Emergency Funds

In last weeks commentary, I discussed "6 Ways to Ruin Your Retirement Plans." In hindsight, I left out one very important item.

Let's call it #7: Emergency Funds (aka 'Rainy Day Money').

We all know about Murphy's Law. Something that can go wrong, will go wrong - sooner or later. Unfortunately, it often comes at a price. If you're fortunate enough to experience a lower end repair, cash flow will cover the expense. However, big ticket items require a different strategy.

Don't get caught in this financial dilemma.

Having emergency funds of 3-6 months of expenses is a cardinal rule when it comes to financial planning. Couples working in different industries can use 3 months as a target it's fairly unlikely they will be unemployed simultaneously. Individuals should shoot for 6 months as they are the solely responsible for household bills.

Since 2008, I've noticed a sea change in client behavior. Individuals and couples have apparently depleted emergency funds for everything from vacations to washing machines. While we could debate what constitutes an emergency? The bigger issue should be getting an emergency fund back in place. Granted, it takes time and discipline to build back up your rainy day account. But, sooner or later, another storm is going to come!

What happens in the meantime? Couples are turning to retirement money for emergencies. The somewhat convenient process of taking premature IRA distributions is becoming a ready source of cash. Unfortunately, it comes at a HUGE expense.

Premature distributions - before the age of 59 1/2 - are taxed and penalized by the Internal Revenue Service (IRS). For example should an individual request $10,000 distribution from their IRA account, the IRS will impose a 10% ($1,000) early withdrawal penalty AND consider the full $10,000 as ordinary income when you file your 1040 tax return at year end. Assuming you are in a 30% tax bracket, this equates to a $4,000 (40%) tax bill at the end of the year.

Let's step back a minute and analyze this from an economic point of view. Everything in life is a compromise, or at least a trade-off. Financial decisions are no different. Would you borrow money at a 40% interest rate AND jeopardize your own retirement? When put this way, I believe most of us would answer 'No'. It's simply too expensive.

So, why do we tap into retirement money when financially pinched? Probably convenience. But, you would be better served to borrow money from a bank or even get a credit card advance should emergency funds not be available. Both come at a significant cost reduction AND don't effect your retirement assets.

At the end of the day, we all strive to make smart financial decisions. Don't let a short term need derail your retirement plans. Make sure you have an emergency fund (aka 'Rainy Day Money').

6 Ways to Ruin Your Retirement Plans

Longevity is the single greatest advancement in the last 100+ years. Due to medical technology, we are all living longer than ever before. If 60 is the new 40 and 50 the new 30, we have many years of healthy living ahead of us! Should you have the option of retiring at 60 or 65, you could live 30+ years in retirement. For many, this will last longer than your career(s).

Your retirement nest egg is going to be more important than ever. Here are 6 common mistakes to avoid:

1. Save Little or Nothing - Most people spend more than they make. This is a fact. How do you think the average consumer has $7,000 in unpaid credit card balances? We live under the banner 'consumption nation' and spending is the American way. However, if you want to retire one day, curbing your spending habits and saving more money is going to be imperative. Try and save 10% of your of your annual pay. This may not happen all at once. So, try starting with 4% and gradually increase your savings as you adjust your budget.


2. Invest too Conservatively - We all know people who invest in money market accounts via their 401k plans or IRA accounts. This is akin to travelling cross country and buying a bicycle for the trip. Yes, you will eventually get to your destination, but boy is it going to take a long time! If you have 10-20 years before retirement, you need growth in your portfolio - a plane, car or motorcycle is a better mode of transportation! If nothing else, you have to outpace the rate of inflation just to maintain your purchasing power. With historic inflation rates averaging 4% per year, today's money market account and CD rates of 2%-3% fail to keep pace.


3. Ignore Tax Benefits - Tax deferred or tax free growth is a blessing in disguise. Because of compound interest, money will grow faster inside a qualified retirement plan (401k, Traditional IRA, Roth IRA, etc.) than outside. Also, because income tax brackets will probably be increasing in the very near future, do not underestimate the benefits of tax FREE growth offered through a Roth IRA.


4. Overestimate Portfolio Growth - The days of annual growth ranging from 10%-12% per year are gone. Yes, we may have some bounce back years after 2008. But, because business models are changing (less borrowing, leverage, etc.), companies will grow at slower rates going forward. Keep your expectations realistic.


5. Ignorant about Investments - When it comes to your investments, ignorance isn't bliss! Owning several mutual funds doesn't guarantee diversification. As a Certified Financial Planner, I've always encouraged clients to learn more about their investments & portfolios. "The more you understand, the easier my job" has been my mantra for over a decade. Having a general understanding of your investments is a must.


6. Set it & Forget it - Monitoring your portfolio is critically important. This doesn't mean you should check the daily changes, but a quarterly review is certainly warranted. If your mutual fund built it's reputation on a certain portfolio manager calling the shots, make sure the individual is still at the helm. Also, check to see if the fund objectives are still the same. It's easy to say I own the "ABC Fund", but that's the same as saying I own the #8 car in the NASCAR race. If Dale Earnhardt, Jr. is still the driver, you're in great shape. However, if the up & coming college kid is in the driver's seat, it may be time for a change.

Stock Market Historical Facts

Today, a few historical facts on the United States stock exchanges.

The New Amsterdam Stock exchange started in 1602.

The first form of the stock market in New York started in 1792 with just 24 stock brokers meeting in the Tontine Coffee House on the corner of Wall and Water Streets.

The New York Stock Exchange (NYSE) didn’t start until 1817 when the brokers created the New York Stock & Exchange Board. They rented out 40 Wall Street and chartered a constitution to govern trading practices. There were 24 brokers involved.

The New York Stock Exchange had its first day on which a million shares were exchanged on December 15th, 1886.

Brokers joined the New York Stock Exchange by purchasing seats up until December 31, 2005, when the system switched to annual trading licenses. Before the switch, the highest amount paid for a seat was $4 million on December 1, 2005.

The first female member of the New York Stock Exchange was Muriel Sibert who joined in 1967.

Joseph L. Searles III was the first African American member to join the stock exchange. He joined in 1970.

After October 10th, 1953, there has never been a day on the NYSE where less than a million shares have been traded.

The NYSE’s largest volume day on record is February 27, 2007. Over 4 billion shares were traded on that day.

When there is a 30 percent drop in the market, the NYSE closes down trading for the rest of the day.

The Dow Jones Industrial average began in 1896 by the Dow Jones & Company to track the success of the market on any given day.
There are thirty different companies listed on the Dow Jones Industrial average and the included companies change from time to time.

The NASDAQ stock exchange began in 1971 with a focus on trading OTC stocks. The name is an acronym for National Association of Securities Dealers Automated Quotation.

In 1998, the NASDAQ merged with the American Stock Exchange to create NASDAQ-AMEX. Despite the merger, both exchanges are still held separately.

In 1987, the Dow Jones dropped 22.6 percent. In September of 2008, the Dow Jones dropped by 7 percent.

Three of the five largest losses by percentage in Stock Market history took place in 1929.

The largest loss happened in 1987 and a day in 1899 rounds out the top five list.

The largest single day drop in the Dow Jones average history was on September 29, 2008 when the index fell 777.68 points.

October 13, 2008 was the largest single gain in the Dow Jones average. The index rose 936.42 points.