The Most Important Chart on Investing You’ll Ever See

Understanding the ups and downs of the stock market.

Here is a basic truth: stock prices rise and fall. Of course, literally speaking, this statement is true. But it’s misleading. That’s because the statement is incomplete; it’s not really accurate to say that stock prices ”rise and fall.”

Oh, sure, on any given day, prices might rise or fall. But over long periods, it’s more accurate to say that prices in the overall stock market rise a lot but fall a little, as shown in the image. This chart clearly shows that when  prices are rising, they rise a lot and for a long time. When prices fall, they fall a little and for a short period. This explains the real reason why the stock market is able to exist.

Think about it. If stock prices were to only rise and fall, there would never be growth in the economy. It would force investors to decide when to buy and when to sell.

Imagine playing with a yo-yo. It goes down, then it comes up. Down, up. Down, up. If that yo-yo were a stock’s price, the trick would be to catch it and release it at the right time. But as the chart shows, investing in the stock market is like playing with a yo-yo while climbing a hill. Even though the yo-yo is still going down, up, down, up, the height of the yo-yo is constantly climbing, thanks to the hill’s incline.

Here’s another way to put it: The market doesn’t simply go up one point and then down one point. Rather, it goes up two points, then down one point. Then it goes up four, down one, up three and down one. Sure, sometimes the down is larger than the previous up, but over long periods, the stock market has always produced net profits. That’s why it’s wrong to be upset when stock prices fall. Instead of lamenting the current decline, focus on what is about to happen next. This point is particularly important following 2008’s terrible performance.

But if you had the opportunity to invest at the moment of your choosing, where on the chart would you choose? And where are we on that chart right now? When you notice that stock prices are declining, don’t be upset. Instead become excited about what lies ahead.

An index is a portfolio of specific securities (common examples are the S&P, DJIA, NASDAQ), the performance of which is often used as a benchmark in judging the relative performance of certain asset classes. Indexes are unmanaged portfolios and investors cannot invest directly in an index. Past performance does not guarantee future results. Originally published in Rescue Your Money
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Should You Buy Travel Insurance?

Yes, but not your parents’ travel insurance.

Remember when airports featured kiosks that let you buy flight insurance? You could buy $50,000 in coverage for a buck or two. The policies were cheap because it was unlikely that the plane would crash. Today, air travel is so safe you don’t see those kiosks at all.

Getting to that island isn’t worth insuring, but the vacation itself still might be. You buy airline tickets and pay for cruises or hotels months before the trip occurs. What happens if you are ill on the day of departure or if there’s a hurricane or a death in the family that precludes your ability to take the trip?

Travel insurance can help protect you. Policies reimburse you for money spent on nonrefundable airline tickets or hotel rooms, protect you from tour operator bankruptcy and arrange for medical services or evacuation if you suffer a medical emergency while traveling. They can even help if you lose your wallet or passport or incur legal problems abroad.

Policies are available through travel agents, online travel sites and travel insurance carriers. Insurance for a $3,500 trip can be as low as $120.

As with all insurance policies, use a licensed carrier. Study what is covered and how reimbursement is determined. And see if you already have coverage through your credit card or insurance company.

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Q&A: Setting Up a Savings Plan for Your Long-Term Goals?

Ric Edelman is a co-founder of Edelman Financial Engines. The following is taken from his weekly radio call-in show.

A 4-step plan to help you reach your savings goals.

Question: I’m 24 and my wife is 20. We have a few thousand dollars in the bank, but I would like to seriously start saving for our future — for our retirement, for our kids’ college when we have kids, and for a house. I am contributing 4 percent of my paycheck to my 401(k) at work, and my employer matches that. My wife doesn’t have a 401(k) at her job. How should we go about setting up the most effective savings plan for our long-term needs and goals?

Ric: First, you get the applause of the day for asking that question. Many people your age don’t think beyond their immediate needs and wants, but because you’re focusing on your long-term goals I’m sure that you and your wife will be financially successful. Many folks in their 50s and older wish they’d started saving at your age.

Let’s begin with your 401(k). You should increase your contribution to at least 10 percent — and to the maximum as soon as you can. Your wife should open an IRA in her name, where she can contribute $5,500. I would also urge her to consider finding a job with a company that offers a 401(k) and matches contributions like yours does. People often fail to realize that 40 percent of compensation is noncash — benefits like health insurance, paid vacation and retirement plans. If your employer isn’t offering those benefits, move to one that does.

Step 2 is to eliminate credit card debts if you have any. After you do, move to Step 3: Create cash reserves. I’d want you and your wife to maintain enough cash on hand to cover at least a year’s worth of spending — to tide you over in the event of a job loss or major unforeseen expense. Finally, Step 4 is to start investing in a diversified, long-term portfolio for the house you want and for college for your future children.

That’s the four-step process, but I cannot overstate the importance of saving for retirement first and foremost. That’s often shocking to folks in their 20s, because it’s hard for them to envision their retirement. Their priorities — after they get past Friday night beer — tend to be buying a car, buying a house, having kids and paying for college, usually in that order.

But the most powerful weapon you have for saving for retirement is time. You now have 40 years to save. If you squander some of those years and delay saving until you’re in your 30s, 40s or 50s, you won’t accumulate nearly as much money as you will need. That’s why I consider this Step 1, with the others lined up behind it.

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Q&A: How Much to Put in 529 Plan?

Ric Edelman is a co-founder of Edelman Financial Engines. The following is taken from his weekly radio call-in show.

Surprise, you can actually save too much in a 529 Plan.

Question: I find it confusing to figure out how much money to sock away in a 529 plan for our children’s college. It seems you have to make judgments based on many factors that are unknown or difficult to estimate — such as the future cost of tuition, the rate of return on the money and so forth. I’m wondering if you have a suggested ballpark figure for how much we need to save to send our kids to a good college 15 years from now.

Ric: We generally advise our clients to save no more than $50,000 to $60,000 in a 529 plan for children as young as yours. It may not fully fund college, but that’s by design: You do not want to overfund the accounts. (A lot of parents, of course, struggle with getting the 50 grand. That’s a separate conversation!)

If you accumulate too much money in the account, the child might not spend it all. If that occurs, withdrawals become subject to taxes and a 10% penalty. So you want to have only enough in the account to be able to withdraw funds tax-free to use for qualifying college expenses.

Another concern: We have seen people put so much money into college savings plans that they put their own retirement at risk. We want to make sure you are saving sufficiently for your retirement before you save for your children’s college.

Talk to a financial advisor to help evaluate whether you are on track with your retirement savings. Then you can examine what you should be doing for college.

This material was prepared for informational and/or educational purposes only. Neither Financial Engines Advisors L.L.C (also referred to as Edelman Financial Engines) nor its affiliates offer tax or legal advice. Be sure to consult with a qualified tax or legal professional regarding the best options for your particular circumstances.
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Q&A: Are Investments in Gold and Silver Certain to Rise in Value?

Ric Edelman is a co-founder of Edelman Financial Engines. The following is taken from his weekly radio call-in show.

Question: We are constantly bombarded with radio and TV commercials from companies touting investments in silver and gold, which they claim are certain to go up in value. If that’s true, why wouldn’t they hoard the stuff for themselves?

Ric: This is precisely why those promoters are, in my opinion, nothing more than scam artists. The reason they promote gold and silver instead of real estate, insurance or securities is that they can do so without any licenses. The First Amendment lets them say whatever they want, outside the jurisdiction of SEC, FINRA, and state securities and insurance regulators.

Common sense ought to be enough to enable consumers to steer away from these pitches (as it has for you). Unfortunately, it seems that many lack common sense.

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Q&A: Fully Funded 529 Plan But Kids Aren’t Going to College

Ric Edelman is a co-founder of Edelman Financial Engines. The following is taken from his weekly radio call-in show.

3 alternative ways to use the funds in your 529 plan.

Question: When I received my two 529 account statements at the end of the last calendar year, I was stunned at how much they had grown — and then I realized I have a problem. My son has decided he wants to be a plumber, and my daughter has decided she really doesn’t want to go to college. I have about $160,000 sitting in the two 529 accounts. What should I do?

Ric: Your situation illustrates why we get concerned about people overfunding 529 plans. Who knew when your children were 5 years old that they would grow up not wanting to attend college? Or they might win a scholarship and not need the money? Now you find yourself having to pay taxes plus a 10% penalty when you make withdrawals.

I have three possible solutions for you:
First, you could transfer these accounts to benefit your nieces or nephews. You might strike a deal with your brothers and sisters: You’ll retitle your two 529 accounts (with $80,000 in each of them), and they will give you $80,000 over the next few years in exchange (to avoid gift taxes).

A second option is for you to go back to college — not necessarily for a degree, but for something like an archaeological expedition to Egypt. Many universities offer trips with an educational component, and you can use 529 accounts tax-free to fund some of them. You could even transfer the accounts to your parents if they are able and would like to go on such an expedition. You’ll need to change the beneficiary designations before making any withdrawals.

A third option would be to leave the money where it is, wait until you have grandchildren and then retitle the beneficiary designations into their names. There’s no expiration date on when the funds have to be used, so this can give you two more decades or so of potential growth.

Of course, by then college might be entirely free, thanks to exponential technologies affecting the delivery of higher education — but that’s a conversation for another day!

This material was prepared for informational and/or educational purposes only. Neither Financial Engines Advisors L.L.C (also referred to as Edelman Financial Engines) nor its affiliates offer tax or legal advice. Be sure to consult with a qualified tax or legal professional regarding the best options for your particular circumstances.
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Q&A: Advice for a 20-Something

Ric Edelman is a co-founder of Edelman Financial Engines. The following is taken from his weekly radio call-in show.

It’s never too early to prepare for retirement.

Question: My 26-year-old nephew lives with his parents and is working at his first serious job since graduating from college. He grosses about $50,000 a year and has $15,000 in the bank. He pays about $2,500 a year in interest on student loan debt of about $82,000. His loans are made up of components with interest rates that vary from 3.25% to 8%. I pointed out to him that if he makes a traditional IRA contribution he will increase his tax refund by about $1,100. Or he could contribute the maximum to a Roth IRA and let it grow 40 or 50 years tax-free. The third option would be to apply that money toward the student debt. His parents and I would like your opinion on which is his best option.

Ric: None of the ideas you mention is a bad one.
I would recommend that he contribute to a Deductible IRA. I question whether the Roth IRA will be tax-free by the time he’s in his 70s. That’s 50 years from now — 25 Congresses and maybe six presidents into the future.

Can we really predict how they will treat the Roth IRA? You don’t have to worry or wonder with the Deductible IRA, because he gets the tax break this year (instead of merely the promise of getting a break some 50 years from now).

However, even after making that contribution, he still has extra money. So I would use it to pay down the 8% college debt. He should not be in a hurry to pay down the portion of the debt that’s costing him only 3.25%. (That rate is so low he can likely earn more through a diversified portfolio over the next few decades.)

If he is not permitted to apply his payments only to the higher interest portion of the debt but is instead required to apply the extra payments across all the loans, then I wouldn’t prepay at all. Instead, he should place all his savings into a diversified investment portfolio.

This material was prepared for informational and/or educational purposes only. Neither Financial Engines Advisors L.L.C (also referred to as Edelman Financial Engines) nor its affiliates offer tax or legal advice. Be sure to consult with a qualified tax or legal professional regarding the best options for your particular circumstances.
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Q&A: A Look at Market Behavior

Should you worry when “experts” say a crash is coming?

Ric Edelman is a co-founder of Edelman Financial Engines. The following is taken from his weekly radio call-in show.

Question: Some “experts” are predicting a bigger-than-ever market crash in the near future. I’m retired and probably wouldn’t have time to recover from that. Is someone in your firm watching carefully the IRAs of persons like me who can’t afford a large reduction in funds to live on?

Ric: There are always “experts” predicting a market crash. They are usually hawking a book, seminar or newsletter — or worse, some crazy investment scheme.

That said, of course there will be another market crash! They occur from time to time. Big ones are called depressions, panics and crashes; smaller ones are called corrections and bear markets. Regardless, it’s not important that prices will drop. What’s important is what happens after. And this is where those pundits always get it wrong: they ignore the “after.”

Market declines are not in the shape of the letter L — that is, prices don’t stay down forever. Instead, markets look more like a U or V — and that’s what’s important. Over time, it all looks like a W tilted upward to the right.

Yes, you can expect that prices will fall at some point — and you can expect that prices will rise thereafter. As an investor, you need to do only three things: diversify, so some of your money doesn’t fall in value when the markets decline; rebalance, so you can buy while prices are down; and maintain a long-term focus, so you are able to participate in the eventual recovery (with the understanding that past performance isn’t indicative of future results).

Investing strategies, such as asset allocation, diversification, or rebalancing, do not assure or guarantee better performance and cannot eliminate the risk of investment losses. There are no guarantees that a portfolio employing these or any other strategy will outperform a portfolio that does not engage in such strategies. Funds and ETFs are subject to risk, including loss of principal. All investments have inherent risks. There can be no assurance that the investment strategy proposed will obtain its goal. Past performance does not guarantee future results.
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Know the Difference Between a Stock and Bond?

Take the Quiz

Our firm has always promoted financial education and literacy. The need for improvement is displayed by the results of a LIMRA survey asking 2,000 Americans 10 questions about basic financial and retirement topics.

The study found that only one in eight scored 90% correct. More than a third (36%) answered five or fewer questions correctly — with some not even knowing the difference between a stock and a bond. Men scored a little better than women (31% vs. 23% correct responses), but both groups failed miserably. Ditto for older consumers vs. younger ones (40% vs. 21%, with age 55 the separator).

And the most revealing factor? Those who have a financial advisor scored highest on the quiz. So if you want to become smarter about personal finance, get a financial advisor!

Test your knowledge of basic personal-finance issues. Here is LIMRA’s quiz:

1. Suppose you had $100 in a savings account and the interest rate was 2% per year. After five years, how much would you have if you allowed the money to grow?
a) $100.10
b) $102
c) $110
d) $110.41

2. If the interest rate on your savings account were 1% per year and inflation were 2% per year, after one year your money would be able to buy:
a) more than it does today
b) exactly the same as it does today
c) less than it does today

3. Over the last 50 years, which option has provided the highest average growth per year?
a) savings account
b) certificate of deposit
c) insurance policy
d) stock mutual fund

4. A stock fund’s beta rating can best be described as:
a) a measure of relative volatility of the fund vs. the S&P 500 index
b) a measure of relative growth vs. the S&P 500
c) a measure of relative capital outflow of the fund vs. the S&P 500
True or False

5. Buying a single company stock usually provides a safer return than a stock mutual fund.
a) True
b) False

6. Annuities are financial products that can provide a series of payments to a person that will last as long as he or she lives.
a) True
b) False

7. If you were to invest $1,000 in a stock mutual fund, it would be possible to have less than $1,000 when you withdrew the money.
a) True
b) False

8. Roth IRA earnings accumulate tax-free.
a) True
b) False

9. A person who is 55 in 2019 will be able to collect full Social Security benefits at age 65. (See Editor’s Note below)
a) True
b) False

10. The IRS currently limits contributions to 401(k) plans for those under age 50 to $19,000 per year. (See Editor’s Note below)
a) True
b) False

Answers to LIMRA Quiz:
1. D 2. C 3. D 4. A 5. False 6. True 7. True 8. True 9. False* 10. True*
*Editor’s Note:
• #9: A person who is 55 in 2019 will be able to collect full Social Security benefits at age 67.
• #10: In 2019 the IRS limits contributions to 401(k) plans for those under 50 to $19,000 per year.

Originally published in Inside Personal Finance
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How Long Will You Keep That New Car?

Don’t be enticed by a loan that will last much longer

Seven years is a long time to wait for anything — but it can seem like an eternity in one situation that comes to mind:

A car loan.

A generation ago, most car loans were paid off after 36 months. But as prices rose, loans of 48 months and 60 months became more common. Then we began to hear about 72-month auto loans. Now, Experian says that 25% of new car loans are for 84 months — that’s right, seven years!

Why? Well, let’s say you want a car selling for $25,000 and you make a $1,000 down payment, leaving $24,000 to be financed at 4%. Would you prefer to pay $542 per month or $328 per month? That lower payment is sure enticing, because it leaves you with an extra $214 per month to spend on other things.

The catch, of course, is that you’d be opting for a seven-year loan instead of one that ends in just four years. One might suspect buyers are choosing seven-year loans because they otherwise can’t afford the cars they want to buy. If you can afford only $500 per month, you can buy a car that costs either $22,000 or $37,000 — depending on whether your loan is paid in 48 months or 84 months. Lots of people choose the nicer car and the longer term.

The difference between buying cars and houses.
That’s a problem, though, because cars are not houses. People tend to keep houses for decades, and houses tend to increase in value over time. Cars are the opposite: People sell them far more frequently, their values fall, and their maintenance and repair costs rise over time.

That last point is a doozy (a reference to the Duesenberg, the most luxurious automobile of the early 20th century which came to mean anything prominent or noteworthy). Automobile warranties typically expire after four years, after which you must pay for all repairs and maintenance. If you have a seven-year loan, you must pay for such repairs while you still have three years of payments remaining. And after four years of a seven-year loan, you’ll still owe about $11,000 — more than the car is likely to be worth.

If the car you’re replacing is less than seven years old, what makes you think you’ll keep this new one so long? Please buy wisely when shopping for a new car. Be sure you can afford the one you want. If you’re not sure of the amount you can afford and what loan package is best, you might want to speak with a financial advisor first.

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