Five Ways to Look at Your Finance--part 2

In one of my past blog posts, I used 5 categories to look at a family’s financial situation: emergency funds, protection, retirement, education, and investment.  I raised some questions in those 5 categories and I’ll try to answer some of them here.  Please bear in mind, though, that every family’s financial situation is different and whatever advices you receive here should be taken in as a grain of salt.  You have to look at your own circumstance and implement what suits you.

 

(1) Emergency funds-If you don’t know the living expense your household has each month, you need to start tracking it now.  Once you have an idea on how much your family spends in each month, multiply that amount by 6, and then that number could be the amount for your emergency funds.  Why 6 times?  Well, that’s assuming if you lose your primary income, it might take you 6 to 12 months to find another source of income.  Some people may think that they need less emergency funds while others might want more.  You can discuss with your family to decide on the amount.

 

(2) Insurance-When looking at the premiums of the term and whole life insurances, people usually think that term life insurance is much cheaper than whole life and they go for the term life.  Yet, there are more to consider when you compare these two types of insurance.  For example, you bought a 20 years term life insurance at a cheaper rate at your thirtieth birthday.  When your term life expires in your 50s, you need to pay a higher premium to get another term life, assuming that you don’t have any major illness that would render you as uninsurable.  On the other hand, you will be paying a much higher premium if you buy a whole life insurance, but either you or your beneficiary would receive some money back eventually.  If you are short on money or still working toward some other financial goal, having a whole life might not be realistic.  A term life at this stage might be enough.  If you have extra money sitting around and you are afraid that you might lose it through investment, then whole life might be a good bet for you.

 

(3)Retirement-When I first heard of annuity, I thought, “wow, that sounds really good; you can keep on receiving payments until you die, almost too good to be true.”  Well, in a sense, it is.  The return rate of annuity may be only 3-4%.  If you don’t choose immediate annuity or if you don’t have sufficient funds at first, you have to wait for an extended time before you can make a withdrawal.  If, unfortunately, you really need that money, you will get taxed and heavy penalty on your withdrawal.  On the other hand, if you don’t have a good investment option and you are afraid that you might lose your money, then annuity is one way to have some form of stable income in the future.  Yet, be aware of inflation.  The fixed amount of income you will receive from an annuity in the future may not be enough to cover the living expenses that also crease from year to year.

 

(4) Education-There are lots of scholarships or grant money waiting for people to apply.  Don’t just assume that your income is too high for any type of financial aid.  The amount of an education financial aid that you could receive usually depends on your income and assets plus those of your child, such as his/her savings or trust funds.  Before applying for a financial aid, you need to calculate the “Expected Family Contribution” (EFC)”, where parents’ assets, including the money in 529, count at a smaller percentage, compared with that of the child’s assets and income.  Even though a 529 account opened under the grandparent’s name doesn’t count as parent’s asset in EFC, the money from that account used in the child’s educational expenses would be counted as the child’s income for the next year’s financial aid application.  Besides, putting money in 529 may affect your EFC number, but keeping money in your savings also has the same effect on your EFC.  If there is no other use for the extra money, parents should still open a 529 account for their child (parents owning the account, not the child) to take advantage of 529’s tax benefit.

 

(5) Investment-I’m a very conservative person and not very knowledgeable in stocks/mutual funds, so I can’t give any advice on investing your money in that field, other than that you need to do your own research.  If you have a mortgage on your house, I believe that the current interest rate on your mortgage is much higher than the interest rate on your savings or CD.  Therefore, why not use your extra money to start paying off your mortgage?  The interest that you save from giving to the bank can be viewed as an earning.  Even though you need to pay more income tax, the saving from the interest you would’ve paid to the bank might still be worth it…unless you know how to invest your extra money for a better return.  The other added benefit for paying off your mortgage (if you don’t have a better investment option) is that your monthly expense would decrease because you have one less item to pay for every month.