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# Money Tiers: Learn Them To Save Money

In mathematics, there’s a concept known as a step-wise function. Its namesake is owed to what the function looks like when you graph it, it looks like steps or stairs (this is sort of what it looks like).

As you slide across the X-axis, the Y doesn’t jump up until after a certain amount. It’s at those boundaries, where the tiers shift up (or down), that you need to pay the most attention. Why is this little trip down memory lane important? Many things in personal finance are step-wise functions and it’s important to understand them because it can save you a lot of money.

When I discussed the impact of your credit score on your loan interest rates, I listed a table of scores and rates. If you remember the chart, everyone with a credit score between 760 and 850 would paid an interest rate of 5.766% on a 30 year fixed loan. Someone with a credit score of 759, just a sniff away from 760, would have to pay 5.988% – or 0.222%. One hard inquiry can shift you from one category to another and cost you a few thousand dollars. That one inquiry can take you from step to another and cost you thousands of dollars.

What other personal finance “functions” are tiers?
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# Roth IRA Workaround: 2010 Conversion Limit Loophole

Can’t contribute to a Roth IRA? There’s a workaround.

I was speaking my accountant a few weeks ago when we began discussing retirement options. One of the ideas we discussed was to contribute to a non-deductible Traditional IRA with the plan of converting it into a Roth IRA in 2010. Prior to 2010, if you earned more than \$100,000 MAGI, you cannot convert a Traditional IRA to a Roth IRA. This limit is the same whether you’re married or single (boo!). Starting in 2010, that rule disappears so anyone of any income can convert (more on the 2010 traditional IRA conversion income limit loophole).

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# The Smartest 401(k) Book You’ll Ever Read by Daniel Solin

The main point of Daniel Solin’s The Smartest 401(k) Book You’ll Ever Read is that your 401(k), or 403(b) or 457(b), and it’s employer match may not be a no-brainer investment because it could be filled with funds that fat on fees and poor on investment selections. His answer? It’s to model the Thrift Savings Plan, the retirement plan available to government employees that consists entirely of low-cost index funds (the expense ratio is around 0.03%), and use low cost index funds for your retirement options. Look inside your mutual fund options to find the ones that most closely model index funds and go with them.

I think The Smartest 401(k) Book You’ll Ever Read by Daniel Solin does a very good job of opening your eyes to the fee-ladened landscape of retirement investing. He takes specific aim at 401(k) because those “captive audience” type programs are more deceitful than you can imagine. Many companies use plan administrators that offer 401(k) plans for free because they know they can make a killing on the back end with expensive fund choices. If they really had the employee’s interests in mind, then they’d simply offer cheap index funds. In fact, some companies actually pay kickbacks to company HR departments to use them. The plan administrators pay companies for the opportunity to offer their fee fattened funds! It’s pretty ridiculous.

Unfortunately, this means that if you mainly invest in low cost index funds, you won’t get much value out of the first few sections of the book (it could spur you to rollover your 401(k) when the time comes!). The book continues to talk about other retirement investments such as IRAs, both Traditional and Roth, and annuities.

One characteristic I like about the book is that the chapters are short. Many are under three or four pages long, which is exactly how long it should take to explain many of the fundamentals about investing. For example, Chapter 14 is called Simple Investing Is Smart Investing is about three pages long and explains why a simple allocation of basic mutual and index funds will be sufficient for most. Chapter 22 is called “Why Fifteen Is Your Magic Number” and uses three pages to explain why you need to save 15% of your income if you want to expect to have a successful retirement. That, coupled with a applicable quote (usually from some important successful investor such as John Bogle), makes this book an easy read. There aren’t large chapters to digest, there aren’t huge concepts to wrap your head around, this book makes everything nice and simple.

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# How To Become A Millionaire (In 6 Easy Steps!)

Becoming a millionaire used to be hard back when gum was a penny and comics were ten cents. Now that a pack of gum costs a buck and comics suck, becoming a millionaire is much easier but still a laudable goal. Don’t believe me when I say that becoming a millionaire is easy? I’ll give you six easy steps that, if you have the diligence and the discipline to discard the temptations of a world filled with easy credit and consumerism, will leave you a millionaire. \$1,000,000 buckaroos. If you don’t follow them, you’ll likely have to start a dot-com that Google will buy or work 16 hour days and climb that corporate ladder (that’s if you don’t hit some glass ceiling because you’re not in the old boys network).

Many of these ideas are so simple the could make you crazy. None of them are sexy. None of them have you racing down the autobahn in a convertible going 150 MPH. None of them have you throwing dice in Vegas and none of them involve games of poker against James Bond. That’s part of the reason so few people do them… that’s exactly why if you do them you will become a millionaire.

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# 7 Responsible Ways To Spend Your Holiday Bonus

Okay okay, earlier this week I wrote seven irresponsible and fun ways to spend your holiday bonus and now I’m going to throw a bone to the responsible crowd out there and list the seven responsible things to do with your holiday bonus. Personally, I think everyone is a mix between the two (or at least I am between the two). If you spend your entire bonus on fun things, then you aren’t saving enough for the future. If you save the entirety and do responsible things with your bonus, then you aren’t really enjoying the fruits of your labor. What I think you really need to do is find a nice happy medium between the two without going overboard in either direction.

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# How To Put Your Personal Finances On Autopilot

Personal finance is boring, but with a little work and preparation in the beginning and some time spent checking in, it can be put on autopilot. That’s right, just spend a little time setting up your personal finance strategy and then spend a little more time each year just to check in on it, and you can ensure that you’re ahead of the average for your age and live comfortably. While leaving anything on autopilot can be tricky, it’s better to participate and be on autopilot than to not participate because it’s too “hard.” Below is a discussion on the different parts of personal finance and how to put them on autopilot.

## Retirement planning: 401(k), Roth IRA

401(k): If you’re starting a new job, it’s been mandated that your employer automatically enroll you into the 401(k) plan if it’s available and allocate your funds into some very basic and safe fund. All you need to do is log in, double check your contribution amount (make sure it’s over the level at which your employer will match your contributions), double check the funds you’re contributing to, and then log out. If you have been on the job for a while and aren’t participating, call up HR for the enrollment form immediately. After you submit it and they set it up, just follow the easy instructions above. Then, just once a year, check to make sure everything is okay and that your allocations are what you think they should be. Do this for 40 years and you’ll be way ahead of the game in terms of retirement funds.
Roth IRA: If you don’t have one, opening a Roth IRA takes literally ten minutes. Some brokerages will let you do auto-deposits every month so divide the annual limit (this year the limit is \$4,000, in 2008 it’ll be \$5,000) by twelve and set your contribution allocations as you would the Roth and don’t worry about it. You have until tax day to contribute to your Roth IRA for the previous year (you have until April 15th, 2008 to contribute for 2007) but make sure your payments indicate which year they apply to.

## Budgeting

The envelope budgeting method is by far the easiest and requires the least amount of tracking and thinking. The premise is that you have different envelopes based on category of spending and that you put how much you can spend in each envelope for that month. As you spend, you pull the money out and when you run out, you no longer spend. It forces you to budget and establishes a simple framework to help remind you. First, open up an ING Direct checking account (email if you want a \$25 bonus). I recommend ING because you can open up new accounts within the interface of your first account in minutes, it’ll take much longer at a regular bank. Open up as many accounts as you have “envelopes,” or categories of spending. Link up your local checking account to your ING accounts and have your paycheck direct deposited into your ING. Then, setup recurring transfers from your main account, where funds are direct deposited, to your envelope accounts, which govern spending in a particular category. As you spend money, withdraw the funds from your account and the balances will reflect how much you still have left in your envelope.

## Investing

Investing is truly no different than 401(k) or Roth IRA autopilot, the difference is in which brokerage you choose. I have no recommendations other than to say that if you prefer a particular mutual fund (I prefer index funds), then go with one of the larger mutual fund companies like Fidelity or Vanguard. On index funds they simply cannot be beat on fees and that’s all you should care about with index funds. If you want to invest in stocks, you’re on your own because I don’t think you can really put that on autopilot. While I don’t believe in checking your stocks daily, unless its for entertainment value, you have to check in periodically to read news and keep up to date, so it doesn’t lend itself well to putting it on autopilot.

## Saving

Finally, saving is again no different than investing or retirement planning because fundamentally all you’re doing is putting money into an account for an expressed purpose. In fact, you should have a goal, a reason to save, because it will help you remain diligent. Mechanically, automatic savings are easy. Many banks have automatic withdrawal features that will let you withdraw a set amount each month from a linked bank account. Simply establish a goal, figure out how long you have, and setup regular and automatic transfers into a high yield savings account to reach your goal. It’s that easy!

## Bills

Many companies will let you link up a bank account or credit card so that your bills are automatically paid on time each month. There is one downside to setting this up, a company can then charge you on that method of payment for things you never realized you authorized (here’s an example of an unauthorized billing from a reputable company). The upside is that you’ll pay at the last minute and you won’t pay late, two pretty good reasons to set up auto-billpay. I have all my bills automatically paid this way from my cell phone to my mortgage to my electricity and water bills. The sheer convenience, and I save on stamps, can’t be beaten.

See how easy it is to set up your personal finances on autopilot? One thing to note is that while it may be easy to setup and convenient to simply let it run, you should check in periodically to ensure that everything is running properly.

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# Seven Wonders of the Personal Finance World

When I was younger, I used to play Sid Meier’s Civilization all the time. One of the best parts of the game was trying to build one of the Seven Wonders of the Ancient World because it gave your civilization a distinct advantage in the world. My personal favorites were the Lighthouse (it gave your ships a farther range and they wouldn’t get lost) and the Hanging Gardens of Babylon (I believe each one of your cities now had a Granary), but fun part was being exposed to these wonder in the first place.

Since then, there have been more “Wonders of the World” like the Natural Wonders of the World, 7 Wonders of the Modern World, so why not create a Seven Wonders of the Personal Finance World? Hokey, I know, but it’s my opinion that, if you can, you should “visit” every single one of these wonders.

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# Target Retirement Funds: Perfect For After 401k & Roth IRA?

Last week, reader AJ sent me an email asking for ideas on where he should be putting his savings once he’s maxed out the contributions to both his 401(k) and Roth IRA. He’s 23, employed in real estate, and has fully funded his emergency fund and was wonder where he should go next.

Question: I’ve been sold on the wisdom of buying index funds and I would like to take a portion of that savings account and buy at least 3 different index funds (total stock fund, total bond fund, and a total international fund.) Reason being, I do not want to be wholly in stocks, be it domestic or internation, or bonds. However, the minimum investment is \$3000 per fund at Vanguard. So at the very minimum I would have to spend \$9000 to begin which is not the problem. However, if I stopped there, my allocation would be all out of whack. I’d be 33% in domestic, 33% in foreign, and 33% in bonds.

At my age, those allocations do not make sense. (Bonds and foreign, I think are too high of a percentage.)

Any suggestions – short of buying enough of each to make the proper allocations?

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