A Random Walk through Financial Peace

Introduction Read: Ramsey Chapter 1 (Chapter 2 Optional) If you don’t have Microsoft Office, download OpenOffice for free:

https://www.openoffice.org/download/

Course OutlineIntroduction.................................................................................................................................................1

Monthly Budgeting......................................................................................................................................2

Credit Cards and Paying Off Debt................................................................................................................3

The Value of a Long-Term Strategy.............................................................................................................5

Investing and Asset Classes.........................................................................................................................7

Short and Mid Term Savings........................................................................................................................9

Long Term Savings.....................................................................................................................................10

Taxes..........................................................................................................................................................14

Appendix (Identity Theft/Protection, Buying House, Buying Car, Student Loans).....................................15

Glossary.....................................................................................................................................................16

Ramsey’s Baby StepsFor the Young Adult age group, we will focus primarily on the first 4 steps – but some of our discussions may lead into steps 5-7.

Step 1: Put $1,000 in a beginner emergency fund ($500 if your income is under $20K/yr)o Begin financial planning and build protection against unexpected expenses

Step 2: Pay off all debt using debt snowball. (Consider excluding mortgage and student loans)o Eliminate the huge anchor to building wealth and road-bock to financial peace

Step 3: Put 3-6 months of expenses into a savings as a full emergency fundo Protection against temporary loss of income

Step 4: Invest 15% of your household income into Roth IRAs and pretax retirement planso Build long-term wealth for income independence

Step 5: Begin college funding for your kids Step 6: Pay off your home early Step 7: Build wealth and give

Monthly Budgeting Read: Ramsey Chapter 3 - Ramsey Steps: 1-3 Dave Ramsey’s online budget tool: https://www.daveramsey.com/everydollar Web/Smartphone budget: https://www.mint.com/ List of 70+ Budget Categories: http://christianpf.com/basic-personal-budget-categories/ Budget Overview: http://www.thesimpledollar.com/preparing-a-budget-ten-tips-for-making-that-budget-successful/

Why have a budget The budget will give you a spending-and-saving roadmap – as well as a monthly measuring stick. If you are working on Step 1 (building a $1,000 emergency fund), knowing where to cut current

spending will be a key to success. An accurate/realistic budget will help reveal areas of spending that have the greatest impact.

A budget can have positive effects beyond financial benefits by ensuring money is able to be used for fitness, charity, gifts, and other things we often want to use our money for but may not feel we are able to afford.

For those in a relationship, a shared budget (with input and acceptance from both partners) can reduce conflicts around money.

Start Your Budget by Looking BackThe best way to predict what you will spend in the future is to see what you have spent in the past. Gather your bank, credit card, and debit card statements over the last three months and classify each line-item into a category of your choosing.

The list of budget items (link above) is helpful resource for thinking of categories to add to your budget - especially for things you have not purchased in the last few months which would not be on your current spending statements.

Walk Through Budget SpreadsheetReview the Monthly Budget Spreadsheet and sample credit/bank statement as an example method to set up a budget – Use the results to find areas where the person can most effectively cut costs to have the biggest impact on their monthly savings.

Credit Cards and Paying Off Debt Read: Ramsey Chapter 4 (Optional Chapter 5) - Ramsey Step: 2 APR Video: https://www.khanacademy.org/economics-finance-domain/core-finance/interest-tutorial/

credit-card-interest/v/annual-percentage-rate-apr-and-effective-apr http://www.investopedia.com/articles/pf/08/pay-in-cash.asp Optional Intro to Interest Videos: https://www.khanacademy.org/economics-finance-domain/core-

finance/interest-tutorial/interest-basics-tutorial Finding a card (pretty good, but not comprehensive): http://www.nerdwallet.com/

Interest Working Against You//Review the Credit Card Calculator Spreadsheet

According to Experian, 53.8% of used cars and 85.0% of new cars are bought by financing.

What to pay off each month:

The Minimum Balance is the amount you need to pay to avoid a late payment, but paying only this amount will result in interest being charged.

The Current Balance is the amount of all the charges that have posted to your account since the beginning of the billing period and when you pay your bill. Some of the charges included in the Current Balance may be for purchases made after the previous billing cycle ended.

Cash vs CardsStudies that show people spend ~20% more when using credit card vs. cash.

Dave Ramsey is big on cash and no cards. However, there are some practical advantages beyond reward points and FICO scores to credit/debit cards that he neglects that are worth noting.

Security: if cash is lost or stolen – it is gone. Also, you get a level of protection on purchases made with a credit card. If a product/service is faulty and the dealer refuses to give you a refund, you can file a fraud claim with your card company (use this VERY sparingly – I have not done this in 15 years).

Visibility: Using only cash makes it difficult to look back and see where your money is going. Cards give you detailed monthly records that you can easily download and compare to your monthly budget to track your spending. If you do not have a budget, these statements are the best place to start one! Also, if you lose a receipt for a major purchase, your credit/debit card statement can give you a leg to stand on if you need to return an item for warranty (or answer questions like: When was my car repaired?)

Credit Cards vs Debit CardsCompromised card: If (when) your number is compromised, you are not liable for any charges made on a credit card or a debit card. However a compromised debit card removes money directly from your bank account and is a much bigger hassle to get corrected. In this case, you may not have access to the

stolen money during the time it takes for your bank to investigate and reimburse you for the stolen funds. When your credit card is used by a thief, typically your credit card company will catch it before you do and put a hold on the card. Over the phone, you can point out the fraudulent charges to be reversed and they will issue a new card in about a week. You don’t have a credit card for a week, but the money in your bank account was never missing.

If you set the limit of your card at or near your monthly budget, it will just cut you off rather than charging you overdraft fees for going over. Typical bank overdraft charges are $25-$35 per “swipe.” Historically, banks will order “swipes” in a given day to maximize overdraft charges. (Let’s say you have $10 in the bank and make charges for: $1, $2, $3, $4 and $10 in a day. The bank will process the $10 dollar charge 1st to clean out the account and then process the next four charges to rack up $100 in fees.)

Credit cards will typically pay some kind of reward points to entice you to use them. Debit cards will offer reward points but debit card pay-backs are often much lower.

Credit cards (when and only when used correctly) build up your credit score. But you should not focus on this by getting more cards than you really need (2) with much higher limits than your monthly budgets. Debit cards are neutral to your credit score.

Credit Scoreshttps://www.annualcreditreport.com/index.action - Only Gov’t source to access your free required reports. Each reporting company owes you a report every 12 months. Check in Jan/June/Just-in-Case.

FICO Score weighting: 35%: Debt History 30%: Debt Levels 15%: Duration of the Debt

10%: Type of Debt 10%: New Debt

As of Jan 2015, in the US:

Auto Loans: $0.84 Trillion Credit Cards: $0.88 Trillion (About 1.1 Billion cards for 150 million card holders) Student Loans: $1.2 Trillion

The Value of a Long-Term Strategy Ramsey Steps: 3-4 Optional Intro to Compound Interest Video:

https://www.khanacademy.org/economics-finance-domain/core-finance/interest-tutorial/compound-interest-tutorial/v/introduction-to-compound-interest

Interest Working for YouSpreadsheet Calculation Walkthrough

http://www.bankrate.com/calculators/savings/compound-savings-calculator-tool.aspx

Reduce Risk by Holding Assets for Longer Periods of Time

Range of Annual Return Rates on Common Stocks for Various Time Periods 1950-2015:

Dollar-Cost Averaging: “Buy Low and Sell High”Don’t be alarmed by the complicated-sounding name. Dollar-cost averaging simply means investing the same fixed amount of money into an investment at regular intervals, over a long period of time. Periodic investments of equal dollar amounts in stocks can reduce (but not avoid) the risks of equity investment by ensuring that the entire portfolio of stocks will not be purchased at temporarily inflated prices. The investor who makes equal dollar investments will buy fewer shares when prices are high and more shares when prices are low. No matter how pessimistic you are, and no matter how bad the financial and world news is, you must not interrupt the automatic pilot nature of the plan or you will lose the important benefit of ensuring that you will buy at least some of your shares after a sharp market decline.

For most people, the real issue is whether they will be willing to continue the program of common-stock investing during periods of market decline, when pessimism appears to be ubiquitous. There would certainly be no benefit to the program if investors failed to stick with it during market decline. It is usually a good time to buy after the market has fallen out of bed and no one can think of any reason why it should rise. Just as hope and greed can sometimes feed on themselves to produce speculative bubbles, so do pessimism and despair react to produce market panics. The greatest market panics are just as unfounded as the most pathological speculative explosions. No matter how bleak the outlook was in the past, things usually got better. For the stock market as a whole, Newton’s law has always worked in reverse: What goes down must come back up. But this does not necessarily hold for individual stocks, just the overall market in general.

Investing and Asset Classes Ramsey Steps: 3-4 Watch Mutual Fund and ETF Overview Videos: https://www.khanacademy.org/economics-finance-

domain/core-finance/investment-vehicles-tutorial/mutual-funds/v/open-ended-mutual-fund-part-1

Asset Return vs. Length of Time

Type of AssetExpected

Return before Taxes

Length of Time Investment Must Be Held to Get Expected Rate of

ReturnRisk Level

Bank Accounts 0 - 3%

No specific investment period required. Many thrift institutions calculate interest from day of deposit to day of withdrawal.

No risk of losing what you put in. Deposits up to $100,000 guaranteed by an agency of the federal government. An almost sure loser with high inflation however.

Money-market deposit accounts

0.5 - 4%No specific investment period required, but check withdrawals limited to three per month.

No risk of losing what you put in. Deposits guaranteed as above. Rates geared to expected inflation and will vary over time.

Money-market funds 0.5 - 5%

No specific investment period required. Most funds provide check writing privileges.

Very little risk because most funds are invested in government securities and bank certificates. Not usually guaranteed. Rates vary with expected inflation.

Special six-month certificates

3.5 - 5%Money must be left on deposit for the entire six months to take advantage of higher rate.

Early withdrawals subject to penalty. Rates geared to expected inflation and will vary.

Treasury inflation protection securities (TIPS)

2.5% + inflation rate

These are long-term securities maturing in five years or longer. Prices can vary if sold before maturity.

High-quality corporate bonds (prime-quality public utilities)

6%

Investments must be held until maturity (20-30 years) to be assured of the stated rate. (The bonds also need to be protected against redemption.) The bonds may be sold at any time, but market prices vary with interest rates.

Very little risk if held to maturity. Moderate to substantial fluctuations can be expected in realized return if bonds are sold before maturity. Rate geared to expected long-run inflation rate. "Junk bonds" promise much higher returns but with much higher risk.

Diversified portfolios of blue-chip US or developed foreign country common stocks

7 - 8%

No specific investment period required and stocks may be sold at any time. The average expected return assumes a fairly long investment period and can only be treated as a rough guide based on current conditions.

Moderate to substantial risk. In any one year, the actual return could in fact be negative. Diversified portfolios have at times lost 25% or more of their actual value. Contrary to some opinions, a good inflation hedge over the long-run.

Real EstateSimilar to common stocks

Some as for common stocks in general if purchase is made through REITs.

Same as above but REITs are good diversifiers and can be a good inflation hedge.

Diversified portfolios of relatively risky stocks of smaller growth companies

8 - 9%

Same as above. The average expected return assumes a fairly long investment period and can only be treated as a rough guide based on current conditions.

Substantial risk. In any one year the actual return could be negative. Diversified portfolios of very risky stocks have at times lost 50% or more of their value. Good inflation hedge.

Diversified portfolios of emerging market stocks

8 - 11%Plan to hold for at least 10 years. Projected returns impossible to quantify precisely.

Fluctuations up or down of 50% to 75% in a single year are not uncommon but have diversification benefits.

Commodities Impossible to predict

High returns could be earned in any new speculative craze as long as

Substantial risk. Gold is believed to be a hedge against doomsday and

there are greater fools to be found.hyperinflation. Commodities play a useful role in balancing a diversified portfolio, however.

Single Stock

Currency Exchange

Impossible to predict

There are no long-term trends associated with currency exchanges.

Currency exchange trading is pure speculation.

Reduce Risk by Diversification (Mutual Funds and ETFs)ETFs are bought and sold just as any individual stock. They can be purchased in the morning and sold in the afternoon. Each buy and sell of an ETF will require a transaction cost. Mutual funds on the other hand are bought at the closing price of the purchase day and cannot be sold until the close of the following day. Low-cost, no-load funds do not charge the investor for purchasing more shares or rebalancing. For many small periodic investments (dollar-cost-averaging), index mutual funds are greatly preferred to ETFs. The simple reason is that it costs nothing for 12 incremental investments throughout the year with a mutual fund, but it would cost in the neighborhood of $12 per investment with an ETF – an additional investment expense of $144 per year.

Short and Mid Term Savings Ramsey Step: 3 Optional Banking Overview Video: https://www.khanacademy.org/economics-finance-domain/core-

finance/money-and-banking/banking-and-money/v/banking-1

Choosing a Fair and Functional Credit Union (or Bank)

Setting up a Money Market Account

Opening an Investment Account

Long Term Savings Ramsey Step: 4

Lifecycle Guide to InvestingAsset Class: Cash -

Vanguard Prime Money Market Fund: VMMXXMoney-market accounts are offered by most banks. They currently have returns around 1%. Shop around and look for the best rates or see your current bank out of convenience. Money-market accounts typically require minimum deposits of about $2,500. The cash portion of a portfolio could also be held in bank CDs or US treasury bills. Money-market accounts provide lower returns but offer the benefit of liquidity. Banks offer lower returns with the added security of FDIC protection.

Asset Class: US Stocks - This should consist of US stock index fund(s). S&P 500 Index Fund: VFINX, IVV, SPY Wilshire 500 Index Fund: VTSMX, VTI, TMWThe Wilshire 5000 is preferred to the S&P 500 because it contains thousands of smaller firms that are not in the S&P 500. Many of the greatest stock success stories of the past century came from stocks that were not in the S&P but grew to become leading corporations. The Wilshire 5000 will include the growth from these stocks. Historically, the Total Stock Market fund has had better returns than the simple S&P 500 fund. However, many 401(k) plans only offer an S&P 500 index but not a Wilshire 5000 index fund. In these cases, the S&P 500 index is preferred over other actively managed large-cap funds because of the lower expense ratios.

Asset Class: Bonds - This should consist of a bond index fund. Total Bond Market Index Fund (US): VITBX, AGG Vanguard Long-Term Bond Index Fund (US): VBLTX, BLV Vanguard Treasury Inflation Protection Securities (US TIPS) Fund: VIPSX, TIP, IPE International Bond Market Funds: BNDX, VTIBX– These funds are made up of international,

intermediate bonds. There is some additional currency fluctuation risk with this class; these Vanguard funds are “hedged” against currency exchange risk to minimize this movement.

High Yield Bonds (Junk Bonds): HYG, VWEHX - These are bonds issued by risky corporations. They tend to fluctuate more than typical bonds but may have a higher return. Consider with caution or safely avoid altogether.

The bond portion of the portfolio should be made up of a broad bond fund. Long term bonds typically have better returns and are a little more volatile than the total bond index. Because of this, young investors may prefer long-term bonds to the broad bond index. On the other-hand, older investors may prefer the stability of the total bond index. TIPS are treasury bond except that principal and coupon payments are adjusted to eliminate the effects of inflation.

Asset Class: Foreign Stocks - This should consist of an international index fund. Total International Stock Index Fund: VGTSX, EFA Developed International Markets: BTAEX European Stock Index Fund: VEURX, IEV, VGK Pacific Stock Index Fund: VPACX, VPLBroad indexes are preferred over more costly actively managed funds or individual stocks. This

portion of the portfolio should consist of developed markets such as the large countries in Europe (United Kingdom, Germany, France, etc...) and developed countries in the Pacific area (Japan, Australia, etc…).

Asset Class: REITs - Real Estate Investment Trust Index fund. REIT Index Fund, ETF: VGSIX, RWR, VNQ International REIT Index Fund: VGXRX, VNQIThis index fund holds only Real Estate Investment Trusts. In other words, it is like buying in to companies that buy and sell commercial real estate. It allows you to own land in the same manner you would own stock.

Asset Class: Aggressive Stocks - Emerging Market and US Small cap index funds. Emerging Markets Stock Index Fund, ETF: VEIEX, VWO, EEM Small-Cap Index Fund, ETF: NAESX, VB, DSCThe emerging market index and small cap index should play a role in a well-diversified portfolio, particularly with young investors. The Emerging Market fund contains stocks from countries such as India, China and Brazil. The Small Cap mutual fund should contain US stocks that are smaller than those in the Fortune 1000.

It should be noted that small caps are contained in the “Total Stock Market” fund and emerging markets are held within the “Total International Fund.” Younger investors who want to have an increased portion of their portfolio to contain these high-risk, high reward funds can purchase these in addition to the broad index funds that already contain them. Older investors may want to drop these from the portfolio since they add risk and are already held within VTSMX and VGTSX.

Asset Class: Commodities – energy, precious metals, industrial metals, agriculture, livestockCommodity Index ETFs: DBC, GSG, GSP, DJPEnergy, Metals, Agriculture ETF: DBE, USO, OIL, DBB, DBP, IAU, DBA

Commodities and raw materials are the elements used to build an economy. Stocks tend to fall as these base elements rise and vice-versa. Because of this, there may be some diversification value for holding a small portion in a well-balanced portfolio. The charts below do not include the commodity asset class but could be included as a sub-section of the Aggressive Stock class – preferably less than half of the class. Investors with a low tolerance for risk should avoid this class – and it would be wise for all investors to keep the allocation of commodities below 2.5%.

US Stocks40%

International Stocks25%

Aggressive Stocks15%

REITs10%

Bonds10% Cash

-Age: Mid-TwentiesLifestyle: Fast, aggressive. With a steady stream of earnings, capacity for risk is fairly high. Need to discipline of payroll savings to build a nest-egg.

Additional Considerations: Increase percentage of REITs and/or

aggressive stocks Small amount of commodity -class

assets within the Aggressive Stock mix

Long Term Bond Index or TIPS Index may be preferred to Total Bond Index

US Stocks40%

International Stocks25%

Aggressive Stocks10%

REITs10%

Bonds15%

Cash-

Age: Late Thirties to Early FortiesLifestyle: Midlife crisis. For childless career couples, capacity for risk is still quite high. Risk options are vanishing for those with college tuitions looming.

Additional Considerations: Increase percentage of REITs Long Term Bond Index or TIPS Index

may be preferred to Total Bond Index Increase bonds up to 20%-25% Minimal amount of commodity -class

assets within the Aggressive Stock mix

US Stocks30%

International Stocks22%

Aggressive Stocks

8%

REITs10%

Bonds25%

Cash5%

Age: Mid-FiftiesLifestyle: Many still reeling from college tuitions. No matter what the lifestyle, this age group must start thinking about retirement and the need for income protection.

Additional Considerations: Increase percentage of REITs Increase percentage of cash Reduce percentage of aggressive

stocks Minimal commodity -class assets Total Bond Index with TIPS Index may

be preferred to Long Term Bond Index

US Stocks21%

International Stocks14%

Aggressive Stocks5%

REITs10%

Bonds40%

Cash10%

Age: Late Sixties and BeyondEnjoying leisure activities but also guarding against major health costs. Little or no capacity for risk.

Additional Considerations: Increase percentage of cash Reduce or eliminate percentage of

aggressive stocks No commodity -class assets Total Bond Index with TIPS may be

preferred to Long Term Bond Index

Automatic for the People

For most investors, a single life-cycle fund made up of diverse index funds would be recommended (if it is offered in your retirement plan). The expense ratios for life-cycle funds should be around 0.20-0.25% if comprised of low cost index funds. One of the advantages to life-cycle funds is the low cost of entry. The Vanguard life-cycle funds described above require a $3,000 minimum deposit to open. To have a fully diversified portfolio when purchasing each index fund separately, one would need about $15,000 to open five individual index funds – and this allows for only a 20% allocation for each asset class. This is quite a hurdle for young investors, particularly to achieve an optimal asset class allocation. The life-cycle fund on the other hand provides a fully diversified portfolio with an appropriate asset class allocation and only requires $3,000 to open.

The life-cycle fund also eliminates the temptation for an investor to shift money into an index fund that has become hot in an attempt to time the market. Life-cycle funds also provide a single mutual fund to manage which helps in setting up future contributions. Plus, it is simple to track a single stock ticker when checking the performance of the fund. Finally, because life-cycle funds are rebalanced annually and the asset class allocation is adjusted with age, they are virtually hands-free – like an automatic transmission. For those starting out, life-cycle funds made up of individual index funds are perfect!

Vanguard Target Retirement 2060 Fund (VTTSX) Vanguard Target Retirement 2055 Fund (VFFVX) Vanguard Target Retirement 2050 Fund (VFIFX) Vanguard Target Retirement 2045 Fund (VTIVX) Vanguard Target Retirement 2040 Fund (VFORX) Vanguard Target Retirement 2035 Fund (VTTHX) Vanguard Target Retirement 2030 Fund (VTHRX) Vanguard Target Retirement 2020 Fund (VTWNX) Vanguard Target Retirement Income Fund (VTINX)

Taxes Watch Traditional IRA, Roth IRA, and 401(k) Videos: https://www.khanacademy.org/economics-finance-

domain/core-finance/investment-vehicles-tutorial/ira-401ks/v/traditional-iras If Article: If a caller says he’s with the IRS, he’s not

Taxes on Income

Taxes on Dividends and Capital Gains

Standard Deduction vs. Itemized Mortgage Interest, Student Loan Interest (if qualified), Tithe

Retirement Savings Traditional IRA Roth IRA 401(k)

Appendix (Identity Theft/Protection, Buying House, Buying Car, Student Loans)

Insurance

Efficient Market Theory

Actively Managed Funds vs. Index FundsExpense Ratios

Data Security

Credit Freeze http://www.creditcards.com/credit-card-news/credit-report-freeze-1282.php http://www.consumerreports.org/cro/news/2014/02/should-you-put-a-security-freeze-on-the-credit-file/index.htm

The most secure way to protect your identity is to issue a credit freeze for your SSN. It costs $10 to freeze reports from each agency ($30 total) and $10 each ($30 total) to temporarily or permanently unlock your reports to apply for a new card, auto loan, mortgage, etc… If you are the victim of identity of theft, you can get this service for free. However, it may not be worth waiting. You have to 1) have your identity stolen, 2) have an account opened in your name, 3) file a police report, 4) fax/mail police report to 3 different agencies to set up the freeze… all the while your account it exposed to further fraudulent activity.

https://www.transunion.com/freeze http://www.equifax.com/help/credit-freeze/en_cp https://www.experian.com/ncaconline/freeze

State

Fees (Aug 2015)

Security Freeze Placement

Date Range

LiftSpecific Party Lift

Permanent Removal

Replacement PIN

Texas

ID Theft Victim Free Free Free Free Free

Non-Victim $10 $10 $12 $10 $10

Protected Consumer Free Not

AvailableNot

Available Free Not Available

If you or a protected consumer are a victim of identity theft and you submit or have previously submitted a copy of a valid police report, investigative report, or complaint made under

Section 32.51, Penal Code, no fees will be charged to place a security freeze on your Equifax credit file, temporarily lift the security freeze for a specific party or specific period of time, to

permanently remove the security freeze from your Equifax credit file, or for a replacement 10-digit PIN. A "protected consumer" is an individual who is younger than 16 years of age at the

time a request for the placement of a security freeze is made.

Buying a Househttp://www.zillow.com/mortgage-calculator/

Student LoansFor students that qualify, there are a number of benefits to getting a federal student loan. Unlike private student loans, the interest rate charged by the federal government is fixed, with the rate resetting each July 1 for the following year. For loans disbursed between July 1, 2014, and June 30, 2015, the subsidized rate is 4.66% for undergraduate loans and 6.21% for graduate student loans.

In addition to a fixed interest rate, federal loans have repayment plan options. The standard 10-year repayment period has the highest monthly payment, but accumulates the least interest. Other options include longer repayment periods (which lower the monthly payment, but cost more in interest) and income-based repayment terms. Flexible repayment terms are beneficial during times of financial distress. Federal loans also have more lenient terms than private loans in other respects; for example, federal loans are not considered to be in default until the borrower misses payments for nine months. Default conditions for private loans depend on the lender’s contract and can be as strict as only one missed payment.

Private lending has historically been less attractive to students due to higher interest rates, lower flexibility in repayment terms, floating interest rates and little consumer protection. Floating interest rates can increase during the life of the loan depending on the fluctuation of prime rates and LIBOR. Interest charged by private lenders varies according to the credit profile of borrowers. In addition, many private lenders, such as Discover and Sallie Mae, may require the student to have a co-signer guarantee the loan. We also note that higher education loans are typically not dischargeable in bankruptcy, according to Sallie Mae.

Glossary