It’s easy to look around at your friends and neighbors and notice that they seem to have more than you do. Maybe they have bigger houses with nicer furnishings—perhaps even swimming pools or tennis courts. There’s a new car parked in the driveway, while you’re trying to figure out if your old sedan will make it through another winter.
Of course, you and your husband did take that great ski vacation last winter to celebrate your twentieth wedding anniversary. And you’ve managed to get two of your three kids through college without going broke.
Once in a while we need to stop and take a good, long look at exactly where we are in our lives. We need to tally up the pluses and minuses—financial and otherwise. We’ll be talking more about assets and liabilities in Chapters 3, “On the Plus Side,” and 4, “On the Minus Side.” In this chapter, we’d like to focus on the difference between need and want, and how important it is to know the difference.
Maybe you really do need a new car. But you don’t need a $42,000 Lincoln Navigator, even if there is one parked in your neighbor’s driveway. A bigger house would be nice, but with the kids getting near the point when they’ll be moving out, do you really need—or want—it? Do you really want the extra responsibilities and costs that accompany expensive cars and large homes?
It’s easy to confuse wants and needs, especially in this affluent society where we’re continually told we need more and more.
A need—a real need—is something we require in order to live. We need food, water, shelter, and clothing. A want, however, is something much different than a need.
Although we say that really need to buy a treadmill before winter sets in, we no more really need a treadmill than we need a mosquito bite. We’d like to have a treadmill before winter sets in so we can avoid accumulating the extra 5 or 10 pounds again this holiday season. And, when we think about it, we actually could achieve that goal without a treadmill if we took to walking outside, cross-country skiing, shoveling snow, or passing up the brie and truffles at the holiday parties.
We need the real needs in life, although there are lots of ways to shave down costs of food, clothing, and housing. If we learn to control and limit our needs, our chances of having enough money to get what we need during the years of retirement improve dramatically.
Don’t Go There
It’s easy to overspend on “needs,” such as food and clothing. We need to eat, but we don’t need to eat steak and lobster every week. Try to cut these expenses when you can so you’ll have enough money to fund other needs, such as emergency accounts and insurance policies.
If everyone knew they would die when they were 62 years old, it would be easier to know what you could spend today. There would be less concern about having enough money for the future, because there would be less future. Fortunately, though, most of us will live to be older than 62, and hopefully will be healthy and active long past that age. Because of that, we will need to have enough money so that we’re not waiting by the mailbox each month for the Social Security check to come in so we can go to the grocery store.
Besides our basic human needs of food, water, shelter, and clothing, people in their 40s and 50s have some basic financial needs. By the time you’ve reached financial middle age, you should have—that is, you need—certain tools to assure your financial health both now and in the future.
We live in an uncertain world. Those of us who hadn’t considered that fact previously got a loud and decisive wake-up call on September 11, 2001, when hijacking terrorists killed thousands of civilians, destroyed the hundred-plus-story towers of the World Trade Center in New York, and badly damaged the Pentagon building.
That event sent an already skittish stock market into chaos, causing great uncertainty, fear, and problems for millions of investors. Maybe you sometimes wake up at night, wondering what the state of your retirement fund will be when you get around to retiring. Internet companies come and go, their huge profits of one quarter plummeting to huge losses in the next. Even established, well-heeled firms are not immune to the shifts and dips of the economy, especially in these uncertain and troublesome times.
Because of all this uncertainty, an emergency fund should be near the top on your list of mid-life financial needs. Unfortunately, funding a source of emergency money is difficult for many who are trying to find enough cash for vacation, summer camp for the kids, and throwing that forty-fifth wedding anniversary party for their parents.
Most financial advisors suggest that you have between three and six months’ income saved in an emergency fund.
You’ll be extremely happy, however, to have an emergency fund available in the event that life throws you a curve ball. You lose your job; it happens all the time. You’re in a car accident and have to supplement your health insurances for the expenses it doesn’t pick up. Your car dies and you need a new one. Your elderly mother needs some financial help while she’s in an assisted living facility recovering from a stroke.
Some people need an emergency fund to tap into because their income is unsteady. If you’re in a business where you earn a lot of money some of the time, and next to nothing at other times, you should have an emergency fund you can use during the lean periods.
Many people have gotten into big debt trouble because they encountered financial hardship and didn’t have an emergency fund. Let’s face it. You need money to live. If your income suddenly stops and you have no emergency money to fall back on, what are you going to do? Pull out your good old Visa and MasterCard, what else?
Sure, you could live perfectly well on your credit cards for several months, depending on your limits. Nearly, everyone from your doctor to your grocery store clerk will be happy to take your plastic instead of cash, and your credit card issuer will be delighted.
The party ends, however, when after three months you’re still out of work and your credit card bill is up somewhere around $12,000. Then what?
Establishing an emergency fund should be a priority in your financial plan. You can use a money market fund (more about those in the next section of this chapter), so your money is accessible and liquid.
Saving up three to six months’ income for an emergency fund is a significant undertaking. And, you’ll want to make sure that you invest your emergency fund—and all your money, for that matter, in the best possible accounts. Hopefully, we all understand that some accounts are better than others for maximizing your money.
The 1990s was a banner decade for the stock market. We sat back and watched it climb higher and higher and higher—knowing all the while that the high times couldn’t possibly last forever. They didn’t. The market dropped dramatically in 2000, hopefully sending the clear message to everyone that it’s important to diversify your investments. It’s really important, especially considering the present uncertainty of the stock market after the terrorist attacks in September 2001, to have some money in funds that aren’t subject to the whims of the stock market.
A client keeps his new car fund in an equity fund, also called a stock fund. This is a mutual fund that limits its investments to shares of common stock. The risk factor of these funds varies, depending on the type of stocks in which the funds invest. The fund had done well until 2000, when it tanked with a 19 percent drop. Goodbye Lexus, hello Honda.
Money such as what you have in an emergency fund, a new car fund, or new house fund, should be invested in a money market fund. A money market fund is a mutual fund with a nonfluctuating $1 investment value per share. That means that you buy a share at $1, and sell the share later at $1. Like a savings account, if you put $800 into a money market fund, you’ll get $800 out—plus the interest.
Money market funds are good, safe choices for short-term investing. Your original investment is fairly secure, while you earn competitive interest rates. Money market funds aren’t the most exciting investment vehicles, but they assure that your money will be there when you need it. That’s why they’re desirable accounts for money such as an emergency fund, which needs to be kept at a constant value.
Money market accounts usually pay more interest than savings or checking accounts at the local bank. And most money market funds permit some check writing, though they may set a minor check minimum—$500. Some money market funds are now insured, so be sure to check with your bank or credit union.
Certificates of deposit (CDs) typically pay higher interest than bank accounts, and some pay more than money market accounts. The problem with using CDs to store your emergency fund account is that, if you need the money and have to withdraw it from the CD before the specified investment time ends, you’ll be penalized—perhaps severely. If there’s a hefty penalty, it’s possible that you could end up with less money than you had invested.
There are various types of money market funds. Some are invested in only U.S. Treasury obligations and are not subject to local income tax liability. Some are invested in municipal bonds and similar investments, so they are known as tax-free investments. If you purchase a tax-free mutual fund that participates only in investments within your state, the fund is called a triple tax-free fund. That means it is not subject to federal, state, or local income tax. If you’re in one of the higher tax brackets, this kind of money market fund might be something you’ll want to consider.
You don’t often hear somebody say that they want insurance. “Boy, I wish I could double up on my homeowner’s insurance,” is a phrase that certainly would cause you to look twice at the person speaking. Insurance, unfortunately, is something we buy because we need it—not because we want it.
We need insurance to protect ourselves from the environment, from others, and from ourselves. Insurance is a way to reduce risk by sharing financial losses within a group of people. There are many types of risks, both financial and nonfinancial. These risks include the following:
When considering these risks, you must decide if the protection you receive is worth the cost of the insurance you buy.
Many types of insurance are required. If you have a mortgage, your lender requires you to have homeowner’s insurance. Most states require auto insurance.
An insurance deductible is an amount you’ll be required to pay in the event that you file a claim. Your insurance company will pay the remaining expenses, after your deductible. The higher the deductible you have, the lower your premium should be.
In addition to these required insurances, you must decide what type of coverage you need for your family, and what you’re able to spend on them. Riders, options, and basic insurance all come at a cost so you need to review the price and the coverage as part of your total financial picture.
You may need to provide your own insurance for some risks by putting aside funds on your own. You might want to set aside money for dental bills or a nursing home stay, for instance.
Let’s look at some of the kinds of insurance that are important to you and your family.
Disability insurance kicks in if you’re unable to work for an extended period of time due to illness or injury. This type of insurance is imperative if your family depends on your income to keep a house, maintain its current standard of living, and so forth.
Don’t depend on health insurance in the event that you’re out of work due to being disabled. Your health insurance will cover (hopefully) your medical bills, but it won’t cover the loss of your salary.
Most disability insurance policies don’t cover the full amount of a salary, but kick in about 60 percent. Hopefully, you’ll have an emergency fund to supplement the gap between your income and the insurance. There are various types of disability insurance, and some factors you should be sure to consider when comparing them.
An own-occupation policy pays benefits if you’re unable to perform your normal work. Other policies will only kick in if you’re unable to do the job for which you’re reasonably trained. Many infirmities permit you to work, but not at the type of job you held prior to your infirmity.
Own-occupation policies are the most expensive type of disability insurance, because it’s more likely that the insurance company will have to pay you. It may not be worth the extra cost unless you’re earning big bucks in a specialized job and would need to take a pay cut if you were forced to change jobs.
When looking at disability insurance plans, keep the following information in mind.
There is a greater probability of being disabled than of dying by the time you’re 65. Disability insurance is coverage that is often overlooked but very, very important.
Your home probably is the biggest investment you’ll ever make, and you need an adequate homeowner’s insurance policy to protect it and what’s in it.
You’ll be required to have homeowner’s insurance before you get a mortgage. The trick is to get a policy that offers the best protection for your home and its contents.
It’s worth taking a look at your current policy to see exactly what it covers. Most homeowner’s policies have personal property coverage, as well as liability coverage. Thus, if your house burns down, all your furniture will be replaced under the personal property coverage. Make certain you have enough to cover what you own.
It’s important to realize that most standard insurance policies don’t cover special property. To insure items such as sterling silver, jewelry, and artwork, you’ll need to get an insurance rider at an additional cost.
In addition to protecting your house and property, homeowner’s coverage also provides liability coverage in case somebody falls down your front steps and breaks an ankle. We’ll spend a lot more time on homeowner’s insurance in Part 3, “Hearth and Home.” For now, just understand that it’s a need.
Adding It Up
Homeowner’s insurance covers your home and its contents against perils, which are the insurance industry’s term for anything bad that could happen to your house. Perils may include fire, damage caused by falling objects (think trees), an explosion in your heater, riots, vandalism, and hurricanes.
If you own and drive a car, you need insurance to protect yourself from injury in the event of an accident. Auto insurance is expensive, and nearly every state requires drivers to have it. Even if it’s not required, however, you can’t afford to go without it.
Auto insurance includes different types of coverage, but the one that nearly all states require is liability. Liability covers bodily injury and property damage for you and others, if you’re at fault in an accident. Most states require that you carry a minimum amount of bodily injury coverage—usually $25,000 per person, and $50,000 per accident.
Your auto and homeowner’s policies provide liability coverage up to a certain amount. What happens, however, if someone sues you for more than the limitations of your policy?
Many insurance companies provide maximum liability coverage under your homeowner’s policy of $500,000. If your neighbor falls down your steps and sues you for $750,000, you’re likely to be in for some sleepless nights.
We live in an extremely litigious society. If you have a pool, a trampoline in your yard, or a dog with a nasty temper, you may need liability coverage that is more than that provided on your homeowner’s and auto policies.
A PCAT policy comes in $1 million increments. If you’ve got sizeable assets, it’s good to think about getting one. A PCAT policy supplements other policies that you have and is not overly expensive (usually about $150 a year). Such a policy should cover damages from accidents at your home and automobile accidents.
Nobody likes to think about needing life insurance. If you’re a source of income for your family, however, it really is necessary. If you’re single, you probably don’t need much life insurance. If you’re married or in a relationship, but don’t have children, you should have life insurance if your spouse or partner would have to make a drastic change in financial lifestyle if you were no longer around. If you have kids, you need life insurance.
Life insurance should be purchased according to income replacement need and should be five to eight times the amount of your current salary. There are two types of life insurance policies: term and cash value.
If your kids are out of college and pretty well settled on their own, a term life plan might not make as much sense for you as it used to. This might be a good time to think about exchanging your term life policy for a cash value plan.
The financial necessities we’ve discussed—an emergency fund, the right accounts, good insurance policies—all can be the step between being comfortable and feeling secure, and fearing that you may lose everything that you’ve worked for. Once you’re secure that you’ve got all your needs covered, you can begin to think about the things you want.
Maybe you want to build a great portfolio (we spend all of Part 5, “Smart Investing in This Stage of Life,” talking about investments), or perhaps you’ve been dreaming of a fabulous vacation to the Australian Outback. A little vacation home might be nice, or maybe now’s a good time to think about upgrading your car. Let’s have a look at some of the wants you can think about after your needs have been met.
Maybe you’ve put off vacations for a while, opting instead to use that money to buy and furnish your home, braces for the kids, a new car here and there, and so forth. Your vacations may have been pretty much restricted to a day or two at the beach, or a quick get-away to a nearby city.
Finally, though, you’re able to think about a real vacation. Maybe you’ll take your family to Disney World for a week, or you and your spouse will finally visit the Eiffel Tower. It’s great to be able to plan to do something you’ve wanted for a long time, but take a minute to weigh the cost of a great vacation against the security you want to have in retirement.
Check out Travelocity.com for comparisons of prices of plane fares, hotel accommodations, car rentals, and even complete vacation packages. It’s on the Internet at www.travelocity.com.
We’re not saying that you shouldn’t see the Eiffel Tower—no way. The opportunity for travel is enriching and broadening. We’re saying, however, that maybe you don’t need to sail to Europe on the Queen Elizabeth II and stay in the most luxurious Parisian hotel.
Great trips are wonderful, but they’re a luxury. Just make sure you don’t go footloose and fancy free at the expense of your mortgage and retirement fund. And watch that you don’t run up outrageous credit card bills that you’ll end up paying until it’s time for your next vacation.
Maybe you’re at the point now where your mortgage payment is very manageable, or you’ve even got it paid off. If so, you might be considering buying a vacation home.
A vacation home can be anything from a hunting cabin in the mountains without running water or electricity to a luxury condo on Maui. What you get depends on what you want, and what you can afford. Some folks love roughing it in the woods, while to others, the only vacation spot worth considering comes complete with all the comforts of home and a beautiful beach.
A vacation home can be a good investment and a means of getting a break at income tax time (more about that in Chapter 12, “A Home Away from Home”), but again, it’s definitely a want—not a need. If you’ve paid off your home or have a very manageable mortgage, you have the funds needed for your children’s college educations, your car payments are under control, and you don’t have any other outrageous bills, a second home may be within your reach.
If you’ve never had a brand-new car, or at least one that you really liked, you might be thinking now about the perfect machine.
Maybe you’re ready to say good-bye to the stodgy station wagon or van you always needed to haul around your kids, their friends, and all their gear. Maybe the sedate sedan you’ve been cruising in just doesn’t do it for you anymore. Perhaps you’re looking for something with a little more style.
Luxury cars are expensive, there’s no question about it, and frankly, unless you’ve got more cash than you know what to do with, we just can’t see spending $30,000 or $40,000 on a car. If you’re in a comfortable financial position at this stage, however, and you’ve always wanted a BMW, go ahead and give one a test drive.
This may be the point in your life when leasing a vehicle makes more sense than buying it. You don’t need a big down payment to lease, and you normally can afford to lease a car that you couldn’t comfortably afford to own outright.
Leasing is the practice of paying a specified amount of money over a specified time for the use of a product. It’s similar to renting, although some types of leases allow you to buy the vehicle at the end of the contract.
An open-end lease permits you to buy the vehicle for its residual value at the end of your agreement. The residual value is what a car is worth at the end of a lease agreement, and the amount you’d pay to buy the vehicle at that time. A closed-end lease agreement states that you simply turn in your vehicle and walk away.
There are some good reason to lease a car, and also some good reasons not to. We’ll talk more about leasing in Chapter 7, “Trading In the Bikes for Cars,” when we discuss buying a car for your teenager.
There are many more wants in which you could indulge yourself if you’re financially able to do so. You could buy a boat, hire a decorator to do your house, or refurbish your kitchen. It’s not wrong to want things, or to buy the things that you want. Just make sure you take care of the needs first.
We’ve spent a significant amount of time discussing necessities versus wants. Hopefully, you have a clear understanding of your financial needs, and what you might be able to afford past those needs.
Just as it is for our children, the cookie jar is tempting. There are lots and lots of goodies out there, and advertisers tell us that we should have them all.
Credit cards and bank credit can be a tempting means of providing us with the toys we think we need. If we recognize the difference between wanting and needing, however, we may be better able to resist the temptations of overspending and running up debt. Middle age is a great time to look ahead, financially. The trick is to balance the present with the future, so you’ll be able to enjoy yourself now as well as after you retire.
It’s imperative at this stage of your life to do a quarterly reality check. Are you struggling to make ends meet? Are you paying the minimums on your credit cards while wondering if you’ll be able to pay them off the next time around? Or are you saving every penny you can, gloating about how comfy your retirement years will be?
Most of us are somewhere in between, and that’s good. You need to recognize what you have, what you need, and what you can afford to want. Hopefully, you recognize that wanting something doesn’t mean you’ve got to have it immediately—or even have it at all.
If you know your limitations and stay within your means, you’ll be much better off financially in the long run and a lot happier in the years to come.