education, retirement, etc. You should design attainable short- and long-term goals. This allows you to build confidence that you can attain a goal before moving on to the next. It allows you to visualize a long-term goal, and not let your current desire to buy some new thing get in the way of attaining that goal.
Once you have your goals in mind, it is time to execute your strategies to attain your goals. By this point, you have some ideas or strategies in place that help you reach your short-term and long-term goals. You may decide to begin taking money from your paycheck and direct it to a retirement fund. You may decide to sell the leased car, buy a cheaper used car, and begin saving the monthly payment. Suddenly, after 12 months, you find you have an additional $2,400 available to invest. Your personal finance journey also involves learning how to analyze your performance, and how well you meet your short- and long-term goals. Should you sell the investments that are doing poorly in the short term? Do you have too much money tied up in real estate? Should you now move from keeping cash to investing in mutual funds?
It is important to look at the performance of our portfolio in order to make sure it is helping you meet your goals, or make the necessary changes. Finally, personal finance teaches you to have the flexibility to occasionally readjust your goals and strategies, and to make adjustments in both your spending habits and savings habits, depending on what events life throws at you. You learn how to make the right choices at the right times, and see opportunity to improve your methods and strategies as you reach different stages in your life.
How does having and maintaining an expense budget help attain my financial goals?
Having and maintaining an expense budget provides you with a map of your current and future expenses, and is a great guide that describes in detail where you are headed financially. An expense budget allows you to make changes in each item or category within your budget, in order for you to redirect that money to attain a goal.
Make your plans as far in advance as possible, and take small, incremental steps to reach larger, long-range financial goals.
How do I begin to set my investment goals?
Many experts agree that you must first establish how much risk you are willing to take, since different portions of your total investment will have different risks and different potential returns. If you are averse to risk, you cannot expect to have investments that earn double-digit returns, since those types of investments tend to have more risk associated with them.
Why is attaining great financial goals easier than we think?
Great financial goals are actually a series of small financial goals. If you make saving and investing and the general management of your money a priority over a long period of time, each of your financial goals is attained. If you do anything in small incremental steps, larger goals are attained over time. And because the changes can be small steps, it is actually very easy to attain large financial goals.
What are some further steps we must take in order to establish investment goals?
Expert investment managers assert that we need to decide several important subgoals in order to establish our investment goals. These subgoals may include the ultimate use for the money, the time horizon for when the money will be needed, the amount of money needed, how much money we have already saved, what types of investments might help us achieve our goals, and the current performance of all types of our investments.
How much time is considered to be short-term, near-term, and long-term?
It is generally accepted that short-term goals may require one to two years, near-term goals may require five to seven years, and long-term goals may require 10 or more years.
What types of goals should I consider before I begin to invest?
You should consider your goals for the use of your investments, in terms of short-term, near- or medium-term, and long-term. Within short-term goals, you might include such items as travel, large consumer purchases, marriage, or health care-related expenses, and perhaps even current income. Within the near- or medium-term category could be such goals as capital for a home purchase, repairs/renovations on a principal residence, creating a business, or acquiring a second home/rental property. Long-term goals could be such items as funding higher education, retirement income, or passing wealth to heirs. It is important to note that your goals may change, especially short-term goals, as your ideas and outlook changes, so you need to be flexible in establishing goals.
Even before I establish goals, what are some things that experts believe help prepare me financially for successful investing?
Experts believe that well before you begin to invest, it is prudent for you to reduce as much as you can any credit card or debt interest and finance charges you pay every month, as these payments ultimately will suppress your investment earnings. You should also have a cash emergency fund set aside that may cover three to six months of living expenses. To establish this, all you must do is identify your expenses for the past few months, and begin to find ways to save this amount to be used in case of any emergencies.
What are some other keys that may assist me in establishing investment goals?
Investing editors at U.S. News & World Report assert that in order to properly establish investing goals, you need to decide what to expect in terms of returns on your investments, set achievable goals in terms of how much you are willing to invest, determine how frequently you are going to invest, and always purchase investments you know and understand.
Even if you only started with small, piggy-bank-type savings, that regular investment can grow surprisingly large if you begin saving when you’re in your early 20s.
What is an important consideration when I think about investing for my retirement?
When you think about establishing goals in order to fund your retirement years, it is important to consider when to begin investing. You may obtain a completely different result if you begin investing for retirement in your twenties rather than beginning to invest in your forties or fifties.
How does creating specific investment goals help me achieve my overall goals?
When you have a specific goal in mind, the goal provides you needed direction, so that you may focus your attention and behaviors toward attaining this goal. A goal may help motivate you to make necessary changes so that you may attain it. Goal-setting forces you to take responsibility for your ultimate financial situation, and with this stronger feeling of ownership of your goal, you will feel successful when you achieve it.
What is the difference between “investing” and “speculating”?
The difference between investing and speculating can be a complex topic. Its origins go back many years, perhaps to the 1920s, when economists and writers tried to illuminate the distinctions between the two concepts. At this time, the only vehicle considered by many to be an investment was bonds, because they provided a steady return, and you could retrieve your principal. When an asset or a share in an asset is acquired with the hope that the investor will receive a profit from the revenue generated by that investment, in addition to retrieving one’s principal, this is characterized by many as investing. Speculation is defined by many as when someone buys a share of an asset (believing its market value may rise), holds it for some period of time, and sells it to someone else at a higher value.
How do I make decisions to buy or sell if I am investing or speculating?
When you are investing, according to author Ben Graham, you decide to enter or exit a position based upon the underlying economics or analysis of that asset. When you are speculating, you decide to enter or exit a position based in large part on your belief regarding the near-term movement of the value of the asset.
How does Forbes characterize the difference between investing and speculation?
In a 2012 article summarizing a book by Jack Bogle, the founder of Vanguard Mutual Funds, the author states there is “harm done when a culture of short-term speculation focused on the price of a stock overwhelms a culture of long-term investment focused on the intrinsic value of a corporation.”
What is the problem with speculating?
When you speculate, you make an investment or buy a stock strictly because you think its price will increase over a relatively short period of time, because of an observed trend or widely held belief. When you invest, you use your fundamental analysis of the inherent value of the asset, believing it will appreciate over time, providing you with a return and the ability to get your principal back at a later date.
What is a “risk/reward ratio”?
A risk/reward ratio is defined by many as a comparison of the expected returns of an investment versus the amount that an investor could lose with the same investment. It is generally thought that the more return one expects to make, the higher the investment’s risk.
How do I calculate a risk/reward ratio?
You may calculate a risk/reward ratio by first deciding the highest price at which you are willing to sell, as well as the lowest price at which you are willing to tolerate, and then deciding how much of your investment you are willing to lose. You divide your net profit, which is the reward (after fees and commissions) by the price of your maximum risk. Through the use of stop-loss orders, you can sell at or near your target prices.
What is a simple example of a risk/reward ratio in action?
A typical example of a risk/reward ratio in action may be if someone wants to borrow $50 from you and pay you $100 at a later date. You will lose the $50 if the debt goes unpaid. But you will make twice the amount of your investment (a 2:1 risk/reward ratio). If the borrower agrees to pay you $150, the risk/reward ratio increases to 3:1. Investors favor risk/reward ratios in the 2:1 range when analyzing potential investments.
What are some limiting factors in using risk/reward ratios?
Most experts agree that use of risk/reward ratios is limited, as they do not take into consideration the probability of attaining a certain target or goal, or the probability of a certain downside risk. But through careful research, you may see the potential high and low. The model also does not take into consideration time or the occurrence of a macroeconomic event that may, in the short term, radically change the price of your investment, thus affecting our reward. So use risk/reward ratios as only one tool when making investment selections.
What is the progression of risk, from low to high, among different classes of investments?
Normally, each type or class of investment carries its own reward and risk associated with the investment that may be plotted on a graph. Moving from low potential return/low risk to high potential return/high risk, there are short-term government debts (from financially secure sovereign nations); mid- to long-term government debts, shortterm loans to the highest rated blue chip corporations; real property that is purchased and then rented or leased; high-yield debt to less stable governments and lower-rated corporations (junk bonds); equities (including small, medium and large capitalized corporate equities); and options and futures contracts (wherein you leverage or borrow funds in order to purchase an investment).
What is the theoretical risk-free investment, and why is it so important?
The theoretical risk-free investment is the return that an investment may bring from an investment that carries no risk. The problem with this definition is that there are no truly “risk–free” investments. Even keeping cash under your bed is risky, as it could be lost or stolen. Also, inflation of prices over time—coupled with government monetary and fiscal policies that may change with different political regimes—may reduce the value of that cash under your bed. So risk-free investments exist only in theory, but are still highly important because they allow you to compare the risks of other investment choices.
Younger people can tolerate more risk in their investments because they are in it for the long haul.
Does my tolerance to risk depend on my age or stage in life?
It is commonly thought that younger people should be more tolerant of risk, for a few good reasons. When you are younger, you may have the opportunity to earn and keep earning money to replenish any losses you may incur. You also have a much longer time horizon in which to offset your losses with gains, should you make an improper investment decision. People nearing retirement may need access to their portfolios in order to provide daily income—and therefore would likely have less tolerance for risk—than someone in his twenties who has many decades of earnings and returns ahead of him.
What is “systematic risk”?
Systematic risk is the risk associated with broad events that affect the entire market or market sector that cannot be mitigated through diversification.
What is “unsystematic risk”?
Unsystematic risk is the risk associated with a particular industry or market sector that can be mitigated through having a diversified portfolio of stocks.
What is a “risk/return trade-off?”
A risk/return trade-off is the principle that the higher the level of uncertainty as to a potential return, the higher the reward. An investment with a relatively predictable low level of uncertainty will have a lower return. This is why individual investors must clearly understand their personal tolerance for risk in order to make the right choices when investing in individual stocks.
How many individual stocks must I own to have enough diversification against unsystematic risk?
Although many experts disagree with assigning an exact number, a diversified portfolio of individual stocks should fall within a range of between 12 and 25 stocks. The answer may be quite complex, as it based upon your tolerance for risk. Investors who are quite riskaverse will seek more diversification, and hold more individual positions. In contrast, an investor with a high tolerance for risk may hold fewer individual positions.
How do professional investors feel about risk?
Many professional investors believe the mitigation of risk is probably as important as analyzing and making specific investments. Over time, investors are rewarded with higher returns in exchange for putting their money at higher risk. But many professional managers believe you can mitigate risk by buying and holding various assets over time, and selecting assets with minimal correlation, so that if any one asset decreases in value, others may increase in value or be unperturbed by the cause of the decline. By diversifying your portfolio with uncorrelated assets, you may be able to experience increases in the values of your portfolio without having to deal with sharp declines.
Why is risk a standard deviation?
As we compare how a potential investment performs against a benchmark, and how far this performance deviates from a norm, the risk can be expressed mathematically, indicating how precarious the investment may be. In other words, the further from the norm, the riskier the investment.
What types of risk exist?
Risks to our investments may be categorized as market risk, default risk, inflation risk, and mortality risk.
What is “market risk”?
Market risk is an investor’s risk in incurring losses due to price movements. There are many types of market risks, as there are many different markets in which we can invest. Some of the most common risks include: Equity Risk (the risk that an individual stock, index, or mutual fund price or the volatility of that investment may change); Interest Rate Risk (the risk that interest rates, the price of money, or the volatility of these categories may change); Currency Risk (the risk that the price of a foreign currency relative to another currency, or the volatility of this price, may change); Commodity Risk (the risk that the price of a particular commodity a company uses, or the volatility of the price of this commodity, may change).
What is “default risk”?
Default risk, or credit risk, is the risk associated with investments in which the company cannot pay its debt obligation. Lenders and investors are always exposed to default risks. Our financial system is built in part on mitigating the effects of these risks by having lenders pay a higher return on a relatively riskier investment, and lower returns on a relatively safer investment. Risks to lenders include loss of principal and interest, disruption in expected cash flows for these payments, and costs borne by the lender in his attempt to collect the amount owed.
Why is “inflation risk” bad for my portfolio?
Inflation, the increase in prices over time, gradually erodes the value of your money. Since 1926, the gradual increase in prices has increased, on average, by approximately 3% per year. In some outlying years, the increase has been very high—approximately 13.5% in 1980, and averaging approximately 6% during the 1980s. This means that if you are planning for retirement soon, you may need much more saved and invested in order to have adequate income later on, as the value of your money may be less because of this inflationary price tendency.
What is “mortality risk”?
You will certainly die. It could happen during the next hour, day, or year, and insurance companies price their products accordingly, using actuarial calculations to factor the probability of the timing of your mortality. Regarding your pension or other post-retirement benefits, your mortality risk is generally accepted to be the risk of dying earlier than expected while you earn such benefits.
What is the opposite of mortality risk?
The opposite of mortality risk—and another important consideration when it comes to considering our retirement planning—is our longevity risk, the risk that we live longer, and therefore have more need for income, than expected.
Americans are living to unprecedented ages in the 21st century, and that means it is best to plan for living into one’s 90s or even 100s.
Why is longevity risk sometimes considered a “silent” risk?
Most other risks have short- and mediumterm consequences. With longevity risk, the risk that we may require much more income because our lives will last longer than planned, has a very long-term consequence, and is not very often considered by professional investors or individual investors trying adequately to plan for their retirement. Unexpected expenses—such as medical expenses and home care expenses—may also occur later in life, and may greatly decrease your available resources during retirement.
What is the “beta” of a stock or mutual fund?
The beta of a stock/mutual fund is the result of a mathematical equation that measures the volatility of that stock/mutual fund when compared against some benchmark, such as other stocks of similar qualities or, in the case of a mutual fund, a benchmark index. Beta measures how the price of a stock or mutual fund might react to changes in price of the benchmark. The benchmark and the investment vehicle may be highly correlated; if the benchmark price increases, so does the investment vehicle, and vice versa. Accordingly, an investment such as a mutual fund with a beta of 1.0 will have a price that will, more likely than not, move with the market. It is closely matched with its benchmark, but a mutual fund with a beta less than 1.0 will not move with the market. A mutual fund or stock with a beta of 1.2 will be about 20% more volatile than its benchmark.
Why do stocks and mutual funds have different betas?
Investments with betas less than zero will move in the opposite direction of the market. Investments with betas of 1.0 will move in the same direction as the market. Investments with betas of 1.0 may also be a major contributor to the benchmark itself. And investments with betas above 1.0 will be more volatile, and may be more affected by minute-by-minute news and market trading activity.
How is beta calculated?
Beta is calculated by analysts using statistical analysis techniques, and is often provided for you when you are analyzing different investment choices, such as individual stocks or mutual funds. Typically, beta is derived by analyzing how an investment choice’s volatility compares to some broad index—in many cases, the S&P 500.
What is the relationship between beta and risk/rewards?
Beta relates to the risk and rewards that might be attained through entering into an investment because a specific investment that has a high beta (more volatility compared with some index) would imply a higher reward or return for the investment. That makes it rather easy to determine if the betas of various investment choices are worthy of further study if their rewards match the implicit volatility.
How do I use beta to analyze an investment choice?
You use beta calculations by first looking at the beta of a benchmark and the expected return of this market index. If the beta of the market as a whole is 1.0, and this broad index returns to investors 8% per year, an investment choice with a beta 50% greater (1.5), should provide a return of approximately 12% (since 12% is 50% greater than the 8% return of the broader index). If, through careful analysis, you do not see this investment choice providing this level of return, it is typically filtered from the list of possible investment choices.
How is beta analysis misused or misinterpreted?
The use of betas in analyzing possible investment choices may be misused or misinterpreted in a number of ways. Typically, high-tech investments may have high betas, yet may be good long-term investments. Utilities typically have lower betas by comparison, but offer very good returns in many investor portfolios. Beta also reviews the past, and past performance is not always an accurate indicator of future performance. Beta may not take into account current or upcoming changes to the company, or broader market shifts that may positively or negatively affect the earnings of a typical investment vehicle. Beta also does not necessarily take into consideration what happens when markets advance forward, whereby a company with a beta greater than 1.0 may outperform the market as a whole.
How can I use beta analysis to help in my investment selection?
Many experts assert that it is good to use beta analysis when you are engaged in shortterm analysis, such as when you are planning to acquire/sell an investment vehicle within a short period of time. However, for longer-term investing, it is more prudent to use a variety of analytical tools to assist in filtering various investment choices.
What is “wealth”?
Wealth is the state of your abundance of assets in terms of marketable or saleable value, minus any liabilities owed, and is often examined in comparison to others in some reference group. Assets of value include cash, investments, home equity, and other valuables such as jewelry, art, and precious metals. The term “net worth” is also used in place of the term “wealth” when it comes to personal finance and investing.
How much must I accumulate in order to be considered wealthy?
According to experts at CNBC, citing a 2013 study by UBS Investor Watch wherein individual investors were asked “Are you wealthy?”, the survey revealed that 60% of respondents who had more than $5 million in net worth described themselves as wealthy, while 28% of respondents with a net worth between $1 million and $5 million described themselves as wealthy.
How do respondents describe the state of being wealthy?
Fifty percent of the UBS survey respondents believed that being wealthy meant “having no financial constraints on activities,” 16% believe it constituted “surpassing a certain asset threshold,” and 10% believed it meant “not having to work again.”
What percentage of American households lack an emergency fund with enough cash to cover three months of living expenses?
Financial experts at Time Inc. assert that roughly half of all American households do not have such an emergency fund.
You don’t have to be worth $76 billion dollars like computer business magnate Bill Gates to be wealthy; a million or more should suffice.
How do I attract wealth in my life?
You have to look first at your attitudes toward money, and understand how these attitudes contribute to your financial situation today. By recognizing these attitudes, you can see which are helping you, and which are blocking your goals. You may have to change some of your beliefs about money and finances in order to begin to attract wealth. Your imagination is very important. In fact, your imagination drives your desire to buy items, since you have a mental picture of the new car or cell phone that you want, you see images of it in commercials, your friends talk about it, and then you buy it. It is a little more difficult to imagine a pile of money 20 years from now that you will use to pay for your kids’ tuition. So you have to teach yourself how to envision personal financial goals, and actually visualize them. You have to give yourself permission to be wealthy, that it is not something reserved only for other people. By having a vision of how it feels to have wealth, it makes you more able to use behaviors and see opportunities that create wealth. Some people think of wealth like water, something that flows to you. If you begin to act as if you already have financial security and have the discipline to meet your goals, financial security and wealth will occur.
How important is the place where you live influencing your perception of wealth?
According to researchers at The Wall Street Journal, attitudes about being wealthy in a rural part of America may be far different from attitudes about being wealthy in Manhattan, perhaps because it requires much more income to live in Manhattan than in rural America.
Why do people spend down their savings?
People are comfortable with predictability, and have a hard time getting used to new situations. If they grew up in an environment where there was never enough, and suddenly have a lot, no matter how painful, people will spend their money down to the level with which they are most familiar and comfortable. If you never had more than $500 in your checking account, and suddenly receive a $1,000 bonus, people without financial goals will find a way to spend that $1,000 down to $500, because they are more familiar with having no more than $500 in their checking account. A person committed to attaining a financial goal will get the money, put it away safely, pretend it doesn’t exist, and maintain his customary spending behavior. A goal-oriented person will change the way he views his checking account, and decide that having $1,500 is his new minimum balance. While the spender is spending the excess, the saver has changed his view of what should be in his checking account to a minimum of $10,000, and is setting aside this extra income to reach that new goal.
So wealth creation is really about my thoughts?
Yes, it doesn’t really matter what your background is, if you decide that it actually feels better to be independent and living debt free, you will begin to take the proper steps to make this happen. You will resist the urges to spend, in favor of a longer-term goal. If you tell yourself that it is OK to have $500 in your account, you will take steps to make this happen. If you tell yourself that it is OK to have $100,000 in your account, you will also take steps to make that happen as well.
Where do the highest and lowest number of high net worth individuals live?
According to the IRS, the states where the highest number of people with a net worth greater than $2 million live are California, New York, and Florida. The states with the lowest number of people with a net worth greater than $2 million live are Alaska, North Dakota, and Vermont.
