Have you ever had a craving for pizza, but couldn’t decide on which kind to get? What if you could only get one? Wouldn’t it be great if you could have a couple slices of lots of different flavors, or different types of crust, maybe even a bread stick or two all in one pizza? This is pretty much how an exchange traded fund or ETF works. Here are some basics about ETFs:

An ETF compiles lots of different stocks into one group or basket- kind of like a pizza made from lots of different styles, toppings, and flavors, but sold as one pizza.

Exchange Traded Funds get their name because they are traded on an exchange just like a stock. This means they can be bought and sold throughout the day, unlike their cousin the mutual fund, which we learned about last week.

At first glance ETFs can look a lot like mutual funds; they are both collections of stocks, bonds, or securities, but there are a few key differences.

• Mutual funds are actively managed so that assets within the fund are bought and sold to gain the most profit. ETFs are more passively managed and typically track or mirror specific indexes.

• Mutual funds typically have a minimum investment requirement, whereas ETFs typically do not have a minimum. In some cases may even be purchased in fractional shares

• ETFs are more tax efficient than mutual funds.

• ETFs allow you to keep more of the profits compared to mutual funds because they typically have a lower management expense.

ETFs can hold hundreds of different stocks across myriad industries, or it can be focused on a single sector or industry. This allows the investor to create a balanced portfolio between risk and potential returns.

If we go back to our pizza analogy, we could say that you are an adventurous eater and like trying new things. It would be nice to be able to order just one slice with crazy flavors, rather than the whole pizza, and still get some tried and true flavors, because what if you end up not liking the new one? With an ETF, you can have a lot of diversification, meaning if one company’s stock (or slice) doesn't do well, there's plenty of other really great tasting stocks to make up the difference. This means you don’t feel the loss as greatly as you would if the whole pizza had been made up of the new adventurous but not-so-great-flavor.

There are some negatives to ETFs. At times they can be a little more complex than traditional mutual funds, this can be overcome with the help of a knowledgeable advisor. Another downside is they pay lower dividend yields-because ETFs track a broader market the yield is averaged out and will end up being slightly lower. There is no one perfect type of investment, and the bottom line always comes down to knowing and understanding what you're investing in, both the good and the bad.

"An investment in knowledge pays the best interest."

-- Benjamin Franklin

A mutual fund is both an investment as well as a company. It allows you to pool your money with other investors which is then used to invest in a portfolio of different things like stocks, bonds, money market instruments, properties, etc.

Mutual funds are operated by money managers who decide how to invest the money in an attempt to produce growth or income for the fund’s investors. A mutual fund’s portfolio is structured and maintained to match a particular investment strategy. In other words, the money managers pick investments that they believe will meet the stated goal of the fund.

When you buy into a mutual fund you are actually buying a portion of the portfolio’s value. The value of the mutual fund doesn’t fluctuate during the day like an individual stock, rather its value is settled at the end of the trading day.

The positives:

• Mutual funds are an easy way for beginner investors to get started.

• Mutual funds give you diversification allowing you to invest in many different things. The more diverse the fund the fewer risks you take on.

• Mutual funds are managed by a professional that makes investment decisions based on the goals of the fund. Typically you don’t have to babysit your investment.

• Mutual funds allow you to reinvest the interest, dividends, and capital gains into additional mutual fund shares.

The negatives:

• Mutual funds may have high fees. Be aware of the expense ratio before buying.

• Mutual fund prices are only calculated at the end of the day, compared to stock, which fluctuates throughout the day.

• You can only sell your shares at the end of the day after the market closes. This limits your ability to react to the market swings, up or down.

• You don’t have control over the portfolio, that lies with the fund manager.

• Mutual funds can sell profitable investments to create capital gain, even if the fund has performed poorly, which means you could lose money on an investment, but still pay taxes on it.

Overall, a mutual fund creates an opportunity for new and experienced investors to diversify their investment dollars in one place, helping you as an investor control some investment risks. Today, mutual funds are used mostly in 401(k) type retirement plans. Very few investors still use mutual funds outside of retirement plans.

Next week I will explain Exchange Traded Funds, (ETF’s). Informal Survey: What is your favorite Mutual Fund? Post in the comments!

“Better to buy part of a company than the whole thing.” - Warren Buffet

Saving money can be a challenge for even the most financially savvy. It takes willpower, sacrifice, determination...and a plan. A lot of people have a savings account, but is that really enough to meet your needs and make your future secure?

Often when sitting down with people to discuss savings we make a “bucket list.” This is a list of 5-6 savings buckets. Each bucket serves a different purpose, and allows families to plan - and save - more effectively.

The buckets are:

Save-to-Spend

Emergency Fund

Long Term Savings

Retirement

Health Savings Account

College Fund*

Bucket 1 - Save-to-Spend: This bucket is for the money you know you're going to need in the near future, for things like Christmas, birthdays, vacations, repairs/replacements, and small emergencies. $1,000-$5,000 may accomplish these immediate needs.

Bucket 2 - Emergency Fund: This bucket is for all those unexpected accidents or disasters. Aim for three to six months income - at a minimum. Depending on your income $30,000-$60,000 might work.

Bucket 3 - Long Term Savings: This bucket is for collecting money for some of the bigger projects you plan for, things like remodeling a bathroom, new HVAC system, or replacing a car. Paying cash for these large ticket items is the way to go. Aim for $10,000-$40,000.

Bucket 4 - Retirement: This bucket is for the next biggest change in your life - retirement, not working again. Actually, retirement may have a few different stages: there are the go-go years, the slow-go years, and the no-go years. Each of these time periods may consume different amounts of your retirement resources.

Bucket 5 - Health Savings Account: Save as much as you can for future healthcare expenses. This account is very valuable, due to the tax advantages.

*Bucket 6 - College Fund: Not everyone needs to have this bucket, but if this is something you want to save for, then certainly it should be included in your list.

If the worst happens and you need money now, if you have properly filled your buckets, you have multiple reserves to pull from. You would start by using the money from your 2nd bucket - your emergency fund. Then, if you needed more you would pull from your 3rd bucket - your long term savings fund, followed by your 1st bucket - your save-to-spend bucket. If things are still uncertain you could then pull from your 5th bucket - your HSA. Only under the worst scenario should you pull from your 4th bucket - your retirement fund.

It's important to know that each bucket is actually a separate account. Don’t think that compiling the funds will accomplish the same thing as each bucket would. When spending it’s often emotional and if the money is there, without a clear demarcation it will get spent on the wrong things. Remember it takes mountains of self-discipline to save money, but not much at all to spend it!!

This plan keeps your future secure while still allowing you to meet your current needs.

“If we command our wealth, we shall be rich and free. If our wealth commands us, we are poor indeed.” - Edmund Burke

People inherently want to be prepared before they tackle something new or difficult. We want to get ourselves ready and organized. Throughout my career in guiding people with their finances I’ve heard many people say things like, “we’d love to get a financial plan, but we’re not ready yet,” “it will take me a few weeks to get ready”, or “I don’t even have a job, how can I make a financial plan?”

The two biggest killers to personal finance are ego and procrastination. Both may be involved when we say or feel that “we’re not ready.”

It’s often our ego that gets in the way of us wanting to open up and talk to someone about something so personal as our finances. I don’t know what everyone’s idea of what “ready” looks like, but in my experience people don’t want to reveal mistakes, a lack of knowledge, or bad planning choices that were made in the past. People may have fear of being judged or embarrassed. This puts them in a conundrum-struggling with their current financial situation, wanting help, but fearful of revealing their current situation. Hiding something out of sight will never fix the problem.

Often, this also tends to be a procrastination issue. Unfortunately, procrastination has a real financial cost. Securing tomorrow starts with planning today. Your financial future is not something that can be put off. The sooner you begin the more money you can save, and the easier the process can be.

Sometimes, life throws a curveball and there’s just no getting ready. Your Boss wouldn’t come into your office Monday morning and say, “Hey, I’m going to fire you Friday, make sure you’re ready.” Instead, it’s usually abrupt - “there’s the door” and you exit the workplace. It’s always better to tackle it head on, as soon as possible. You can do this!

It is the process of doing that actually gets us ready. Planning your secure tomorrow is never a cookie cutter blueprint. Everyone starts at a different point, which means it doesn’t matter where you are at right now. What matters is you take that first step.

“You can’t pick cherries with your back to the tree.” -J.P. Morgan

It’s the start of a new year, a time when people make resolutions and set goals. 2020 was chaotic and created difficulties, especially financially, for many people. This has prompted many to reevaluate their finances and attempt to gain a little more financial security, some for the first time. This has forced many to ask, “Where do I start?”

The short answer- at the bottom. When building anything, be it a physical structure, a business, or a financial platform you need a strong foundation.

Your number one task is to get organized. Build a personal balance sheet containing a summary of your assets and your liabilities. Subtract your liabilities from your assets to determine your net worth.

Your net worth is the bottom line-foundation number. This is the number you want to grow. It’s that simple.

Next you want to protect yourself, your family, and your assets. This includes proper insurance and an estate plan.

Now that you have a base you can work on developing your cash reserves. You should be putting money into a savings account every month. He who saves early saves the most. The bigger your savings grow the more you can invest and build a sound financial future.

“Compound interest is the eighth wonder of the world. He who understands it, earns it...He who doesn’t...pays it.” -Albert Einstein

Homeowners insurance can be very confusing - let’s be honest how many of you have actually read your policy and know its limits, etc.? That's what I thought, not many! After all we only have it because it is required by the mortgage lender and we are confident that, just like life insurance, it will never happen to us, so we would skip it and save the money - right? Even though for many Americans their home is their second most important asset (You can ask me later what the first most important asset is).

If life insurance is any indicator then a full forty percent of the homes would not be insured, simply because that is how many people run around without life insurance. But I digress, back to the subject of homeowners insurance.

Years ago I bought a rental house with my older brother and his wife. Yes the three of us were business partners, imagine going into business with a family member! I owned half and they owned the other half. Well we all remained great friends and kept our family relationship in top order - while the partnership ended 20 years ago when we sold the house, I would do it all over again with them, they were the best business partners I could have had at that young age. 

We had a tenant whose 12 year old son was caught playing with matches - unfortunately he was caught after the house caught fire and burned down! They lost everything they owned (they did not have renters insurance) we lost a house. So I know first hand about a house fire and the importance of maintaining the proper insurance.

There are two general types of property coverage for residential real estate: dwelling and homeowners policies. 

Dwelling policies are more limited in their scope of coverage, the policy is more basic for the property and most things are added via a “rider” to the policy. Perhaps you could say it is an alls-carte - you can pick and choose what you may need. Often they are used to cover rental houses or vacation homes.

A homeowner policy is more of a package of coverages for the owner of the property. It will typically have the broadest coverages. These policies have two parts: 1. the property coverage, insuring the home and contents, and 2. providing liability coverage, should there be a problem, where the owner is liable for something occurring on the property or through some sort of bad act by the property owner or an immediate family member for which he/she may be responsible.

Having the proper amount of insurance coverage is key. This can be tricky with home values changing on a regular basis. However, you should have the value of the home evaluated on a regular basis.

Here is the rule:

In order to have your home properly insured the insurance property coverage must equal a minimum of 80 percent of the replacement cost of the home. The home’s market value is a pretty good estimate of this figure as replacement cost is one of the factors that contributes to a home’s market value. 

People often ask, why 80 percent and not 100 percent? The reason is that traditionally, 20 percent of the home’s value is placed in the value of the land upon which the home sits. If the home is damaged generally speaking the land is not and a new home can be rebuilt in its place, making the land a consistent value of the overall property.

Here is the formula for replacing a damaged home:

(Insurance carried/Insurance required) x amount of loss = amount of reimbursement

This is how it works in real life, a homeowner experiences a $100,000 loss on their home worth $300,000. 80 percent of $300,000 is $240,000, this is the amount of coverage a homeowner should carry. Now lets put this into the formula:

(240,000/240,000) x $100,000 = $100,000 In this case the homeowner would be reimbursed the full amount of the loss.

Here is another example, in this case the same homeowner had not updated their policy in several years, which let the policy fall behind the value of their home, they did not maintain the 80%. The coverage they carried was based on a home value ten years ago when they purchased the home at $200,000, required coverage at that time was only $160,000.

($160,000/$240,000) x $100,000 = $66,667, this is what the homeowner would receive for their $100,000 loss. The balance they would have to come out of pocket to complete the required repairs. 

Falling behind on the insurance can be a real problem in high inflationary times because values can increase rapidly

As a side note, neither of these examples takes into account the deductible, that amount would be deducted from the amount of the reimbursement to get the final reimbursement amount. A homeowners policy may have different deductibles for different types of losses, so it is wise to keep track of that deductible amount. This is where a good savings plan is helpful to have the funds at the ready for such a need.

Many people go through life never experiencing such a loss to their home or property, however that does not mean that you should not be covered. This is something that you don’t want to “self insure”, maintain adequate coverage because if and when something happens, you will be glad you did. Pull out your homeowners policy and review it. Make sure the coverages work for your personal situation. If it is lacking in any area call the agent and get it updated or call me and I can walk you through each of the issues.

REMEMBER:

Regarding Hot Tips: "Assume you are always the last to know." ~ Charles Kirk