Have you noticed that lately when you shop for something on Amazon, that item has a habit of popping up on other websites? It’s as if Amazon has worked out a way of saying, “Oh hi, did you forget to buy this? Well, you can now. Just click.” In some instances, that might be helpful. It also is a clear demonstration of how the internet has a way of “following” what you’re up to.
What does this have to do with investing? As you start doing research into investments — as you should — you might begin to see all kinds of “invitations” popping up on web pages, email, Facebook and other social media accounts. You’re ready to make money, so these might be a good way to start. Before you dive in, you’ll want to consider these red flag warning signs about investing.
- High Return, No Risk
High return? Possible. No risk? Not likely. That makes for a nice headline to draw you in but has no basis in real investing. You’ll find investing in opportunities like mutual funds will often have three tiers of risk: low, moderate and high. The risk is always there. Anyone who tries to tell you otherwise just isn’t telling you the truth.
Did you hear the story about Apple co-founder Ronald Wayne? He sold his stake in the company back in 1976 for a paltry sum of $800. Had he tucked away those shares and sat on them, they would be worth around $63 billion. You actually might hear this story retold as a sales pitch. You can’t miss a “once-in-a-lifetime” opportunity, right?
Actually, you can. If the opportunity is so great, then the sales agent should be able to back it up with dependable facts and research. Ask for that and see what happens.
- Tax-Free Havens Offshore
Wouldn’t it be great to never pay taxes again? That’s not going to happen, especially with investment capitol. A broker might suggest setting up an offshore account to insure you won’t be paying taxes, but what happens if that investment tanks? Try getting your money back from one of those offshore brokerage firms. It’s not going to be easy. Of course, you won’t have to worry about paying taxes on money that has disappeared.
- Overly Slick Sales Materials
A website for a potential investment might be nicely produced. It will have lots of pictures — stock photos — of smiling people happy with their dividends. It will make bold proclamations about this opportunity. What it won’t have are a lot of tangible facts like providing contact information for the company you’re investing in. Upon closer inspection, you might discover spelling or grammar errors in the copy. Run, don’t walk, away from that “opportunity.”
- Unanswered Questions
When you go to buy a car and set up financing, there is a moment when the salesperson has to take the contract back to their manager to see what can be done. They never let you in on that conversation because they already know what can be done. They want you to pay a hefty finance charge. The same thing can happen with investments. You might ask questions only to get a, “Let me find out and get back to you” response.
There is no question you can ask that shouldn’t have an instant coherent response. If the agent is hemming and hawing, then you should invest elsewhere.
- Ground-Floor Investments
Getting in on the “ground floor” of a company can often be a huge benefit — see the Apple story above. However, there is also a lot of risk with an unproven entity. So many things can go wrong with a business start-up that it’s probably one of the riskiest investments you can make.
If you want to pursue that investment, then ask to speak to direct reps from the company. Don’t take the word of a broker that things are going to “go off the charts.” A company rep who is honest will tell you the challenges ahead. That is someone worth investing in.
All of this boils down to that wise adage, “If it looks too good to be true, then it probably is.” Words to live by.
Anum Yoon loves all things related to personal finance. She founded Current on Currency after realizing there wasn’t a personal finance blog that tailored posts for international students. Current on Currency has since expanded to become a millennial money blog, so follow her on Twitter @anumyoon to check out her updates.
What is the sunk cost fallacy? The idea that any money or time you already spent on a thing matters. That money is gone. That time is gone. You shouldn’t let the time or money you spent on a bad idea keep you from throwing the bad idea away. Preferably far away.
This comes up all the time. People finish terrible movies because they spent $10 to buy the ticket, rather than walking out of the theater and enjoying the rest of their evening doing something more interesting. This isn’t a very big deal with a movie, you lose, what, another hour or so? However, the effect is significant and unfortunately seems to become stronger when the stakes get higher.
Like in Investing?
Yup, the sunk cost fallacy is all over the place in investing. The major danger here comes from anchoring. No, this has nothing to do with newscasters.
When you initially buy a stock, people often get anchored to the price they paid for it (in investing parlance, your cost basis). If the price then, gets cut in half, or doubles they think about the new stock price relative to what they paid for the stock. This is exactly wrong.
What you paid for a stock should not enter into your analysis. It is a sunk cost. It might matter for your tax considerations, but if you own a company that is intrinsically worth $5 per share, that’s what it is worth. The only factors in your decision making should be the intrinsic value of the shares, and the market price of the shares.
This seems obvious, but some of the earliest mistakes I made investing were related to this. The first stock I ever invested really heavily in was Safeway. They were making money hand over fist compared to the price of their shares, management was using that money to buy-back shares at a breakneck pace. It didn’t take a genius to figure out that something good would happen.
Not being a genius, I bought a significant amount at $15 per share. It went up a little bit, to $20 per share, and even though the company was still cheap relative to it’s intrinsic value, I sold, thinking I had made a great profit.
The nutty thing about this is that if I had discovered the opportunity a 3 months later I would have bought it at $20 per share, but I was so focused on what I paid for the stock that the higher market price got me excited to sell.
The stock proceeded to get bought out for $30+ shortly later.
There is another side to this too, I had a friend that bought Microsoft at roughly $35 a few years ago. It proceeded to drop between $5 and $10, I don’t remember exactly how much. It concerned him a great deal to be “losing money” on the trade. It stayed low for a few months or a year, and then went back up to $35. He was so excited once the stock was back at what he paid for it, that he sold immediately.
What he didn’t take into account was that Microsoft was then making even more money than when he originally bought the stock! As of this writing Microsoft trades at $65, and has paid out a substantial amount in dividends as well. (I make no recommendation about Microsoft). Had my friend not been so focused on his sunk cost and instead focused on the business, he would have nearly doubled his money.
Dealing With It
This bias is extremely powerful and it’s hard not to feel that stocks that have gone up since you’ve bought them are somehow better than stocks that have gone down. Unfortunately, when deciding what you should keep in your portfolio what you paid for a stock (outside of tax considerations) shouldn’t matter to you at all! You should be only focused on whether the stock is more likely going to go up or down in the future not what it did in the past.
How do I deal with this? Use a broker that hides your cost basis from you. If you don’t remember what your cost basis is, it can help prevent you from making bad decisions because of your cost basis. For this I like Loyal 3, but they have a very limited selection of stocks that they’ll trade.
Unfortunately the bottom line here is that this is dangerous knowledge. Simply knowing it makes it more likely that you will do worse in the market.
Whether you will be heading to the other side of town or moving across the country, moving can quickly become a major expense. There is no need to blow your moving budget if you are willing to spend time planning and preparing before you move. Two of the most important considerations are how you will move from one location to another and exactly what items you want to take with you.
Hire a Professional
Many people decide to move everything themselves to save money, but this isn’t always the best solution. The amount of household goods which need to be moved, the distance between homes, vehicles available, and the number of people who can be reliably counted on to provide assistance for packing and unloading often create a situation that costs more time and money to pull off successfully than initially anticipated.
Credit cards are great. I’m a huge fan. More often than not they allow you to obtain basically 1% back on purchases, give or take. (That’s those points people are always going on about).
Unfortunately these are only great if you NEVER PAY INTEREST. In the case of credit cards this is simple. Pay your statement balance in full every month and you never need fear paying 15, 20 or even 25% interest.
How Bad is it to Pay Credit Card Interest?
Really, really bad.
If you maintain a $10,000 balance on your credit cards you’ll end up paying something like $200 per month just for the privilege.
If you can’t keep up with the interest, you’ll probably have to declare bankruptcy. The interest rates on credit cards are so high that your balance will double every 3 to 5 years.
So, let’s say that your $10,000 balance is getting charged interest at a rate of 25%. After 6 years the balance will be $40,000 and the annual interest will be $10,000. That’s right, after 6 years your annual interest is equal to your original balance!
So How DO You Avoid Paying Interest
It turns out to be simple, but as with most things, Saturday Night Live said it best.
This is all of Personal Finance
- Don’t Buy Stuff You Can’t Afford
- If You Don’t Have Money You Should Not Buy Anything
Problems In Life Have Solutions Which Fall on Two Axes
A solution can be simple or complex and the implementing the solution can be easy or hard. What does that even mean?
Well, it’s best to learn by example, if I have a bacterial infection I can take antibiotics (for the time being anyway). This is a complicated solution which is easy for me to implement. I am not clever enough to have come up with antibiotics. (Seriously, it would never have occurred to me that some mold could be used to fight bacteria.)
A complicated solution that is difficult to implement might be Chemotherapy. The treatment is complicated, and very hard to do.
A simple solution that is easy to implement is like making yourself a sandwich. You’re hungry. You just take some meat, bread and (hopefully!) veggies. Boom, sandwich.
A simple solution that is hard to implement is diet and exercise as a method of losing weight. It isn’t complicated, burn more calories than you consume, but it is hard.
People hate simple hard solutions, and they love complex easy solutions. Given the choice between a hypothetical pill that would make you fit and a regimen of diet and exercise who wouldn’t prefer the pill?
This is exactly why there are so many snake-oil salesmen in the personal finance game, there are a million get-rich-quick books. There are probably just as many lose-weight-easy books. There is no complex-easy solution to your finances, there is also no lack of people who will try to use complicated methods to bamboozle you into thinking they have an easy solution for your finances.
There is no easy solution.
There is only the simple solution.
You Must Spend Less Than You Earn
So what if you already are in a significant amount of credit card debt? Well, my rule of thumb is that you should treat anything you buy as costing 3x as much. Why?
That’s a reasonable rule of thumb for how much it’ll cost you after the interest.
What does this mean? Well, food is still worth buying. Need to eat, I’m willing to pay 3 times for food if that’s what it costs. Need to live somewhere; willing to pay 3 times for that too. I am not willing to pay 3 times as much to go to the movies. I am not willing to pay 3 times as much to go out to eat.
So if you have credit card debt, excluding your credit card payments and interest:
You Must Spend Less Than 1/3rd of What You Earn
Have you heard of No-Exam Life Insurance? Unfortunately, many people still don’t know about it or may not know how to get it. This might be why studies show that 38% of people who want life insurance put it off.
Sadly, many delay getting life insurance until it’s too late.
The question of whether no-exam life insurance is the right choice comes up a lot. This option isn’t right for everyone, but in the right circumstances, it can be the only choice that makes sense.
So, what are those circumstances?
Age can be a factor in choosing no-exam life insurance, whether a person is young and healthy or “too old” for traditional life insurance.
- No-exam policies require less information, but age will always affect rates. According to Ty Stewart, owner of simplelifeinsure.com, “Rates for a young healthy person will be only fractionally higher whether you take the exam or skip it”
- Beyond age 70, most traditional policies won’t offer coverage. No-exam providers may offer an option called Final Expense life insurance, available to anyone 89 years or younger.
You Don’t Want an Exam
There are many reasons why someone might want to avoid having an exam for the life insurance process.
- You haven’t had an exam in a while
- Fear of needles, blood, etc.
- Just too busy!
- High-risk health conditions
If it has been a while…
If you were healthy at your last exam, but it has been a couple years, it may be smart to avoid having a new exam, because there may be new health issues the person isn’t aware of. These range from higher blood pressure or cholesterol to elevated blood sugar or urine protein levels.
Some of those are normal as we age, but any increase from the prior exam increases the cost of life insurance. Urine protein in particular can simply vary from exam to exam, but could also be a sign of kidney problems. Insurance companies raise rates a lot higher because of this increased risk.
Even worse, now the exam results are added to the Medical Information Bureau (MIB). Any future life insurance application with a different company will refer to the MIB and see those results.
Afraid of needles or doctors?
You’re in good company. About 20% of people have severe needle phobia. Another 20% have a phobia of doctors. This means that getting an exam can be an uncomfortable, panic-ridden experience.
Fear of needles or doctors can temporarily elevate blood pressure. Higher blood pressure is a top reason life insurance companies lower a person’s health bracket, increasing cost. If you’re trying to get life insurance, higher blood pressure is not what you want.
Do you have [fill in the blank]?
Perhaps you’ve been denied life insurance coverage due to a chronic health condition, or you’ve recently discovered you have a high-risk condition such as diabetes.
In these cases, no-exam life insurance may be the best option available. Policy types exist for these situations, including Guaranteed Issue and Graded Death Benefit policies. The latter type requires answering a few questions but may give a lower price than a Guaranteed Issue policy.
Fast Coverage is Needed
Sometimes, a person may have reasons why it’s not practical to wait the 6-8 weeks needed for a regular life insurance policy.
- Obtaining a small business loan
- Divorce decree may require life insurance to finalize proceedings
- Leaving on vacation, especially overseas
- Selling a structured settlement (such as a pension) may require a policy to protect the buyer
In these cases, no-exam life insurance is the ideal solution. Many providers will approve a policy in hours or even minutes.
Dangerous Job or Hobby
Life insurance companies will ask about a person’s job, and often ask about hobbies. If the company decides that a person’s job or hobby is high risk, the policy premium goes up. Sometimes, it goes up a lot.
There are some no-exam life insurance providers who don’t ask about these things, and if they don’t ask, they can’t raise rates!
You’ll need to talk to an agent, since most no-exam life insurance companies will only work through agents. But don’t worry–rates are fixed by law. The cost to you is the same whether you use an experienced agent or attempt the process yourself.
Consider the circumstances discussed above. If you fall under any of these, it’s worth looking into this type of policy, especially if you’ve been turned down for traditional coverage.
In all cases, getting a no-exam life insurance policy is faster, easier, and far less intrusive, and probably less expensive than you’d think.
The current tax code is a mishmash of law and loophole that’s been built up over many years. In some cases, like the 401(k) the loophole was later championed by someone and made into real law. If the 401(k) was kind of an accident, the IRA was pretty much on purpose. We’re going to discuss something quite similar for educational savings accounts. The 529 plan is a little more like the 401(k) in this respect. The Coverdell ESA (Educational Savings Account) was a little more on purpose.
I’m just kidding. There’s no way you want to know that the Coverdell came out of a big budget reconciliation act in the late 90s. (Also the one that gave 529’s some of their fun tax benefits!) You also probably don’t care that it was named after the senator Coverdell. Eh, even reading into this section this far should get you something. Enjoy a video I watched today as a reward:
What’s the Benefit of the Coverdell ESA?
Okay, now we’re getting to the stuff a reasonable person would care about. The entire point of the Coverdell ESA is that it’s basically a Roth for educational expenses rather than retirement.
Let me repeat that. You know the awesome roth thingy?
The one I’m always going on about?
The one we have a video about here?
You can have that for educational expenses.
What are the Limitations for the Coverdell ESA?
Well, bad news first. You can only contribute $2,000 annually to a specific beneficiary. Beneficiaries have to be under 18, so this isn’t a great way to save money for yourself to go back to school. It’s really to save for people roughly the age of the kid photographed above.
Additionally, you can only contribute to a Coverdell ESA if your Modified Adjusted Gross Income is less than $110,000 for individuals and $220,000 for couples filing jointly. If your salary is higher than that, check out our article on how to keep your MAGI reasonable.
The beneficiary also has to use the account for qualified educational expenses before they turn 30. So that means if you’re putting money aside for your kid figuring they’ll go to school, they need to use that money in their 20’s or earlier.
This shouldn’t be too hard unless their waiting a real long time to get started with school:
How Do I Deal with the Coverdell ESA limits?
Well, fortunately you have some options if you have created a Coverdell ESA and it turns out to be a mistake, maybe you contributed more than your kid would end up needing in school.
Maybe your kid got a full scholarship. All kinds of things can happen.
Fortunately, you can change beneficiaries. The new beneficiary has to be a related person. The IRS doesn’t want to create a market for Coverdell ESAs by allowing you to transfer to just anyone.
One major difference between Coverdell ESAs and Roth IRAs is that you can’t just take contributions back out, tax free! This is a big difference in my view, as a major selling point of Roth’s is that you might as well always max it out. After all if you change your mind you can just take your contributions right back out, no penalties, no questions asked.
For the Coverdell ESA you have to treat each distribution as though the money has been mixed around in the account, and you must pay taxes on a distribution as though it contains representative parts of (non-taxable) contributions and (taxable) earnings.
Best bet with the Coverdell ESA is to only put money in that you’re pretty sure will get used for educational expenses by the beneficiary you have in mind or at least some under 30 relative.
What Expenses Count as Qualified Educational Expenses?
Well, I’m glad you asked. You can get the story straight from the horse’s* mouth here. I’ll give you a broad brush though:
First off, normal living type expenses are NOT qualified educational expenses. Room and Board, medical bills (even if they are charged by your university!) do not count. Nor is the cost of a car to get to school. Short version is, don’t be silly, you know that these things aren’t educational expenses. Don’t be an ass about it.
Tuition and mandatory fees ARE qualified educational expenses…very probably. (I mean probably talk to a real accountant, but I’m pretty sure). Of course this is kind of the well, duh part. Tuition pays for the education it’s an educational expense, go figure.
Student loans are NOT qualified educational expenses.
I know what you’re thinking. What’s up with that!?
Well, student loans are a way of paying educational expenses, they aren’t educational expenses themselves. That’d be like calling your contributions to an ESA a qualified educational expense.
But what about interest on student loans?? Why isn’t that an educational expense???
Those are deductible anyway (at least I’m pretty sure), so you’re paying them with pre-tax money anyway.
Other expenses can depend, like books and that sort of thing, but the upshot seems to be that any expense required by the school for attendance can be counted as a qualified educational expense. Consult a tax advisor, be realistic.
Disclaimer: I am not a tax advisor. This is not tax advice. I’m not even an accountant. I got a BS in physics. This is for entertainment purposes only. I do not believe the IRS to be made up of horses. Nor do I believe them to be afflicted by the terrible condition known as “horse’s mouth”.