12/14/2012 6:09 PM ET|
Year-end money moves to avoid
Now is the right time to simplify your financial life for 2013. But conventional wisdom on how to do it might be dead wrong.
The old-school advice for simplifying your finances boils down to "less is more": Consolidate your accounts, cancel unused credit cards, and streamline your investments.
In today's world, however, less is often less. Trying to simplify your financial life can boomerang on you with unexpected consequences.For instance, cutting down to one or two credit cards -- or doing without them entirely -- can hurt your credit scores. Consolidating your financial accounts could actually cost you more, and even leave you more vulnerable to lawsuits.
Here are some thoughts on avoiding pitfalls as you simplify your finances for an easier 2013.
Start with a purge. Don't hang on to paperwork "just in case." You should have a clear reason for hanging on to documents. If it's tax-related, you typically should store it for seven years. In many cases, you can scan a document and toss the original (but don't trash official documents such as marriage, birth and death certificates). Financial institutions are required to keep copies of your statements for six years, so you don't necessarily need to keep hard copies.
Two gadgets can make your paperwork decluttering go faster: a cross-cut shredder and a really fast scanner, like the ScanSnap from Fujitsu.
Streamline your credit cards the smart way. I cringe when I hear people being advised to close credit card accounts, especially if they're told to do so because "a large number of cards could hurt your credit rating." The FICO scores used by most lenders don't punish you for having "too many" lines of credit. In fact, having multiple open accounts is usually a positive factor in your scores.
What can hurt your scores is shutting credit accounts, or piling all your charges on one or two cards. The FICO scoring formula is sensitive to how much of your available credit you're using. Reducing available credit by closing accounts, or using too much of your available credit on any card, can cause your scores to drop.
The less of your credit limit you use, the better. That's true whether or not you pay your balance in full every month (which you should, by the way). A good rule of thumb is to use 30% or less of your credit limit at any given time. If you regularly use more than 50% of the limit on any card, consider shifting some charges to a second or even third card to ease the burden on your scores.
You can switch to cash or debit cards for everyday purchases. For big-ticket or online purchases, however, you'll probably want to use credit cards, since they offer consumer protections that other methods of payment lack.
If your FICO scores are high (say, 750 and above), and you won't be in the market for a major loan within the next year, you can consider closing some unused accounts, particularly retail store accounts you don't use or cards that charge an annual fee. Otherwise, a smarter course is to keep those accounts open.
If you're having trouble keeping track of all your credit accounts, consider using an aggregation service such as Mint.com. Checking in weekly will help you monitor your balances and spot any fraudulent charges on otherwise dormant cards.
Remember, the only smart way to use credit cards is as a convenience. If you have credit card debt, you need to make a plan to get it paid off as quickly as possible. If it would take you five or more years to pay off this debt, you may want to check with a legitimate credit counselor (find one here) or bankruptcy attorney.
Consolidate, but with caution. It can be tough to monitor multiple retirement and investment accounts. You could pay more in account fees and find it difficult to maintain appropriate asset allocations.
But that doesn't mean you should lump all your accounts together, or even bring them all under one financial institution's roof.
Let's take the common recommendation to roll old 401k accounts into individual retirement accounts, for example. You'll likely have more investment options with an IRA, but you could end up paying more for them if your 401k gave you access to the lower-cost institutional funds provided by many large-company plans. (There's a reason financial institutions are so eager for you to roll over into an IRA -- they'll typically make more money by charging you retail rather than investor prices!)
Also, funds in IRAs have fewer protections from creditors, should you be sued or wind up in bankruptcy court, than 401k's. IRAs are typically protected up to $1 million, while protection for 401k's is unlimited. That's not a concern for most people, but if you have a large balance (or are likely to accumulate one) you might want to factor this into your decision.
Another option to consider is rolling your old 401k accounts into your current employer's plan, if that's allowed. Again, that will make it easier to keep track of your investments, but you'll want to make sure you're not transferring your account away from a really good plan unless your current one is better.
Insurance is another consideration. The chances that you'll ever need the coverage provided by the Securities Investor Protection Corp. are slim. SIPC pays back investors if a brokerage goes broke or if securities are stolen by a broker. If a failed firm can't be merged with another brokerage, SIPC divides up the broker's remaining assets among customers and then uses its own funds -- up to $500,000 per account, including a maximum $250,000 for cash claims. If your claim exceeds those limits, which is rare, the broker often has insurance that will make you whole. Still, some people are uncomfortable keeping more than $500,000 at any one brokerage firm. If you have substantial assets, you may want to spread them around.
Simplify your investments. You may need to keep your money in different investment accounts, but you'd be smart to seek simplicity when choosing your actual investments. You can eliminate the hassles of asset allocation and re-balancing by choosing so-called lifestyle or target-date maturity funds. These funds offer broad diversification and regular re-balancing so that your portfolio stays in tune with your long-term goals. The best such funds don't try to beat the markets, since most funds that attempt to do so fail miserably. Instead, they use low-cost index and exchange-traded funds to match the market returns. If you don't have access to good-quality lifestyle or target-date funds, look for a good balanced fund (60% stocks, 40% bonds) or build a simple portfolio using low-cost index funds and then re-balance back to your target asset allocations once a year.
Set up savings "buckets." When I had a single savings account, it was hard for me to keep track of how much of the money was earmarked for various purposes. If I had an unexpected car repair, would there be enough left to pay our property taxes when they're due, plus cover our insurance premiums and our holiday splurge? Now each goal has its own labeled savings account at an online bank that doesn't have minimum balance requirements or charge monthly fees. Each month, money is automatically transferred from our joint checking account at a brick-and-mortar bank into each of these savings buckets. Every large, irregular expense -- from vacations to car repairs -- has its own account, and I can tell at a glance where we stand. If a car or home repair exceeds the amount we have saved, I can shift money from our emergency fund or cut our spending until the bucket is refilled. The system sounds more complicated than maintaining one savings account. In fact, it has greatly simplified our lives, because I know the big expenses are covered.
Automate your payments. If paper checks are still a big part of your financial life, explore the advantages of electronic banking. Direct deposit means no more standing in line at banks to cash your paycheck (plus fewer opportunities for thieves to steal or alter your check). Electronic bill payment typically is safer and more secure than sending checks through the mail. Plus, many bills can be automated. You have several choices: setting up recurring payments through your bank's bill payment system (a good option if the bill amount is the same every month), having bills charged to a credit card or authorizing billers to take the money directly from your checking account. Even if you're nervous about ceding control of other bills, you should make sure that minimum payments to credit cards and loans are made automatically, so you don't run the risk of missing a payment and damaging your credit scores.
Rethink consumerism. Buying less leaves more money in your pocket for saving and investing. Buying less also means less hassle. The less stuff you buy, the less stuff you have to maintain, insure, repair and replace or donate when you're done with it. Breaking the habit of shopping and spending can be a surprisingly powerful way to simplify your life.
Liz Weston is the Web's most-read personal-finance writer. She is the author of several books, most recently "The 10 Commandments of Money: Survive and Thrive in the New Economy" (find it on Bing). Weston's award-winning columns appear every Monday and Thursday, exclusively on MSN Money. Join the conversation and send in your financial questions on Liz Weston's Facebook fan page.
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