Financial Engines Market Update, Q4 2017: Ending on a High Note

Global equity markets ended 2017 on a high note. Economic growth was steady across
nearly all major developed economies, employment numbers remained strong, and
inflation remains low. Despite political uncertainty and diplomatic tensions, equity
markets had a great year. Large-cap stocks in the S&P 500 index gained another +6.6%
in the fourth quarter to end the year up +21.8%. Stocks of smaller companies, represented
by the S&P SmallCap 600 index, also did well. They gained +4.0% in the fourth
quarter and +13.2% for the year.

International stock markets managed to keep up with the strong domestic-market
performance in 2017. The MSCI Europe, Australasia, and Far East (EAFE) index gained
+4.2% for the fourth quarter, finishing up +25.0% for the year. Emerging-market
equities did even better, gaining an impressive +37.3% in 2017.

Bonds were modestly positive, with the Barclays U.S. Aggregate Bond index gaining
+0.4% in the fourth quarter. As economic conditions continue to improve, short-term
rates have risen, while long-term rates have remained low. Inflation is still muted in the
United States, which is helping keep rates down.

The Financial Engines perspective.

The year 2017 ended on positive note as global growth continues to improve. Market
volatility has remained unusually low in recent months. But this does not mean that risk
is absent. Sudden political events or economic turmoil could change market sentiment
quickly. It is important to remain diversified to help weather potential storms and reach
your long-term goals. At Financial Engines, we continue to monitor market conditions
to keep your portfolio allocation on track.

Have questions?

Financial Engines advisors are here to help.

© 2018 Financial Engines. All rights reserved. This publication is for informational purposes only and does not constitute investment advice or an offer to buy or sell any security. Future market movements may differ significantly from the expectations expressed herein, and past performance is no guarantee of future results. Financial Engines assumes no liability in connection with the use of the information and makes no warranties as to accuracy or completeness. Future results are not guaranteed by any party. Financial Engines® is a trademark of Financial Engines, Inc. All other intellectual property belongs to their respective owners. Index data is derived from information provided by Standard and Poor’s, Barclays Indices, and MSCI. The S&P 500 index and the S&P SmallCap 600 Index are proprietary to and are calculated, distributed and marketed by S&P Opco, LLC (a subsidiary of S&P Dow Jones Indices LLC), its affiliates and/or its licensors and has been licensed for use. S&P®, S&P 500® and S&P SmallCap 600®, among other famous marks, are registered trademarks of Standard & Poor’s Financial Services LLC, and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC.© 2016 S&P Dow Jones Indices LLC, its affiliates and/or its licensors. All rights reserved. Source: MSCI. The MSCI information may only be used for your internal use, may not be reproduced or redisseminated in any form and may not be used to create any financial instruments or products or any indices. The MSCI information is provided on an “as is” basis and the user of this information assumes the entire risk of any use made of this information. MSCI, each of its affiliates and each other person involved in or related to compiling, computing or creating any MSCI information (collectively, the “MSCI Parties”) expressly disclaims all warranties (including, without limitation, any warranties of originality, accuracy, completeness, timeliness, non-infringement, merchantability and fitness for a particular purpose) with respect to this information. Without limiting any of the foregoing, in no event shall any MSCI Party have any liability for any direct, indirect, special, incidental, punitive, consequential (including, without limitation, lost profits) or any other damages.
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Employer match means more money for you.

Piece of pie

Let’s say you’re walking down the street and see a couple of hundred dollar bills blowing down the sidewalk. Would you pick them up? What if it was a thousand dollars? It seems obvious to take money that’s up for grabs. Unfortunately, the average employee is leaving $1,336 of “free money” on the table each year.1 How? By not saving enough in their 401(k) to get the full employer match.  A 401(k) with employer match is a valuable employee benefit. But how does it work exactly?

401(k) basics.

Let’s start with why a 401(k) itself is so valuable. It offers some key advantages:

  • Tax benefits. Tax advantages of a traditional pre-tax 401(k) work two ways. First, the amount you contribute isn’t taxed when you put it into the plan. This reduces your taxable income, and therefore the amount of taxes you pay in the present. Second, your contribution also gets to grow on a tax-deferred basis in the meantime.
  • Compound growth. Compounding is what helps your money grow over time. As your money grows and your earnings then get reinvested in your account, you have a bigger pool of money that can make earnings going forward. So basically, your earnings are making earnings.
    • Let’s assume that your 401(k) averages 8% a year in earnings and you have $1,000 in your account in year one. You’ll start off year two with $1,080, which in turn grows by 8%. This puts you at $1,166 to start year three. This rate of growth would continue each year as long as earnings stay steady.

The matching contribution.

A matching contribution is what it sounds like: It’s when your employer matches your own 401(k) contributions with company money. If your employer offers a match, they’ll typically match up to a certain percent of the amount you put in.

Let’s say that your employer matches your contributions to the plan, dollar for dollar, up to 3% of your salary. If you contribute 2% of your salary to your plan, your total 401(k) contribution will be 4% of your salary each month after the employer match is added. If you bump up your contribution by just 1% (so you’re putting in 3% of your salary), your total contribution is now 6% with the employer match.

If that sounds like a good deal, that’s because it is. The employer match is one of the main reasons a 401(k) is valuable for employees. Where else can you get an immediate return on your investment?

Piece of pie

Unfortunately, many workers don’t take full advantage of the employer match because they’re not putting in enough themselves.

 

The picture to the right shows how an employer match could help fill out your annual retirement savings.

Why it matters.

A recent survey noted that “for three-quarters of employers, a defined contribution plan (like a 401(k)) is the primary source of retirement income for their employees.”2 How much you save, the match you get, and the performance of your investment choices can have a huge impact on what that life in retirement will look like. So don’t miss the low-hanging fruit that is the employer match — put enough of your paycheck into your 401(k) each month to get the maximum contribution from the company you work for. Your future retired self will thank you.

 

1 May 2015. Missing out: How much employer 401(k) matching contributions do employees leave on the table? Financial Engines. Retrieved November 15, 2017, from https://financialengines.com/education-center/wp-content/uploads/2016/07/Financial-Engines-401k-Match-Report-050615.pdf
2 2013 Trends & Experience in Defined Contribution Plans. Aon Hewitt. Retrieved December 13, 2017, from http://www.aon.com/human-capital-consulting/thought-leadership/retirement/2013_Trends_Experience_DC_Survey.jsp
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Market Summary: November 2017

Expectations of corporate-tax cuts propel U.S. stocks.

U.S. stocks performed strongly in November. Small- and mid-cap stocks surged in the second half of the month, reversing losses early in November. They closed up +3.52% and +3.68% respectively (S&P 600 and 400 indices). Large caps followed, closing up +3.07% (S&P 500 index) and finishing with positive returns for the 13th month in a row. International stocks also had a positive month, but their returns were more modest than those of U.S. stocks. Year to date, international stocks are still outperforming U.S. stocks.Developed-market and emerging-market stocks rose by +1.05% and +0.20% (MSCI EAFE and Emerging Markets indices) respectively. Interest rates ended November up for the month. This led bonds to close down, with the Bloomberg Barclays Aggregate index returning -0.13%.

Overall, it was yet another period of low volatility in stock markets, with the S&P 500 not moving more than +/-1% on any day in November. Markets that tend to be more volatile were, true to form, more volatile in November. Small-cap U.S. stocks had four days of +/- 1% moves, and emerging-market stocks had three.

Interest rate basics.

The American dream is still alive and well, with goals like owning a home and paying for children’s college education at the top of many financial wish lists. However, with college costs and home prices continuing to soar, the amount of debt we’re taking on has increased as well. In fact, the average American will pay more than $600,000 in interest over the course of a lifetime.1 So how do you figure out the difference between “good debt” and “bad debt?” And how do you get OUT of debt? Getting a handle on how interest rates work is a good place to start.

First, let’s get some of the lingo straight.

  • Lender: The individual or company that loans you money with the expectation that they will be paid back.
  • Principal: The amount of money borrowed.
  • Annual Percentage Rate (APR): The amount of interest you’ll pay on your loan each year.
  • Fixed Interest Rate: An interest rate that doesn’t change during the lifetime of the loan.
  • Variable Interest Rate: An interest rate that changes over time, usually along with an index such as the prime rate or federal funds rate.

Now that we know the lingo, we can get into what interest is and how it works. Interest is what lenders charge when they loan money to someone else. Why do they do this? Instead of using their funds for something else, such as investing or buying another asset, they’ve loaned it to you. What’s in it for them? Interest. They charge interest based on an interest rate, which is typically a percentage of the amount borrowed.

Let’s say you take out a five-year, $5,000 loan with a 3% APR. Your interest rate is 3%, and by using a simple interest equation, we can calculate how much you’ll owe at the end of the life of the loan.

$5,000 (principal) x 3% (annual interest rate) x 5 (the number of years in which you agreed to pay back the loan) = $750.

With your fixed 3% interest rate, this means you’ll pay an additional $750 in interest over the five-year lifetime of the loan, meaning you’d pay back $5,750 total.

Seems easy enough, right? If only it were always that simple.

Enter compound interest. We’ve talked about compounding before and explained how it can help your investments grow. But when it comes to your debt, compounding is not your friend. Compound interest means that you have to pay interest not only on the amount you initially borrowed, but also on any accumulated interest! In other words, any loan interest you don’t pay off gets added on top of the loan principal — and you now have to pay interest on that new higher amount. Essentially, you’re paying interest on your interest.

Compound interest is assessed during regular intervals known as compounding periods. Based on the terms of your loan agreement, this can be either annually, semi-annually, quarterly, or monthly. Depending on the frequency of your compounding periods, you could end up paying back a lot more than you initially borrowed.

Consider this example: The average credit-card APR reached 16.15% in 2017.2 Take our $5,000 scenario from earlier but add monthly compounding at 16.15%. You could end up paying more than $7,415 if you’re making the minimum monthly payment needed to remain in good standing with the credit-card company.3

OK, got it. Now what?

Debt isn’t necessarily all bad, especially if you’re managing it responsibly. Just be sure you understand how interest rates and compounding periods factor into the equation. Read the fine print, consider the timeline of when you can expect to pay off your loan, and run calculations. This knowledge can help you prioritize which debts to focus on paying down first or even provide motivation to refinance or pay down debts faster.

Once you’ve gotten a handle on the terms of all your loans, make a plan for how you’ll tackle your debt. Consider the interest rates you’re being charged as you make your plan: debt with the highest interest rates (“bad debt”) not only packs a wallop, it also ties up money that could otherwise be used to invest or make progress towards short-term savings goals. By focusing on getting rid of your high-interest debt, you can start putting the power of compounding to work for you instead of against you.

 

1 Yeager, J. (May 7, 2012). A Lifetime of Debt. AARP. Retrieved September 21, 2017, http://blog.aarp.org/2012/05/07/a-lifetime-of-debt/
2 https://www.creditcards.com/credit-card-news/interest-rate-report-92017-up-2121.php
3 For each month, Credit.com calculates and adds the interest accrued during that month to the amount owed during the previous month. Then they subtract the monthly payment to arrive at the new amount owed. They repeat the process and track the amount of time needed for the amount owed to reach $0. Note that Credit.com is a third-party website and Financial Engines is not responsible for information or interactions that occur there.
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Pay attention to your 401(k) plan’s fees.

If you’re like many Americans, you make regular contributions to your retirement plan at work. Whether you’re enrolled in a 401(k), 403(b), 457, or Thrift Savings Plan, you’re probably also responsible for  managing how your contributions are invested. And you’re the one who has to evaluate how these investments align with your goals.

While you can control the amount of money you contribute and how it’s invested, there’s one area you may not have much control over: your plan’s fees and expenses. Why is this important? While contributions to your account and the earnings on your investments can increase your retirement income, your plan’s fees and expenses can decrease your return.

Fees and expenses for retirement plans generally fall into three categories:

Plan administration fees.

It costs money to run a 401(k) plan. Someone needs to pay for basic administrative services, including recordkeeping, accounting, and trustee work. These expenses may be paid with fees taken from your account. In some cases, your employer may pay these fees, or they may be charged against other assets in the employer’s plan.

Investment fees.

These can often be the biggest expense in a retirement plan. These fees are associated with the individual investments that you’ve chosen for your account, and vary for each investment option. Common investment fees include sales loads and management fees. These fees are deducted from your account, so they directly impact the net performance of your investments.

Management fees and other investment-related services are typically charged as a percentage of the money you’ve invested. Your plan administrator should provide you with a description of any expenses charged against your account.

Individual service fees.

If you use optional features in your plan, you may have to pay additional service fees. For example, if you take a loan from your account, a loan fee may be deducted from your account value.

Why should I care?

Here’s an example of how the expenses can affect your savings. If you have a balance of $10,000 and make no additional contributions, you could have more than $90,000 in your account after 35 years if you average 7% in returns (less average fees of .5%). But if your average annual fees were 1 percentage point more (1.5%), your ending balance would be a little more than $65,000 — a difference of nearly $25,000. That’s more than a 25% difference. Fees matter!

What should I do next?

Get clear on the costs associated with your plan, and how they may be impacting your account. For more information about the fees and expenses in your plan, check out the summary plan description (or “SPD”) you received when you enrolled. It includes information on your plan’s services and how it operates. Some SPDs spell out which administrative expenses you pay and which your employer pays. It may also detail how employee-paid expenses are allocated among plan participants.

Any plan that lets you to choose your own investments must also provide you with detailed investment information when you first enroll and annually after that. This disclosure is often titled “Plan and investment-related information,” and is meant to help you compare the investment options in your plan. It typically includes a chart that shows historical investment performance, expenses, and fees for each option in the plan. The Employee Benefits Security Administration (EBSA) has provided a guide to help you understand what to look for in this important document.

As you research the potential impact of your plan’s fees on your retirement income, it’s worth remembering that nothing worthwhile is free. Make sure your review includes all the services you’re receiving — you want to be sure the value you’re receiving is in line with the costs. Consider the scope and quality of services being provided in addition to the fees.

Finally, don’t let fees alone drive your investment decisions. You need to consider your risk tolerance, timeline, and overall asset allocation in addition to fees and performance history. Higher investment management fees don’t automatically translate to better returns, just as lower fees don’t mean a fund is the right one to suit your needs.

Still not sure what to do? Contact your plan administrator with questions about the fees and expenses charged to your plan, or consider getting professional investment help for your retirement accounts.

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Renters and homeowners insurance — are you covered?

Have you recently bought a new home or moved into that cool new apartment building? Congratulations! Before you start planning your housewarming party, however, you’ll need to tie up an important loose end: insurance.

Homeowners insurance and renters insurance are as essential to your dwelling as the front door. In fact, most mortgage companies require borrowers to purchase homeowners insurance and landlords are increasingly requiring tenants to buy renters insurance. But even if you own your home outright, you still need homeowners insurance to protect that which you can’t afford to lose. It’s really that simple.

There are some similarities between the two types of policies, but there are also some significant differences — so it’s important to understand what these policies generally do and don’t cover. Costs can also vary widely depending on your selected deductible and coverage options. Be sure to shop around and understand the costs before purchasing a policy.

What does homeowners insurance cover?

If your home is damaged or destroyed by fire, hurricane, hail, or lightning, your homeowners insurance will help pay for repairs or replacements. Many policies will also cover damage to other structures on your property, such as a tool shed or gazebo. Furniture, clothes, and other personal belongings are also covered if they’re stolen or destroyed. Be aware, however, that expensive personal property, such as jewelry, will be covered by homeowners insurance only up to a certain amount. If you want to protect pricey items, you can add a personal property endorsement or floater to your homeowners policy.

Homeowners insurance doesn’t cover everything, however. For examples, most policies won’t cover damage or destruction caused by a flood or earthquake — so if you live in an area where floods or earthquakes happen regularly, it may be wise to purchase a supplemental policy. Burst water pipes can be another headache. Most policies will cover damages caused by a burst water pipe, but they won’t pay to repair or replace the pipes themselves. Other incidents that most homeowners insurance policies won’t cover include:

  • Termite damage.
  • Sewer backups.
  • Mold.
  • Sinkholes (except for homes in Florida and Tennessee).

Remember that all homeowners insurance policies are different, so read the fine print and talk with your agent about your specific policy’s coverage.

What does renters insurance cover?

Renters insurance is designed to protect you and your personal property — and provides broader coverage than many realize. For example, your renters insurance may cover:

  • Off-site property. For example, if you have a storage locker, most renters insurance policies will cover your off-site belongings up to 10% of the total policy.
  • Personal property while you’re traveling. If your luggage is stolen or your clothes are damaged while you’re traveling, your renters insurance can help cover these losses.
  • Relocation if you have to vacate your home. If you need to leave your place due to an incident that makes it temporarily uninhabitable, you may be covered until repairs are made. In this case, your renters insurance can help cover a hotel room, boarding for your pet, and other costs that crop up because of your temporary relocation.
  • Your car being burglarized. If you have personal property in your car and someone steals it, your policy may help replace the stolen items.
  • Spoiled food if electricity goes out. If there’s a power outage or the refrigerator stops working, your renters insurance policy may help pay to replace the food that went bad.
  • Injuries that happen to others when they’re at your home. All renters insurance policies come with a minimum of $100,000 in personal liability protection. Let’s say you have a friend over and your dog bites your friend, leaving a wound that requires stitches. Renters insurance will cover the cost of your friend’s medical bills up to the personal liability protection included in your policy.

Like homeowners insurance, renters insurance policies can have quite a bit of fine print and details. If you have questions, reach out to your agent or renters insurance company directly.

Moving into a new place, whether you bought it or are renting it, can be exciting. But don’t let the excitement get in the way of purchasing and understanding a homeowners or renters insurance policy. It’s more important than unpacking, painting, and yes, even the housewarming party.

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How to start and grow an emergency fund.

Life happens. And when it does, it often costs money. Whether it’s a broken appliance, car repairs, or even a lost cell phone, having an emergency fund to cover the cost can help keep you from racking up credit card debt or being unable to pay unplanned bills. Unfortunately, half of U.S. adults don’t have a stash of cash to buffer them against life’s unpleasant surprises.1 If you’re in this group, it can be beneficial to start working on your rainy-day fund today.

How much should I save?

How much you need depends on your family size, whether you own or rent your home, and the number of cars you need to keep in working order. Overall, shooting for $2,400 in quickly available cash is a reasonable starting point, but your needs may be different. This assumes you have some basic insurance in place, including:

  • Life insurance for any family members whose earnings you depend on.
  • Health insurance.
  • Homeowners/renters insurance.
  • Auto insurance.

To build up a buffer for more extensive emergencies such as losing your job, you can save in your 401(k) plan. You want to make sure you capture all of the employer matching contributions available to you.

Start small.

Expecting to build a large emergency fund quickly isn’t realistic. But any amount is better than nothing! $1,000 in reserve could help you get through a few small bumps that otherwise might require you to use high-interest credit cards and go into debt. Begin by setting small, achievable goals. For example, your first goal could be to accumulate $500. Once you have that much in the bank, increase your goal amount to $750 or $1,000. You’ll be surprised by how quickly it will all add up, even if you’re adding money bit by bit.

Free up cash by cutting expenses.

Monthly expenses. Take a look at the bills you’re paying each month and consider what you could reduce or eliminate. For example, do you have both Netflix and cable/satellite TV? You could cancel the service you use less often and redirect that money to your emergency fund each month. Similarly, do you have a gym membership that’s gathering more dust than sweat? Consider cancelling that as well — especially since there are a variety of exercises you can do for free at home (or outside with a pair of sneakers!) to improve your fitness. In addition, look at other insurance policy options for your home or car. Even if you only save $10 per month by switching providers, you can put that money in your emergency fund, and watch it grow over the months and years.

Incidental costs. Do you stop by a coffee shop most days? Do your daily meals often involve eating out or ordering in? If the answer to either of those questions is yes, you have an opportunity to change your habits and redirect that money into an emergency fund. Revamp your routine to brew your own morning coffee, bring your lunch to work, or just commit to one less meal out per week. Once again, the money you’ll save from these small changes can add up over time.

Make a plan, and start saving.

Like any savings plan, you should identify your end goal, start small, and save consistently. Here are a few tips:

  • Set a monthly target. Take a percentage of each paycheck and have it automatically deposited into your emergency account.
  • Allocate extra cash. Resolve to put all or part of any extra income, such as a tax refund, a bonus, or gifts from grandma into your fund.
  • Earn extra income. Get a part-time job, find contract work, or look for other ways to supplement your income on a short-term basis while you get your emergency fund in place.

Keep it safe, and keep an eye on it.

The whole point of an emergency fund is for it to be available at a moment’s notice, since emergencies rarely give you any warning. Generally, that means keeping your money in a savings account at a bank.

The downside of this tactic is you’ll earn very little interest on your money in a low interest-rate environment. In fact, it’s likely that rising expenses and inflation may cause your emergency fund to lose buying power over time. You may need to keep topping it off as the years go by to maintain your target balance.

For this reason, make sure you don’t save too much in your emergency fund. Think of it like an insurance policy. You may never use it all so there’s no reason to over-fund it when you can put extra money to better use in a retirement fund or other higher-earning investments.

Financial protection against the unexpected.

If life throws you a curve, you don’t want to max out your credit cards, drain your retirement plan, or sell investments to cover expenses. Having an emergency fund can give you flexibility and relieve some stress when the unexpected happens. The key is a willingness to sacrifice a little today for more security tomorrow.

 

(2017). 2016 FINRA National Financial Capability Study. Financial Industry Regulatory Authority. Retrieved May 4, 2017, from http://www.usfinancialcapability.org/results.php?region=US
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Chipping away at debt.

Debt can be one of the biggest roadblocks to setting and achieving long-term financial goals.

With debt weighing you down, everything from growing your emergency savings to saving for retirement can feel out of reach.

So how do you chip away at it?

1.   Don’t normalize debt. Attack it!

Some debt, like a mortgage or education expenses, can be “good debt” because it has the potential to benefit you financially in the long-run. Credit card debt, however, is mostly bad.

Whether good or bad, the consensus is that less debt is better. If debt becomes one more bill you pay at the end of the month, it’s easy to push it to the back of your mind. But often, debt is not an ongoing essential living expense, so don’t treat it like one. Outline an aggressive payment plan and keep track of your progress.

How do you establish a payment plan? If you haven’t already, consider putting a monthly budget in place. Having a plan for what you’ll do with your money before it comes in can be a game-changing in terms of helping you stay true to your goals.

2.   Say “no” to credit card debt.

It should be a priority to reduce all debt as quickly as you can, but consider prioritizing debt that carries the highest interest rate. Credit cards typically have very high interest rates. This means you could end up paying much more than you first spent, especially if you’re making only the minimum payment.

Think about transferring credit card debt to a card with no annual fee and a lower interest rate to avoid growing interest. Then concentrate on paying off that single credit card and don’t add any more debt on other cards. Remember — your credit card is not your emergency fund!

3.   Quantify the full cost of debt.

Debt consists of the principal balance plus interest, which can compound quickly. Need motivation to pay down your debt? Imagine what your finances may look like if you could take the money you pay in interest each month and put it toward something else. Debt plus its compounding interest means you have less to invest in your financial future. That’s a good reason to stay focused.

Overwhelmed? Thinking about debt consolidation?

Debt consolidation is the process of taking several smaller loans or debts and combining them into one. With only one debt, you have a single monthly payment to make, which is often much lower than what you were paying across all of your debts. It also eliminates multiple interest rates on your debts, and may come with a lower interest rate than you paid previously.

The most common methods of debt consolidation are:

  • Transferring debts to a single credit card.
  • Applying for a home equity loan.
  • Approaching lenders for specific debt consolidation loans (see this government resource for more).

Proceed with caution. Credit cards usually have specific fees associated with interest rates and transferred balances. A lower interest rate may cost you up front, and a transferred balance may come with a processing fee. Do your research and consider negotiating your rates and terms before transferring balances. Be aware of other trade-offs as well. For example, if you agree to a lower interest rate, you may end up paying more during the life of the loan if the term of the loan is significantly longer.

Remember: the three key areas of improvement you’re seeking from debt consolidation are a significantly lower monthly payment, a reduction in interest rates, and a relationship with a lender that gives you peace of mind.

There is no silver bullet.

There are lot of “tips and tricks” to reduce debt. You can limit going out to eat, pick up a side gig, or organize low-cost hangouts with friends and family to save money — then use those savings to reduce debt.

These actions can help, but the bottom line is there is no trick. The key to reducing debt is to take control and commit to making a change. Outline a payment plan. Pay down debt with the highest interest rates first. Stick to your budget and payment plan. Don’t accrue more debt in the process. The satisfaction of sending that last payment and seeing a zero balance will be well worth the effort.

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Is homeownership on the horizon? Here’s how to grow your down payment.

So you’ve decided to buy your first home! Before you start scrolling through real estate listings and filling out paperwork to get prequalified, you’ve got something more important to think about, though: getting a down payment in place.

While many things can affect your choice to rent or own, one of the biggest hurdles to homeownership is usually financial. If you’re a renter looking to become a homeowner, the best thing you can do to help make your dream a reality is to have a financial plan in place to help you get there. Build your down payment nest egg now, and set it up to grow.

How much to save?

It’s generally recommended that you put a 20% down payment on a home. This can help lock in a lower monthly mortgage payment. It can also save money on interest and insurance in the long run.1

Accumulating the money to cover a 20% down payment, however, requires some planning that doesn’t stop with putting money aside each paycheck. Depending on how soon you plan to buy, you’ll want to make sure you have access to your money when you need it. You’ll also reach your goal faster if your savings can grow along the way. Here are some ways to pick up the pace.

Direct your dollars into a money market account or high-interest savings account.

Finding a place to park your short-term savings and earn a decent return is particularly challenging if interest rates are at historic lows. It’s worth searching for accounts that offer higher-than-average interest rates — which can keep your money working harder for you. Plus, with these types of accounts, your money will still be accessible to you when you need it.

If your homeownership runway is a little longer, consider a certificate of deposit (CD).

CDs are savings certificates with a fixed interest rate and maturity date. These conservative investments can be suitable if you won’t need access to your funds until after the maturity date, which can be three to five years. Keep in mind that there are penalties for early withdrawal — so choose your timeframe and terms wisely.

Investing your money in the stock market? It could be an option.

The key consideration here is how long you expect to have your money in the market. If your time frame is less than five years, you want to be thinking of your down payment as savings, not an investment. Stocks are riskier than CDs, money market accounts, or other high-interest savings accounts. You might make more money if you put your dollars into the stock market — but you could lose a good amount, too. If you’re not planning on buying a home in the next five years, you might consider investing some of your down payment. To minimize risk, however, you should make sure you’re diversified (so, not invested 100% in stocks), and actively reduce the amount of risk in your portfolio as you get closer to your target home purchase date.

Homeownership is a major life step and accumulating enough savings to make it happen can be a tall order. Taking a strategic approach to how and where you save, however, can help turn your homeownership dream into a reality.

1 Why is 20% ideal for a down payment? Zillow.com. Retrieved on July 24, 2017 from https://www.zillow.com/mortgage-learning/20-percent-down-payment/.
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