Dave and Nick field questions from friends, networking associates, clients, and more in this comprehensive list of Common Questions to Ask a Financial Advisor.
If you want to listen to their two-part podcast series based on these questions and answers, click below.
Common Questions to Ask a Financial Advisor
What is the bare minimum I should be putting into savings from each paycheck?
This is circumstantial and specific to the individual. It all starts with your budget and your priorities. Save something. If you shoot for saving at least some of your income you are on the right track. The bare minimum is anything you can afford to save with the idea that you want to get to 10% at some point.
Start with saving ten bucks a week. Figure out your budget. Figure out your priorities and get yourself to cash flow positive where you will actually have a surplus to save 10%.
Use 10% as a guide, but don’t beat yourself up if you’re only able to do 5%. It comes down to where you are in life and where you are financially.
For example, you might be putting a large of your money toward paying student loans so you don’t have as much to throw into savings. But eventually, that equation turns and what was 5% might be 20% because you paid off a big student loan or other big debts.
Sometimes we’re too hard on ourselves and think, “I’m not saving 10 percent so I’m never going to get ahead. I’m never gonna be successful!” Sometimes that is true in the short-run but not in the long term.
The flip side of that would be if you are in a good position financially, but you’re spending a bunch of money on stuff that you don’t necessarily need just because it’s fun. You want to make sure you are saving at 10 percent before you take on new debt that pushes you out of that range.
Think about how your life is going to change if you’re young and single right now and making a good income. If you are planning to get married, buy a house, and have kids then doing as much as you can right now makes more sense because you know in a couple of years that’s going to shift.
So, just keep all those variables in mind. It’s different for everybody. Do what you can.
What is the best way to improve your credit score?
This is definitely not our area of expertise. However, your credit score is made up of different categories.
- Payment history – This tends to be the most important. Make all of your payments on time.
- Credit usage – How much credit are you using compared to what you have? For example, you have $10000 of credit. Are you using all of it, none of it, or some of it? The lower that percentage is the better off you are in terms of your credit score.
- Age of your credit accounts – The longer you have established credit the better off you are therefore so is your credit score.
- A mix of credit – Do you only have a credit card? Do you have a mortgage or a car payment? It’s actually better if you have a wide variety of different types of credit when it comes to credit scores.
- New credit inquiries – How many times has your credit score been run in the last few months?
The best way to improve credit is to continually make payments on time. That’s probably not the fastest because making payments on time means taking time to make payments right? So, if you have payment history issues it’s going to take a while for old late payments to drop off and the good new ones to come on.
One of the fastest ways to improve credit scores is credit usage. One way to do that is by paying down high-balance credit cards. Unfortunately, that’s probably not the easiest thing to do because you wouldn’t have a bunch of money on a credit card if you had the money to pay it off. So another way around that is to contact your credit card companies and ask them for a credit limit increase because that will technically change your credit usage.
Establishing credit when you’re 18 and getting a credit card is a good thing for establishing credit. It’s also a very dangerous thing. It’s kind of like juggling fire.
In general, be smart about how you use your credit. Establish credit. If your credit score isn’t good you shouldn’t be taking on more debt. What’s the point of getting an improved credit score? It’s to borrow more right? But if your credit score is good then maybe you don’t need to be borrowing more anyway.
Do you think the market will crash soon?
The markets, in general, are down 10 to 13% for the year depending on which market you look at. Some people think the market has already crashed. There’s no technical definition of a market crash. A market correction is anytime the market drops more than 10 percent.
If you consider the recent highs in the market, we are definitely in a market correction right now and those happen on average about once a year. A bear market is when the market drops more than 20% from its high. On certain indices, we’re actually in a bear market right now because the Nasdaq is down more than 20% from mid-December. Bear markets tend to happen a lot more regularly than people realize and they last about eighteen months in general.
Will we have a crash eventually? As my grandpa used to say, “Even a stopped clock is right twice a day.” So when you listen to people talk about impending gloom and doom, eventually, they will be right. But we also know that much more often the market rises and the economy grows. So, keep those things in mind. If there’s going to be a market crash nobody’s going to know it ahead of time.
The better question would be are you prepared for it when it does happen? It will happen. It could be tomorrow. It could be another 5 years
It’s part of the equation. It’s part of investing. We are not going to try to predict when the next market crash will be. There will be a market crash at some point depending on how you want to define it. There will be bear markets and there will always be corrections. It’s the price we pay for that higher return you get for taking short-term risks.
Which is better, an IRA or 401K, for a new person just starting off in their career?
A 401K is dependent on your employer and an IRA is not. You can set up an IRA account on your own.
So, if you’re just starting out you want to consider that employers typically match contributions to a 401K up to a certain percent. IRAs will not have any match. If your employer is contributing money you should try to at least match what they are putting in to take full advantage of the match. If your employer is not matching then it comes down to how much you want to save.
The advantages of an IRA are that you can invest in just about anything you want on your own. But the downside is that it has lower investment limits or yearly contribution limits. So if you want to save more a 401K may provide you with better answers. However, the 401K is going to have a limited menu of investment options that your employer created.
The best program for a new person starting off is to find a job with a 401K that gives you ten to fifteen percent no matter what you do.
Unfortunately, there are very few if any of those left out there. So the only other benefit of a 401K over an IRA is you get the tax benefit right now as opposed to having to wait until the end of the year.
So, if you’re putting money in a 401K they are not withholding the taxes so getting that tax benefit now as opposed to an IRA where you have to put in at the end of the year. Technically you could probably change your withholding around a little bit to make those better.
It’s easier to save out of payroll than it is once the money hits your account. If it’s gone before you have a chance to mess around with it that can be a lot easier for people.
If you are going to go the IRA route try to make a monthly contribution. Even if it’s not for the full amount of the IRA limit. You can always
top it off at the end of the year, but try to get in the habit of doing something around payday. Especially if you’re new to saving and investing. That also lets you take advantage of dollar-cost averaging. When the markets are down you’re better off buying then. So rather than try to guess the direction of the market put a little bit in every month automatically – don’t think about it and it’ll play out.
The fact that you start saving at a young age is more important than whether you have a 401K or an IRA.
How do I decide when I should start taking social security?
The things that we look at to help people decide are health and longevity. If you are going to delay social security where is that difference going to come from early in retirement? You are eligible to start drawing social security at 62 and you can delay up until age 70.
And every year your benefit grows approximately 8%. So if you delay you’re going to get bigger payments and you’re going to get fewer payments over your lifetime. We just don’t know how many payments, so that’s where health and longevity come in.
If you think you’re going live past your mid-70s or late 70s you’re probably better off mathematically delaying as long as you can.
However, you’re not really going to know until you can’t do anything about it. So you have to make your best guess.
If you’re retiring in your mid 60 s and you’re going to delay social security you’re going to replace that income from somewhere. If you have a 401K, an IRA, or some other source of income to replace the social security income in the short run.
Another thing to consider is the psychology of money. If you tend to be more conservative and worried about the markets and taking money out of investments you might want to consider taking social security sooner. That way, you’re not losing sleep over the fact that you don’t have a steady income coming in.
A lot of people want to take social security at 62 because they’re afraid that if they don’t take it at 62 they won’t get it. It’ll just mysteriously disappear. We don’t believe that’s true. At some point, social security may change but it’s certainly not going away and it’s certainly still a valuable thing. What may potentially happen is that there might be some adjustments but it’s probably going to be based on what you’re actually taking.
What income amount should I be making before I start my plan?
It depends on what you mean by financial planning. It’s never too early to start financial planning, saving, and planning for retirement. If we are talking about a true investment plan, you may start that later. But if you’re talking about what we call financial Planning, you can start in grade school. It’s all about making sure that you’re learning how finance works and not spending more than your income and covering those basics.
When should I engage with a financial planner? Typically when we first talk to people is when they get that first job out of college and they need to figure out their student debt and what to do with those first benefits and things like that.
There’s always planning that can be done and if you are at a lower income you don’t want to be paying more for the financial planning than you’re saving and investing, especially at a young age.
Can you set up a retirement fund for a child and if so how?
Yes, you can. If a child is under the age of eighteen an adult must serve as a custodian on the account. You can open a Roth IRA or what’s called a uniform gift to minors account for your child.
For a minor retirement account, you have to have an adult signer and then when the child turns eighteen the big thing to consider is income. You have to have income that is reported to the government, as in a real paying job.
So if Johnny’s out mowing lawns and you’re not reporting that to the government then you can’t have a Roth IRA so you probably want to report that to the government and then you can fund the account.
Most people do a Roth IRA because when Johnny’s 13 and mowing lawns he’s not paying federal taxes anyway, so there’s no point in getting a federal tax deferral. So usually we talk about the Roth IRA in this scenario. But in this case, let’s say Johnny makes $1500 one summer and wants to put all that into his Roth IRA. He can do that but he does have to report that income to the government and then he would have to pay self-employment tax on some of that $1500. However, he doesn’t have to pay federal income tax. He won’t have state income tax but the payroll tax as the self-employment tax will apply, so there’s a little bit of a cost to reporting that income.
If it’s $1500 he can contribute up to $1500 and it doesn’t necessarily have to be Johnny that contributes all of it. You could gift him more to contribute. We do see parents do that from time to time as a way to get started.
If the income is already W2 income, from an employer bagging groceries at the grocery store or busing tables somewhere, they are going to get a W2 so that income is already reported to the government. Payroll taxes and everything are already taken care of so you don’t have to worry about that.
One thing you do have to be careful about is you can’t pay your kids to do household chores and report that as income. There are some issues behind some of that stuff so just be careful with how that all works.
Please talk to a tax professional to get all of your questions answered when it comes to starting and funding a retirement account for a minor child.
Can you pull money out of a SEP and invest in real estate?
A SEP is a Simplified Employee Pension. You can absolutely do that. However, it is going to be taxed as income when you pull it out, and, depending on your age, you will be penalized as well. For example, if you pull $200000 out of a SEP IRA to buy a piece of property. You might be paying 40% or so in tax on that money to take that money out. Depending on the investment value of the property you’re buying.
That’s a pretty steep hill to try to make up. So the short answer to the easy part of the question is yes, you can. Should you? No, you probably shouldn’t.
The more complicated part of the question is can you buy property with an IRA plan?. We are not experts on this but we looked into it a few years ago for a few different clients. The high-level rundown essentially involves creating your own company that has a retirement plan and then rolling your SEP IRA into that company’s retirement plan. Then that company is owned by 401k and you can use the money in the company’s retirement plan. We think it has to be a 401k, but we aren’t 100% sure.
But then the company’s assets inside that 401k can be used to buy a piece of property or a business. It can’t be vacant land or a second house. It has to be an income-producing business. So rental properties are likely okay, but buying a piece of vacant land doesn’t qualify.
Again we aren’t experts on this and it’s been a while since we looked at it. There is a lot of legal work involved to do it correctly. Essentially you’re getting around paying that big chunk of taxes for pulling your money out. You are potentially sheltering the growth of that money, the property, and the income it produces inside a retirement account. It saves you a lot of taxes. The downside of it is that following all the IRS rules is very expensive and the companies that do this are essentially legal entities, law firms, or consultants.
This is a way to buy something that’s going to be valuable enough to be worth all this expense and headache. The other thing is there has to be somebody to run this new business you created. It can end up not being the retirement that you wanted.
Investment-wise, financial-wise, and tax-wise it may look really good and it may be right for the right people but just because you can do it doesn’t mean you should do it.
Why don’t financial planners speak of gold or silver as an investment for a balanced portfolio?
First of all, this is not a universal truth. We’ve seen plenty of financial planners who we have respect for include precious metals in investment portfolios. We’ve seen good arguments for using them, and good arguments for not using them.
In the portfolios we use, and the portfolio construction people at East Bay that we work with, we don’t generally like to include them. It’s not that they’re always bad. When we’re looking at what goes in a portfolio we need to make sure it provides diversification and potential returns.
Without getting too far in the weeds on asset allocation, if you start with a hundred percent stock portfolio anything you add to that needs to provide either a superior return or reduce the risk. So if you just take stocks and bonds (*the last three months haven’t played out this
way, but long term they will), stocks go up when certain things happen in the economy and bonds generally don’t do as well. Then vice versa when bonds are doing well stocks typically aren’t doing as well. We don’t expect that bonds are going to outperform stocks but they give us some ballast in the ship.
Gold can do that at certain times too, but it’s a little less predictable. Gold is just not as reliable and in that sense, there’s an old adage, “Gold is a great way to get all of the volatility of the stock market with all the long-term return of a certificate of deposit.”
The reason we put up with the volatility in the stock market is that the long-term average on the stock market is about 10%. With gold, the long-term average is 3.5 or four percent (estimated). It’s approximately the same as the long-term return on a certificate of deposit. With all of the volatility gold zigs and zags, every bit as much as the stock market does so that’s not a good risk-reward tradeoff from our point of view.
Other metals may actually be better investments than gold. Gold only has value because it’s pretty. There is no industrial use for gold but e there is for silver and copper. There is also tungsten and plutonium too, which are all precious metals. They get used in electronics and construction. They tend to be seen as a hedge against inflation which is on everyone’s mind right now, but they’re not a perfect hedge. The time to have bought them would have been when inflation was low.
In the past, if you wanted to buy gold you had to go to a precious coin dealer and buy physical gold. Or you could buy a gold mining company. Now there are exchange-traded funds that track the price of gold, silver, and other precious metals. And it’s easier to take them in and out of a portfolio.
Sometimes when people talk about buying gold, they’re not talking about buying gold in your IRA so that you can move it in and out. They’re talking about buying physical gold because they think the world is ending. If you really think that things are going to spiral to that point, it won’t matter because the economy will be gone or look very different. You won’t be able to walk into the grocery store with your solid Gold Swedish kroner and walk out with food. In this scenario, you’d better be off buying farming equipment so you can produce food on your land.
How often should you change your investments, or not?
We are firm believers that you change your investments when your circumstances change, not when the markets change. For example, getting ready to retire or you have a windfall that changes your circumstances. Some of the best investment advice that we’ve ever given is don’t do anything. It’s probably the most common. It’s also the most counterintuitive a lot of times when you’re feeling the pain of the markets going down.
What is a good retirement or savings investment option for someone living paycheck to paycheck?
You can’t save if you’re living paycheck to paycheck. Make sure you’ve covered your bases and save what you can. More important than retirement savings is getting a good handle on your cash flow and your budget. Make sure you are working your way out of living paycheck to paycheck. Whether that’s paying off debt or reducing some expenses. Free up some money to give yourself a little bit of leeway and build the all-important emergency contingency fund so that you have options.
Saving for retirement and investing only works if you have the time to put in it. If you’re living paycheck to paycheck and you’re trying to put money into a retirement account and then in six months you turn around and pull it back out, you’re actually doing yourself more harm than good.
Is a Roth or traditional IRA a better investment for retirement?
When you’re in retirement Roth is great. Nobody is going to regret having a Roth in retirement because you don’t have to pay taxes when that money comes out.
While you’re saving though you need to look at your tax bracket and your current income and make an educated guess. That’s all it will be is an educated guess about whether your taxes will be higher when you’re in retirement taking those funds out or higher now. If you’re in a high-income situation now there’s a pretty good argument for making traditional IRA, or pretax 401k contributions now and then paying those taxes in retirement.
If you’re in a lower text bracket now you may want to go ahead and do a Roth. It’s like social security, if you can tell us exactly what taxes are going to be when you retire and what situation you’re going into we can give you the correct answer, but most people don’t know.
So, having some Roth and some pre-tax funds is going to be really helpful so you have options. To give a practical answer rather than just a bunch of “it depends”, we suggest that unless you feel like you’re in a super high tax bracket now, go ahead and do a Roth as long as you can afford to pay the taxes now. If it becomes a budgeting issue then do traditional IRA contributions to reduce your current tax burden and make it a little bit easier. Having your tax situation diversified in retirement is useful, which is similar to diversified investments.
It is important to consider your goal. Do you have young kids that will be going to college someday? There are some different reasons to have a Roth IRA. Pulling money out for college and things of that nature might make a little bit more sense in terms of how and when you use that money.
That’s A Wrap
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