HOW TO: Save Money and Pay Off Debt

By Olivia Sandham

Although the two don’t seem to logically go hand-in-hand, saving money while also paying off debts is certainly possible.  With a few simple adjustments to your lifestyle and budget, you can create a comfortable and debt-free future.

 

The first step to saving while paying off debt could be to create a household budget that trims unnecessary expenses.  This budget will only be feasible if it allows for some discretionary spending to avoid feeling trapped or “broke”.  Examples of areas that could easily be trimmed without too much lifestyle shock include eating out one less night a week, consuming one or two less high-priced beverages (such as cutting back on a latte or cocktail), and switching groceries to generic brands.  Think about how much you could save each week by making these changes, then multiply that by 4-5 times per month!  These small changes can certainly impact the amount of additional money you will have to put toward paying off debts and increasing your savings.

 

The second step to saving while paying off debt is to consider designing a debt payoff strategy that best suits your needs.  Paying off debts utilizing the “snowball” effect is a popular method of paying your debts in a specific order.  You could choose to either 1) Pay off the smallest balance first, which can be motivating in a short period of time because you see the number of debts you owe drop, or 2) Pay off the highest interest rate first, which makes the most sense from a pure financial approach, since you will keep more of your money in the long-term.  Choosing the best debt payoff strategy will be a personal choice so that you find a strategy that you will want to maintain over the long-run.

 

The last step to saving while paying off debts is to build your emergency fund and future investments.  Once you have designed a trimmed budget and chosen your debt strategy, you can plan to have additional money placed into an easy-to-access emergency savings account.  Although this account will not produce much (if any) interest, there will be no penalty for taking the money out should you absolutely need it.  However, once you are able to build your savings to a sufficient amount (three to six months of expenses is typically recommended), you can then start to invest part of your monthly additional money into accounts that will produce higher return rates, such as an investment account or an IRA holding diversified mutual funds.

Maximizing your 401(k) and retirement plan earnings

Dan Danford, CFP® and Founder/Chief Executive Officer of Family Investment Center, has been advising how to invest 401(k) and retirement plans for years. In the video below, he answers this question about what to do when dissatisfied with your 401(k) funds:

I want to shift my money to different funds within the plan. When making this decision, which do you think I should focus on more: the funds' expenses or the returns the funds have earned?

Danford explains why you should focus on expenses first, but that there is an important caveat when it comes to ensuring you are comparing apples to apples with different 401(k) funds.

Key Questions Mutual Fund Investors Should Ask

1. What are the fund’s expenses? There is a significant correlation between fund expenses and long-term returns. The internal expense ratio is a compilation of various management and portfolio expenses. Different kinds of funds may cost more or less to operate. But, the fund you pick should be at or below the average for funds of its type.

2. What is the turnover rate? High turnover rates (more trading in the portfolio) are expensive. This, in turn, increases the expense ratio. Besides that, stocks or bonds sold at a gain may generate a taxable distribution later in the year. Shareholders prefer not to pay taxes on these capital gains distributions, so funds with lower turnover are popular for taxable accounts.

3. What is the investment style? Performance tends to follow sectors. So, when small cap value funds prosper (not lately), most funds managed in this style will prosper, too. It helps to know each fund’s style in building a diversified portfolio. Funds that drift often arrive at a hot sector too late in the game.

4. Who manages the fund? Not the fund family, but the actual portfolio manager. How much experience do they have? Are they responsible for past performance, or has that portfolio manager moved on to better things?

5. What is the fund’s policy towards holding cash? Cash (in the form of short-term government bonds) is a drag on stock portfolio performance in rising markets. It also provides a cushion when they fall. Who should make strategic cash calls? In general, I’d rather have all stocks in the fund and hold cash (if any) on my own.

6. What are the returns? Compare fund returns with similar investments and time frames. Look towards other funds with similar objectives before deciding whether to buy or sell. Seek good longer-term performance.

No one knows what the future holds, so every investment choice, in that sense, is a guess. But we can stack the odds in our favor by making reasoned, informed, choices.

Dad's Divorce: Overview of mutual funds

Dan Danford is a regular contributor to Dad's Divorce, a web site for men going through the divorce process. Most of his advice, though, is general enough that everyone can use, particularly this podcast on mutual funds. You can watch it right here.

Should I invest in China?

QUESTION: Looking at international stock, it appears that companies in China are going strong. I’m wondering if that’s a market I should consider as an investor. Are there mutual funds that specialize just in China? Or should I look at individual stocks in China? Or is it even wise to concentrate in one country?

ANSWER from Dan Danford: International investing is one facet of a well-diversified portfolio. There are multiple ways to accomplish that, and you mention several. I'll get back to that in a minute.

Remember, though, that any investment "idea" is already factored into market prices by the time you hear it. By the time you read something in Money magazine, or the local newspaper, it's been circulating in investment circles for a very long time! That means that smart money has already acted on the idea, and it's likely that prices already went up as a result. The time to buy a really good idea is before prices go up. Go back and read those articles again: I'll bet one "proof" of their idea's worthiness is that prices have already risen. That should be a warning sign, not a buy signal.

That's why market timing doesn't work very well. Our suggestion is that you build a well-diversified portfolio - including China and other foreign countries - regardless of current news. That way, you'll be buying some segments before investors drive up the prices. Over time, this approach accomplishes solid returns with less risk.

A good international mutual fund will already own some Chinese investments, along with promising companies around the world. If you choose, you can buy Exchange Traded Funds ("ETFs") that specialize in certain countries or regions. Check out iShares at www.iShares.com for detailed information. Again, though, we'd suggest that you build a diversified portfolio, and not attempt to time the various international markets. ETFs tend to be index funds, so you may choose a no-load mutual fund with an accomplished manager. We like Scout Worldwide (UMBWX) right now.

Buying any particular international company is risky, indeed. The usual company risks are augmented by a few others. Currency risk, political risk, and international trade risks, to name a few. Best to leave this to expert international fund or index managers.

Don't forget that many U.S. companies draw considerable profits from sales in other parts of the world. Some professionals point out that the S&P 500 (large U.S. companies) has a strong international component. Many large companies here are genuinely multi-national and owning them already adds an international flavor to your portfolio.

Straight stock not a good idea for most investors

One day each week, we post a question and answer on the blog. Got a question for us? Post it in the comments section or e-mail it to robynsekula@sbcglobal.net.

QUESTION: I have about $420,000 put away so far for retirement. I’m 45 years old. I’d like to put some of that in stocks to diversify. Right now, it’s divided between four mutual funds. Are there any guidelines for how much money I should invest in straight stocks and how much in some type of secure investment?

ANSWER FROM DAN DANFORD: You may be asking the wrong guy. We manage a number of million-dollar IRA portfolios, and almost always use mutual funds. The key is to use funds with different investment strategies and market sectors to achieve diversification. Done properly, you get the benefits of owning stocks but without the "company-related" risk associated with a particular corporation.

The problem with individual stocks is that each company carries risk that can't be erased. No matter how good the company is - and we can all name dozens of good companies - there's a chance that some event might doom the company. A massive lawsuit, maybe, or some competitive or natural disaster. In brief order, the company can go from stable to bankruptcy. Shareholders can lose it all. Not likely, perhaps, but possible. The only way to reduce this risk is to buy other company stocks. Each additional stock in the portfolio reduces this company-specific risk.

That's where mutual funds come in. Most funds have a rule that no individual stock can comprise over five percent of the portfolio. Hence, they've already achieved a level of diversification beyond what's necessary to reduce the company-specific risk. Picking stocks requires a lot of time and effort, and watching a portfolio of 20 is ridiculous for most amateurs!

It's important to note that other types of risk don't go away with mutual funds. Market risk and Inflation risk and Political risk can still move markets up and down, and mutual funds will move up and down with them (so would individual stocks, for that matter). To reduce (but not eliminate) those risks, carefully choose funds with different investment strategies and market sectors. That should temper some of the fluctuations while preserving the performance potential of stocks.

Mutual fund critics point to the cost as a shortfall of this strategy. And I agree that it can be. Another key part of the strategy is to focus on funds with low internal management fees. There is a direct reverse correlation between the rate of mutual funds fees and their performance for shareholders. Do like we do; choose known funds, with good performance, and low fees. Diversify across sectors and management styles. Watch the mangers you select with care, but not too closely. Over time, your nest egg will grow nicely. At your age, and with this amount of capital, you should have a very nice retirement. If you ever want professional attention, give us a call!