“I wish more people would ask these questions,” said Pam Dumonceau, a registered investment adviser in Denver with over 20 years of experience.
They weren't unusual questions. In fact, they were the most basic personal finance questions. But they're the questions we all face and should probably be asking. Questions that return some kind of conventional-wisdom answer. Questions — in some cases — that ask these professionals to justify their own value to the average person as, respectively, a registered investment advisor, financial literacy teacher and tax preparer.
Here, find those questions and the rule-of-thumb advice, edited for length and clarity, given by a few people who know money.
Buy or rent?
Pam Dumonceau, president and CEO of Consistent Values Inc., a Denver registered investment adviser: There's a lot of conversation these days about the younger generation that doesn't want to buy. But really if you look at the long term, having your housing paid off someday so you don't have a cost of housing is really a nice objective. So really it doesn't matter if you buy in 2014 and the price goes down a little before it goes up — the only way to do that is to get your toe in the water and get started.
Amy Fidelis, marketing and education director of mpowered, a Denver-based financial-literacy nonprofit:It really depends on a couple of factors. How long do you plan on staying? Are you going to need to leave the property quickly at some point? Are you ready to take on the responsibility of fixing things and upkeep? Over time, in terms of passing on generational assets, homeownership does tend to lift families out of generational poverty. But in the work we do we see a lot of people that lost their job and now they can't make the mortgage.
Mark Sanders, certified public accountant in Greenwood Village: If you can afford it, I think there are upsides to owning, but it's not as hard and fast as it would have been, say, 10 years ago. I've always been a homeowner, but we could be losing some of that benefit.
OK, how much of my income should go toward housing costs?
Dumonceau: There are rules of thumb, about 25 to 30 percent going to housing, and in our community, I think that's workable. I think it's more important also to personalize it and look at one's budget. I know people who are really homebodies, and they spend 40 to 50 percent on housing but they don't care to travel.
Fidelis: What we like to do is look at all of the housing expenses, so rent, mortgage, gas, water, insurance, and we like to see it less than 30 or 35 percent total, so the actual rent or mortgage might only be 20 or 25 percent.
Sanders: I typically say around 30 percent. I don't like to see clients go much more than that anymore just because life seems to be very uncertain, and people don't have a nest egg.
How much time should my emergency fund cover?
Dumonceau: The variation would be somewhere between six months to two years of expenses. I'm not using the gross-income multiple, I'm using the expenses multiple. Oftentimes for retirees, I say two years of expenses. They can ride out a two-year market contraction and still be OK.
Fidelis: Here's where I might diverge from conventional wisdom. Six to nine months of living expenses. That's helpful, but it might not be the most useful to someone who's not saving at all. I might say a month's rent. Or get $1,000 saved up and breathe a little. And from there, move on. What do I need to be able to sleep at night?
Then the trick is, what's an emergency? Unfortunately, new tires on the car, not technically an emergency. It never feels like that. Medical issue, loss of a job, hours reduced at work, that kind of stuff is important.
Sanders: I tell clients six to 12 months. My experience with my practice, however, is that people have typically two or three months. I've had clients from the crash of 2007-2008, I had one client finally just get a decent job. She was working at Starbucks. She just got a decent job three weeks ago.
How many credit cards should I have?
Dumonceau: I think everybody needs at least two, because you could have one lost or stolen, and you'd need the other one. I don't know that people need more than two.
Fidelis: Are you playing the credit game or not, right? That's the question. I like one for emergencies or for online purposes, or if you have your system down, so you can get rewards. If you're new to that system, then I might start using a secured credit card to start to build credit. The trick is, it's best to pay it in full every month so you're not paying interest.
Sanders: Three per each adult in the household. One is in the event that there's an identity-theft problem with a card, you want to have another card. If you max out a card, you want to have a card for an emergency. Three credit cards should be sufficient. If your credit is good, you should have enough room to carry yourself in an emergency.
Which debt should I pay first?
Dumonceau: The most expensive. The highest interest-rate one. So usually credit cards are the highest interest-rate ones. Put all the money you can on the highest-interest-rate one first until that one's paid off, then go to the next-highest interest rate. And I do see people send in extra money to the mortgage, and the mortgage costs 3.5 percent, and the credit card might have 12 percent.
Fidelis: What can they take from you? That's the question we like to ask. What are the consequences of not paying? If I don't pay on my house, it could result in foreclosure, and that would impact a lot of parts of my life. Then we go down the line. Credit cards, those are unsecured. Yes, I will damage my credit by not paying those, but they can't immediately take the roof over my head. That has a longer process attached to it. We've seen clients have great success when they call up their creditors and talk to them. Making a deal up front is a lot easier.
Sanders: This is the cliche, but pay off the most expensive debt first. Or try and pay off the balance you can pay off the quickest. Try and focus in on one or two debts. If you've got nine debts out there, you're not going to be able to knock any of them down.
Should I be saving for retirement while I have credit card debt?
Dumonceau: Yes, still save for retirement, at least take advantage of a match if you have a match in your 401(k) at work. Be honest with yourself. Are you ever really going to get that debt paid off? If not, just get started in the retirement savings, because it's much harder.
Fidelis: Yes, because you can't make up for time. When it comes to the time value of money and using compound interest, building interest on top of interest on top of interest, I need time to support that. And that means starting early and saving frequently. I know the mathematical answer is you're saving on interest by paying off your debt. I like to attack the debt very aggressively for sure, but it doesn't mean waiting until the debt is attacked to start saving for retirement — or for an emergency fund for that matter.
Sanders: Yes. Always save something.
If I have some extra money, ha, what should I do with it?
Dumonceau: If you've maxed out your 401(k), I guess maybe a Roth. Once a Roth IRA has been open for five years, one can get the original principal with no penalty. So we oftentimes recommend that everybody — even if you can only afford $100 a month — open a Roth and start your five-year timeline, because after your five years, you can get your original principal with no penalty and no taxes. So your Roth can double as an emergency fund.
Fidelis: If you're looking at a serious windfall like an insurance settlement or an inheritance, you want to wait on that a while and get some advice from a certified financial planner on what you're going to do. If we're talking smaller, like a tax return, some conventional wisdom is you can divide it in two: You're saving half of it and putting half of it toward debt. If you divide it into thirds, you're saving a third, putting a third toward debt and spending a third of it, so you can feel that “win.”
Sanders: If you get a bonus at work, see if you can allocate more of that toward a retirement contribution. If you get a tax refund, a lot of times (clients) will use their annual refund for a vacation or a big home expenditure or tuition payments. Try and put it to a good use. It's impractical for me to tell people to invest that money. I will tell you that I have never had a client who has taken their tax refund and put it into an IRA account, which we're allowed to do now. No one has ever done it.
Uh, how do I diversify?
Dumonceau: It takes a little bit of understanding of what you're investing in to know if you're diversified. And that's not easy for the average person, but the average person has probably been introduced to target-date funds, and those accomplish diversification. I personally like the lifestyle funds best. Some people who are very young are still conservative. But those funds are all really well diversified, the name-brand ones, Fidelity or T. Rowe Price or Vanguard.
Fidelis: It really is not having all of your eggs in one basket, so you don't own only stock — or all of one kind of stock. So you're not all large-cap, or developing markets or something like that. That's where I like to have a planner look at it. What is your 401(k) in, what's in your IRA?
Sanders: First look and make sure that we're taking advantage of our retirement plans that are available. Whether we get a tax deduction or not, we always want to start with our retirement planning. If they're maxing that out, talk to an adviser, whether it's a CPA or an investment adviser and get their input. See what they say. It is such a moving target. You can't listen to your dad, you can't listen to your brother-in-law. Or you shouldn't. Seek that professional advice if you can get it.
Should I budget everything? Every dollar?
Dumonceau: Well, I think you definitely want to make sure that you're covering all the biggest categories, but it's fine to have a little bit of fudge in there, and whether the money gets spent on Starbucks or happy hour, it can just be a little bit of pocket change. My experience of 20 years and nine months of doing this stuff is that your budget has to fit your personality. If you're not the kind of person that is going to budget down to the penny, then don't ask that of yourself.
Fidelis: If you have never made a budget, then, yeah, you might want to track every dollar. Once you get into a system that you like, once you can separate out your accounts by expense type, then maybe you don't have to track to the penny because you've already got a system. But you've got to make room for your humanity. What do you want, why do you want it, and are you doing the rational thing? But also the emotional thing — so, the money you can just goof off with.
Sanders: In a vacuum, sure. No, you cannot budget every dollar.
Should I have a will even if I don't have much money?
Dumonceau: Everyone needs a will, but even more important than that, everyone needs powers of attorney, because Colorado state statute will have a will for you if you don't have one, but what if you're incapacitated and can't take care of your own affairs? I had a client whose son was taken ill and the landlord wouldn't even let her in to take care of his dog. In Colorado, we recommend a medical power of attorney and a financial power of attorney.
Fidelis: More than a will, you need an estate plan. You need to get the advice of a professional to see what that looks like. The conventional wisdom on death is yes, we all die.
Sanders: Yes. I do a lot of estate planning for people, and that's the starting point. Even if it's a very simple will.
Should I have life insurance?
Dumonceau: If nobody's depending on you, you know, you're single and you don't have any dependents, you don't need a whole lot of life insurance. Life insurance is for the purpose of replacing your income. If you're the breadwinner in your family, then yeah, you need life insurance, somewhere around 5 to 10 times income. More like 10 times income for people who have young babies. The other funky one that throws people off is, the at-home spouse still does need life insurance, because if the breadwinner loses their at-home spouse, then they'll probably need to hire a nanny. I would still recommend around quarter-million, half a million on an at-home spouse.
Fidelis: It should be part of your overall financial portfolio. We do like insurance. Protecting what you have is a big part of the game.
Sanders: That gets into more — are we single, do we have a family? I think if you're a single person and you don't have dependents, you don't really need life insurance. But as an example, you may want to leave some money to your siblings or your parents. I would say it depends on your family situation.
Should I do my own taxes?
Dumonceau: If they're simple, TurboTax, and the H&R Block one, TaxCut, for the majority of people, those are great. But if somebody has rental properties, if they have a business, if they have a complicated situation, then they are much better off going to a professional tax preparer.
Fidelis: I like to ask people how they value their time. What's it worth to you and what do you know about it and how complex is your situation? With complex situations or if you owe the IRS, you definitely want to be working with a professional.
Sanders: Not everyone needs a CPA or someone with my background. I will tell you that I don't recommend people doing their own taxes, especially with the changes we have now in 2013 and going forward. H&R Block and TurboTax are not the answers.
They can't advise you on your overall financial condition. They can't offer planning and advice going forward. It's looking backwards on the previous year's activity. I'm also looking ahead and making recommendations for the current year, (as in), “You need to make an estimated tax payment,” “You need to think about refinancing your house.” What other ideas are out there going forward to make next year better?
Should I pay someone to help me with my finances?
Dumonceau: Well, the history of my industry is that we don't serve people well who don't have very much money. People who don't have very much money don't know where to turn to get good financial advice. Our industry really targets the folks that are the millionaires next door and above.
The average baby boomer has $14,000 in retirement savings. For the majority of people, they're not going to get a lot of value out of paying. But there are some fee-based advisers now who specifically target that person, and they only charge a fee and they keep up with them.
Fidelis: Is it someone that's going to try to sell me a product? That can be fine, but are you aware of what theyÅ are selling you vs. what's available in the market? That's why we partner with the Financial Planning Association of Colorado so you can get access to a CFP that has maybe more training than a lot of others. What do you want them to do? Here at mpowered, we're a nonprofit. We do charge fees in some cases because we want the client to have ownership. We provide accountability and support like a personal trainer would.
Different planners have different ideas of what net worths they want to work with. I work with a lot of people who don't know what their net worth is — and I don't know why they would. Where would they come across that?
Sanders: Even if you're a single person, I could see the need for a little bit of a financial checkup or tune-up. I don't deal with thresholds. If you have a couple of different financial components such as retirement, insurance, mortgage, rent, loans, you should probably every year or so find someone and just pay them even for an hour or two of their time to just go through everything with you, make sure you're not missing anything.