Financial Literacy

Although 75% of people that pay income taxes look forward to receiving a large income tax refund (over $3,000), all of the arithmetic points to this tactic as being a financial mistake.

Current income taxes for federal and state returns combine for 50% at the top rates. For medium and high income earners, income taxes are the largest obstacle to saving and accumulating money. If you do not actively reduce your tax burden, then it is like handing the IRS a cash ‘tip’ of thousands of dollars a year.

Your tax planning should include strategies for tax minimization but also for creating a minimal tax refund. What are some reasons why it is not in your best interest to get a large tax refund?

1. You are delaying access to your own money that you have already earned. This is money that you cannot spend, invest, donate, or save until you receive it back from the government a dozen months later. Why would you do this?

2. The most common reason people want a large refund is because it is a lazy way to save or afford a large purchase. Unfortunately, this is a costly way to create a random-sized lump of money – instead of a controlled amount of monthly savings to hit specific savings targets when they are needed. The financial literate have tiny tax refunds and map out their savings needs to make certain they occur.

3. This money is a free loan to the government, at your personal expense. Federal, state, and local cities are already warning that there will be refund delays this year from late tax changes and they claim to be perpetually underfunded and understaffed. Again, why are you actively allowing a government bureaucracy to decide when to release your own money back to you?

What would the government do if roles were reversed and, instead, you held onto their money for a year? You’d pay steep penalties, plus interest, and be audited by the IRS forevermore.

Plan your taxes and use the IRS withholdings calculator to minimize your refund and get your money under your control for your maximum benefit, not theirs.

There is a website that aggregates down-payment assistance programs from across the country. There are just under 2,300 assistance programs in the U.S., but most counties have between 5-20 programs, depending on your circumstances and the types of homes that qualify. The company is Down Payment Resource and RealtyTrac claims the average down payment assistance is $11,565.

Down payment assistance can take several forms: credits for closing costs or low-interest loans that are forgiven the longer you remain in the home. In addition to down payment assistance, the Federal Housing Authority that purchases mortgages lowered their down-payment requirements from 10% down to only 3%-down mortgages.

To see if you qualify for one of these programs, search their website at:

http://downpaymentresource.com/are-you-eligible/

Or get more information from RealtyTrac:

http://www.realtytrac.com/news/realtytrac-reports/down-payment-assistance-analysis-q1-2015/

Today, there are Russians having their homes foreclosed upon because their mortgage is priced in U.S. dollars while their home currency that they earn money in, the Russian ruble, has lost half its value in the last 6 months. During the 2008 financial crisis, Icelanders were foreclosed upon whose mortgage was in Euros while the Icelandic kroner collapsed in value. Romanians are protesting because many took out mortgages in Swiss Francs which jumped up in value. And finally, U.S. homeowners with variable interest rates lose their homes when their mortgage resets at a higher interest rate.

All of these foreclosures are predictable and preventable mistakes by the financially illiterate. In each instance, the borrower tried to lower their mortgage payment a tiny speck by taking on giant additional risks that they could not manage or afford. In these cases, they were pushed out of their home by something they could not control; either a move in currency rates or interest rates.

Matching assets and liabilities is a banking-101 concept of aligning a loan to a particular asset. In the case of a mortgage, when you take out a loan against a large asset, that loan must match the earning currency to make loan payments and not reset the interest-rate during the time frame you are planning to own the asset. When you take a mortgage tied to a foreign currency, you’ll lose your home if either your home currency falls (the money you are earning becomes worth less) or if the mortgage currency rises (your loan payments and balance become worth more). This is a giant mismatch that you should avoid or know how to professionally hedge. Be aware that hedging may only be able to protect you for a couple years while the mismatch could be for far longer than that, still forcing you into foreclosure.

Another mismatch is the timing of owning the home. When your mortgage has a variable rate it is always likely that it resets at a higher rate than today, possibly creating an unaffordable payment for your income. Interest rates typically move down slowly but jump up very quickly, likely quicker than you can re-finance to lock in a lower rate. How long do you plan on owning the home? If you plan on moving in 2-3 years, it is fine to take out a variable rate loan that will re-set in 5 years because you will have sold the home by then. But if you have no plans to move, 5 years later who knows where interest rates will be and you may have an unaffordable mortgage that eventually forces you into foreclosure. Realize when you are foreclosed upon, you lose all the equity that you have paid: down payment, home improvements, and the loan amortization – all of these will be gone. (For most retirees, 70% of their net worth is home equity or a paid-off home so they can actually afford to retire.)

So make certain your mortgage matches your home currency and the length of time that you plan on being in the home. Avoid these two predictable landmines that will force you from your home by trying to save a couple dollars in monthly payments.

In the last year, there have been many currencies that lost a significant amount of value:

• The Russian ruble has lost 34%
• Argentine Peso lost 24%
• The Norwegian Krone and Swedish Krona both lost 14%
• The European Euro lost 13%
• The currencies of Japan, Israel, Poland, and Czech Republic have all lost 10%
• Even the Canadian dollar lost 9%

In each of these examples, natives in these countries and currency holders would have been better off by holding their money in any other stronger currency; even gold made a small profit against nearly all currencies.

Since currency prices tend to move in a trend (it takes time to reverse structural forces or central bank policies), once a currency begins a move over 5%, in my experience, it tends to continue in that direction. What to do when your home currency is at risk for falling more than 5% to any of the major currencies? It is time to consider moving some of your money into a stronger currency.

It has never been easier to move some of your money into other currencies:

• Through most brokerage accounts you can use exchange trades funds or currency funds.
• Everbank offers certificates of deposit denominated in several currencies or baskets.
• European and Asian banks commonly offer multi-currency accounts.
• Some multi-currency accounts also permit holding ounces or grams of gold.
• Buying the stock of a company whose predominant sales is in the currency of your choice.
• Note that the worst exchange rates continue to be at airports and train stations.
• Bitcoin can move up and down +10% in a single day, so it is not a stable location of value.

Your home currency is very important – whether it is facing a 10%-50% loss of value, goods are going to be increasing in price. If you have no currency hedge then you will incur the full loss of your money; while those that have held some stronger currency will have more financial options.

Mortgage rates have been trending down all year and are just under 4.00% today for a 30-year fixed mortgage. Many people missed the opportunity in January 2013 when rates dropped all the way down to 3.50% before they shot up to 4.50% a few months later.

Now is your chance to grab some cheap money before rates pop-up again. Rates are so low that some people can move from a 30-year term down to a 15 or 20-year term with a monthly payment that is the same or lower that their current payment.

Another consideration is if you have any debt with a rate higher than 4%. You may want to consider rolling this debt onto your mortgage to lower your interest expense.

Like any financial move, there are elements you need to consider:

• Will you spend your interest savings or use it to pay down principal each month?
• If your debts are moved to your mortgage, will you rack them back up again?
• Can you knock out small unsecured debts without adding them to your mortgage?
• By putting the new monthly savings toward reducing the principal loan balance, would you be increasing payoff length of your mortgage?

Managing any debt, no matter how small, requires discipline or it can ruin your credit rating and your net worth. Managing larger debts and a mortgage requires more diligence at budgeting and planning or you can potentially lose your home. If you do not have the psychology, budgeting, and discipline then there are painful lessons if you open credit cards, let alone car loans or mortgages. Contrarily, there are financial benefits for conservative use of loans:

• Credit card loyalty programs benefits
• Home ownership
• Income producing real estate
• Income producing business assets
• Access to emergency funds with credit

With interest rates at such low levels, now is a good time to examine all of your debts and determine if you may be financially better off by refinancing them today.

The price of crude oil has fallen by 30% since the summer. Depending on your state’s gasoline taxes, the average person will spend $525 less on gasoline in 2015.

So what are you going to do with your extra $525? In my opinion, the same thing that you should do with all unexpected income: divide it into portions and make certain that some of those portions increase your net worth.

Whether you receive an inheritance, win a prize, receive a gift, or in this case, have an expense drop, you have two main choices: spend it all or save it all. Of course, the most prudent action is to save it all and then only spend some of its investment income. But to be realistic, most people will spend some portion and hopefully save some portion. This savings can go toward: paying down debt, adding to a retirement or college savings accounts, or some other net-worth building location.

The reason that you should use some of any unexpected money to add to your net worth is because: anytime you can improve your net worth for free, then you should do it. Extra income or a reduction in your expenses allows you to increase your net worth without money being taken from your routine budget. If the price of gasoline were to shoot back up tomorrow, then what would you have to show for 6 months of lower prices: something or nothing? Adding to your net worth is the only way to permanently benefit for the rest of your life from an unexpected gain.

In the case of dropping gasoline prices, you could also set some of this $525 aside as a reserve to pay for higher than average gasoline prices when they go up again. Or, you could do what the airlines and trucking companies do, hedge your gasoline price. One way to do this, as a small retail investor, is to purchase an exchange-traded fund (an ETF is a fund that trades just like a stock) that tracks the price of gasoline. If you buy some of this ETF periodically as the price of gasoline is falling, then you may be able to sell it for a profit as gasoline rises. This profit will help offset your fuel expenses later – if and when prices move higher.

For some people, $525 may not be a lot of money. However, these concepts apply to any amount of unexpected income. Whatever you decide to do with your $525 windfall, it will have a permanent impact on your net worth. Do you want it to be favorable, neutral, or unfavorable? The financially literate will move this money in a way that is certain to be favorable to his or her net worth.