I’m 28 years old with a wife and a six month old baby. We’ve always been money-conscious, but would really like to focus our efforts. We both have Roth IRAs, but are not satisfied with them. They are heavily loaded, and we weren’t that familiar with them when we were advised to set them up. My question is where you would recommend I go for a long-term investing vehicle? I always hear to go with no-load mutual funds but would like your opinion.

This is a great question. I’ve said it before, and I’ll say it again… Friends don’t let friends pay mutual fund sales loads.

My personal preference when it comes to long-term investing centers on low cost, no-load mutual funds. When I say low cost, what I’m really talking about is “passively-managed” index funds that seek to match the market as a whole, or some segment thereof.

As for my favorite places to invest, Vanguard is at the top of my list. We also have some money with Fidelity and have been quite happy with their offerings. A third option would be Schwab, who has a bunch of low cost mutual funds with a low minimum investment of $100.

A slight variation on the above would be to go with index ETFs instead of index mutual funds. The underlying premise is the same, but you get a bit more flexibility when it comes to trading shares. If you do go this route, make sure you select a good discount broker so the trading costs don’t eat you alive.

Of course, there are other options to consider, such as opening a Treasury Direct account so you can buy Treasury securities such as T-Bills, T-Notes, T-Bonds, Series EE Savings Bonds, Series I Savings Bonds, etc. This will allow you to purchase these securities direct from the Federal government with no middleman.

Just keep in mind that the optimal composition of your portfolio depends on many factors, so you really need to give a lot of thought to your time horizon, risk tolerance, etc. before you make any major moves.

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» Skip Lunch, Save $100k
» Retirement Savings Rate Poll Results
» Pay Off Debt or Invest?
» FDIC Insurance Higher on Retirement Accounts
» Figuring Out Your Retirement Contributions for 2010

Many people got religion about saving money during the recent recession. This reversed a trend of steadily climbing U.S. debt burdens–or is it just a temporary pause in that trend?

The answer depends largely on whether people continue the good savings habits they acquired during the recession. You may not be able to do anything about national savings rates, but you can take some steps to make sure your own savings rate stays on track.

Keeping the savings habit going

On the surface, it may seem counterintuitive to find that savings rates actually improved during the recession. After all, incomes were down, and low bank rates created little incentive for saving. Even so, people were scared into good savings habits, and found they could get by with less.

Here are four things you can do to continue good savings habits as the economy turns from recession to expansion:

1. Lock-in low interest rates. If you refinanced your home loan, make sure you locked in those lower interest rates with a fixed-rate mortgage.
2. Eat in more often. Many individuals cut down on their restaurant habit during the recession. Continuing to eat at home more often will make going out seem special again–and could be good for your waistline as well.
3. Reduce your credit card usage. By choice or by force, many people have cut down on the number of credit cards they have. Even once credit becomes more freely available again, keep in mind that having fewer credit cards gives you fewer ways to get into financial trouble.
4. Avoid “expense creep.” Over the years, it seems bills for services like mobile phones and cable television have ballooned drastically. The recession forced people to cut back to what they really need, and you can keep pocketing those savings if you guard against letting unnecessary services or luxuries gradually creep back into your lifestyle.

If Americans were able to increase savings rates during a recession, just imagine how powerful those habits could be once incomes start rising again and there’s more to put into your high yield savings account. If you really want to build wealth rather than just fight off trouble, maintaining good savings habits in an economic expansion is the way to do it.

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While it’s difficult to overcome the urge to react to unexpected events in our lives, patience and consideration of the facts almost always yields better results than emotional reactions. We encounter this every day, from holding off on hitting that send button on a nasty email you haven’t yet fully digested, to not punching the guy in the face who just said something stupid to your girlfriend.

In retrospect, such instinctive responses that were delivered without considering the full context, the facts and the likely outcomes most often lead to regret and often, financial pain, down the road.

“Storm of the Century”

While the media loves to talk about the “Storm of the Century” every few years to keep eyeballs glued to the set, we actually have had the snowfall of the century this year in many parts of the Northeast.

Well… We have some friends who tend to make rapid, emotional decisions that often have heavy financial implications. Last week, they proclaimed, “We’re moving to California. This snow is ridiculous and we’re not dealing with another winter like this.”

In truth, they probably won’t see another winter like the East Coast has had, but their minds are made up. They’ve already talked their parents into moving out West with them so they can still see the grandkids, and he’s already looking for work.

They’re serious; they’re moving because of snow.

Take a deep breath

Based on my recollections, this winter has been off the charts. In fact, I can recall several winters where we didn’t even have any snow to speak of, perhaps a dusting here or there. So, I looked into it a little further.

As it turns out, we haven’t had this much snow in our region for over 100 years, dating back to when they first started tracking snowfall in 1884. Hmmm… Maybe it was a Storm of the Century. But still… Moving?

What’s the big deal about moving? Well, if snow is the sole catalyst, it just strikes me has highly irrational – and expensive.

• An equivalent house (they have a roughly 3,000 sq ft new-construction home) in a reasonably desirable area of California is going to cost more than double what it does here.
• California is essentially bankrupt. It’s inevitable that services will be cut while taxes are being raised – and current tax rates are already higher than most states. Is this a place you want to be moving TO? Or running FROM?
• Moving costs are not trivial.
• What if the job doesn’t work out? It’s tougher to find high paying jobs than it used to be.

It’s now evident this wasn’t a typical snowfall season. Since we haven’t had this much snow in over 100 years, it is unlikely that we’ll see something similar anytime soon. This winter was an outlier, pure and simple.

Wanting to avoid bad winter weather is a lot like the understandable, yet irrational feeling of not wanting to drive a car again after a bad car accident, or even people that are afraid to fly even though the trip to the airport is more hazardous than the plane flight itself. While disasters do occur, they are extremely rare, and repeat events of similar magnitude are nearly non-existent.

So, if there’s a once per hundred year earthquake on the fault line which causes damage and fear, will our friends turn around and move back East? This business of reacting to rare events can get pretty expensive!

Investment decisions

This brings me to how similar thinking affects investors. Left to their own devices, millions of retail investors damage their prospects for an optimal retirement asset allocation by constantly tinkering with it. In the midst of the financial crisis, friend after friend proclaimed that they were boldly moving all their money out of stocks and into bonds – Treasury Bonds that is.

Many retirement accounts offer some sort of “conservative” bond fund, and tons of people have flocked into such investments. Not only did most of these people exit at the worst possible time – pivot bottom in March 2009, but they then shifted money into a money-losing Treasury fund while stocks rallied over 60% from their lows in less than a year (compare Mar 9 onward)!

If you thought Treasuries could never lose money, think again. With yields so low that investors were actually taking a negative yield just to stay liquid in short term paper, the only direction for Treasuries to move was down (driving yield up). And they did. It was so plainly obvious to me in 2009 that I shorted Treasuries in my trading account with a practical risk-free gain in my book.

So, what you have here is people that initially had a reasonable asset allocation suited to their risk tolerance and time horizon (often 20-30 years from now!) shifting money around at the worst possible time. By deviating from a long-term strategy with short term reactive measures, their nest egg at retirement could be hundreds of thousands of dollars short.

While stocks make people nervous, no responsible financial adviser would propose a 0% stock allocation and 100% Treasury bond allocation for a 30 year time horizon. History has demonstrated that you’re lucky if you even beat inflation over decades long periods of time in Treasuries, while equities always outperform other conventional asset classes over long time periods.

Regardless of what your long term strategy is – be it asset allocation in your 401K, career moves, altering a small business strategy, or whatever the situation may be – before you “go with your gut” and make a major decision based on a single data point, your emotions, or a perceived reality, make sure you consider the context and what the possible long-term implications are.

What are some of the worst “Gut Reaction” moves you’ve seen?

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» “Borrowing” Money from an IRA

For those that are unaware, an HSA is similar to a flexible spending account (FSA), but better. While both provide a tax break on qualified medical expenses, the HSA has a higher annual contribution limit ($6150 for families, $3050 for individuals) and it’s also not subject to the “use it or lose it” provision.

Another very important difference is the freedom to invest funds in an HSA in much the same way you can invest the money in your IRA. While your employer might have a “preferred” HSA custodian, you can actually use an custodian you want.

A better use for our HSA?

All of this got me to thinking… Assuming that you can afford to pay for their medical expenses out-of-pocket and make HSA contributions, should you make claims against your HSA? Or should you leave the money in place and let it grow, completely tax free?

When you really think about it, the HSA combines the best attributes of the Traditional and Roth IRAs. That is, it combines the deductible contributions of a Traditional IRA with the tax-free distributions of a Roth IRA. Add to that the high contribution limits and you’re talking about a very powerful investment vehicle.

Getting your money out of your HSA

Obviously, we’ll eventually want to get our money back out of our HSA. How can we do that? Simple. According to IRS Publication 969:

When you pay medical expenses during the year that are not reimbursed by your HDHP, you can ask the trustee of your HSA to send you a distribution from your HSA.

The go on to say that:

You can receive tax-free distributions from your HSA to pay or be reimbursed for qualified medical expenses you incur after you establish the HSA… You do not have to make distributions from your HSA each year.

(emphasis added)

But wait… It gets better:

If you are no longer an eligible individual, you can still receive tax-free distributions to pay or reimburse your qualified medical expenses.

One other little safety net is that, once I turn 65, the 10% penalty for non-qualified distributions goes away.

Here’s a quick translation:

• You can take distributions in return for any qualified medical expense that you incur after open your HSA
• You are free to wait as long as your want to take these distributions
• You can even take distributions after you’re no longer eligible to contribute to an HSA
• You can also claim qualified expenses incurred after you lose eligibility
• Once you turn 65, you can take non-qualified distributions by paying taxes (like a Traditional IRA) without paying the 10% penalty

Of course, you’ll have to save your documentation to make this happen. The good news is that you can simply scan and archive the paperwork (just be sure to keep backups!) as the IRS accepts scanned documents.

Your thoughts

So, dear readers, what do you think? If you’re in a position to cover the out-of-pocket expenses associated with your healthcare while contributing to an HSA, should you take distributions from your account? Or should you leave those funds in place to grow tax free such that you take better advantage of them in the future?

As for us, leaving the money in place is a pretty attractive proposition, and we’re currently archiving receipts instead of taking distributions while we consider our options.

N.B. It seems like I’m not the only one that thinks this way.

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Tracking notes in Quicken

As a quick refresher, I track my loans under a mock security name of “LC Loans,” and with a stable share price of $1. If I invest $25 in a note, I “BUY” 25 shares of LC Loans. As principal is repaid, I “SELL” the appropriate number of share. Interest payments are recorded as dividends (DIV), and so on. I do this on a monthly basis with a single, aggregated BUY, SELL, DIV, etc. transaction. But I hadn’t figured out the default thing until this past weekend.

How to record defaults

As it turns out, the solution is very simple. In this case, it was a $25 note that went into default, and the borrower never made a single payment (nice, huh?). Initially, I thought I’d simply record a “SELL” transaction in Quicken for 25 shares of “LC Loans” at a price of zero. Unfortunately, Quicken wouldn’t let me assign a share price of $0.

My workaround was simply to leave the share price at $1, and to record a $25 “commission” in the commission field. The end result is that I deducted 25 shares of my investment without adding any cash value to my account. This has the same net effect of selling them for $0/each, or just magically erasing them.

As for timing, I recorded this transaction during the month in which the loan was finally declared a lost cause (November 2009). Quicken now gives me a completely accurate picture of my true portfolio performance, including the effects of both idle cash and loan defaults.

Any other suggestions?

If you have any tips or tricks for tracking your Lending Club investments, please share them in the comments. While the above approach doesn’t allow you to track things on a note-by-note basis, it’s very easy to implement, and gives you accurate numbers for your portfolio as a whole.

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» Lending $100 Giveaway Reminder
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Whether you tend to save money or overspend is largely determined by your financial habits. Have you ever noticed that good financial habits come much more naturally to some people than to others?

It’s not all in your mind, but that’s the starting point when it comes to saving. Psychologically, some people are just more geared toward saving than others.

Spender or saver? Five questions to ask yourself

Here are five questions to help you determine whether you’re a natural saver or spender:

• Is the present more important to you than the future? People are often encouraged to live in “the now” rather than worry about the past or the future. However, those who live too exclusively in the present have a hard time seeing the value of saving. After all, the act of saving money is literally trading off benefits today for benefits tomorrow.
• What’s more satisfying to you: instant or deferred gratification? This is related to the first question, but it comes down to what gives you more pleasure – the ability to do what you want, when you want, or the satisfaction of setting and meeting goals. The more you take pleasure from long-term achievements, the more inclined you are to save money.
• Are you susceptible to peer pressure? Keeping up with the Joneses has a great deal to do with the spending habits of Americans. The more important you think it is to keep up appearances, the more likely you are to spend more from your savings account than you can afford.
• Do you think of debt as a natural financial condition? Most people have to take on debt at some time, and there’s nothing wrong with that. However, while some live with it as a permanent condition, others start thinking about how to pay off debt as soon as they incur it. The less comfortable you are with debt, the more inclined you are to save.
• Do you communicate with your family about finances? If you don’t communicate financial goals to your partner or spouse and kids, you are more likely to get into conflicts over spending priorities. The net result of compromising your financial goals every time is that your family as a whole will spend more than it should. It’s important to carve out regular time to thoughtfully evaluate your family’s finances. This not only includes tracking spending habits but also where you will keep the money you’ve saved. Shop around online to identify the banks that are offering the best savings account rates, CD rates, and money market account rates for your hard-earned funds.

Even if you’re a natural spender, you can still acquire good saving habits. You may have to work a little harder at figuring out ways to counteract some of your natural inclinations, but you can make changes for the better if you’re willing to try.

See also: Money Management Practices of Couples

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As you know, we constantly monitor our marketplace to provide better rates to borrowers and great returns to investors. We keep an eye on our own market dynamics as well as the overall economy trends.

This time, we observed that defaults continue to trend lower, which gave us the opportunity to decrease rates to borrowers while preserving investors’ net returns (rate minus defaults & fees). Also, lower interest rates help attract higher quality borrowers, leading to less defaults, so it is a virtuous circle.

So there you have it… Lending Club has been able to drop their rates because borrowers have been behaving themselves. It’ll be interesting to see how the “virtuous circle” plays out in the coming months.

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As an investor, I’m not crazy about this change, as I’ll earn a bit less while shouldering the same risk that I’ve always faced. Prospective Lending Club borrowers, on the other hand, should be thrilled with this move. If you’re looking to refinance your high interest debt, now appears to be a good time to do so.

I’m still looking for an announcement to provide some context for this change, but haven’t found anything yet. I’ll update if/when I know more.

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» Lending Club Historical Repayment Rates
» Lending Club Update – November 2009 Performance
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If you’re like most people, you may think that retirement is so far away that it can be dealt with later. The reality is that it is never too early to begin planning for retirement, and there is no better day than today. But some of you out there may be wondering, “How can we adequately save for retirement when my spouse and I only have one income?” Well, you’re in luck, as there are some options available to help you meet your goals.

Spousal IRAs

Whether you are a stay at home parent or simply taking time off work, you should still be taking the appropriate measures to save for retirement. Most individuals who work for a company have the option to save for retirement via a 401(k) or other savings plan.

Even if they don’t have a retirement plan at work, working individuals can save money in an Individual Retirement Account (IRA) because they have qualifying income. But what about those who do not have an income of their own, such as a non-working spouse? This is where the “spousal IRA” comes to the rescue.

A spousal IRA is a special type of account that is funded with the working spouse’s income. Technically, there really is no such thing as a spousal IRA. It just means that a non-working spouse can rely on a working spouse’s income to contribute to fund an IRA. In order to qualify, you must file a joint tax return, and the working spouse must make enough income to fund the account.

Based on current IRA contribution limits, you can contribute up to $5,000 ($6,000 if you are over 50) per year in either a traditional (deductible) IRA or a Roth IRA.

Traditional Spousal IRA

The non-working spouse can contribute up to $5,000 ($6,000 if over 50) to a traditional IRA as long as the working spouse has enough income to justify the contribution. These contributions can be deducted on the joint tax return up to a certain adjusted gross income (AGI) limit. Depending on your income tax bracket, this deduction can result in significant upfront savings.

The deductibility of the spousal IRA begins to be phased out when your joint modified AGI reaches $166,000 and is completely phased out at a modified AGI of $176,000. However, if the working spouse does not have a retirement plan at work, the full deduction can be claimed regardless of income. These contributions grow tax-deferred until retirement. Once withdrawn in retirement, the earnings are taxed at your ordinary income rate.

Roth Spousal IRA

If tax-free growth is more desirable, the non-working spouse can contribute to a Roth IRA. The Roth IRA allows you to contribute up to $5,000 ($6,000 if over 50). Just keep in mind that your contributions will become limited once your joint AGI reaches $166,000 and will be completely phased out once it reaches $176,000 (meaning you cannot contribute to a Roth IRA).

The big advantage of the Roth IRA is that, since you are placing after-tax dollars into the account, they will grow completely tax-free. That means that there will be no income taxes due when you take the money out in retirement.

Taxable Accounts

Although taxable accounts are not the preferred option for retirement saving, they may be advantageous for one income households. Since retirement options are limited for the non-working spouse (i.e., they have no workplace savings plans), a taxable account can be used to supplement retirement savings.

Because investments in this type of account will be typically be held for a long time horizon, they will be taxed at the favorable long-term capital gain tax rates when you liquidate them. Currently, the long-term capital gain tax rate is 5% or 15% depending on your marginal tax rate.

So there you have it. No more excuses. Start saving for retirement today! And remember… You have until April 15th to fund an IRA for last year, so you can still make up for lost time.

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» links for 2007-01-09

A healthy challenge for each of us

In response to my recent article on when you should start investing, FCN reader John laid out his financial “order of priority.” John’s rundown moved me to prioritize my own specific plan, publish it here on FCN, and challenge you to do the same.

We all have unique circumstances, but because financial fundamentals remain consistent, we’ll likely see a lot of similarities sprinkled amongst the difference between our individual plans.

In writing this article, I have two specific goals. First, I want to challenge everyone reading it to prioritize their financial plan. Second, I want to highlight the fact that unique circumstances sometimes call for deviations from well accepted “best practices” such as Dave Ramsey’s baby steps.

My financial order of priority

Before giving you my ordered list, I should briefly touch on our giving strategy, and also outline our 75/25 method of debt reduction and savings contributions we adhere to throughout most every step.

• We always give away at least 10% of our pretax income.
• 75% of our discretionary income (i.e., after living expenses, etc.) is applied to high interest debt reduction (post tax.)
• 25% of discretionary income gets evenly distributed among our liquid and retirement savings accounts (post tax.)

Once we have given, paid the bills, and divvied up our cash into our budgetary envelopes, all remaining money goes toward savings, debt, or interest on debt. Below is our current road map of financial priority.

1. High interest debt repaid. For us this means around $4,200 in a Lending Club debt consolidation loan that was used to pay off credit card and auto loan debt.
2. Finish building emergency fund to one month of expenses. (if not already achieved via our 75/25 method)
3. Repay 2nd mortgage. This is not our next smallest debt, but rather the one with the next highest interest rate.
4. Repay my student loans. Again, this loan carries our 3rd highest interest rate.
5. Repay my wife’s student loans. Here I deviate from the highest interest plan adhered to earlier and opt to pay this lower rate loan off prior to repaying our 1st mortgage.
6. Finish building emergency fund to six months expenses. (if not already reached via our 75/25 method)
7. Max out tax sheltered retirement savings. This includes a 401(k) and 403(b) (mine and my wife’s, respectively), both of our IRA accounts, and possibly other tax sheltered accounts we may have in the future (like a SEP-IRA.)
8. Repay first mortgage. If all goes according to plan, this will be our last debt and will work to pay it off early using all discretionary money remaining after step 7.
9. Savings for children. At this point, we have no children (yet), and see our freedom from debt as being more beneficial than worrying about contributing to their education. As time goes by, however, we will start saving thinking about branching out into things like a 529 college savings plan.

What about you?

Now that you know our plan, please share yours. While certain details of your approach might clash with ours, that’s okay. It’s not imperative we agree on every little detail and, in fact, what’s right for me might not be right for you. The important thing is for each of us to have a written plan in place that is tailored to our specific needs.

So… What is your financial order of priority?

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As of February 1, I’m rocking a 10.23% net annualized return on a portfolio that is currently composed of 233 notes. You can see from the graph below that my performance is currently right around average. I’d be thrilled if this keeps up.

Regular readers know that I’ve had one default thus far, which was a byproduct of my initial “high risk,” auto-selected portfolio. I’ve had one other loan in that portfolio go late, though that borrower is not on a payment plan and has been meeting their obligations.

In contrast, all of the loans in my “low risk,” auto-selected portfolio are current. The same can be said of my hand-selected portfolio, which is how we’ve invested the bulk of our funds. If you’re curious about how I select notes, check out my Lending Club loan selection criteria.

If you’ve been investing with Lending Club, I’d love to hear the details. How long have you been doing it? How many notes do you have? How do you select them? And how has your performance been?

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New customers are eligible for this special offer after opening a new OptionsHouse account with a minimum of $3,000. You must apply for the commission-free trade offer by inputting promotion code FREE100 when opening the account. New accounts receive 100 commission-free trades for each stock or option trade executed within 60 days of funding the new account.

The short version: new customers only, $3000 minimum, promo code = FREE100

After you use up your free trades (or after they expire in 60 days), you can make stock trades for $2.95/each and options trades for $9.95/each. I’ve never used OptionsHouse, so if you have an opinion, I’d love to hear it.

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Getting started

For those that aren’t familiar with Lending Club, I thought I should start from the beginning… Not surprisingly, you get started by logging in. From there, simply click the “Invest” tab along the top.

This will pull up a screen that offers you three different “auto-invest” scenarios: More Conservative, Moderate, or More Aggressive. There are a couple of things to note from this screen…

For starters, you can click on the “More Options” tab to get a slider that gives you access to a continuum of strategies. Next to that is a button labeled “filters.” Click this button gives you access to a wide variety of filters that allow you to set specific investment criteria.

Those options are all well and good if you’re comfortable with auto-investing, but I’m not. If you’re looking for more control, look no further than the “Build a Portfolio from 117 Notes” link over to the left.

Selecting your filters

Once you decide to build your own portfolio, you’ll want to develop a set of custom filters to rule out loans that you deem unacceptable. The good news is that you really only have to do this once, as you can save your filters.

Filters can be accessed over in the sidebar of the “Browse Notes” screen. Though they’re all collapsed, you can see the primary filters that I use in the picture below.

Setting up your filters

If you’re intent on selecting your loans by hand, you’ll need to learn how to effectively filter out the loans that don’t interest you. The following is a rundown of how I set up my filters.

• Inquiries in the last 6 months. This filter can be set from 0-10. I limit it to 3, as I’m not interested in lending money to people who appear desperate to borrow.
• Delinquencies (Last 2 yrs). I set this one to zero. In reality, I won’t lend money to anyone that has a delinquency on their credit report (ever), but Lending Club doesn’t have a “no delinquencies, ever” filter. Thus, I use this one to pre-filter and then I double check by hand.
• Min length of Employment. This can be set between 0-5 years. I’m looking for stability, so I require 3 or more years in their current job.
• Max Debt-to-Income Ratio. Note that this is not a typical DTI calculation in that it doesn’t take housing expenses into account. On the first pass, I typically limit this to 10%, though I’ll sometimes relax it to 15%.
• Exclude loans already invested in. Lending Club loans sometimes take awhile to get completely funded, and I don’t want to accidentally invest in the same one more than once, so I check this box.
• Public Records. I exclude all borrowers with a public record on their credit report. Fortunately, Lending Club has an absolute filter for this one, so I don’t have to review them by hand.
• Month since last Delinquency. As noted above, I don’t want to lend to someone with a delinquency on their record, so I set this to the most stringent setting (60 months or more) to get rid of as many as possible.

Once you have your filters set up, click the “Save” link near the top. You’ll now be able to quickly and easily filter the current crop of loans whenever you come back (by clicking the “Open” link).

Manual review

While the filters above do a good job of filtering out the least attractive loan requests, I next do a quick manual review before investing. Here, I’m looking for two main things…

As noted above, I’m not willing to invest in anyone with a delinquency on their record, no matter how long ago. Thus, I quickly scan through the loan requests and rule out anyone with a delinquency. The good news is that only a few such loans are left after running the filters outlined above.

Next, I compare the monthly payment on the requested loan to the borrowers gross monthly income. If it’s more than 10%, I pass. There’s nothing magic about 10%. It’s just an arbitrary threshold that I’ve selected to make sure the loan payments won’t be a huge burden to the borrower.

While this sounds like a lot of work, it’s really not. If you click on the title of the loan (after filtering), it will expand to reveal more information. In order to efficiently review the loans, I click on each title (one-by-one), eyeball the delinquencies and payment-to-income ratio, and then collapse anything that isn’t acceptable. That leaves me with a slate of expanded, candidate loans from which to select.

Other considerations

In my experience, the above process knocks out the around 75% of the listed loan requests and it only takes a few minutes. From here, I follow my gut. One big thing that I do is to avoid business loans. In general, small businesses have a high rate of failure, and I don’t the added risk.

Other than that, I take look at what the loan is for and ask myself if the details add up. Borrowers are asked to include a loan description. Some do, and some don’t. If they can’t be troubled to explain why they need the money, I pass. If their reasoning doesn’t make sense, I pass. If a lender has asked them a question and the answer doesn’t make sense, or if the borrower has evaded part of the question, I pass.

Another common sense test is whether or not the request is consistent with the available information about the borrower. For example, many people request money to refinance credit card debt. In such cases, I compare that amount to the revolving debt on their credit card. If they’re requesting a bunch of money and don’t have much in the way of revolving debt, I steer clear.

Closing thoughts

While I haven’t been at this for a long time (less than a year), I’ve had a fairly good experience thus far. I’ve had one loan (from my auto-selected, high risk portfolio) go into default. That being said, all of my “low risk” loans are being paid on time, as are all of my manually selected loans.

Could I get away with using the auto-selected portfolios? Quite possibly, but I like having a bit more control, and I’ve managed to streamline my loan selection process to the point that it doesn’t take too much time. If Lending Club added a bit more flexibility to their filters, I could do it in even less time.

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We continue to rely on methods of identity verification used by traditional lenders, but in an era of online identity theft, Lending Club is continually redefining industry best practices.

We cannot disclose our exact methodology, practices, or sources of information, as this could simply empower the fraudsters we are trying to disarm. But what we can say is that we use information gathered from social networks to help give us more confidence that a member is in fact who they say they are.

While it makes sense for them not to disclose detail of their approach, it would be fascinating (at least to me) to know how they’re implementing this. Any guesses?

Regardless of how they detect it, when they do find a case of ID theft, they say that they work with the true owner of the identity to track down and prosecute the fraudster, and they also reimburse lenders the unpaid principal balance of loans that involve identity theft.

Have any of you had any experience with a fraudulent Lending Club loan? I’ve had one default thus far, but I’m not aware of any instances of outright fraud.

Source: Lending Club Blog

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Perhaps you’ve been asking yourself this question but have been unable to settle on an answer that you’re comfortable with. If so, you’re not alone… Many people push investing to the back burner because they’re unsure where, when, or how to begin building their nestegg.

In fact, it seems that many people want to start investing, but simply aren’t ready to take the plunge. And even if they are ready, they have no idea where to start. In this article, I’ll be focusing on the issue of readiness.

The obvious answers

Many people aren’t comfortable tying up their money in long term investments until they’ve met a couple of key milestones.

1. Consumer debt is paid off. Getting rid of your high interest consumer debt should be high priority. It’s probably best for you to forget about investing until your most burdensome debt obligations are met.
2. Liquid savings buffer built. Having ready access to money when you need it is always important. Make sure you have a comfortable amount of money set aside in a high interest savings account before you begin investing.

While debt reduction and emergency savings are certainly important considerations, there are other important factors to consider.

Other factors to consider

• Age. While there is no ‘one size fits all’ age to begin investing, the sooner you start, the sooner compound interest can begin working for you. Optimal investment vehicles and portfolio allocations will differ depending on age, so be mindful to choose age appropriate solutions.
• Matching funds. Does your employer match your 401(k) contributions? Are you fully vested in their contributions right away, or on a graduated scaled based on years of service? If they do offer a match, this should only speed your decision to contribute.
• Children. If you have kids, you might be tempted to begin saving for their education, but you shouldn’t put this ahead of retirement savings. Instead, you should consider consistently putting 15% of your income toward retirement investments prior to saving for education.
• Job status. How stable is your current source of income? If you have a stable job and solid savings, you might feel more comfortable locking up a portion of your income in retirement accounts. If your situation is more tenuous and you may be let go tomorrow, you should build a larger emergency fund.
• Marital status. If you’re considering a move into investing and have a significant other, be sure to include them in the decision making process! When married, these long-term decisions affect both spouses equally, so be sure to communicate and decide accordingly. The best decisions are usually made together.
• Insurance policies. It is important to carry the proper types of insurance at each point in our lives. A decision to invest should not be made without balancing our investment strategy with situation appropriate insurance coverage. Health insurance, disability insurance, long-term care coverage, and life insurance coverage are all important and need to be considered alongside any decision to invest.

In closing

While there are certainly other factors to consider before making the decision to invest, this list should provide a good foundation and get you started in the right direction.

When making important financial decisions, always move slowly, ask question, and consider as many contributing factors as possible. You might even consider consulting with a professional advisor for feedback.

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One of the ways 2009 made history was by having the most sustained episode of deflation since the 1950s. As the year progressed, however, it was clear that inflation was making a comeback. This emerging trend should be a reminder that planning for inflation is critical to your retirement savings plan.

How inflation affects retirement savings

You still see articles wondering if a million dollars will be enough for retirement. Increasingly, though, new generations should regard the premise that a million dollars is adequate for retirement as a quaint notion.

Given the historical average inflation rate of 3.75% a year, by the time a 25-year old today reaches 70 years of age, he would see inflation turn that million dollars into the equivalent of $190,781 in today’s dollars. All of a sudden, that doesn’t sound like such a lavish retirement nest egg, does it? Clearly, any retirement savings target has to factor in the effects of inflation over time.

Factoring inflation into a retirement savings plan

Here are some tips for factoring inflation into your retirement savings plan:

• At an average annual rate of 3.75%, inflation will double approximately every 19 years. Use this as a rule of thumb to figure out how many times your cost of living will double by the time you need the money.
• Don’t use your retirement date as the endpoint for your retirement planning. Remember, you could easily live another 20 years or more in retirement — time enough for your cost of living to double yet again.
• Inflation may vary greatly from year to year, but keep that 3.75% average in the back of your mind before locking in any certificates of deposit (CDs) or any other long-term investments. Also be sure to consider the impact of taxes. If you’re looking for a “safe” investment, it’s currently better to keep your bank deposits short and flexible — e.g., in a high-interest savings account or money market account — until bank rates recover.
• In the long run, you’ll need to consider investing more aggressively to protect your nest egg against the devastating effects of inflation. Without the higher returns offered by stocks and bonds, it will be virtually impossible to outpace inflation.

Because of the compounding effect of inflation over time, failing to account for inflation in your retirement savings plan can be as devastating as losing more than half of your money. However, if you get an early start and make sensible investments, you can get the power of compound interest rates working for you rather than against you.

Sources: US Bureau of Labor Statistics, BLS Data

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Our plan for 2010 is getting serious with about saving for retirement, especially now that we’ve reduced our monthly expenses and automated our bill payments. I’m mailing in my paperwork to consolidate my student loans tomorrow and, if all goes well, my interest rate will drop to 2.5%. That’s low enough that we’re comfortable increasing our retirement contributions while paying down our debt.

Setting contribution amounts for his 401(k)

My husband’s job offers a 401(k) with a match of up to 5%. The matching funds are immediately vested which means that even if he left for another company, he can take all of the money in his 401(k) with him. We’re already contributing enough to get the entire company match, but we’re looking to do more.

My husband wants to keep his investments simple and just focus on a few funds. The problem for us is finding the right mix of funds to invest in. In the end, we went with a couple of growth funds for the majority of his holding. We would have preferred to put his contributions into low cost index funds, but there aren’t any offered in his plan.

While a 1% or so difference in expense ratios between a typical index fund and the funds offered in my husband’s 401(k) might not seem like much, it adds up to some significant money down the line. I ran the numbers, and if you invest $100,000 over 20 years in an index fund with a 0.75% expense ratio vs. a fund with a 1.9% expense ratio, there’s a difference of $216,700!

Thus, we’re going to focus on funding his Roth IRA instead of putting extra money (beyond the company match) into his 401(k).

Setting contributions amounts for our IRAs

My husband now has to decide how he wants to invest his Roth IRA contributions. When he started a new job here in North Carolina, he started investing with Vanguard because of their low fees and the fact that he had enough money stashed away to meet their minimum investment requirements.

I have my retirement funds with Sharebuilder, and I’ve set up an automatic monthly deduction for my Roth IRA for 2010. Back in 2009, I decreased, and then paused, my Roth IRA contributions so I could devote more money to paying off my car loan and building up our house down payment.

In terms of investments, I’ve been focusing on mutual funds instead of individual stocks since I don’t have a lot of money, and I want good diversification. I actually started setting aside money for retirement through an employer plan when I was 21. I wish I could say that I continued my contributions uninterrupted, but I ended up cashing it out when I left that job.

Not only did I have to pay taxes on the distribution, but there was a penalty on top of that, decimating what little savings I had. I learned my lesson and now I don’t touch my accounts unless I’m contributing more money or rebalancing my portfolio.

Focusing on the future

Since we’re now making regular contributions, and we’re still quite young, we have the powerful effects of compounding on our side. We’ve also learned a valuable lesson about cashing in our retirement accounts, and won’t be taking any early withdrawals. Instead, we’ll be focusing on increasing our contributions each and every year.

I know people who think you need to have a huge amount of money to invest effectively, but that’s simply not true. Even small amount add up — at least you’re doing something. You can always increase your contributions as your earning power increases.

As things stand, we intend to adjust our contributions every January and then automate things for the rest of the year. That way our investment program will be both convenient and sustainable.

Your thoughts

So… What do you have planned for this year? Are you increasing, decreasing, or holding steady with your retirement contributions for 2010?

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This (potentially) valuable tax credit is known as the “Retirement Savings Contribution Credit,” and it’s available to anyone who meets the income requirements and makes a qualifying retirement contribution.

For tax year 2009, you can claim this credit if you AGI is no more than:

• $55,500 (married filing jointly),
• $41,625 (head of household), or
• $27,750 (single, married filing separately, or qualifying widow[er])

The credit ranges from 10% to 50% of your contribution amount, and the maximum contribution on which the credit is calculated is $2000. In other words, you can get a credit of up to $1000. The actual rate can be determined by completing IRS Form 8880.

Eligible retirement plans/accounts include a traditional or Roth IRA, or elective deferrals to a 401(k), 403(b), 457(b), SIMPLE IRA, or a salary reduction SEP-IRA. Contribution to a 501(c)(18) plan are also eligible.

And guess what? It’s still not too late to take advantage of this tax credit for 2009. Even if you haven’t made any retirement contributions, you can still fund a traditional or Roth IRA up through the day your taxes are due. So what are you waiting for? Get cracking!

See Chapter 5 of IRS Publication 590 for complete details.

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While Schwab still trails some discount brokers (e.g., TradeKing @ $4.95/trade), they’re well ahead of others (e.g., E*Trade @ $12.99/trade). When combined with their very low mutual fund investment thresholds, this change makes Schwab a fairly attractive option for people who are just starting out.

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So why is this so hard for us to grasp, adopt, and live by? It’s not complicated, it’s not unreasonable, and it makes perfect sense. So what’s the deal? Why do most Americans spend money that they don’t have?

Well, I don’t have the answer for that, so… Rather than opening that can of worms, I will present sound information that will help us grasp the Save Then Buy concept, adopt this commonsense philosophy, and live by the wisdom of it’s simplicity.

Save money, then buy – grasp the concept

If people would simply take a step back and rationally analyze the Save Then Buy mindset, there’s little chance that they could come up with a valid argument against it. Moreover, if one were to make an equitable comparison between the Save Then Buy mindset and the modern American cultural norm of Buy Now Pay Later, there’s little doubt that they would deem the former as the best financial choice.

If we can see the wisdom of the concept, but have not yet adopted it… What is holding us back?

An example

Let’s take a look at a simple example of Save Then Buy versus Buy Now Pay Later in the context of a college education…

Save Then Buy: A prospective college student might seek a low level job in an industry of interest, then either attend classes while earning enough to fund them, or save for a few years and begin schooling once they have enough saved, gathering no debt along the way.

Buy Now Pay Later: With this mindset, a prospective student would first seek financial aid (most often in the form of loans), amass a mountain of debt throughout their college years, and graduate with tens of thousands of dollars of student loan debt.

While some might argue about the value of getting that college education as quickly as possible, my view is that the Save Then Buy student will come out on top across the board. They will have gained work experience prior to and during their education which will help them refine their field of study, and will provide them with necessary experience for launching their new career.

In fact, they will often already have a job with a company in their field of expertise, and can start climbing up the ladder with their new degree. They’ll also start their professional life with no student loan debt, and can begin saving and investing out of the gate.

The Buy Now Pay Later student will graduate with no relevant job experience, no job, and a mountain of debt. They will have to go into the world and compete against better equipped Save Then Buy candidates.

Save money, then buy – adopt the philosophy

I’m guessing that many people reading this article currently have a Buy Now Pay Later mindset. That’s okay… I used to be hold that view myself.

The good news is that you can change your behavior today. You no longer have to be a slave to a poor economic mindset just because “everybody else is doing it.” Break free from a culture of temptation and start living by a new personal economic mindset that is based on wisdom and sound financial principles.

Will it be hard?

Sure… It might be. Was it hard for me? Not really. All I had to do was calculate how much our debt was costing us. Once I had the numbers in front of me, the reality of $1,300+ of my hard earned money going toward interest on my debt was all the motivation I needed.

Get mad at your debt

Using the spreadsheet that I developed, you should sit down and take a long hard look at how much your debt costs. I can virtually guarantee that you will wind up with some good healthy anger toward your debt, which should help motivate you to adopt the Save Then Buy philosophy.

Save money, then buy – live by simple wisdom

Now that we’ve fully explored the concept, analyzed the numbers, and gotten mad about our current situation, all that remains to be done is to adopt the concept. Don’t buy stuff you can’t afford. Instead, save your money money until you can comfortably afford the expenditure.

From laborer to capitalist

In making this transition, you should also stop thinking like someone who trades their time for money, and instead start thinking like someone whose goal is to live off the proceeds of their money. If we want to win with money, we have to start considering our future every time we open our wallets. With each decision we make, we should be moving ourselves closer to the wise goal of living off the proceeds of our assets.

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What is a donor-advised fund?

A donor advised fund is essentially an umbrella charity run by an investment company. You can make donations into an account over which you serve as an “advisor” and take an immediate tax deduction. You can then advise the company on how to invest the money, as well as when and where to direct the funds in the form of a charitable grant.

Advantages of donor-advised funds

The primary advantage of a donor-advised fund is that you can use it to aggregate charitable contributions in a specific year even if you want to spread the donations themselves out over time. This can help maximize your tax savings while giving you time to make prudent decisions about who gets what (and when).

Beyond the above, you can also directly donate appreciated stocks, mutual funds, etc., which saves you from paying capital gains taxes on them prior to the donation. While some charities are set up to take such donations, others aren’t. A donor-advised fund makes this strategy available to all.

Finally, if you make lots of charitable contributions, a donor-advised fund can simplify your paperwork. Instead of getting receipts from many individual charities, you get a single tax receipt. This is especially helpful if you want to donate securities, as outlined above.

Disadvantages of donor-advised funds

The biggest disadvantage of a donor-advised fund is that you technically lose control over the money. According to IRS guidelines, your contribution must both irrevocable and unconditional. While you are allowed to advise the fund on how to invest and when/where to donate funds in your account, all such moves must be approved by the fund.

In reality, this is less scary than it sounds, as the approval of grant recommendations is typically automatic as long as the recipient is a bona fide charity. In fact, I’ve never heard of a case where a legitimate grant request has been turned down. The restrictions come because the fund itself is technically the charity to which you’re donating.

Other downsides to donor-advised funds are management fees and minimum investment requirement. While the fees aren’t huge (typically less than 1% plus whatever expenses are associated with the underlying investments), they are definitely something to consider. As for minimum investments, the lowest values I’ve been able to find are in the $5k range for the initial contribution with subsequent contributions starting at $500.

What about taking credit vs. remaining anonymous?

If it’s important to you to receive credit for your donation (i.e., for the recipient to know who you are), then you’re in luck. Donor-advised funds allow you to name your fund (e.g., The Smith Family Charitable Fund) and will provide the recipient with contact details when they disburse the funds.

Conversely, if you’d prefer to remain completely anonymous, a donor-advised fund can provide an additional layer of isolation between you and the ultimate recipient. Thus, you can make truly anonymous donations

Who offers donor-advised funds?

Donor-advised funds are available through a number of mutual funds families, including Vanguard, Fidelity, Schwab, and T. Rowe Price.

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Cash flow

I start with cash flow because you need to make sure that you’re not spending more than you earn. finances are not sinking you more and more into debt. Grab a budget spreadsheet and input all your income and expense numbers. If your expenses are higher than expected, looks for areas where you can cut back.

For example, instead of going out to see a movie every weekend, try visiting museums and art galleries on free nights, visiting local and national parks, or seeing if there are any free concerts and festivals. If you’re still intent on seeing movies, consider signing up for Netflix or Blockbuster.

If you’re looking for ways to increase your income, consider starting a second job or building an alternative income stream based on a hobby or other passion. It doesn’t have to make you full time money in order to improve your bottom line.

Emergency savings

I’ve learned from personal experience that the only way to lessen the pain of an emergency is to prepare for it. Cars break down, jobs get lost, and appliances stop working at the absolute most inconvenient time.

Make sure you’re comfortable with amount of emergency savings that you have. If not, then start building it up. By putting it in a high yield savings account, you’ll have easy access to it and earn a bit of interest at the same time.

Outstanding debts

It might help to separate this category into high interest consumer debt such as credit cards and low interest and/or tax advantaged debt like student loans or your home mortgage. Attack the high interest debts first, as they can get out of control if put them off too long.

The easiest way for me to pay off my credit cards has been automating my credit card payments. Try to pay the minimum on all but one of your debts. Put the rest of your debt reduction money into either your debt with the highest interest rate. If you’re not comfortable with that approach, try attacking the lowest balance first.

Retirement accounts

If you have retirement accounts, make sure that your asset allocation isn’t out of whack. If they are, then you should rebalance them. You may also want to review your fees and expenses to see if you can save some money.

If your job offers a 401(k) retirement plan and you haven’t already joined, you should enroll. Many companies offer a match on a percentage of your contribution, and failing to take advantage of this free money can be a costly mistake.

You can also get started by opening a Traditional or Roth IRA through your favorite brokerage or mutual fund family.

Your thoughts

How does your financial snapshot look? Is it better or worse than a year ago? What are you planning on doing in 2010 to improve things?

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Reduce your debt

Debt reduction should, in my opinion, always be numero uno. This is especially true if you’re dealing with high interest consumer debt. But even if your debt has a low interest rate, you might still want to make debt reduction a high priority. Whether or not you should pay off your mortgage early is a hotly debated topic, but even that is worth considering.

Build your savings

Your first line of defense when it comes to your finances is your emergency fund. Open a high yield savings account and work to build it up as a hedge against job loss or other unexpected curveballs that you might come your way.

A lot of people say to maintain a minimal emergency fund until you are out of debt, but I disagree. I think you should always pay yourself at least a small amount. That’s why I stick to a 75/25 savings plan.

There are, of course, other savings priorities that you might need to consider. For example, if you have a high-deductible health plan, you should be funding a Health Savings Account (HSA) so you can pay for health expenses with pre-tax dollars. Unlike a Flexible Spending Account (FSA), you can modify your HSA contribution levels throughout the year.

Fund your retirement

When it comes to funding your retirement, you have several options.

Individual Retirements Accounts – These come in two main flavors: Roth and Traditional. I personally prefer Roth IRAs over Traditional IRAs, but your needs may be different. Regardless of the type you choose, funding your retirement is an important priority. If you are under 50 years old, the 2010 IRA contribution limits are $5,000 or 100% of your taxable compensation, whichever is less.

If you are 50 or older and have sufficient taxable compensation, you can contribute $6,000 in 2010. The extra $1000 is referred to as a “catchup” contribution. Either way, getting started in January is your best bet for fully funding your IRAs. In fact, you still have time to make your 2009 contributions if you haven’t done so yet — the deadline is April 15, 2010.

Employer plans – Depending on where you work, you might have access to a 401(k), 403(b), and/or 457(b) retirement plan. We’ve previously outlined the contribution limits for these plans. In short, you can make elective deferrals of $16,500 to these plans in 2010 with an additional $5500 in “catchup” contributions if you’re 50 or older. If your employer matches your contributions, you should at least take advantage of the match so you’re not leaving money on the table.

Taxable investments – If you’re doing all of the above and still have money to spare, you should consider investing in a taxable account. You can do this either through a major mutual fund family, or through a discount broker. Either way, you’ll want to pay attention to tax efficiency when deciding what to hold where.

Save for college

Once you have everything else under control, you might be interested in funding your child’s education. Here are some of the best ways to do so…

529 Plans – When it comes to 529 plans, you have your choice between prepaid tuition plans and college savings plans. The former is a hedge against tuition inflation, while the latter depends on the performance of the underlying funds.

Regardless of which route you choose, make sure you do your homework. The good news is that qualified distributions are state an federal tax free (at least for now), and you might also get a state income tax deduction on your contributions.

Education Savings Accounts – The “Education Savings Account” (ESA) is a less-utilized college savings vehicle that has undergone some attractive changes since its inception as the “Education IRA.” Like a 529 plan, qualified distributions from an ESA are tax free.

ESAs can be used not only for qualified college expenses, but for certain K-12 expenses, as well. The contribution limits were raised from $500 to $2,000 in 2002 and remain there today. If you’re in a position to fund your child’s education accounts, make sure you look into this as an option.

What are your financial goals for 2010?

As I noted above, everyone’s financial priorities are likely to differ at least a little bit. While the above outline is a good place to start, you’ll want to tailor things for your own needs. You might even have things on your radar that I haven’t touched on.

What are your financial goals for the coming year?

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Because inflation has been so low, however, there’s not much new under the sun. The IRA contribution limits will be staying the same in 2010 as they were in 2008/2009. What follows is a table of contributions limits dating back to 2002, and running through next year.

Remember, you can make your 2009 contributions all the way up until April 15th 2010. As for your 2010 contributions, you can start immediately on January 1st, with a deadline of April 15, 2011.

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Related Articles at fivecentnickel.com:

» IRA Changes for 2008
» Ratcheting Up Our 403(b) Contributions
» Look Before You Leap: Roth IRA Conversions in 2010
» 401(k), 403(b), and 457(b) Contribution Limits for 2009
» 2007 IRA Contribution Limits
» Roth IRA Conversion Limits Going Away
» 2009 Traditional and Roth IRA Contribution Limits
» Income Limits for Converting Traditional IRA Funds to a Roth IRA

In life, we’re routinely faced with situations that require an immediate reaction. Consider the need to pay monthly bills and keep your head above water. Beyond these short-term reactions lie proactive decisions that provide longer-term benefits.

For example, paying yourself first with just $50 extra per month to go directly into an IRA, 401(k), or other account is a proactive step that will lead to a better retirement. While such thinking results in obvious benefits, however, it typically requires delayed gratification.

With budgets becoming increasingly tight for Americans, being proactive in just a few facets of your financial decision-making can provide you with enormous benefits and set yourself up for long-term financial success.

I’ve highlighted below a few situations in which it pays to be proactive rather than reactive. If you find yourself constantly reacting to financial situations, you may want to ask yourself why, and whether it’s time to get a little more proactive.

Emergency savings

Having an emergency fund prevents painful emergency fees, payday loans, credit card interest payments, and other non-essential payments that you wouldn’t otherwise incur. Nobody sets out in life saying, “I’m looking to pay exorbitant fees on debt for the rest of my life,” but that’s the situation many people find themselves in without proper planning.

Life happens, and the repercussions of living without a safety net can last for years. You risk bankruptcy or foreclosure, or at least being forced to sell off personal assets at a loss to make ends meet.

If nothing else, having cash to fall back on will help you sleep better at night and should outweigh the perceived benefits of owning a high-end car or the latest HDTV technology. If you don’t have an emergency fund, think about what it would take to build one. The near-term sacrifices will be worth it in the long-term.

Budgeting

Living paycheck-to-paycheck carries thousands of dollars per year in hidden costs. Without sufficient cash on hand, you lose out on things like early payment discounts on taxes, insurance, etc. You’ll also wind up facing unnecessary overdraft fees when your accounting is off by as little as $1. Beyond this, you’ll be unable to take advantage of one-time opportunities where having cash on hand can save you money (see below). If you can’t stand budgeting, at least consider implementing a reverse budget to avoid these problems.

One-time events

Americans have been presented with numerous one-time opportunities to exploit situations created by the financial crisis, but only those with liquid cash and/or good credit have been able to take advantage of them. Examples abound, including the homebuyer tax credit, cash for clunkers, and the opportunity to buy into the stock market when investor capitulation sent shares down by as much as 50% (70% for Emerging Markets).

An upcoming opportunity is the cash for appliances program, which is being rolled out state-by-state. This program will allow you to replace your aging appliances with a more energy efficient model at a substantial discount. You will also realized the long-term benefit of decreased energy costs.

Perhaps your existing appliance are already reaching the end of their useful life. If you combine the government’s incentive program with adequate cash on hand and a bit of research, you can realize a very strong return on your investment in 2010.

Paying for convenience

People sometimes take the easy route instead of the smart route at the expense of a few dollars here, a few dollars there. This translates into hundreds, if not thousands of dollars per year in leakage from your after-tax budget. A simple example involves buying food and drinks at the movie theater instead of taking them with you.

Here’s another example: I went to a Borders and browsed the store for books for my wife last week. I found several that I knew she’d love, but instead of just buying the books on the spot, I whipped out my iPhone and checked out the prices at Amazon. Even with the in-store “discounts” and club card, the savings at Amazon were over 30%. By planning ahead and allowing time for shipping, I saved a quick $30 on Christmas and personal book purchases.

Finally, we shop at Costco several times per year and buy in bulk instead of paying significantly more per unit at a grocery store. While shopping at Costco takes a bit more planning, and the up-front costs are higher, we save a ton of money. Surely, you encounter these sorts of situations daily. Each time you’re making a purchase, think about whether you could’ve done better with a bit of advance planning.

High ROI expenditures

Seeking out a high return-on-investment (ROI) is a smart way to improve your bottom line. There are some very simple and inexpensive ways to reduce utility expenses at home that many people don’t consider. For example, while buying conventional light bulbs is cheaper than CFL bulbs, there’s no question that you save money with CFL bulbs over the long term. Other examples include reducing your utility costs by switching to a low-flow shower head, planting shade trees around your house, and investing in an energy audit for your home.

Investment strategies

Reacting to market news by altering your investment strategies has wreaked havoc on retirement funds of millions of Americans. While Western society has hundreds of years of historical market data indicating that over long periods of time, equities outperform bonds and cash, millions of investors sold out of stocks last winter/spring, effectively locking in their losses.

They just couldn’t take the continued declines and bad news. Unfortunately, those individuals that reacted to recent market performance and deviated from a long-term investment strategy missed out on a huge rally. In contrast, investors that stayed the course are now seeing their 401(k) balances at or above the pre-crash levels (Vanguard notes that 60% of 401(k) accounts now have more money in their accounts than prior to the start of the crash).

While cynics will point out that monthly investments and company matches continued along the way, the point is that by sticking to the same long term strategy, these 60% are in pretty good shape compared to those who panicked and reacted to poor market performance by jumping ship.

No responsible investment adviser would advocate 0% equities in a retirement account with a 20+ year time horizon, but I have colleagues and friends in their 30s who completely sold out of stocks earlier this year and said they’re never coming back. Their investment portfolios will almost certainly lag behind inflation, meaning their money will be shrinking.

Closing thoughts

As you can see, there are many situations in which we’ll be forced to react if we haven’t gone to the trouble of planning for the future. Yes, being proactive and planning ahead requires short-term sacrifices, but the long-term benefits make it all worthwhile.

Do you have additional examples of being proactive vs. reactive in your financial life? If so, please share them in the comments.

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Related Articles at fivecentnickel.com:

» How do you Keep Track of your Finances?
» Joint or Separate Finances?
» Don’t Be Afraid to Ask for a Discount, The Sequel
» 24 Hours of Personal Finance
» From the Archives (January 13th – January 19th)
» Helping Your Parents With Their Finances
» Ten Steps to Simplify Your Finances, Part 4
» Get Focused on Your Finances

Beyond this, the aggregate limit (employer + employee contributions), which is specified by Section 415(c)(1)(a) of the Internal Revenue Code, will also be unchanged at $49k/year (this is the so-called 415(c) limit).

Given the lack of changes, there’s a good chance that whatever you had planned for last year will hold for this year, as well.

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Related Articles at fivecentnickel.com:

» 401(k) Limits to Decrease in 2010?
» 401(k), 403(b) and 457(b) Contribution Limits for 2008
» 401(k), 403(b), and 457(b) Contribution Limits for 2009
» Traditional and Roth IRA Contribution Limits for 2010
» Open Enrollment Time
» Minimizing Our Taxes with a SEP-IRA, 403(b) and 457(b)
» Roth IRA Income Limits for 2007
» links for 2007-04-12

According to Quicken, however, I’m running at about 7.5%. Why the difference? The primary cause of this difference has been laziness on my part resulting in an uninvested balance that hasn’t been earning any interest.

When I transfer money in, I don’t always get around to investing it right away, and when payments come in, I sometimes let them accumulate for awhile before re-investing. Unfortunately, Lending Club doesn’t pay any interest on your idle funds.

While it would be great if they did pay interest on your uninvested balance, there are apparently a number of regulatory hurdles that a non-bank must clear in order to do so. The good news is that, as your portfolio grows, a small uninvested balance has much less of an impact.

Regardless, the lesson here is to actively invest/reinvest any available funds if you want to maximize your return. The good news is that Lending Club has an auto-reinvest function (see below) which will automatically create a new investment order when you have funds available, and then e-mail you when it’s ready.

I haven’t really used the reinvest function because I prefer to hand-select my loans. However, I could (and probably should) use it to at least remind when I have funds available. Once I get the notification, I can always login and customize the order.

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Related Articles at fivecentnickel.com:

» Lending Club $64.62 Signup Bonus
» Lending $100 Giveaway Reminder
» Lending Club Portfolio Fully Funded
» Free Money from Lending Club – $25 Signup Bonus
» Prosper Resumes Peer-to-Peer Lending
» Lending Club $25 Bonus Reminder
» Lending Club $25 Signup Bonus Reminder
» Lending Club Reduces Interest Rates for Borrowers

Despite all of the attention paid to emergency funds, relatively little attention is paid to when you should tap into yours. With that as a backdrop, I thought I’d tackle the following question that I recently received from a reader:

What should an emergency fund be used for? I have read several blogs and some seem to think that it should be used in the event of unemployment. Some other bloggers suggested that it be use for things such as car repair, house repairs, etc. What do you suggest?

That’s a great question, and there really isn’t a one-size-fits-all answer. It really depends on how you’ve set things up, and how far you’ve made it down the path toward financial security. In the early stages, an emergency fund will mostly be used to cover urgent needs that might otherwise negatively impact you physical or financial well-being.

Take, for example, Dave Ramsey’s Baby Steps for getting out of debt. The first step is to build up a $1000 emergency fund. That way you won’t be forced to whip out the credit card when your car breaks down, the furnace stops working, etc.

Obviously, a $1000 emergency fund wouldn’t go very far if you lost your job. That’s why the typical recommendation is to eventually build up three, six, or twelve months of living expenses (Ramsey recommends 3-6 months in Baby Step #3). Such funds are obviously capable of sustaining you and your family for an extended period, and are thus typically used in the event of unemployment.

This isn’t to say that you can’t or shouldn’t use some that money when your car breaks down, but it’s important to build the fund back up after tapping it. Otherwise, it will gradually run down and won’t be able to sustain you when you really need it.

Of course, there are all kinds of answers in between. For example, you might have a main emergency fund with several months worth of expenses saved up, as well as “satellite” funds earmarked for car repairs, home repair, etc. If this sort of system sounds attractive, you might consider opening an account with ING Direct, as they allow for the easy creation of subaccounts accessible through a single login.

A couple of notes:

First, because of the importance of being able to access these funds in a pinch, you should keep them in a savings account or no penalty CD. Alternatively, if you have a fairly large emergency fund built up, then you might consider building a short-term CD ladder with your money spread across (say) twelve 12 month CDs.

Second, it’s important to recognize that certain things, no matter how inconvenient or uncomfortable they might seem, are not emergencies. In other words, if your car break down and you can’t get to work, that’s an emergency. But if your TV breaks down and you can’t watch your favorite TV show, that’s not an emergency.

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Related Articles at fivecentnickel.com:

» How Large is Your Emergency Fund?
» Building an Emergency Fund
» Ten Things to Do With Your Tax Refund
» Create Your Own “Extended Warranty Fund”
» Buying Non-Laddered CDs With Your Emergency Fund
» An Emergency Fund Victory
» Saving for College
» The Best Ways to “Spend” Your College Windfalls

The short answer is that yes, as long as you’re careful with your money, you should be able to retire on a million dollars, or even less. What follows are some things to consider when evaluating how much you’ll need to retire.

Consider the income generated

If you take the 4% safe withdrawal rate as a rule of thumb, your $1M nest egg will generate an inflation-adjusted $40k in annual income.

Of course, the reliability of that 4% rule depends on a lot of things, such as time horizon, the composition and expected performance of your investment portfolio, whether or not you retire into a collapsing stock market, etc.

If you’re not comfortable with that number, feel free to use your own. The point here is that $1M can generate a considerable amount of investment income.

Consider your expenses

It’s commonly said that your expenses will go down in retirement. For example, if you own a house, you’ll hopefully have paid it off before you reach retirement age, so that’s typically a major savings over having a monthly mortgage payment.

Similarly, you’ll no longer have a number of work related expenses, such as dressing for and commuting to work. Another work-related “expense” that will go away is that you’ll no longer be saving for retirement. Also, unless you retire very young, you most likely won’t have child-rearing expenses when you retire.

Of course, there are some areas in which your expenses might increase (e..g., travel, healthcare, etc.) so be sure to factor those things in when running the numbers.

What about health insurance?

This is a potentially big one. While some retirees have health insurance through their former employer, many don’t. In the future, I’d bet even fewer retirees will have access to such benefits. Of course, the healthcare landscape is changing in this country, so your needs in this area might also change.

Despite these unknowns, I think it’s safe to say that the high cost of health insurance will be especially problematic for young retirees, as they’ll have a long ways to go before they’re eligible for Medicare.

Tax considerations

Another important factor is taxes. The structure of your investment portfolio will play an important role in determining your income in retirement. If you’ve saved primarily in Roth accounts, your money will come out free of income taxes. That’s huge.

If, on the other hand, you’ve saved in a traditional 401(k) or IRA, you’ll owe income taxes on your distributions. The good news here is that you’ll likely be in a lower tax bracket at retirement. The bad news is that even the lower tax brackets might have tax rates in the future.

Consider the effects of inflation

While the 4% safe withdrawal rate gives you an “inflation-adjusted” 4% of your initial portfolio value in income per year, this doesn’t account for the fact that $1M at retirement age will be worth much less than it is today.

In other words, if I gave you had $1M in your pocket today, you’d be in a much better position than if you had $1M in your pocket 30 years from now. This is simply due to the devaluing effects of inflation.

Consider this: After 30 years of relatively tame inflation (3% per year) the purchasing power of $1.00 will be roughly $0.40. This is exactly why people say that “a million bucks ain’t what it used to be.”

Consider other sources of income

Of course, another important consideration is whether or not you’ll have any alternate sources of income. For example, my parents retired with a much smaller nest egg because most of my dad’s retirement savings throughout his career went into a generous pension plan that now covers their living expenses.

In fact, in most years, they take the required minimum distribution (RMD) from their other IRAs simply because they have to. They then invest that money elsewhere because they don’t need need it on a daily basis.

Your thoughts

How much money you’ll need in retirement is a complex topic. I’ve given you some issues to think about above, but I’ve undoubtedly missed some things. Do you have anything to add?

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There’s been a lot of talk about whether or not you should suspend your retirement contributions when you’re working to get out of debt, but… I would think and long and hard before I decided to forego a match.

This isn’t to say that you shouldn’t scale back if you’re in debt reduction mode, but many of the best 401(k) plans match 50-100% of your contribution up to a certain point. If you don’t want to keep going full bore with your retirement savings, at least consider socking away enough to secure the full match.

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» One Year Ago This Week (February 11th – February 17th)
» The Best 401(k) Plans
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» Don’t Miss These Tax Breaks, Part 1
» Figuring Out Your Retirement Contributions for 2010
» Creating a Financial Snapshot

Is there any credible data as to how long companies such as Lending Club are likely to persist (5, 10, 20, 50 years)? That’s probably one of my biggest concerns… I worry that I’ll add money every month until one day they file for bankruptcy, and I’ll lose everything. I’m very interested in your thoughts.

That’s a great question, and unfortunately I don’t have a crystal ball. I can, however, comment on what might happen if Lending Club gets into financial trouble. Here’s what the Q&A in their prospectus has to say about it:

Q: If Lending Club were to become subject to a bankruptcy or similar proceeding, who would service the member loans?

A: We have executed a backup and successor servicing agreement with Portfolio Financial Servicing Company (“PFSC”). Pursuant to this agreement, PFSC stands ready to service the member loans. Following five business days’ prior written notice from us or from the indenture trustee for the Notes, PFSC will begin servicing the member loans. If our agreement with PFSC were to be terminated, we would seek to replace PFSC with another backup servicer.

In other words, if Lending Club runs into trouble, there are plans in place for a backup servicer to step in and take over the loan servicing.

That being said, there is a large section in the prospectus devoted to risks of investing through Lending Club. Included in this section are a number of possible risks associated with Lending Club itself.

They go through a variety of scenarios, but the upshot is that a bankruptcy or similar proceeding could cause delays in payments on notes and, in the extreme, it’s possible that you could wind up as an unsecured creditor of Lending Club.

It’s worth noting here that uninvested funds are held in a Wells Fargo bank account that offers “pass through” FDIC coverage to individual investors (subject to FDIC limits).

So… What does this mean for me? I remain cautiously optimistic, but Lending Club only represents a small percentage of our overall portfolio. As such, I’m comfortable with the attendant risks.

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Related Articles at fivecentnickel.com:

» Lending Club $64.62 Signup Bonus
» Lending $100 Giveaway Reminder
» Prosper Resumes Peer-to-Peer Lending
» Lending Club Portfolio Fully Funded
» Testimonial From a Peer Lending Borrower
» Free Money from Lending Club – $25 Signup Bonus
» Lending Club $25 Bonus Reminder
» Lending Club $25 Signup Bonus Reminder

While you’re more than welcome to view the webinar itself, it’s about 35 minutes long. Thus, I thought I’d put together an executive summary for you.

The webinar was presented by a couple of Lending Club execs (John Donovan [COO] Jack Cohen [SVP, Legal & Collections]) and they presented a ton of statistics.

Lending Club borrower requirements

For starters, Donovan and Cohen noted that fewer than 9% of loan requests are accepted by Lending Club. They require a minimum FICO score of 660, though the average score of approved borrowers is 713.

They further require a debt-to-income (DTI) ratio of less than 25%, though I think they exclude mortgage payments from this calculation. Beyond this, they require a credit history of at least three years, no current delinquencies, and no bankruptcies in the past seven years.

Finally, they won’t approve a borrower who has has more than ten recent credit inquiries.

How does Lending Club set rates?

Rates are set based on the perceived level of risk. Overall, the average rate paid to investors on Lending Club loans is 13.4%. However, this ignores fees and losses due to borrowers who fail to repay the loan.

Thus, here’s how it breaks down:

Average rate: 13.4%
Servicing fee: 0.7%
Expected losses: 3%
Average return: 9.7%

Late payments, delinquencies, and defaults

Donovan and Cohen then turned their attention to ‘deadbeat borrowers’ (my term, not theirs). The following image depicts the different degrees of lateness on a Lending Club loan.

Of the loans that first enter the grace period (1-15 days late), the majority are due to things like failed ACH transfers. For those that are unaware, Lending Club loans are all set up to auto-debit the borrowers bank account. Thus, if a borrower changes banks and fails to update their banking info, the loan will slip into the grace period.

Two-thirds of all loans that enter the grace period are brought back to current within 15 days. Of those that slip beyond 15 days, they are re-categorized as being “Early Late,” and about 10% of these will be brought back to “Current” status before going more than 30 days late.

Loans that are 31-120 days late are considered to be “Late,” though between one-third and one-half of these are successfully brought back to being “Current” status before default. The most common causes of “Late” loans are job loss, reduced salary, unforeseen medical expenses, or family situations such as divorce.

After 120 days, a loan goes into “Default.” Once a loan reaches this stage, there is a 10% chance of the funds being recovered. Turning that around, there’s a 90% chance that you’ll never see your money again once a loan reaches default.

Finally, if Lending Club loses hope of recovery, a loan is re-categorized as “Charged Off.” This isn’t to say that the money is definitely lost. There’s a slight chance of this money being recovered, and if is you’ll get it back. But don’t hold your breath…

One final note is that, in the case of a deceased borrower, Lending Club will pursue a creditor’s claim against the estate (just as any other creditor would do).

Of course, throughout this entire process, Lending Club is working to get borrowers to live up to their obligations. What follows is a graphic that shows the steps that they take at each stage.

What about payment plans?

During the collection process, Lending Club will sometimes place borrowers on a payment plan. In fact, one of my borrowers is on just such a plan. The graphic below illustrates how this works.

In short, the borrower’s payment is temporarily reduced to allow them to get through a rough patch, after which the base payment is increased such that the loan will still be paid off on time. Not an ideal situation from an investor’s perspective, but certainly better than allowing the borrower to default on the loan.

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Related Articles at fivecentnickel.com:

» Lending Club Update – December/January Performance
» More on Lending Club’s Reduced Interest Rates
» Consolidate Your High Interest Debt With Lending Club
» Lending Club – June 2009 Performance
» How to Account for Lending Club Defaults in Quicken
» Lending Club $64.62 Signup Bonus
» Lending $100 Giveaway Reminder
» Lending Club – August 2009 Performance

Guess what? Lending Club has upped the ante this month with a $64.62 signup bonus. This odd amount is in honor of the $6.462B that banks earned last quarter. As always, all you have to do is open a Lending Club account and link up a bank account to get the bonus.

Here’s how it works…

1. Visit Lending Club using a link in this post
2. Open and activate your account
3. The $64.62 bonus will be deposited in your account shortly thereafter.

That’s it, easy money. Note that there are some eligibility requirements for opening a Lending Club account (must be 18, certain states excluded, etc.), but those should quickly become apparent when you click through.

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Related Articles at fivecentnickel.com:

» Free Money from Lending Club – $25 Signup Bonus
» Lending Club $25 Signup Bonus Reminder
» Lending Club $25 Bonus Reminder
» Get a $25 Bonus from Lending Club
» Lending $100 Giveaway Reminder
» Lending Club Portfolio Fully Funded
» Prosper Resumes Peer-to-Peer Lending
» Lending Club $100 Giveaway

Stuff you’ll need

Before you begin, be sure that you have the following at your disposal:

• Your Taxpayer ID number (TIN). For individuals, that’s your Social Security Number (SSN), for entities that’s your Employer ID Number (EIN).
• Driver’s License or State ID number and expiration date
• Bank routing and account number
• IRS Name Control – Whatever that is… Only required for legal entities

Three easy steps

Once you’re ready, there are three basic steps:

1. Choose your account type
2. Fill out your personal and banking information
3. Choose a password, password reminder, and security questions/answers

Once you’re done, they’ll send you an account number via e-mail as well as an “Access Card” via snail mail. You’ll actually need that Access Card to login, so plan ahead.

I had planned on doing screenshots of the process, but it was so easy that it didn’t warrant them. They say it will take ten minutes, but it was more like three. I actually set up two accounts, one for me and one for my wife (you can’t do a joint account), and the confirmation e-mail showed up within seconds.

I’ll update once the Access Cards have arrived and we’ve had a chance to poke around a bit.

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According to Jo:

What you guys (lenders) do for us who are in desperate need of loans is a fortuitous favor. Speaking for myself, I am unable to get a loan the conventional way. For this, I am thankful.

I hope things continue to go well for you, and that those who owe you will pay you back in a responsible manner. If not, this will cause many potential lenders to shy away from this method of investing as part of their portfolio.

I, too, hope that things continue to go well.

From the lender’s perspective, there is definitely a nice “feel good” component to peer lending. That being said, it’s still important to remember that this is a business transaction. If you get too attached to the idea that you’re helping people out, you might get burned.

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» Lending Club $100 Giveaway
» Win $2500 From Lending Club
» Lending Club Review and Account Opening Process
» Lending Club Update – November 2009 Performance
» Lending Club Reduces Interest Rates for Borrowers
» Lending Club Update – December/January Performance

In other news, two more loans showed up as late during November. In one case, Lending Club has worked with the borrower to get them on a payment plan (I’m still investigating exactly what this means) and in the other case, the borrower has subsequently made some partial payments.

Because these loans were being paid on time and in full for several months before getting into trouble, and because the borrowers appear to still be interested in making good on their obligations, I remain cautiously optimistic that they will get back on track. I have, however, activate my FOLIOfn account (accessible through the Lending Club login) and might try my hand at selling one or both of these at a discount on the secondary market.

Once again, I had a couple of borrowers pay off their loans early, so I’ve re-deployed that cash (along with some additional funds that I’ve added to my account). I now have around 180 active loans with a net annualized return (as noted of above) of roughly 9.2%.

As before, I’m planning more of the same… I’ll be steadily adding money every month, and reinvesting the repayments as they come in. I’ve already changed some of my loan selection criteria, and will be looking closely at the three troubled loans in hopes of identify additional risk factors that can be avoided in the future.

Look for a followup post in the not too distant future where I talk about what exactly I’m looking for when I select Lending Club loans. As always, if you’ve been investing with Lending Club, I’d love to hear about your experiences in the comments section.

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Related Articles at fivecentnickel.com:

» Testimonial From a Peer Lending Borrower
» Lending Club Update – December/January Performance
» Lending Club – July 2009 Performance
» Lending Club – June 2009 Performance
» Lending Club Update – October 2009 Performance
» Lending Club – August 2009 Performance
» Lending $100 Giveaway Reminder
» Lending Club $64.62 Signup Bonus

Consider the following… Even if you make too much money to contribute to a Roth IRA, you’ll soon be able to make a non-deductible contribution to a Traditional IRA and immediately convert it into a Roth IRA. In other words, the removal of the income limit for conversions effectively removes the income limits for contributions.

Or does it? As it turns out, there’s a relatively nasty “gotcha” associated with these conversions. More specifically, if you have any tax-deferred money in an IRA (Traditional, SEP, or SIMPLE) you’ll have to factor those in when determining the tax status of your conversion. Here’s a snippet from Fairmark.com that explains the problem quite well:

“For example, if you happen to have a traditional IRA with $96,000 of money from a 401k rollover (zero basis) and you make a $4,000 nondeductible contribution to a new IRA, thinking you can convert it to a Roth at little or no cost, you’ll be wrong. You have to add the two IRAs together to determine the taxable amount, and in this case your conversion will be 96% taxable.”

Bummer. This is actually a significant problem for me, as I have a relatively large SEP-IRA that is chock full of tax-deferred dollars. Thus, if I were to stash $5k in non-deductible contributions in a Traditional IRA with the intention of converting it to a Roth, the majority of the conversion would wind up being taxable.

The Solo 401(k) solution

The good news is that there’s a workaround, though it’s moderately inconvenient. Because this “pooling” of tax-deferred funds applies only to IRAs, I can actually set up a Solo 401(k) and roll my SEP-IRA funds into it. I’ll then be free to set up a dedicated Traditional IRA to receive non-deductible contributions that will get converted straight into the Roth with no nasty tax implications.

I actually mentioned this possibility back in October of 2007, and then promptly forgot about it. A few weeks back, I was reminded of it when I ran across a post talking about this strategy over on TheFinanceBuff. Time is now running short, but I should still be able to pull it off before the end of the year.

The downside of this strategy

Probably the biggest downside for me is that I’ll have to leave Vanguard (at least temporarily) to make this happen. The reason for this is that Vanguard doesn’t accept IRA-to-401(k) rollovers. Thus, I’ll likely wind up moving the money to Fidelity.

That being said, Vanguard does, however, accept 401(k)-to-401(k) rollovers, so I could ultimately move the money back in. Is this a deal breaker? Not really, though I’ve grown quite fond of Vanguard over the years.

Other concerns (though not big ones in my book) are that:

• You have to start filing a Form 5500-EZ with the IRS every year once your 401(k) account reaches $250k in value. With a SEP-IRA, there is no such reporting requirement.
• With an IRA, you can withdraw money at any time for any reason. Sure, you might have to pay a penalty, but you can do it. With a 401(k), you have to meet specific hardship guidelines before you can touch the money.

Like I said, not major issues, but still something to consider. In the end, I’m leaning toward doing it, though I’m still not 100% sure. Thoughts?

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Here’s the scoop:

Offer is valid for one new Individual or Joint optionsXpress account opened and funded with at least $500 by US residents on or before December 31, 2011 at 11:59 CST, and having executed 3 trades within twelve months of account opening. To receive $100 bonus, account must be funded with at least $500 cash or securities transferred from a brokerage firm other than optionsXpress. The $100 bonus will be deposited into the new optionsXpress account within one month after meeting the terms and conditions of this offer. optionsXpress may charge the account for the cost of the $100 bonus should account fail to remain open with minimum funding (excluding trading losses) 6 months from the account open date.

The only potential gotcha is that you have to leave the account open and maintain the minimum funding for at least six months from the account open date. If you don’t they reserve the right to take back the bonus.

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Here’s how it works…

1. Visit Lending Club using a link in this post
2. Open and activate a lender account
3. The $25 will be automatically deposited in your account shortly thereafter

That’s it. Note that there are some eligibility requirements for opening a Lending Club account (must be 18, certain states excluded, etc.), but those should quickly become apparent when you click through.

*Note: The signup page won’t say anything about the bonus, but they’ll be able to track and credit you using the special link in this post.

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As I noted previously, you’re free to use whoever you want as an HSA custodian. The only downside is that I won’t be able to have the contributions withheld from pre-tax dollars if I don’t use my employer’s preferred HSA custodian. Instead, I’ll have to wait until the end of the yeat to deduct our contributions.

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Assuming that you max out, this means that you’ll be the proud new owner of bonds in two forms. Yuck. The good news is that you can convert your paper bonds into electronic form. The TreasuryDirect website explains how. In short:

1. Open a TreasuryDirect account (if you don’t have one)
2. Notify them using the “Contact Us” that you want to convert paper bonds
3. Wait for an e-mail saying your account has been prepared for conversions
4. Login to your TreasuryDirect account and click “My Converted Bonds”
5. Click “Manage Direct” and then select “How to Convert My Paper Bonds”

From there, just follow the instructions and you’ll be home free. I’m still not sure why they have separate limits for paper and electronic bonds, but it is what it is. At least you don’t have to hang onto the paper bonds if you don’t want to.

Note that I haven’t completed this process myself (yet), but I will be doing so soon, and will post more details when that happens. In the mean time, if you have any tips, please weigh in.

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What is a Series I Savings Bond?

Series I Savings Bonds (also referred to as “I Bonds”) are a low-risk, inflation-indexed savings instrument issued by the Federal government. Unlike CDs, which have a fixed interest rate, I Bond rates are adjust semi-annually based on the prevailing inflation rate, in May and November.

The I Bond rates is actually made up of two components, a fixed rate that sticks with the bond over its lifetime and a variable rate that changes every six months based on the Consumer Price Index (CPI).

How to Purchase I Bonds

You can purchase I Bonds in one of two forms: electronic or paper. Electronic purchases are done via TreasuryDirect, whereas paper bonds can be purchased (with no fee) from most banks.

The primary limitation with I Bonds is that you can only purchase $5k worth of them (per format, so $10k total) per calendar year per social security number. The good news is that you can convert your paper bonds into electronic format following the purchase.

Electronic I Bonds can actually be purchased in any amount between $25-$5k, whereas paper bonds are issued in denominations of $50, $75, $100, $200, $500, $1000, and $5000.

Advantages of I Bonds

Aside from providing inflation protection, I Bonds offer some tax advantages, as well. For starters, the interest accrues within the bond itself, so you are not taxed on the proceeds until you choose to redeem the bond (more below).

A second tax advantage is that I Bonds are not subject to state income tax, such that the tax equivalent yield is actually higher than that of an equivalent, fully taxable investment.

Note: Jim also made the excellent point in the comments that interest on I Bonds (as well as EE Bonds) is tax-free if used for college tuition (with some restrictions; details).

Redeeming I Bonds

I Bonds have to be held for a minimum of one year before they can be redeemed, and they cannot be transferred through market sales. In other words, once you buy one, your money is locked in for 12 months. Period.

You can redeem your I Bonds between 1-5 years after purchase for a three month interest penalty. After five years, you can redeem your I Bonds without a penalty. If left untouched, your I Bonds will continue to earn interest for up to 30 years.

Are I Bonds right for you?

The answer to this question will depend on your circumstances, but I’m of the opinion that I Bonds can be a great alternative to CDs. The reason for this is that they provide inflation protection and they also offer a few tax advantages (noted above) as compared to CDs.

Look at it this way… If you buy one today and have to break it in a year, you’ll have earned a little better than 2.5% after paying the three month penalty (assuming rates remain the same). In the mean time, if inflation kicks up, so will your interest rate.

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Even with that delinquency, however, my “High Risk” portfolio is back in the black, as I’ve earned more than enough in interest to cover the loan that I lost. Assuming things keep going as they are, that one bad loan will soon be a distant memory.

During October, a couple of borrowers paid off their loans early, so I’ve re-deployed that cash (along with some additional funds that I’ve added to my account). At the end of the month, I had 148 active loans with a net annualized return of 11.82%.

From here on out, I’m planning more of the same… I’ll be steadily adding money every month, and reinvesting the repayments as they come in. If you’ve been investing with Lending Club, I’d love for you to share your experiences in the comments section, below.

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In the mean time, I’ll just say this… The interest rate on Series I bonds is made up of a fixed rate component and an inflation component. Rates are updated twice a year, in May and November.

The latest update saw the fixed component increase from 0.10% to 0.3% and the inflation component went from 0% to 3.06%. In other words, they’re now offering a total return 3.36%, which compares favorably with prevailing CD rates.

For a bit of background, Series I bonds can be cashed in after a minimum of 1 year. If you break them between 1-5 years, there is a penalty of three months of interest. After five years, there is no penalty. More info here.

Source: TreasuryDirect and Bargaineering

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Here’s the scoop:

New customers are eligible for this special offer after opening a new OptionsHouse account with a minimum of $3,000. You must apply for the commission-free trade offer by inputting promotion code FREE100 when opening the account. New accounts receive 100 commission-free trades for each stock or option trade executed within 60 days of funding the new account.

Pretty easy… New customers, $3000 minimum, use promo code FREE100. Once you use up your free trades, you can make stock trades for just $2.95/each and options trades for $9.95/each.

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When we first started our CD ladder (Novemeber 2008), we bought a one, two, three, four, and five year CD. Rates topped at out 5.15% for the five year CD, and our overall average was 4.66%.

Fast forward to today… We’re now looking at 3.35% APY for a five year CD at the same bank — nearly 2% lower. On the surface, we should probably run away kicking an screaming, but when you dig deeper, the situation isn’t too bad.

If we roll that lowest rung into a new five year CD, the average rate will dip to a bit under 4.50%, which still isn’t too shabby. The big concern, of course, is that interest rates will spike and we’ll be locked in at a low rate. Then again, we can escape with “just” a six month interest rate penalty.

In other words, if we can hang on for a year or so, our effective interest rate would be roughly half the current rate (around 1.70%). If we make it for 18 months, we’d take home 2/3 (just under 2.25%), and so on.

When viewed in that context, the situation isn’t nearly so bleak. If rates jump, we can simply break the CD and re-deploy our cash. Sure, we’ll give up some interest earnings, but our money will still have performed on par with prevailing high yield savings rates, so we’re not risking much.

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Of course, we don’t all face this dilemma. After all, access to Roth IRA accounts is limited by income (but see here and here), and access to a Roth 401(k) or Roth 403(b) is limited by whether or not your employer offers one. Many don’t, even if they offer tax-deferred versions of these accounts.

But what if you do have access to Roth accounts? How do you decide where to put your money? What follows is a quick overview of the major issues.

The tax deferred option

One of the biggest arguments in favor of using tax deferred accounts is that you’ll get your tax savings up front. These guaranteed savings can help those with limited means save/invest more money than they might have otherwise.

Taking an immediate tax break might also be a good option if you’re in a relatively high tax bracket. After all, if your income falls in retirement, you’ll have dodged higher taxes during your earning years in favor of lower taxes in retirement.

But what if tax rates increase dramatically between now and retirement? Even if you fall to a lower bracket, the applicable rate might wind up being higher. In that case, you’d have traded lower taxes during your earning years for higher taxes in retirement.

Another downside to tax-deferred accounts is that they effectively convert capital gains (currently tax at a favorable rate) into regular income. This is a very important fact to consider when deciding where to hold certain investment types.

The Roth option

Roth accounts make the promise of completely tax free withdrawals in the future in return for paying your taxes right now. This is a particularly good option if you expect to be paying higher taxes in retirement than you are right now.

Another risk that you’re running by using a Roth account is that Congress might change the rules. I currently view this as rather unlikely, but consider (for example) what would happen if we would adopt something like the Fair Tax between now and when you retire…

In such a case, you would have paid full income tax on your Roth contributions, and then you would be taxed again in retirement when you spend this money. Double taxation. Yuck.

What are we doing?

So how have we solved the problem? As with all things that involve uncertainty in the investing world, we’ve decided to diversify our risks. I honestly have no idea what will happen with tax rates going forward, and I can only project what our income might look like in retirement.

In view of these uncertainties, we’re taking advantage of both tax-deferred and Roth investment accounts. In doing this, it’ll be impossible for us to be 100% right, but we also won’t be 100% wrong. Given that we have both account flavors (not to mention a taxable investment account) at our disposal, we’ve given a lot of thought as to optimal asset locations.

In short, we keep our most tax inefficient investments in retirement accounts, with those with the highest expected rate of return in Roth accounts. Our taxable account, on the other hand, is loaded up with tax efficient investments.

What about you? If given the choice, how would you proceed?

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While it’s no secret that I’m a huge fan of The Vanguard Group, I thought I’d point that Schwab has reduced the minimum initial investment on their mutual funds to $100 each. Their expenses ratios are also very competitive. For example, the S&P 500 and Total Stock Market Funds weigh in at 0.09%

If you’re looking to get started investing, but the high minimum investments have been scaring you off, then you should definitely check out Schwab Funds. And no, they didn’t pay me to say this.

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What’s a “safe” withdrawal rate?

While there are no easy answers, the stakes couldn’t be higher. If you pick a number that’s too high, you’ll run out of money before you run out of time. If, on the other hand, you pick a number that’s too low, you’ll wind up leading an unnecessarily ascetic lifestyle, ultimately dying with a huge pile of cash.

If you ask around you’re get a variety of answers. By far the most common one that you’ll run across is the 4% rule. In short, this rule holds that you can “safely” withdraw an inflation-adjusted 4% of your nest egg from the year that you retire onward.

Of course, the topic of safe withdrawal rates is very complex, and the reality is that “it depends.” In other words, it depends on your time horizon, the composition of your investment portfolio, whether or not you retire into a collapsing stock market, and so on.

The only thing that we can say for certain is that higher returns will better support whatever withdrawal rate you settle on. But how can you boost your returns without appreciably increasing your risk? Well… What would you say if I told you that the average investor can easily increase their returns by 1% per year while taking on virtually no additional risk?

Maximizing returns by minimizing expenses

Sounds too good to be true, right? After all, 1% can make a huge difference in the size of your nest egg, but there is (typically) no such thing as a free lunch. Well, consider the following.

The average expense ratio for actively managed mutual funds is in the neighborhood of 1.5%. On top of that, numerous studies have revealed that the majority of actively managed funds underperform their target indices, sometimes by a lot. Why? Mostly because of the added expense of the fund manager.

In contrast, index mutual funds (or equivalent ETFs) have dirt cheap expense ratios (often in the 0.1-0.2% range), thereby allowing them to essentially match the returns of their target indices.

So how can you increase your returns without taking on more risk? Simple. Keep a close eye on expenses. Instead of overpaying for underperformance, focus on constructing a portfolio with using high quality, low cost investment vehicles. Of course, this is often easier said than done.

For example, you might have a fee-laden 401(k) with limited options. Sure, you could lobby your employer for changes, but they might resist. In that case, your best option might be to simply contribute enough to get your employer’s match and then focus on investing outside of your 401(k), where you’ll have complete control.

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In doing so, I ran across the ten day CD rate guarantee at Ally Bank. In short, if you open a CD with Ally and the rates go up within the first ten days, they’ll automatically increase your rate to the higher level.

When you fund your CD within ten days of opening or renewing your Ally account, you automatically get the best rate we offer during that time period.

This isn’t a huge deal, but it’s nice to know that you won’t have any regrets about locking in your rate a few days before they raise them. Since our CDs are already at Ally (formerly GMAC Bank), and since their rates are still near the top, we’ll be leaving the money in place and just changing the term.

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