Your Two Bits

Contradiction?

Wouldn’t you love to win the lottery? Many people would…and many people try. Unfortunately winning the lottery doesn’t mean you’re financially set for life, even if you win tens of millions. This article is a nice reminder of that fact.

There are so many cases of people winning large sums in the lottery and ending up worse off than they began, because they don’t know how to manage the money. The irony is that most people who understand how to manage their money and what makes a good investment are more likely to “spend” their money on investments that are designed to reward investors. The lottery isn’t designed this way. Only a few “lucky” people will win.

Unfortunately, once those people do win the lottery, they have a seemingly large supply of money that they know even less about managing than the money they previously had. This perception means that their already poor saving and spending habits are magnified, eventually leaving them worse off than where they started.

…unless they learn how to manage their money. If they have already learned how to be good money managers, they will likely be very careful about how they proceed with the lottery winnings. I would recommend proceeding with a combination of advice that two financial radio show hosts offer.

1. Celebrate (Clark Howard)
2. Wait (Dave Ramsey)

Clark Howard often recommends to people that they take 10% of their windfall, whether it is from the lottery, an inheritance, or unexpected bonus and do whatever they want with it. This allows them to enjoy the money and get some of that desire to spend out of their system, while keeping the amount reasonable.

Dave Ramsey often recommends to people who will be receiving a life insurance benefit that they park the money in something like a CD for 6 months. He advises them not to do anything major with the money, simply take some time to work through the grieving process. Similarly, in a lottery-type situation, people should park the money and take some time to seriously think through what they would like to do with it. Doing so will likely also create a reality check regarding how far that money will actually go.

Statistically (and by design), most of us will not win the lottery; however, many of us will receive unexpected money at some point. My take on your two bits is to celebrate with a small portion and then park the money while making a deliberate plan regarding what to do with the rest—you may even want to consider taking a money management course.

Photo Credit: Letra Pequna on everystockphoto.com

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Which should you do, pay down debt or invest? You can find different arguments for or against, but I generally say that you should pay down debt, assuming you have a minimal amount of savings ($1000) to cover emergencies. A good list of reasons for paying down debt is provided in this post at I’ve Paid for This Twice Already.

However, my biggest reason is the risk factor. I think Dave Ramsey sums it up best when he says, “I’ve done extensive research and found that 100% of home foreclosures occur on homes that have a mortgage.” Sometimes he might substitute “home foreclosures” with “car repossessions,” but it’s the same idea: If you have debt, you have risk. And don’t get me started on the issue of people willing to incur debt-related risk where they’re sure to lose money but are afraid of investment risk where they have a good chance of making money.

Ultimately it’s up to you to decide how much risk you are willing to take; my main recommendation is that you at least make it a conscious choice.

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Does anybody have to worry about taxes on capital gains right now? It seems most are worrying about capital losses. However, with the market so low compared to where it was last summer there is a decent chance that people who are currently investing (and likely buying low) will have reason to consider capital gains tax rates before they sell their investments in the future.

(Note, this assumes investments, such as mutual funds and stocks. Other types, such as real estate, have slightly different rates.)

2009 Capital Gains Tax Rates

Basically, you pay your regular income tax rate, if you sell the the investment within a year of buying it. If you wait at least one year from the date of purchase, your tax rate drops significantly.

However, the law regarding these tax rates is set to end after 2010. At which time the tax rates would return to what they were up to 2003, which also includes a slightly lower rate for holding investments more than five years.

2011 Capital Gains Tax Rates

Let’s hope that Congress votes to keep the rates low—better yet, let’s encourage them to do so.

That’s my two bits. What are yours?

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Is education worth it? There seems to be a general inclination in our country to suggest that you can’t put a price on education—whatever the cost, it is worth it to get the best education possible. This applies both to arguments for funding elementary and secondary public schools as well as to individuals looking for the perfect college program.

While I would agree that education has great value, both in your own quality of life and for effecting change in the world around you, I would also suggest that education is not always “good debt.” If you can’t afford an education at a specific institution, seriously rethink your approach to your education.

First off, how do you determine “the best” education? It would probably be easier to debate a topic like abortion than try to pin that one down. There is a lot of subjectivity regarding what is best for people with different interests or for those pursuing different professions. For example, if I’m planning on becoming an airplane mechanic, an engineering degree from Stanford’s engineering program in Aeronautics and Astronautics probably won’t help all that much. I would be better off both financially and in my professional preparation, by looking for a two-year vocational program.

But you may have heard the argument that going to an Ivy League school is your best route, because Ivy League graduates tend to make connections with important people and have better job opportunities after graduation. While in some instances this may be true, I recall reading an article several years back—which unfortunately I could not find—suggesting that the reason students who attend top-tier schools tend to get better job offers after graduation, is not necessarily because of the school itself. Rather, it is because they tended to be wealthier and better connected to begin with. Students who are wealthier and have solid family and professional contacts tend to go to more prestigious universities, and because they are already wealthier and better connected, they tend to get better jobs after graduation.

High school and college students are done a disservice when they are constantly told that they need an education to succeed but aren’t taught how to figure out what educational opportunities make financial sense. An article by Sandra Guy on FastWeb has a good suggestion: At a minimum, create a budget based on how much you are likely to make after you graduate and include the expense of repaying your student loan. You can estimate the loan repayment with a loan calculator (I recommend using Microsoft Excel’s loan amortization calculator). This could be a reassuring exercise or a wake-up call about your educational aspirations.

Personally, while I didn’t perform the exercise Guy suggests, I did consider my ability to pay for school. After applying to graduate school, I was accepted to my two top picks: 1st) University of Michigan’s School of Information, and 2nd) Indiana University’s School of Library and Information Science. At the time, the two schools had relatively similar programs and were ranked neck and neck by U.S. News & World Report. However, among universities as a whole, Michigan was ranked in the top 25 but Indiana (IU) wasn’t even in the top 100. Not coincidentally, Michigan also cost twice as much as IU. I wondered if the additional expense for Michigan was really worth it, but a part of me kept thinking, “Yeah but wouldn’t it be so much cooler to tell people you went to Michigan?” That was the vain part of me. Then the rational part of me would say, “Yeah, but that is a lot of money. Do you really want all that debt?” Then my better half (my wife) said, “Why don’t you go with the one that is working for you?”

That was the best advice I could have received. There were a number of things that had happened with IU that just seemed to be clicking with me and fitting my needs. I accepted IU’s offer and it continued to work out. I loved the program and had a great experience. It prepared me very well. It’s possible life would have turned out differently in terms of my career and pay had I gone to Michigan, but I doubt it. Nothing against Michigan but considering my industry’s salary range and what I earn, I’d be surprised if I made much if anything more as a result of a degree from Michigan. I doubt it would have been enough to warrant the additional student loan debt I would have incurred.

Financially speaking, all of your education has failed you if your major or graduate program is something like ancient Roman history, with the intent to teach high school and the tuition alone costs you $25,000 a year—unless you have the money to pay for the program. A lot of things besides education have value—cars, houses, boats, family vacations—and some things certainly have more value than others. But they also have a price. Just be smart about how you weigh the value of an education.

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Since last week’s post regarding whether to keep contributing to a 401(k) if your employer drops the match, I have had a few discussions with people on this topic. Last week’s post was written assuming that you are going to keep contributing to some form of retirement investment; however some people have asked, if they should stop contributing to all investments. The short answer is “No.” The longer is answer is “It depends, and here’s why.”

In general, you really don’t want to lose any of that retirement savings momentum. That’s why the short answer is “No.” However, there may be exceptions. One person asked if they should stop contributing to the 401(k) so that they could build up their emergency savings. My gut reaction was to say to keep contributing; however, as I pondered the issue, I changed my mind a bit.

First of all, if a company is freezing its 401(k) match, that is most likely because they are struggling financially to some extent. If the company is struggling financially, you may have reason to worry about your job. Depending on your debts and amount of emergency savings, you may want to build your cash reserves in the short term. In this case, I am more open (albeit still very nervous) to stopping contributions to the 401(k) and not investing anywhere else. However, my openness comes with some caveats.

Create a Plan
Do not stop making contributions until you have a plan of action in place. This plan should include a few critical elements:

1. Determine how much money you are going to save. In other words, at what point will you be ready to begin contributing again? Write down an actual dollar value.
2. Once you reach your desired dollar value, are you going to begin contributions to your 401(k) or invest in something else? If something else, have that something else already selected. I would suggest even going so far as filling out the application with all but the signature and date.
3. Determine an alternate investment, in case re-investing in your company’s 401(k) plan is not an option, either because the company no longer exists, or your position no longer exists, or you have to wait for open enrollment.
4. Save every penny that was going to your 401(k) when you stop making contributions.
5. To help you save every penny, at a minimum save the money in a savings account that is separate from your general checking account—even better would be an account in a completely different bank. I would look for something like a money market account; it might give an interest rate that helps you keep up with inflation.

Hopefully, you aren’t in a position where you feel the need to stop all contributions; however, if you are, at least have your “exit strategy” in place.

That’s my two bit’s worth. I’m interested to hear what thoughts others have.

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