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Talking about Insurance is Boring! (but Necessary)

September 29, 2008 · Filed Under Insurance, PF Basics · 4 Comments 

In the Personal Finance Basics series I’ve (very slowly) been working through, it is now time to talk about insurance.  So, what is insurance? (it’s boring! – well, ok, that might be true, but that’s not what I mean here).  I mean, what is the definition of insurance?  Actually, I don’t mean that either.  I mean what does insurance accomplish?  I think it makes sense to think of it as a transference of risk.

Insurance is a transference of risk

photo by NIOSH

In exchange for a small amount of money, the insurance company will give you a large amount of money in the rare case that you need it.  You are therefore transferring the risk of having to pay a large amount of money to the insurance company.  I think this definition works well for most types of insurance, but not perfectly.  For instance, it does not apply strictly to most health insurance plans in the US since we want our insurance to cover all office visits and procedures, not just the very expensive and rare ones (though it does do that also)

Do I really need insurance?

Determining whether or not you need a certain type of insurance is a very important first step.  Each person’s individual circumstances will determine which types of insurance are necessary.  You should discuss this with a qualified professional and/or a trusted person (or persons) who can give you good counsel.

The least expensive (at least in the short-term) form of insurance is always self-insurance (I mean no insurance).  Of course, if you end up needing the insurance payment, then self-insurance becomes significantly more expensive.  But if you can afford the payment if the risk is realized, then you don’t need to purchase insurance.  For instance, if you have the money to rebuild your house (and replace everything in it) if it burns down, you don’t need homeowner’s insurance.  If you can afford to lose a lawsuit, you don’t need an umbrella policy.  If your family can afford to continue their current standard of living if you die, then you don’t need life insurance.  If you can’t afford any of these, however, then insurance is a good idea (a very good idea)

Again, each person has reasons for whether or not they need a certain type of insurance  – there is no one size fits all answer to this question.  I’m listing some common insurances that you should consider – it doesn’t mean you should buy them all (I don’t currently own all these types) nor does it mean there aren’t more that you should consider.

Common types of insurance

  • Health – At the very least, you should have a major medical policy that will pay for expenses like surgeries or serious illnesses that can quickly generate enormous bills for you.  Even if you have to pay for office visits ($) out of pocket, the risk of a huge hospital bill ($$$$$) is too much to ignore.
  • Home Owner’s or Renter’s – These policies pay for rebuilding or repairing your house and/or your personal belongings in case of a disaster such as a fire or robbery.  Having such a policy is a very good idea for almost everyone (and most mortgage companies will require one).  Just note that some disasters, such as floods or earthquakes, are not typically covered under home owner’s policies.  Also, look for a policy that provides "replacement cost" for your items.
  • Auto – Auto insurance is mandatory in most places in the US, I believe.  Even if it was not, it is still a good idea for everyone who drives.  Not only do most policies provide payments to cover damage to your car and other cars in an accident, they also cover liability issues that may result.
  • Personal Liability (Umbrella Policy) – If you want to ensure you are very well protected, purchase a personal liability policy.  This policy acts like an "umbrella" to cover your liability over and above that which is provided by your auto and home owner’s insurance.  As Dave Ramsey says, the best way to protect your assets in the case of a liability suit is to put a big, fat, ugly insurance company between you and the other party.
  • Disability Insurance – The greatest asset that most people will have in their lifetime is their ability to earn an income.  Disability insurance is what protects this asset.  If you are unable to work, disability income will replace some or most of your income.  There are two flavors, short and long term.  Long-term is extremely important if you were to suffer some sort of debilitating injury or illness and not be able to work for years.  The best (and most expensive) type is "own occupation" insurance.  It means the insurance company will pay-out as long as you are unable to work in your current occupation.  In other words, if you have a professional job, they are not going to force you to get a job at McDonald’s and stop paying you benefits.  On the other hand, if your job entails sitting in an office in front of a computer (like mine does), if you can’t do that there’s a pretty small chance there would be some other kind of job they could make you do.
  • Long-term care – Long-term care insurance pays for care in the event that you can no longer care for yourself.  Due to the enormous (and ever-rising) costs of long-term care (in a competent facility), LTC is probably a good idea for most people.  Though inexpensive for young people, the recommendations I’ve seen are to wait until between the ages of 50-60 to get a policy.  There are a lot of options and policy types for long-term care – too many to go into any detail in this post.
  • Life – Life insurance is very necessary for some people and quite unnecessary for others.  If you are single and have enough money for a proper funeral, you don’t have much need for life insurance.  Likewise, if you are married with no (or grown) children and a large enough net-worth for your spouse to continue his/her current lifestyle, again you don’t have much need for life insurance.  On the other hand, if you are the sole breadwinner of a family with a few small kids, your needs are enormous.  I’ve heard that the general rule of thumb for life insurance is seven times your annual salary – but personally, I think that the actual need varies greatly by your specific situation.  There are numerous life insurance needs calculators you can find online.  If you need life insurance, my advice to you would be to get a 20 or 30-year term-policy and get a lot of coverage (term policies are very inexpensive, so load up on the coverage).

Of course, there are many other types of insurance out there (but I’m already over 1100 words on this post) but I feel these are the most common that are needed by most people.  Would you suggest any other types for most people to consider?

Photo Credits: NIOSH

Exploring the “Hows” of Giving to Help Others

September 26, 2008 · Filed Under Giving · Add a Comment 
Photo by Victory of the People

I’m sure we’ve all heard numerous times regarding the importance of giving.  Everyone from your pastor to various bloggers have discussed it.  I’ve even talked about the importance of giving in the past.  ChristianPF is preparing to run a 10 Day Give challenge to inspire others to make it a priority as well.  For Christians, the most basic impetus is that God tells us to give and to help others.  But all people (ok, most) have a sense that giving to help others is a good thing to do – it’s good for those you are helping obviously, it’s good for the world as a whole, and it’s good for yourself as well.  So, we’ve talked about "why" we should give, I’m curious "how" people give.

Large or Small?

Do you give small amounts freely whenever you get the chance?  Like dropping $5 at Cold Stone for their Make-A-Wish donations or giving a few bucks for Alex’s Lemonade Stand donations at Rita’s? (we apparently spend a lot of time at dessert type restaurants)  Or do you save it up to give only larger donations?  If so, is this because you feel there is a greater impact giving significant amounts?  Or is it for tax deduction purposes?  We tend to do both – more of an emphasis is on larger donations, but we also occasionally give small donations at random times (like at Cold Stone last night) (if using Twitter and Plurk is considered "microblogging", would that be called "micro-donating?")

Directly or through Charitable Orgnizations?

Do you only give to established charities or through organizations?  Or do you like to target your giving directly to the people in need?  The former seems a lot easier to do and maybe you feel like you can be assured that it will go to better use (as long as you’re comfortable that most of the money is actually getting into the hands of people who need it and not being used for administrative costs).  I personally don’t have a lot of experience giving money directly.

Scheduled or Spontaneous?

Do you schedule your giving so that you ensure it gets accomplished?  I mentioned earlier that I like to automate as much as possible in my finances and also that I actually have a a special tithe fund to make sure I do not lose track of any money we’ve decided to give.  My wife feels that this is somewhat sterile.  She thinks there is too much regimentation and process and not enough heartfelt giving.  She would like to do more spontaneous giving whether or not we have money allocated in our tithe account to do so.  How about you?  Do you like to schedule and automate it or just give as you are lead to give?  Do you keep close track of how much you give or just give when the opportunity arises?

Why Types of Charitable Organization?

If you do give to charitable organizations, do you typically give to a certain type of organization?  For instance, if you are a spiritual person, do you give only (or mostly) to related charities or do you give to secular ones as well.  Or, if you are an atheist or agnostic, do you give only to secular charities or do you also give to religious ones that you feel are doing worthwhile work?  For our scheduled giving, we typically give to Christian organizations but for our micro-donations we give to all organizations.  In the book I’m currently reading, Your Money Counts , the author suggests that Christians should give mostly to Christian organizations.  His rationale is that all people give to secular charities while only Christians give to Christian ones.  I’m curious if that is true…it probably is.

So what does this all mean?

I’m not really sure what it all means.  I’m just curious to see where everyone stands on this.  I imagine that most people dabble in a mix of the few options I discussed.  Maybe not, maybe I’m the loner who worries about making sure I donate all the money I "said" I would.

I do think we will all agree that helping and giving are two very good things that we can do for each other.  And though this post was written in the context of giving financially, giving doesn’t necessarily have to be solely about money.  Maybe that should have been another question – do you typically give financially or otherwise?  For instance, in the process of starting up this blog, I have been blessed with much help from established bloggers and have learned a great deal and made some new friends.  And that certainly was good for the one being helped (me!).

Photo Credits: Victory of the People

This Week in the Blogosphere: Recovering From Illness Edition

September 25, 2008 · Filed Under Blog Links · 5 Comments 

Well, in case anyone noticed, I missed a couple days this week due to illness. And since I haven’t gotten to the point where I have all my posts scheduled beforehand, when I couldn’t get out of bed Tuesday morning, I wasn’t able to edit and publish the post for the day. And that continued through yesterday.  By Wednesday afternoon I was feeling a bit better and back at work. Actually, my wife and I were both sick Tuesday and Wednesday (though I had the worst of it so she still had to ferry the kids around to and from school). Whenever we get sick, I always seem to get sicker than she does – does anyone else experience that phenomenon?

Anyway, I thought I’d use today’s post to point out some good articles I’ve seen in the last week or so (for some reason, I’m just not inspired to talk about insurance today!)

The Apostle of the Turtle points out two compelling reasons to turn off the TV .  We don’t watch a lot of TV at our house (much to my children’s chagrin) but we still do watch some. In fact, we regularly watch only two shows – Monk and Psych on Friday night and both of their seasons just ended.

Until Debt Do Us Part asks "Why Die Rich?"  Ahhh, yes, hoarding – I get accused of this frequently (It’s something I’m working on)

To combat any natural tendencies toward hoarding (or is it just me?), consider taking part in ChristianPF’s 10 Day Give .

My wife hates coupons for some of the reasons presented (by The Happy Rock as a guest post on Bible Money Matters) in this post discussing how coupons can actually cost you money . I’ve heard so much about how great coupons are though that we finally relented and started a two month subscription to the Sunday paper solely for the coupons. The stats so far: 4 Sunday papers, total coupon savings $0.00.

I am a late adopter, mostly because of price. I know that sounds weird for someone who uses so much technology on a daily basis, but I don’t like spending a lot of money.  I still remember when the first CD players came out and cost like $5000 or something.  One Caveman’s Financial Journey discusses how being a late adopter can save you money.

Everyone wants to do more in less time, so check out these 5 tips for being more productive from Wise Money Matters.  These seem like really good ideas. Honestly, though, I’ve not tried any except #3 (what is this I keep hearing about some big bailout?).  As far as #3 is concerned, I really like it.

ChristianPF shares some creative ideas for the seemingly lost art of the thank you. I think that whether or not people are polite and friendly varies a lot based on where you are in the United States. For instance, I noticed that when we moved from AZ to NC, people were much more polite in random interactions.  Actually, I was amazed how much different it was.

God bless…

How I Use My Bank Accounts: A Three-Tiered Approach

September 22, 2008 · Filed Under My Finances · 3 Comments 
Photo by Odalaigh

Previously, I discussed my current method for following through with a budget . In that post, I mentioned that automating as much of my finances as possible is the most effective thing I do to keep on track financially. I’d like to expound on that by detailing our current set of bank accounts and the purpose of each account. In general terms, we use three separate accounts to handle the bulk of our bill paying and saving, a checking account, a large-purchase account, and an emergency fund.

Checking Account

Our checking account is the primary account of this system. It is the gateway for all of our finances. Almost all of our incoming money is dropped into this account and almost all of our outflows are pulled from it. It is an account at a brick and mortar bank with a local branch so that I can withdraw cash, cash checks, and deposit money easily. Both my and my wife’s paychecks get direct deposited into this account. We use the free bill pay feature to pay as many bills as possible (I LOVE not having to mail all those bills out!). We even arrange most of our charitable contributions through bill pay as scheduled payments that are sent out by the bank each month (it’s not quite like using the "automated tithing machine," but it’s close I guess). Our mortgage payment and some others are automatically debited from this account as well. Again, the overriding principle is to automate as much of our inflows and outflows as possible.

Large-purchase Money Market Account

We also have a money market account hosted at same bank as checking account for convenience and same day transfers back to the checking account. This money market account is not the emergency fund (and contains a lot less money than the emergency fund). Rather, it acts as the buffer between the checking account and the emergency fund. The main goal of this fund is to be available when a large purchase is made or a big bill comes in that the checking account can not absorb. In that case, I transfer some money from this account back to the checking account. This allows me to maintain less money in the very low-interest checking account while not using the emergency fund for expenses that are not strictly "emergencies." I then replenish this account back to its targeted level.

Emergency Fund & Subaccounts

Even though the large purchase fund earns more interest than the checking account, it still earns much less than the emergency fund I have at EmigrantDirect.com . The Emigrant account is currently earning 3% which is about what the other popular online accounts are earning. Though I think INGDirect is more popular among personal finance blogs (maybe at least partially because of their generous affiliate program?) (Emigrant has an affiliate program but they won’t let me in it for some reason), I’m very happy with my emigrant account. It offers free transfers to and from the account, a pretty good interest rate, good email and phone support (the affiliate program emails notwithstanding), and a really useful sub-accounts feature.

I have setup a number of sub-accounts for short-term savings goals:

  • Emergency fund – This is our cash reserve we use to try to help weather significant financial storms
  • Vacation fund – This used to be our student loan payoff fund, and we very intentionally changed it to our vacation fund after paying off the last student loan .
  • Yearly expense fund – We put money into this fund for bills like life insurance, household employee taxes, etc that are fairly large and only paid once (or a few times) a year.
  • Home purchases fund – The money in this fund is earmarked furniture purchases, home improvement projects, etc.
  • Charity fund – Though my income is very consistent, I do get bonuses from time to time. To ensure that we give the decided-upon percentage of our income, whenever we receive extra income, I transfer the appropriate percentage into this fund. I feel this is a very easy way to keep track of the money and save it up for big donations as needed.

Again, as I said, I automate as much of this as possible. So, I schedule monthly transfers from my checking account to each of these sub-account funds.

So why so many accounts?

I use these multiple accounts to provide protection now and to plan for the future. The three main accounts of the checking account, large purchase fund, and emergency fund provide a layered system to (hopefully) avoid having to go into debt for major purchase and/or emergencies. And the automated transfers to the other funds help me to plan for the future to be able to pay our big bills and simultaneously enable us to do things like vacations and home improvements, again, without going into debt.

Having all the funds seems a little onerous, but it’s not that bad. Of course, you have to remember that my philosophy is to do everything as simply as possible. That means that I find it very worthwhile to take extra time to set something up if it means that the ongoing maintenance of it will be very simple as a result of the upfront work.

Photo Credits: Odalaigh

Book Review: The Bogleheads’ Guide to Investing – Part 2

September 19, 2008 · Filed Under Book Reviews · 2 Comments 

By Taylor Larimore, Mel Lindauer, and Michael LeBoeuf

This is part 2 of a multi-post book review of the excellent book, The Bogleheads’ Guide to Investing .  If you haven’t already, please check out part 1 now .

What else is good about the book?

Consider taxes

When we left off yesterday, we had just finished talking about how costs were critically important when choosing mutual funds.  If you are investing in a taxable account, it is most likely that the biggest expenses you will face are taxes.  It is therefore quite important to consider taxes when planning your portfolio.  The most important suggestion the authors have is to ensure that your least tax efficient funds are in your tax-advantaged accounts.  If you don’t have the luxury of any tax-advantaged accounts, make sure that you are investing in tax-friendly mutual funds.

Why would I want to invest in index funds to only get the market average?

Of course it makes perfect sense that you should strive to get better returns on your investments than the market in general, as provided by index funds.  This is one case, however, where common sense is just not correct.  In yesterday’s post I listed the reasons the authors give for investing in index funds.  Another item the authors would like you to consider is that it is extremely difficult to pick the best mutual funds in advance.

Multiple studies are referenced by the authors showing that the "hot" funds for one-year, five-year, or ten-year periods are very unlikely to be the "hot" funds in the subsequent period.  An example presented is from a Vanguard study where they looked at the top 20 US equity funds for the ten-year period ending in 1993.  Over the next ten-year period, only one of those top 20 funds were even in the top 100!  Remember, you need to pick a fund before it experiences its great growth.  It does you no good to have last year’s hot fund if it is performing below average this year.

The authors wrap up Part I of the book with chapters on investing for college, managing a windfall, and a discussion on whether or not you need to hire a financial advisor to manage your money for you.

The importance of rebalancing

Part II of the book starts off with a discussion on rebalancing.  The authors present two basic rebalancing strategies:

  • Time-based – Rebalance after a certain time period.  Most people do this quarterly or yearly.  Of note is a Morningstar study mentioned in the book that showed people who rebalance every 18 months get the same benefit and lower costs than those who do it more frequently.
  • Expansion bands – Rebalance when your original asset allocation gets skewed by more than a predetermined percentage (say 5%).

Behavioral Economics

There was some fantastic information in this chapter about why smart people make bad investment decisions.  I will list the items presented by the authors here but I can’t do into more detail today.  I am planning to do a number of posts on these topics, however, as I find them very interesting and important to understand.

  • Greed & Fear
  • Ego & Overconfidence
  • Loss aversion -a loss if felt more than an equal gain
  • Paralysis by analysis – spending too much time analyzing a situation and never acting
  • The endowment effect – people tend to confuse familiar with safe and overvalue what they already know
  • Following the herd
  • Mental accounting – treating money differently based on where it comes from – i.e., viewing your tax return as a windfall
  • Anchoring – clinging to an old belief or comfortable opinion even if it is wrong
  • Financial negligence

The final three chapters stray off of strict investment advice and cover the topics of ensuring you outlive your money, protecting yourself through insurance coverage, and passing on your estate when you die.  These contain some useful information and act to round out the book.  Again, this book is certainly more than a strictly investment advice book.  Though it does not go into terrible detail on these other topics, there is  some good "bullet-point" level information in them.

What is not-so-good about the book?

Overall, I really found this to be a useful book but there were some issues with it.  First, if you are not into index funds, you are going to have a hard time reading this book.  The authors are very pro-index funds and that philosophy is reflected throughout the book.  Of course, if that is you, maybe this is a good book for you to read to examine what the authors claim about their strategy and give it a fair look.

Though this book is not strictly about Vanguard, there are references to Vanguard littered throughout it.  They do mention other index funds, but they clearly love Vanguard.  Of course, what can you expect from a book with this title?

Finally, I didn’t really get the organization of the book.  The chapters do not flow logically for me.  I know that this is a minor point (and it probably says more about the way my brain works then the authors’ organizational capability) but it can give the feel that the book is disjointed and somewhat scatter-brained.

So what is my recommendation?

I really think this is a useful book for someone who wants to learn the basics of investing.  There is a lot of educational information in here about the stock market and especially index funds. Of course, the authors are espousing a certain investment philosophy and I just so happen to agree with that philosophy.  Actually, I wasn’t totally sold on the low-cost index fund thing when I first started reading this book.  It did a good job of explaining some of the issues that I was confused about in a way that made the index fund strategy more understandable and plausible.

After reading through the book and my notes, I have decided to put this book onto my virtual bookshelf.  It really does present a great overview of the low cost mutual fund strategy of investing.  I feel it is a valuable read for that reason. I highly recommend that you read this book as I think you might learn a lot from it.  Whether you buy or borrow it does not matter, though at over 300 pages, you might have to renew it.  For full disclosure purposes, I borrowed it from my local library (twice).

Want to borrow this book? Search your local library

Want your own copy? Buy this book now at Amazon.com

Check out the other books currently on my virtual bookshelf

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