Money Blue Book

Life is unpredictable. As much as we may try to project what is to come in the future, our feeble attempts at fortune telling and soothsaying inevitably fall short of reality. That’s life and that’s just the way of the world. We may try to walk the steady and safe path paved with good intentions, but sometimes life just insists on chucking a banana peel to trip you up when you least expect it. It’s not always fair and it’s not always just. Bad things happen to good people and sometimes unfortunate circumstances befall even the best of us. But the unforeseen and the unexpected don’t have to ruin our lives and cause everything that’s going for us to fall apart at the seams. We can plan for such an occurrence and protect ourselves the best we can by creating a back up financial contingency plan. Having a “Plan B” savings account and readily accessible emergency fund set aside will give you piece of mind in knowing that you will be taken care of should the worst case scenario occur.

I’ve personally had many unforeseen and unexpected situations spring forth in the last couple of years, and have learned that life comes at you fast. In the last few months, I’ve had to deal with a family health emergency due to the sudden passing of my grandfather which required me to go on emergency leave to fly overseas to be with him. I’ve also had to deal with a significant tax liability bill recently that seemingly came out of no where in the tune of almost $10,000. Most recently, my car suddenly broke down, necessitating me to pay out a good chunk of cash - $80 for an emergency taxi ride, $140 to tow my car to the car dealership for servicing, and an additional $1,200 for the cost of repairing my vehicle’s broken alternator, car battery, and to replace the break pads. All of these sudden expenses are part of the natural course of living but they weren’t expected. Thankfully, I’ve learned to practice what I preach and have been able to maintain sufficient emergency funds to deal with most of my financial emergencies.

Anticipate the Unexpected, and Save Up Enough Money In Readily Accessible Accounts To Cover Several Months Worth Of Living Expenses

There is no hard and fast rule as to how much one needs to have stored away in an emergency fund, but most personal finance bloggers such as myself advocate sufficient liquid savings to survive for at least a few months with no incoming funds. That is, you need sufficient savings to pay for the cost of living in case you are suddenly bed ridden for whatever reason, at least until you can get back on your feet and generate income again. Personally, I keep at least $5,000 cash stored in my bank account for emergency purposes that I try my best to not co-mingle with other investment objectives. That amount of money that I keep aside is designed to handle financial emergencies such as sudden large tax bills, health related injuries or medical bills, emergency car repair, and even the lack of income due to unanticipated unemployment. While some financial advisers advocate earmarking one’s backup emergency fund savings to cover only truly emergency living expenses, I personally take a broader approach and use my  emergency fund money as a monetary buffer for various out of the norm, over the limit type expenses that include necessary car repair charges and unplanned vacation trips. Of course, I make a very strong effort to rapidly replenish the funds as soon as the temporary financial emergency crunch subsides.

So what should we consider as ideal assets for emergency fund planning purposes? Obviously the best sources are ones that are very liquid, that earn interest, that imposes no penalties or interest charges for withdraw, and those that are easily accessible and able to be withdrawn at a moment’s notice preferably in cash money form or equivalent. The most liquid form would clearly be money stored in a piggy bank or bills stashed under your mattress, but with bank branches located everywhere and interest generating accounts easily accessible through the Internet and 24 hour ATM machines, bank related holding accounts are the supreme form of emergency fund savings. Such bank related accounts and assets would include checking accounts, savings accounts, certain forms of laddered CD’s, and money market accounts. The recommended emergency fund storage solution for most people would be to keep at least 3-6 months worth of living income stored in a high yield savings account or money market account. Bank savings and money market accounts (not to be confused with broker based money market funds) are ideal for emergency fund saving purposes. They offer not only high interest earning opportunities but they also provide instant account access, allowing funds to be withdrawn quickly for emergency situations.

While it’s nearly unanimous that putting your money in a high interest savings account is the best way to save and contribute to an emergency fund, there is much greater debate when it comes to two other commonly used forms of emergency funding - money invested in the stock market, and credit cards (specifically 0% credit cards that offer introductory 0% APR interest for balance transfers).

Using Your Stocks, Mutual Funds, or Retirement Savings As Your Emergency Fund Is A Bad Idea

Personally, I have used my brokerage account as my emergency fund before, however I highly advise against the practice. Not only is the money not very liquid and difficult to convert to immediate cash to pay off emergency debts, but oftentimes such hasty and immediate sales of stocks and mutual funds end up being very counter productive and detrimental to one’s overall long term investment strategy. Currently I have a decent amount of money invested in various individuals stocks, mutual funds, and exchange traded funds (ETF’s) through my online discount broker. Most of my brokerage money is being invested as part of a long term investment strategy. Having to sell my equity positions immediately and prematurely would disrupt my investment approach and force me to incur unplanned short term capital gains or sustain premature capital losses. Worse yet would be to withdraw funds from one of my retirement investment accounts such as my 401K, Traditional IRA account, or ROTH IRA. Not only would I disrupt the compound interest process that such tax deferred retirement accounts offer, but the withdraw itself may require me to pay out hefty early cash out penalties. While your investment account is obviously there as a final dead end source of money, one should look to other more liquid and less financially detrimental sources of emergency funds.

I Frequently Use No Fee Balance Transfer Credit Cards To Handle Emergency Expenses, But The Practice Is Only Suitable For Those Who Can Responsibly Handle Credit Card Bills and Payments

The use of 0% credit cards and balance transfers is my favorite and most commonly used source of emergency funds. I know this practice is highly frown upon by anti-credit card types, but it’s worked well for me over the years. Of course, the use of credit cards and particularly the practice of carrying large balance transfer balances (even at 0% APR) isn’t suitable for everyone. For those that have a history of overspending, or who have not demonstrated a responsible and mature ability to micromanage credit card balances, payment due dates, and minimum payment requirements, 0% balance transfer credit cards should be avoided. Those that can’t properly handle the use of credit cards and manage the logistics of balance transfers will risk making a terrible balance transfer mistake and wind up getting themselves into deeper financial trouble with credit card debt than they started out with. But for those who know how to make a balance transfer and know how balance transfer credit cards work, they are an invaluable financial tool to have in your emergency fund holster.

Back when I incurred a sudden and very unexpected $10,000 tax bill, I utilized my excellent FICO credit score to secure an attractive balance transfer card offer of 0% APR interest for 12 months. I utilized the 0% credit card’s high credit limit to pay off the $10,000 IRS tax bill and took advantage of the balance transfer card’s one year introductory period to slowly pay off the credit card debt which was basically the same IRS tax debt except in a much more manageable no interest form. Because I was diligent in making regular payments, I eventually paid back the entire liability and incurred absolutely no interest or penalties in the process. Balance transfer credit cards, when used properly, can help get you through such tough times and offer you a readily available source of interest free funds when you need them the most.

Of course, if the sudden financial emergency is quite substantial and the amount owed greatly exceeds what you anticipate being able to cover within the balance transfer card’s introductory rate period of 6-12 months or longer depending on whether you can keep rolling the balance onto a new 0% balance transfer credit card offer, I would suggest using something like a low interest balance transfer credit card for the life of the loan instead. While you’ll be paying a little bit more with a low interest balance transfer, at least the payments are predictable and you can take your time making regular payments towards paying off the bill without worrying that interest charges will drastically spike after the promo period is over.

Most investors are familiar with superstar investment guru and easy going philanthropist Warren Buffett. How could you not? After all, he’s the single richest billionaire in the entire world and one of the most influential value focused investors. While the wealth snapshot order has swapped places a few times, at least on this recent Forbes ranking of the world’s richest billionaires, Warren Buffett is seated at the very tip of the money stacked totem pole, surpassing even Microsoft uber-geek and fellow billionaire, Bill Gates. But to label him a mere superstar investor would seem to dilute the sophistication of a man who spent a life devoted to a uniquely patient and value minded, get rich slowly type approach to building long term wealth. Warren Buffet is not your typical get rich quick financial motivator, but one who regularly preaches patience, with a keen eye for the undervalued potential of possible long term investments. The Oracle of Omaha, as Buffett is often fondly referred to today, is also the chairman and CEO of Berkshire Hathaway, the corporate manifestation of his immense and massive self made wealth, despite otherwise living and practicing a life of true humility and frugality.

Despite his tremendous wealth, Warren Buffett is also one of the most generous financial figures in the world in terms of how much he has contributed and donated back to society through charitable causes. A few years ago, he gathered up the bulk of his $40 something billion fortune (at the time), and made the decision to donate his money to the Bill Gates and Melinda Foundation as well as to a few other notable charities dedicated to the improvement of health and education in the United States and around the world. How’s that for enlightened and compassionate capitalism? Rather than spend his vast wealth on fancy cars, $2 billion dollar homes, or on over-the-top accessories that even hip-hop rappers would envy, Warren Buffett chose to live a relatively frugal life comprised of smart financial planning and wise long term investments that rely heavily on value choices. As a staunch supporter of wealth redistribution and progressive tax policies that favor the poor, he is also one of the most down to earth CEO business men out there - and yes, that’s him playing his quirky but famous ukulele in the picture.

So How Did Warren Buffett Become So Rich, And What Is His Single Most Valuable Piece Of Investment Advice For New Investors?

I’ve read Warren Buffett’s works and listened to him speak on Youtube, and I’ve come to greatly admire the man. For those that want to emulate his approach to investing and replicate the secret of his success to long term investment growth, his method can easily be summed up in a few short sentences. It is a concept all long term value investors have known all of their lives, but sometimes it takes a great role model to sum it up through a few inspiring words:

“Occasional outbreaks of those two super-contagious diseases, fear and greed, will forever occur in the investment community. The timing of these epidemics is equally unpredictable, both as to duration and degree. Therefore we never try to anticipate the arrival or departure of either. We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”

- Warren Buffett, 2001.

The Oracle of Omaha’s way of creating wealth has always been making value centered financial decisions based on principles of frugality and longevity. His ability to continue investing until his 70’s (and hopefully much longer into the future) have enabled him to practice his long term strategy to its full potential. But his tremendous financial success has always been his ability to channel and harness the eternal capitalistic concepts and emotions of human fear and greed. By playing on and understanding the counter correlation between fear and greed, Buffett has been able to shape his outlook to better determine when a presented opportunity represents one that’s worth taking and when it merely represents a potentially risky financial bait that must not be succumbed to. Thus when the stock, financial, and real estate markets are dropping and everyone is hastily running into the hills for their financial lives, Buffett sees an opportunity. But when prices are soaring and flying high - encouraged by euphoria and near unanimous over-optimism and exuberance about future prospects, Buffett clenches down and exercises extra caution.

Learn To Invest Like Warren Buffett By Understanding The Interplay Between Investment Fear and Greed

For capitalism and democratic concepts of wealth creation to thrive, there has to be an ultimate driving force - and that is greed. Greed is good, and as one well known movie put it - greed captures the essence of the evolutionary spirit and it works. There is nothing inherently wrong with greed as long as it can be properly channeled into a powerful motivating factor to achieve success. But greed has its place - and so does fear. There is a proper time and place when both greed and fear should be acted upon. Upsetting the proper dynamic between the two capitalistic emotions has the potential to lead to disastrous financial results.

Warren Buffett truly understood human nature and the inherent lemming pack mentality that curses most individual stock market investors. When we see a particular financial investment take off and expand two or threefold in a short period of time, we immediately become enraptured over the financial potential, and our greed induced instincts cause us to blindly pursue the investment bandwagon. It is in our very nature to do so. That is how stock market bubbles and even real estate bubbles are formed - through the unwavering lemming effect whereby greedy investors join the rapidly expanding investment pyramid until the base comprised of new entrants can no longer sustain the prices and valuations at the top.

So to succeed financially in the spirit of Buffett’s approach, one has to obtain a more prudent, long term, value-based opportunity outlook. When stock prices are low and dropping, fear causes the majority of people to want to escape and pull their money out of the market in instinctive response. When the markets are seeing red and valuations are dropping, the tendency is to pull your money out of fear. But Warren Buffett sees this moment of fear as the ultimate chance for greed to triumph in the long term. It is not about timing the market, but about looking for the potential upside. When the market has tanked or is tanking, there is much higher potential upside. For undervalued investments, Warren Buffet would see this as the perfect opportunity to take on new positions for the long haul - particularly when the stock or fund fundamentals are sound.

On the flip side, when the entire market is in consensus that a particular investment ought to keep soaring and continue on its upward trajectory, in Buffett’s eyes, that is when cooler heads must prevail and caution ought to be taken. When everyone is in near unanimous agreement that stock prices should keep going higher, the potential for a massive reversal of potential is much greater. When others are greedy, that is when you must exercise fear as a counter intuitive response to the masses. The potential downside at that point is much greater and it’s likely the time to exercise greater restraint. Steps to protect oneself could be to purchase options to hedge against downside risk or to limit one’s investments to less volatile positions.

Thus, if you want to invest like Warren Buffett, heed his most important advice - invest and seek out opportunities when there’s blood on the streets, but hold your cards closely and guard yourself when everyone else seems to be ebullient about financial prospects. It’s counter intuitive to human nature, but it’s the perfect balance and manipulation of fear and greed. Learn to invest in long term value sectors using low expense broad market Exchange Traded Funds (ETF) and low cost mutual funds. Pick out a general low cost online discount broker or open a Roth IRA, and buy and hold investment positions that you believe will grow in the long term, and finally, resist the urge to constantly check your stock prices and bail at the first bump or trouble. Think long term, not short term.

Invest In Value For The Long Term and Understand That Stock and Real Estate Markets Will Naturally Rise and Fall Over Time

Inevitably and invariably, markets ebb and flow, and stock prices never maintain their upward trajectory forever, but at the same time, they also never head downward forever. So long as one maintains a long term investment outlook based on the understanding of fear and greed, we can all learn to profit like Warren Buffett has over the years. Buffett was able to make smart value based investment decisions because he had a long term opportunistic approach to investing. When he acquired control of a simple textile company called Berkshire Hathaway in 1965, he used that company as his primary investment vehicle to acquire and invest in companies that he understood, and retained management services of those he trusted. The key was that he held on. He did not attempt to outplay the market or try to time the market, or guess when he should exit or enter the market. He simply remained patient and sought out opportunities when others were fearful and exercised extra caution when others were greedy.

When the entire world was enraptured with the dot com craze from 1999 to 2001, Warren Buffett was ridiculed for ignoring and failing to cash into the high flying technology stocks that seemed to triple in valuation overnight in leaps and bounds. During this high flying dot com era, Buffett continued to invest his company’s assets towards acquiring old fashioned but valuable investments such as carpet cleaning businesses, roofing enterprises, furniture rental stores, and boring paint making companies. When the stock market finally plummeted and self imploded due to gross over valuation, Buffett’s company was one of the ones that remained unscathed and has continued to prosper since then.

In the world of taxes and financial planning, the terms adjusted gross income (AGI) and modified adjusted gross income (modified AGI or MAGI) are particularly significant. They are frequently used to calculate and determine the extent of certain benefits and deductions. AGI in particular is used to determine qualification to take certain itemized deductions and used to calculate taxable income. It is also the key determinative factor to rebate payment under the 2008 economic stimulus tax package. Qualification for the stimulus payment is not based on salary or after-tax take home income, but rather on the taxpayer’s total adjusted gross income, which is a terminology encompassing a broader range of income sources.

The term modified adjusted gross income is particularly important as well. It is used to determine qualification to take certain tax adjustments like the child tax credit and eligibility for certain education expense credits. Overwhelmingly though, the MAGI’s significance is most commonly associated with tax deferred investment retirement accounts (IRA’s). It is a key income factor in determining Roth IRA contribution limits and phaseouts, as well as qualification for IRA to Roth conversions. The higher the MAGI, the more the Roth IRA contribution limit is reduced and ultimately phased out. The MAGI term is often overlooked because the amount calculated in MAGI is often similar or even the same as the adjusted gross income for most ordinary tax situations.

For clarification, here are the income and deductions that comprise both the AGI and the MAGI:

1) Adjusted Gross Income (AGI) - is comprised of all gross income sources reduced by adjustment deductions. This total income amount represents the amount before you take your personal exemption, or choice of standard or itemized deductions into account. Thus standard and itemized deductions are not factored into the AGI. The adjusted gross income is also the delineating and final number on the first page of the 1040 federal tax form that separates above-the-line adjustments such as business deductions, from below-the-line itemizations such as the charitable deduction.

The following income sources added together comprise a taxpayer’s initial gross income figure:

• Salary and wage income,
• Interest income,
• Dividend income,
• Income from certain retirement accounts,
• Capital gains,
• Alimony received,
• Rental income,
• Royalty income,
• Farm income,
• Unemployment compensation.

To reach the adjusted gross income, the above total gross income amount must subtract the following deductions below:

• Deduction for contribution to an IRA,
• Health savings account deductions,
• Student loan interest deduction,
• Certain business expenses of reservists, performing artists, and fee basis government officials,
• Certain moving expenses,
• One half of self employment tax,
• Penalties on early withdrawal of savings,
• Alimony paid,
• Health insurance premiums due to self employment.

2) Modified Adjusted Gross Income (MAGI) - is basically the AGI figure, modified for various tax adjustments by excluding the items listed below. When the original AGI was calculated, certain deductions were subtracted from it. To arrive at the MAGI amount, take the AGI and add the following items back to it:

• Any deduction you claimed for a normal contribution to a Traditional IRA.
• Any deduction you claim for student loan interest or qualified tuition and related expenses.
• Any income you excluded because of the foreign earned income exclusion.
• Any exclusion or deduction you claimed for foreign housing.
• Any interest income from series EE bonds that you were able to exclude because you paid qualified higher education expenses.
• Any employer-paid adoption expense you excluded.
• Any amount claimed as domestic production activities deduction.

Tax Planning Tip For Lowering Your Modified Adjusted Gross Income (Useful for avoiding the Roth contribution limit and phaseout).

While many deductions are added back to the AGI to reach the MAGI amount, you should note that contributions made to an employer sponsored retirement plan such as a 401K is not one of them. If you anticipate reaching the annual income limit for Roth contribution phase out, you may want to seriously consider increasing your contributions to your employer’s sponsored plan. For example, in 2008 you may only make contributions to a Roth IRA if your MAGI is below $169,000 if you’re married filing jointly or below $116,000 if you’re a single filer. The amount you may contribute to a Roth starts to phase down once your MAGI reaches $159,000 as a joint filer or $101,000 as a single filer. If you anticipate reaching the phase out period and you’re on the fence, contributing some extra money into your job’s 401K plan will help reduce your overall AGI as well as your MAGI, since the contribution’s not one of the many items added back to calculate the MAGI.

Updated Tables For 2007 and 2008 Tax Years.

Because of the power of compound interest, it is never too early to start saving for your future and planning your retirement nest egg. The earlier you start taking advantage of tax deferred investments, the more money you’ll have to live on when retirement rolls around. Don’t count on dying young to relieve you of the need to save either. Statistics show that improvements in medical technology and lifestyle changes, coupled with increased health awareness are extending our lives longer than before.

For the younger, single people out there, I know it can be strange discussing retirement so early on, but you must remember that your actions now have a huge impact on your future welfare. The cash you invest today in a tax deferred retirement account has a disproportionately more significant impact on your wealth level than money invested later. Don’t delay or keep putting it off - even catch up contributions won’t be much help if you wait too long to save for retirement.

When it comes to saving for retirement, there are a variety of tax deferred options such as the common employer sponsored 401K plan. But there is also the Traditional Investment Retirement Account (IRA) and the Roth IRA. Both are excellent ways to save for the future but you must be mindful of IRS rules when funding them - by being aware of the annual contribution limits, the contribution deadlines, and the applicable income phaseout ranges. I’ve created a list of helpful tables that cover the most important funding rules below. The income phaseouts listed on the charts are based on modified adjusted gross income (modified AGI or MAGI), which is derived by adding certain income back to the adjusted gross income (AGI). If you want clarification, check out the IRS explanation for modified AGI. For many taxpayers however, the MAGI will oftentimes be the same as their AGI.

1) Traditional IRA and Roth IRA Contribution Deadlines

With certain exceptions made for weekends, the April 15 deadline for filing your federal income tax is also the deadline for investors to make their final Traditional IRA and Roth IRA contributions for the closing tax year. For example, April 15, 2008 is the contribution deadline to make a IRA or Roth contribution towards the 2007 limit. After that date, all contribution money will go towards the 2008 tax year limit. This differs from a 401K, which has a contribution deadline that ends on December 31 of the tax year. Thus you should never miss the final deadline to contribute for the prior year. Contribution limits for the IRA and the Roth are considered by the IRS to be “used it or lose it” benefits. Those who fail to contribute the maximum allowed contribution to their IRA or Roth by the deadline, forfeit the limit for that year.

Note that even if you’ve already filed your tax return before April 15, you can still contribute to your IRA or Roth by the filing deadline, so long as you file an amended 1040X return thereafter to declare it.

2) Traditional IRA and Roth IRA Annual Contribution Limits

Qualification to contribute to an IRA or Roth account requires the contributing taxpayer to have earned income or taxable compensation, comprised of wages, salaries, fees, tips, commissions, bonuses, and taxable alimony. While the traditional IRA is available to all with no income restrictions or contribution phaseouts, only the Roth reduces and limits your contribution if your income goes above certain levels. However for both the IRA and Roth, you are permitted to contribute the lesser of the normal contribution limit noted below or the entire amount of your total taxable income. You are not required to contribute the full amount but you cannot exceed the contribution limit. Those who are 50 years old or older are entitled to higher contribution limits called “catch ups” to help them expedite the pace of their investment.

Another thing to keep in mind is that for married couples, both the husband and wife may make separate contributions to their own individual retirement accounts, even if one of them is not working. This has the potential to effectively double the combined total they may contribute as a married couple.

3) Roth IRA Contribution Phase Out Due To Higher Income

Unlike the IRA which has no contribution phaseouts due to income, the amount of money that may be contributed to a Roth IRA per year is dependent on tax filing status, modified adjusted gross income, as well as age. Once the contributor reaches a certain modified AGI level, his or her maximum Roth contribution limit may be phased out or gradually eliminated in linear fashion. The phaseouts in the chart above show income ranges that span between a floor and a ceiling. Those with income below the lower floor amount may contribute the maximum amount. Those that exceed the higher ceiling are completely phased out and will not be permitted to contribute to a Roth IRA for that year. Of course, they can always still contribute to a traditional IRA.

Because the phaseout range is liner, if your income fell precisely in the middle of the income range, you would only be able to contribute 50% of the maximum Roth contribution limit shown above. Keep in mind that IRA and Roth’s share the same combined contribution limit. You may open multiple accounts, but the total contribution amount cannot exceed the limit.

4) Income Phase Out For The Traditional IRA Contribution Deduction

Traditional IRA’s, unlike the Roth, offer a unique tax benefit - contributers may be qualified to take a tax deduction on the amount they contribute. However, whether the entire amount can be deducted or only partially deducted from income depends on factors including tax filing status and income range.

An important factor that affects the phase out range is whether the contributer is already an active participant in an employer sponsored retirement plan, such as a 401K from work. For those who already participate in such a plan, their IRA contribution deductions are phased out quicker and at lower income levels than those who don’t participate in such a plan.

For married couples, if neither you nor your spouse participate in such a plan, the entire amount you are qualified to contribute towards your IRA may be deducted from income. If either of you participates in such a plan however, then deductibility depends on your tax filing status. There are two tables below - one for those covered under an employer plan, and the second one for those who are not. For those who are not personally covered by an employer plan, different rules apply if their spouses are covered (Spouse Covered) and for those whose spouses are not (Spouse Not).

For Those Who Are Covered By An Employer Sponsored Retirement Plan:

For Those Who NOT Covered by An Employer Sponsored Retirement Plan:

So what are you waiting for? Go open a Roth IRA right now! If you don’t qualify due to income phaseout, then at the very least you should go open a Traditional IRA.