Year-End Money Moves to Make Right Now
As 2019 comes to a close, our hosts Sandy Block and Ryan Ermey offer up last-minute money moves to make before the year's end. Also, the pair discuss strategies for building an emergency fund and how mutual fund expense ratios can affect returns.
Ryan Ermey: Stop whatever you're doing. Okay, you don't have to, but there are some key money moves to make now -- or at least before the end of the year -- and Sandy breaks them down in our main segment. On today's show, we tell you why you need to start building an emergency fund in the new year and I tell Sandy what the big deal is with mutual fund expenses. That's all ahead on this episode of Your Money's Worth. Stick around.
- Episode Length: 00:24:01
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Sandy Block: Good. Getting ready for the holidays, Ryan.
Ryan Ermey: Yes, indeed, as we all are, and a quick programming note on that front. Sandy and I are going to take a little bit of time off for the holidays to see our families, so in lieu of a new episode next week, we will be rerunning our classic episode with Knight Kiplinger about money discussions to have with your family over the holidays. So, gather around the fireplace.
Sandy Block: Get your wisdom from Knight.
Ryan Ermey: Get some eggnog and listen to the dulcet tones of Knight Kiplinger. We will be re-releasing that podcast. In the meantime, we do have an episode today and we're talking about something that a lot of people are going to be thinking about or resolving to do in the upcoming year, and that is building an emergency fund.
Sandy Block: That's right. We've seen a bunch of surveys that have come out in the last few months saying that Americans on average have less than $400, less than a $1,000 -- it depends on who's being surveyed. Not very much money for emergencies, which basically means we're ... a lot of people are living paycheck to paycheck and are not prepared for the things that life throws at you, whether it's a car break-down or a loss of a job.
Ryan Ermey: Right. People tend to think about them as... exclusively for job loss, because they are a lot of times expressed in those sort of terms. That it should be enough to replace your income for X amount of time. But you don't know what's going to come up. You mentioned it could be car repairs, it could be home repairs, it could be unexpected medical bills. You really need to be prepared because if you aren't, and one of these things come up you could find yourself dipping into your retirement savings. You could be running up a tab on your credit card and going into debt. These are things that are going to cripple you financially -- cripple your financial future.
Sandy Block: Right. One thing that a lot of people struggle with, particularly younger people, is what to do if you don't have an emergency fund, but you also have debt. Maybe you're paying off student loans, maybe you've got a credit card balance. I think a lot of people say, "Alright, I'll start creating an emergency fund after I've paid off my debt." I think a better recommendation and one that we got from Pam Capalad, a certified financial planner and founder of...
Ryan Ermey: ... Brunch and Budget.
Sandy Block: ... of Brunch and Budget, a former guest, she says focus on a small amount, such as a month's worth of living expenses, and devote some of your extra money to this account while you're paying off the debt. Don't make it either/or. Here's why this is a good idea. If you focus entirely on paying off your debt and you have no emergency fund, and then an emergency occurs, you're going to end up with even more debt, and you'll be in a cycle of debt possibly forever. Because what are you going to do? You're going to whip out your credit card, so you're going to have even a bigger debt.
Sandy Block: Maybe you can't save three or six months, but start small. Just try and build a small cushion that will help you. The thing that our colleague Miriam Cross wrote in a column about this a few months ago is it gives you less stress and it gives you more options. Maybe your emergency really is that you have a really bad roommate and you want to move. If you have an emergency fund, you have that option. If you don't, you're going to have to stay with that bad roommate for as long as it takes you to build up your fund.
Ryan Ermey: Well, yeah, and this is why Pam called it the "yes fund." She didn't like calling it an emergency fund. It gives you the ability to say, "Yes, I can buy new tires for my car, or yes, I can take advantage and move out if this roommate's no good." In general, we recommend, or financial planners recommend, we talk to financial planners who recommend that you should have three to six months' worth of income saved up. Now, you can adjust that down if you're, say, young, debt-free, could move back in with mom and dad. Whereas, if you have a lot of debt, if you have a mortgage, if you have a brood of children, or if you own a business or work as a freelancer, then you're probably should be more than six months.
Ryan Ermey: But the bottom line is that you should start small. Start with something. Maybe you're saving for retirement and paying down your student loans and you have some amount of debt. Find some kind of happy medium where you're chipping away at that, let's call it a "yes fund," just so that, as Miriam says, you can have some measure of peace of mind should something like that come up.
Sandy Block: Right. The best way to invest this money is in something that's not going to be very exciting, because you want this money to be in a super safe place because you may need it. It's not like your retirement savings, which you can invest in the stock market because you're not going to touch it for another 30, 40 years. This is money you might need next. We'll put some recommendations, but basically you're going to look for an FDIC, federally insured savings account. The online banks offer the best interest, but these days best means...
Ryan Ermey: Couple percent.
Sandy Block: ... 1.5 or 2%. The goal here is not to make money. The goal here is to save money and have money...
Ryan Ermey: And have some liquidity.
Sandy Block: ... right, available when you need it.
Ryan Ermey: That's exactly right. Going into the new year, start building some good money habits, and one of those is starting to chip away at that yes fund. You still have a few money moves left to make before the ball drops. Sandy breaks them down next.
Ryan Ermey: We are back, and we're here with, well, just the two of us again.
Sandy Block: There's no one here.
Ryan Ermey: Sandy is going to be our de facto guest today. What we're talking about is year-end money moves. We talked about some of these back in November, things that we thought you should get a jump on. These are moves that you should really be making right here at the last minute before December 31st. Maybe a good place to start here, Sandy, is with charitable giving.
Sandy Block: Right. As you probably know, our tax system operates on a calendar basis. If you believe that you are going to itemize on your tax return and deduct charitable contributions, you have until December 31st to make your charitable contributions. Last week, we talked about donor advised funds. If you are a big giver or you want to give money now and decide later where to donate, go back and listen to that segment because we've got a lot of good advice there.
Sandy Block: But if you're just making charitable gifts, as I said, you have until December 31st. However, if you make the gift with a credit card, you can still claim it on your 2019 tax return, even if you don't pay off the credit card until next year. That's something to think about. Another one, and this applies to people who don't necessarily itemize, if you claim the standard deduction and you have a child in college, you may be eligible for the American Opportunity Tax Credit. It's worth up to $2,500 per undergraduate student. If you haven't maxed that out and there are bills due in January, pay them now because then you can claim the credit on your 2019 tax return. Again, this is one of the many, many credits and tax breaks that you do not need to itemize to claim. So, if you've got a kid in college, you need the money, you need the refund, go ahead and pay the January bill before December 31st.
Ryan Ermey: What if you are doing some learning on your own?
Sandy Block: Same thing. The Lifetime Learning Credit, which is more appropriate for people who are older and going back to school because it applies to graduate work, that is another one that you could prepay next year's January bill before December 31st and then get that credit when you file your 2019 tax return. Now, if you don't have a kid in college, but you're saving for college and you have a 529 college savings plan, those contributions won't cut your federal tax bill. But quite a few states do give you a state tax break for contributions. So make those and states operate on a calendar year, as well, so make those contributions. They make great Christmas gifts. Your kids will thank you later, I promise. Grandparents, friends, lots of people can contribute to a 529 Plan. Again, if you do that before the end of the year, you might be able to get a cut on your state tax return.
Sandy Block: Now, it's probably too late to put a lot more money in your 401(k). You've probably gotten your last paycheck by now, but if you're self-employed, you can contribute a lot to a solo 401(k) of to $56,000 or $62,000 if you're over 50. Most people aren't going to put that much in, but you have until April 15th to contribute. You must set it up by December 31st if you want if you want to deduct...
Ryan Ermey: If you want to take the deduction.
Sandy Block: If you want to deduct it on your 2019 tax return. If nothing else, if you think you're going to put some money in a solo 401(k) between now and tax day, set it up before December 31st so you can claim that on your 2019 tax return.
Ryan Ermey: That's just one of the many retirement saving options that we touched on for self-employed and freelance workers. So, go back and give that episode a listen to talk about ways to save. Now, what about flex spending accounts? I know that some of them you have to have it emptied by December 31st.
Sandy Block: Right. Healthcare flexible spending accounts are use-it-or-lose-it. Some of them give you until March. It depends on your employer, so find out. Some of them give you until March, but some of them you have to use all the money by December 31st or you forfeit the balance. Fortunately, there are tons of ways to use that money. I have done a Walgreen's run at the last minute, so I know of what I speak. Contact lenses, contact lens solutions, thermometers, all kinds of things.
Ryan Ermey: First aid kits.
Sandy Block: First aid kits. We'll put a link in the show notes. New this year, I believe or new recently is that you can use the money to pay for genetic testing. If you wanted to find out if there's a medical history in your family, you use the money for that, too. So check your flexible spending account balance, see what the deadline is and go shopping if you need to.
Ryan Ermey: Now, I know that you have some more fun tips coming up, but before we do, real quickly, since we were talking about taxes and such, I do have to throw an investory thing in there...
Sandy Block: Right, because that's...
Ryan Ermey: ... if you don't mind.
Sandy Block: No. Go.
Ryan Ermey: I'm stealing your thunder. But if you sell investments before the end of the year and they've appreciated quite a lot, you could owe capital gains tax. It should be noted that any investment that you sell at a loss, it's called harvesting those losses. To the extent that they offset your capital gains, you can harvest those losses to avoid paying capital gains tax. So...
Sandy Block: Right.
Ryan Ermey: ... on to ... oh, did you have more?
Sandy Block: No, I was just going to say that even if you didn't actually sell any investments, you just decided to hold on to them, if you had taxable mutual funds, you may have gotten capital gains distributions. Whether you didn't do anything, they're still required to pay those out. Again, that's if you got a lot of those, you could be hit really hard when you file your taxes. So see if you've got any losers that you can cut loose between now and the end of the year to offset those gains.
Ryan Ermey: Right, yeah. You'd get them from a mutual fund if the fund, itself, sold out of appreciated investments and they pass that capital gain along to you, quite generously. Al right, so on to some fun stuff. We have some good travel stuff before...
Sandy Block: Right. In our cover story for December, we mentioned spending. We were talking so much about taxes and saving, but this is a good time to check your credit cards and redeem rewards points, miles or cash back you've accumulated because people spend a lot of money. I feel like all I'm doing lately is writing checks.
Ryan Ermey: Oh my gosh.
Sandy Block: People spend a lot of money this time of year, so you could use some of these points or cash to buy holiday gifts, treat yourself to a massage because you might need one. If you're planning on spending a lot of money on gifts and travel during the holidays, check out a credit card with a generous initial bonus of cash back or points and then you could offset some of that spending, as well. One we recommend is the Chase Preferred Visa, which gives you 60,000 points if you spend $4,000 in the first three months. We'll put some more recommendations in the show notes. But that's a good way to, if you're spending a lot, you might as well get something for it.
Ryan Ermey: Yeah, I mean, especially if you're a last-minute shopper, like I have been in the past, going to the mall on Christmas Eve...
Sandy Block: Ugh, ugh!
Ryan Ermey: ... to get everything, maybe getting a part of that $4,000 dent right out of the way early could be incentive for you to go and do it. But man, I mean, it's good advice, especially to look up the points because (a) people forget about the points and don't redeem them or just kind of...
Sandy Block: They do expire sometimes, yeah.
Ryan Ermey: They're tucked away somewhere. Yeah, you're right. I mean, this time of year I swear I think my credit card's actually warm to the touch in my pocket. All things to keep an eye on here at the end of the year. We will link the entire story in the show notes. It is the cover story of the December issue of Kiplinger's Personal Finance, Money Moves to Make Now. We think you should make them all right now. Well, maybe not right this second, but enjoy the time with your family first over the holidays, and then maybe, while listening to our talk with Knight Kiplinger, go out...
Sandy Block: Make these money moves.
Ryan Ermey: ... and make some of these moves. If you're checking your investment returns over the past year, pay special attention to fees. I'll tell you why after the break.
Ryan Ermey: We are back and before we go, a new Explain Like I'm Five segment. Today, I'm doing the explaining, so Sandy, what would you like to know?
Sandy Block: Well, now that it's the end of the year, maybe you're looking back on how your investments have done. One of the things that people see when they check out their mutual funds is expense ratios. What is a mutual fund expense ratio?
Ryan Ermey: Yeah, and it's a good time to talk about these. Like you said, if you're reviewing your investments at the end of the year, maybe you're taking a look at performance, taking a look at all the various mutual funds or exchange traded funds that you own. If you own any of these, they charge an expense ratio. What it is, it's the amount of money that the fund company charges for management of the fund. It's calculated by adding up all of the fund's expenses, which are predominantly what the company is paying the manager, but also things like what they pay for record-keeping or legal expenses, or maybe some auditing -- something like that.
Ryan Ermey: That all gets wrapped up into the fund's expenses. Then you divide that by the fund's total assets, so it's expressed as a percentage. Let's say a fund has a 1% expense ratio. That means that you pay $100 in annual fees for every $10,000 that you own in the fund. It's whatever amount of money that you have invested in the fund, you're going to be paying a percentage of those assets in order for that fund to be managed.
Sandy Block: Why should I care about this? And do the math.
Ryan Ermey: Yeah. I did do a little bit of math in advance of...
Sandy Block: So you don't have to.
Ryan Ermey: ... of taping, so you don't have to. To be fair, I didn't really have to, either. There is an excellent Bankrate calculator that I will put up in the show notes that I used for these numbers. The main thing is, and this has been an enormous trend in investing, that cost is one of the biggest, if not the biggest determinant of investment outcomes. It's worth it to look at your portfolio to see if it makes sense to reduce your costs. This is where something like an index mutual fund or an exchange traded fund, something that's passively managed, and what we mean by that is, there's not a manager going in there and making trades and setting a strategy.
Sandy Block: And earning a big salary that you pay for.
Ryan Ermey: Right. It's usually just automatically, electronically, robotically, whatever adverb you want to use, it tracks an index. It holds a representation of whatever the index holds. There's not much management involved. Let's say you own a diversified, large company stock fund that tracks the S&P 500. If you don't really care about the strategy of the fund, or if it's something that you're not particularly passionate about, it might make sense to invest in an ETF or an index fund that holds something very similar, that holds, say, the S&P 500.
Ryan Ermey: I've done a little bit of math. Well, Bankrate has done a little bit of math on two hypothetical large cap stock funds, like the kind I was just talking about. One is an actively managed fund charging the aforementioned 1% in annual expenses. The other is an index fund. Basically, it's the Vanguard 500 Admiral Shares. They charge a 0.04% expense ratio. So, what's the difference? Well, over 30 years, and for this exercise, we're assuming a relatively conservative 7% return for a large cap U.S. stock fund. On a $10,000 investment, that if you just plunk $10,000 in the fund, it earns 7% of the year, you don't do anything to it. With the active fund charging 1% in annual expenses, you would end up with $56,000, but you would have paid more than $8,000 over that span in expenses. By contrast, in the passive fund, you'd end up with $75,000, having paid only $401 in expenses.
Sandy Block: Right. Which is a really compelling argument for paying attention to expenses. I think right now everybody's doing so well, everybody's making money because the market's been going on for a long time, that maybe people are kind of losing track of how important that is. But as you said, this is the one thing that you can control. If the market goes down, you're really going to start noticing...
Ryan Ermey: Oh, yeah.
Sandy Block: ... the difference between the 1% fund and the 0.0% fund.
Ryan Ermey: Some people, for this reason and for the reason that the majority of active managers ... well, it depends on the asset class, or whatever. But it's really hard to beat the market consistently. People who are really evangelical about index funds, say you're low-cost and you're doing just as well or almost, fractions away from just as well as the index, when most active people can't beat it, anyway. I own actively managed funds. It's just that if you own an actively managed fund, then it has to be that much better. It has to be...
Sandy Block: The guy's got to...
Ryan Ermey: Yeah, exactly. It has to absolutely justify the expense ratio. When you're looking at how your funds did at the end of the year, pay attention to cost, as well as performance because it could be that you could find a much lower cost substitute for a fund that you might not even be that happy with. It could have a drastically, drastically positive effect on your returns.
Ryan Ermey: That'll wrap it up for this episode of Your Money's Worth. For show notes and more great Kiplinger content on the topics we discussed on today's show, visit Kiplinger.com/links/podcasts. You can stay connected with us on Twitter, Facebook or by emailing us at firstname.lastname@example.org. If you like the show, please remember to rate, review and subscribe to Your Money's Worth wherever you get your podcasts. Thanks for listening.