8 Ways To Help Family Members In Financial Trouble
by Katie Adams
What do you do when a family member becomes unemployed? Or suffers an unexpected injury and can't work or has insufficient insurance to cover mounting medical bills? How do you respond when you learn a loved one can't pay their bills? Let's take a look at a few options you can consider to help your family members in trouble - without hurting yourself financially.
1. Give a cash gift.
If your loved one is having a short-term cash flow problem, you may want to give an outright financial gift. Decide how much you can afford to give, without putting yourself in financial jeopardy, and then either give the maximum amount you can afford all at once (and let your loved one know that's the case) or perhaps give smaller gifts on a periodic or regular basis until the situation is resolved. Make sure it's clearly understood that the money is a gift, not a loan to be repaid, so you don't create an awkward situation for the gift recipient. If you're considering giving them a substantial sum of money, you'll need to keep an eye on the annual gift exclusion set each year by the Internal Revenue Service (IRS).
2. Make a personal loan.
Your family member may approach you and ask for a short-term loan. Talk frankly, clearly write out the terms of the loan on paper, and have both parties sign it. This helps both parties be clear on the financial arrangement they're entering into. Some loan details you'll want to include are:
•the amount of the loan
•whether the loan will be one lump-sum payment, or if it will be divided and paid out in installments upon meeting certain conditions (i.e. securing another job, paying down existing debt, etc.)
•the interest rate you will charge for making the loan and how it will be calculated (i.e. compound or simple interest)
•payment due dates (including the date of full repayment or final installment due)
•a recourse if he or she doesn't make loan payments on time or in full (i.e. increasing interest charges, ceasing any further loan payments, taking legal action, etc.)
If you are going to lend more than $10,000 and/or you're going to charge an interest rate that is substantially different than the going rate for most borrowers, you may want to talk to a tax professional. There can be unique tax implications for low interest loans among family members.
If you're worried about potentially straining your relationship by having to administer the loan (i.e. collect payments or call when the payment is late), consider using a service, such as Prosper.com or VirginMoney.com. These companies can draw up the contracts and even collect automatic payments from your loved one's bank account. (To read more on this subject, see Outfox The Debt Collector's Hounds and Negotiating A Debt Settlement.)
3. Co-sign on a bank loan.
Your loved one may be interested in obtaining a loan or line of credit (LOC) to help with short-term financial needs but what if his or her credit requires getting a co-signer? Would you be willing to co-sign on a bank or credit union loan or LOC?
Before simply saying "yes" and essentially lending a family member your good credit, it's important to realize that there are legal and financial implications to co-signing on a loan. The most critical thing to understand is that you are legally binding yourself to repay the loan if the other borrower fails to do so. The lender can take legal action against you and require that you pay the full amount, even if you had an agreement between you and your family member that you would not have to make payments. This delinquent loan will also now affect your personal credit. So if your sister/brother/uncle fails to make payments on the loan on time and in full the lender can report the negative account activity to the credit bureaus to file on your credit report which, in turn, can lower your credit score. (Keep reading about debt and credit in The Importance Of Your Credit Rating, Debt Consolidation Made Easy and Expert Tips For Cutting Credit Card Debt.)
Co-signing a loan is serious business. The fact that your family members need a loan co-signer means that the lender considers them too great of a risk for the bank to take alone. If the bank isn't sure they'll repay the loan, what guarantees do you have that they will? It may also mean that you could have more difficulty getting a loan for yourself down the road, since you are technically taking on this loan and its payment as well.
Before co-signing for a loan, make sure you:
•Ask for a copy of your family member's credit report, credit score, and monthly budget so you'll have an accurate picture of his or her finances and ability to repay the loan.
•Meet with the lender in person (if possible) and be sure that you understand all the terms of the loan.
•Get copies of all documents related to the loan including the repayment schedule.
•Ask the lender to notify you in writing if your family member misses a payment or makes a late payment.
Finding out about potential repayment problems sooner rather than later can help you take quick action and protect your own credit score.
4. Create a budget and help create a bill-paying system.
Often, people in a financial crisis simply aren't aware where their money is going. If you have experience using a budget to manage your own money, you may be able to help your family in creating and using a budget as well. To break the ice you may want to offer to show them your budget and your bill-paying system and explain to them how it helps you make financial decisions. As you work together to help them get a handle on their financial situation, the process will point out places where they can cut back on expenses or try to increase their income to better meet their financial obligations. (To learn more, read Expert Tips For Cutting Credit Card Debt and A Guide To Debt Settlement.)
5. Provide employment.
If you're not comfortable making a loan or giving a cash gift, consider hiring your family member to assist with needed tasks at an agreed-upon rate. This side job may go a long way towards helping them earn the money they need to pay their bills, and help you finish up any jobs that you've been putting off. Treat the arrangement like you would any other employee - spell out clearly the work that needs to be done, the deadlines and the rate of pay. Be sure to include a provision about how you'll deal with poor or incomplete work.
6. Give non-cash financial assistance.
If you're uncomfortable or unwilling to give your family member cash, consider giving non-cash financial assistance, such as gift cards or gift certificates. You'll have more control over what your money will be used for and you can easily buy gift cards in varying amounts at most stores.
7. Prepay bills.
You may want to consider prepaying one or more regular bills your loved one receives (i.e. rent/mortgage, utility bills, insurance premiums, etc.) to help them during their current financial crunch. Offering to do something, such as paying their car payment may help them avoid a short-term crisis and give them the little extra time they need to work out of their situation.
8. Help them find professional assistance and local resources.
You simply may not wish or be able to provide your family member with financial assistance or hands-on help. But you can still play a key role by helping them find local professionals that can steer them in the right direction, such as:
•Career counselor and employment agencies
•Welfare agencies and similar services
•Credit and debt counselors
•Lenders who can provide short-term solutions
Conclusion
As always, the most important step is sitting down with your loved one and asking specifically what help they need to work their way out of their current situation. From there you'll have a better idea of the type of information and assistance they need. For example, if they need to make more money you could help them look for jobs and update their resume. If they need help repaying credit card debt, you could call local credit counseling agencies to learn what services they offer, how much it costs and how it could benefit your family member.
Family members and money aren't always a good mix. But, in tough economic times or when faced with unexpected emergencies, your loved ones may truly need your financial assistance. Before you commit to helping, be sure to think through what you can and can't afford to do. Remember, if your own resources are limited, there are meaningful, effective, and creative ways to help your family member(s).
Some debt just seems to keep coming back, to learn how to stop it read Dawn Of The Zombie Debt.
by Katie Adams, (Contact Author | Biography)
Katie Adams is a freelance commercial writer, marketing and public relations professional with 18 years experience. She has written extensively about financial issues and was previously Director of Regional Communications for Fannie Mae. Adams earned a B.A. from the College of William and Mary and lives with her family in Virginia Beach, Virginia. She is actively involved in international philanthropic work to improve orphan care and accelerate sustainable development in Central America. Visit her website at www.katieadams.homestead.com.
http://www.investopedia.com/articles/pf/09/help-family-members-trouble.asp
Saturday 5 December 2009
Increase Your Disposable Income
Increase Your Disposable Income
by Andrew Beattie
Although it is not the only factor in deciding how wealthy an individual is, disposable income does have a significant influence. If you have little or no money after taxes and expenses, then it is hard to save and invest for the future. In this article, we'll look at four ways you can increase your disposable income.
1. Get a Raise - or a Second Job
There is no shortage of books and articles that give advice about getting more money out of your employer. They provide counsel on everything from dressing well to taking a pay cut in exchange for performance bonuses. One of the most highly touted techniques is to go for further training or education. This can cost you money now, but it will hopefully translate into higher wages and a more secure position in the company. (To read more, see Invest In Yourself With A College Education.)
Regardless of how you go about it, getting a raise is the most obvious way to increase your income. Along the same lines is the possibility of having another job on the side. Working two jobs in tandem can be physically and mentally draining, but it will bring more money in when you need it.
The problem with increasing your income through your job is that you expose yourself to increased income taxes. The tax loss resulting from entering a higher income bracket is not prohibitive, but it is discouraging. You are working harder and often longer hours, but the returns on your effort are diminishing as your income tax rate increases. Basically, you have to work harder just to add a little more to your pocket. This is compounded by the fact that most people never see the extra wages because their lifestyles adjust to absorb it. For example, you may notice that your taxes have increased so, in order to minimize your tax bill, you decide to move into a bigger house to get more of a homeowner's deduction on the mortgage. Although you can technically afford it, the larger mortgage payment leaves you with the same disposable income as before.
2. Start a Business
Starting a business, even a small one, is a legitimate way to bolster your income. Much like a raise or second job, running a business will put more demands on your time and require more effort. The difference is that you will see more of the income from your labor because taxation for business owners is a small pinch when compared to the slap that the IRS gives to employees. Some of your business write-offs can even be claimed against other income sources, but you have to follow the rules carefully. (To find out more about this subject, see Tax Credit For Plan Expenses Incurred By Small Businesses, Plans The Small-Business Owner Can Establish and Capital Gains Tax Cuts For Middle Income Investors.)
The major drawback of starting a business is that there is no guarantee of success or income like there is with a raise or a second job. Starting a business takes a certain type of person, one with the motivation and the ability to handle the details involved in implementing an idea. The time, effort and nerves that it takes to run a business (that has no certainty of success) means that very few people will take this route.
3. Investing Income
Investing income is considered a form of passive income. This is a misnomer because it does take active effort to create income from investing - you have to research investments, build and maintain your portfolio, etc. - but it is generally considered to take less effort than, let's say, shoveling concrete day in and day out. Investing income can come from stocks, bonds, real estate, or many other forms. The common theme is that they ideally produce a return on the money you put into them. (To find out more, see Investing With A Purpose and A Guide To Portfolio Construction.)
Creating income through investing is a process of accumulation. Even if you consistently get a return on investments (ROI) of 20%, if you only have $1,000 in the investment, you will add a little less than $200 to your yearly income after any fees and taxes have been paid (and there is no guarantee of consistent returns of even 10%). Searching for stocks with a history of dividends, sometimes called income stocks, can help create some income now, but it will still not be as rapid in results as a second job. As you put more money in, however, more money comes out in the form of returns. Investing is a great way to increase your disposable income in the long run, but it won't do wonders for your immediate situation unless you have a huge chunk of capital just sitting around. Investing takes patience, time and discipline (it is also subject to taxation). That said, it is one of the surest ways to gradually add to your disposable income without exerting yourself too much.
4. Spend Less
The best way to increase your disposable income is to protect the money you earn by spending less. Tightening your budget will take some effort in the form of sacrificing a few luxuries, but the increase to your disposable income will not require longer hours or incur any extra tax. The more after-tax dollars you hold onto, the easier it is to do things like investing to secure more income in the future.
You don't have to scour the classifieds or create a business model or subscribe to a bunch of financial magazines, you just have to spend less than you are currently making. Earning more may help you, but spending less is the only iron-clad solution to the problem of living paycheck to paycheck and never having enough. (Keep reading about this subject in The Indiana Jones Guide To Getting Ahead, Downsize Your Home To Downsize Expenses and Enjoy Life Now And Still Save For Later.)
Conclusion
Of all the ways to increase your disposable income, the simplest one is by far the best. Spending less and saving more can be used in conjunction with any of the other strategies as well as being the only one that isn't going to affect your taxes or require more of your time. In the words of Benjamin Franklin, "If you know how to spend less than you get, then you have the philosopher's stone."
To read more, see Three Simple Steps To Building Wealth, Starting Early With Financial Planning and Understanding The Time Value Of Money.
by Andrew Beattie, (Contact Author | Biography)
Andrew Beattie is a freelance writer and self-educated investor. He worked for Investopedia as an editor and staff writer before moving to Japan in 2003. Andrew still lives in Japan with his wife, Rie. Since leaving Investopedia, he has continued to study and write about the financial world's tics and charms. Although his interests have been necessarily broad while learning and writing at the same time, perennial favorites include economic history, index funds, Warren Buffett and personal finance. He may also be the only financial writer who can claim to have read "The Encyclopedia of Business and Finance" cover to cover.
http://www.investopedia.com/articles/pf/07/disposable_income.asp?viewed=1
by Andrew Beattie
Although it is not the only factor in deciding how wealthy an individual is, disposable income does have a significant influence. If you have little or no money after taxes and expenses, then it is hard to save and invest for the future. In this article, we'll look at four ways you can increase your disposable income.
1. Get a Raise - or a Second Job
There is no shortage of books and articles that give advice about getting more money out of your employer. They provide counsel on everything from dressing well to taking a pay cut in exchange for performance bonuses. One of the most highly touted techniques is to go for further training or education. This can cost you money now, but it will hopefully translate into higher wages and a more secure position in the company. (To read more, see Invest In Yourself With A College Education.)
Regardless of how you go about it, getting a raise is the most obvious way to increase your income. Along the same lines is the possibility of having another job on the side. Working two jobs in tandem can be physically and mentally draining, but it will bring more money in when you need it.
The problem with increasing your income through your job is that you expose yourself to increased income taxes. The tax loss resulting from entering a higher income bracket is not prohibitive, but it is discouraging. You are working harder and often longer hours, but the returns on your effort are diminishing as your income tax rate increases. Basically, you have to work harder just to add a little more to your pocket. This is compounded by the fact that most people never see the extra wages because their lifestyles adjust to absorb it. For example, you may notice that your taxes have increased so, in order to minimize your tax bill, you decide to move into a bigger house to get more of a homeowner's deduction on the mortgage. Although you can technically afford it, the larger mortgage payment leaves you with the same disposable income as before.
2. Start a Business
Starting a business, even a small one, is a legitimate way to bolster your income. Much like a raise or second job, running a business will put more demands on your time and require more effort. The difference is that you will see more of the income from your labor because taxation for business owners is a small pinch when compared to the slap that the IRS gives to employees. Some of your business write-offs can even be claimed against other income sources, but you have to follow the rules carefully. (To find out more about this subject, see Tax Credit For Plan Expenses Incurred By Small Businesses, Plans The Small-Business Owner Can Establish and Capital Gains Tax Cuts For Middle Income Investors.)
The major drawback of starting a business is that there is no guarantee of success or income like there is with a raise or a second job. Starting a business takes a certain type of person, one with the motivation and the ability to handle the details involved in implementing an idea. The time, effort and nerves that it takes to run a business (that has no certainty of success) means that very few people will take this route.
3. Investing Income
Investing income is considered a form of passive income. This is a misnomer because it does take active effort to create income from investing - you have to research investments, build and maintain your portfolio, etc. - but it is generally considered to take less effort than, let's say, shoveling concrete day in and day out. Investing income can come from stocks, bonds, real estate, or many other forms. The common theme is that they ideally produce a return on the money you put into them. (To find out more, see Investing With A Purpose and A Guide To Portfolio Construction.)
Creating income through investing is a process of accumulation. Even if you consistently get a return on investments (ROI) of 20%, if you only have $1,000 in the investment, you will add a little less than $200 to your yearly income after any fees and taxes have been paid (and there is no guarantee of consistent returns of even 10%). Searching for stocks with a history of dividends, sometimes called income stocks, can help create some income now, but it will still not be as rapid in results as a second job. As you put more money in, however, more money comes out in the form of returns. Investing is a great way to increase your disposable income in the long run, but it won't do wonders for your immediate situation unless you have a huge chunk of capital just sitting around. Investing takes patience, time and discipline (it is also subject to taxation). That said, it is one of the surest ways to gradually add to your disposable income without exerting yourself too much.
4. Spend Less
The best way to increase your disposable income is to protect the money you earn by spending less. Tightening your budget will take some effort in the form of sacrificing a few luxuries, but the increase to your disposable income will not require longer hours or incur any extra tax. The more after-tax dollars you hold onto, the easier it is to do things like investing to secure more income in the future.
You don't have to scour the classifieds or create a business model or subscribe to a bunch of financial magazines, you just have to spend less than you are currently making. Earning more may help you, but spending less is the only iron-clad solution to the problem of living paycheck to paycheck and never having enough. (Keep reading about this subject in The Indiana Jones Guide To Getting Ahead, Downsize Your Home To Downsize Expenses and Enjoy Life Now And Still Save For Later.)
Conclusion
Of all the ways to increase your disposable income, the simplest one is by far the best. Spending less and saving more can be used in conjunction with any of the other strategies as well as being the only one that isn't going to affect your taxes or require more of your time. In the words of Benjamin Franklin, "If you know how to spend less than you get, then you have the philosopher's stone."
To read more, see Three Simple Steps To Building Wealth, Starting Early With Financial Planning and Understanding The Time Value Of Money.
by Andrew Beattie, (Contact Author | Biography)
Andrew Beattie is a freelance writer and self-educated investor. He worked for Investopedia as an editor and staff writer before moving to Japan in 2003. Andrew still lives in Japan with his wife, Rie. Since leaving Investopedia, he has continued to study and write about the financial world's tics and charms. Although his interests have been necessarily broad while learning and writing at the same time, perennial favorites include economic history, index funds, Warren Buffett and personal finance. He may also be the only financial writer who can claim to have read "The Encyclopedia of Business and Finance" cover to cover.
http://www.investopedia.com/articles/pf/07/disposable_income.asp?viewed=1
How much life insurance should I have?
How much life insurance should I have?
--------------------------------------------------------------------------------
The main purpose of life insurance is to provide the same standard of living for your family and cover your financial responsibilities in the event of your death.
The two most common methods for determining insurance needs are the following:
Rule of Thumb Method - Most commonly used, and easy to calculate. Simply calculate your annual income and multiply this figure by five- to 10-times your annual income. It's a quick method, but not the most precise nor situation-specific.
Actual Needs Method - Here you'll need to compute all of your debts, expenses and inflows in a similar budget and balance sheet format. Once you've done this, you'll want to make sure that you obtain enough insurance to payoff all of the debts (current and future-college for the kids), next you'll want to add a yearly expense cushion (maybe cover five- to 10-years of expenses). When you have these figures, add them together and this is how much insurance you should obtain.
Standard of Living Method - Determine the amount of money the survivors would need to maintain their standard of living if the insured person died. Multiply that amount by 20. The thought process here is that the survivors can take a 5% withdrawal from the death benefit each year (which is equivalent to the standard of living amount) where at the same time the survivors should be able to invest the death benefit principal and earn 5% or better. (For more, see What To Expect When Applying For Life Insurance.)
(This question was answered by Steven Merkel.)
http://www.investopedia.com/ask/answers/09/how-much-life-insurance.asp
--------------------------------------------------------------------------------
The main purpose of life insurance is to provide the same standard of living for your family and cover your financial responsibilities in the event of your death.
The two most common methods for determining insurance needs are the following:
Rule of Thumb Method - Most commonly used, and easy to calculate. Simply calculate your annual income and multiply this figure by five- to 10-times your annual income. It's a quick method, but not the most precise nor situation-specific.
Actual Needs Method - Here you'll need to compute all of your debts, expenses and inflows in a similar budget and balance sheet format. Once you've done this, you'll want to make sure that you obtain enough insurance to payoff all of the debts (current and future-college for the kids), next you'll want to add a yearly expense cushion (maybe cover five- to 10-years of expenses). When you have these figures, add them together and this is how much insurance you should obtain.
Standard of Living Method - Determine the amount of money the survivors would need to maintain their standard of living if the insured person died. Multiply that amount by 20. The thought process here is that the survivors can take a 5% withdrawal from the death benefit each year (which is equivalent to the standard of living amount) where at the same time the survivors should be able to invest the death benefit principal and earn 5% or better. (For more, see What To Expect When Applying For Life Insurance.)
(This question was answered by Steven Merkel.)
http://www.investopedia.com/ask/answers/09/how-much-life-insurance.asp
5 Costs Of Financial Procrastination
5 Costs Of Financial Procrastination
by Investopedia Staff, (Investopedia.com)
As long-time procrastinators will attest, this deferral of something that needs to be done is rarely an isolated instance, and it usually occurs habitually and for trivial reasons.
Procrastination can have a number of undesirable consequences, such as
But what can be quantified – at least to some extent – are the costs associated with putting off decisions and actions when it comes to personal finances and investments. Beware of such "financial procrastination," because the price tag of needless delay in this crucial area can be steep.
Five Costs of Financial Procrastination
Broadly speaking, we can classify the costs of financial procrastination in five main areas:
1. Investing Delays
Delays in putting your money to work through investments can eventually end up costing you a lot.
Consider the case of two hypothetical investors, Ms. A. Lacrity and Mr. D. Lay, who begin investing $2,000 annually at ages 30 and 40 respectively in a tax-deferred account such as an individual retirement account (IRA).
Annual Rate of Return
5.00%
5.00%
Period (years)
30
20
Annual Investment
$2,000
$2,000
Total Investment (I)
$60,000
$40,000
Total Value (V)
$132,878
$66,132
Growth (V – I)
$72,878
$26,132
Cost Of Procrastination
$26,746
Of course, the fact that A. Lacrity invested an additional $20,000 over 10 years accounts for part of the difference in the two portfolios.
Two points need to be noted here:
•The higher the rate of return, the higher the cost of procrastination – According to Ibbotson Associates, the compound annualized return for the S&P 500 for the 30-year period from July 1979 to July 2009 was 10.75%; for the 20-year period from July 1989 to July 2009, it was 7.76%. Long-term government bonds returned 9.46% annually for the 30-year period beginning July 1979, and 8.55% for the 20-year period commencing July 1989.
•If we therefore assume an 8% annual rate of return in the previous example instead of 5%, the cost of procrastination rises dramatically. As can be seen in Table 2, this cost increases to over $95,000.
Annual Rate of Return
8.00%
8.00%
Period (years)
30
20
Annual Investment
$2,000
$2,000
Total Investment
$60,000
$40,000
Total Value
$226,566
$91,524
Growth
$166,566
$51,524
Cost of Procrastination
$95,042
2. Putting Off Investment Decisions
Putting off investment decisions until the market "improves," or consciously delaying investing in a bid to "time the market," can also cost thousands of dollars over the long term. Many professionals view market timing as an exercise in futility, primarily because missing the market's best days can erode returns significantly.
One study shows that $10,000 invested in the S&P 500 on January 1, 1980, would have grown to $121,029 on June 30, 2008. But if the investment missed just the 10 best-performing days for the index over this period, it would have only grown to $70,745 or about 42% lower.
Another study shows that $10,000 invested in the S&P 500 for a 30-year period from January 1, 1979 would have grown to about $229,000 by December 31, 2008, or an 11.0% annual rate of return. Missing the best 20 months over this timeframe would erode the value of the investment to approximately $42,000, or 4.9% annually.
An investor who invested $100,000 in the S&P 500 at the beginning of March 2009 would have obtained total returns (including dividends) of 51% by mid-November of that year. Had that investor procrastinated for a couple of months and invested at the beginning of May, total returns by mid-November 2009 would have shrunk by half, to about 26%. The cost of procrastination in this case would be 25%, or $25,000 on a $100,000 portfolio.
The best way to avoid missing out on days when financial markets are on a red-hot streak is to ensure that you stay fully invested in it. In case you are concerned about investing "at the top," one solution would be to make periodic investments through an automatic plan rather than through a lump sum. (To learn more, read Dollar Cost Averaging Pays.)
3. Tardiness in Organizing Personal Finances
Getting your financial house in order is a vital area that may tend to get overlooked in the hustle and bustle of daily life. In some cases, this tardiness may have a direct opportunity cost - for example,
For example, tardiness in depositing checks may lead to an overdrawn account, while putting off paying bills may lead to missed due dates. While financial penalties in the form of overdraft fees, late charges and interest costs are an inevitable consequence of such procrastination, the bigger impact may arise from negative revisions to one's credit profile and credit score. (For more, check out 5 Keys To Unlocking A Better Credit Score.)
A couple of minor bills that you never got around to paying can eventually end up as a red flag on your credit report. Lenders who view your credit report may then view you as a higher-risk borrower, and charge you a higher interest rate to compensate for this perceived greater risk. This can result in thousands of dollars in higher interest costs for big-ticket items such as a house or a car, a steep price to pay for procrastinating on a couple of bill payments.
4. Late Filing of Taxes
Since the tendency to procrastinate is directly proportional to the unpleasantness of the task, it is not surprising to note the large number of people who miss the deadline for filing their tax returns every year. By that token, April 15 must probably rank as one of the most dreaded dates for procrastinators in the U.S. But it makes sense to file taxes by the due date, because penalties and interest can make late filing an expensive proposition.
The IRS charges a monthly penalty of 5% of the tax payable for failure to file income tax returns by their due date, up to a maximum penalty of 25%. So if you were unable to get your paperwork together in time to meet the tax filing deadline, and ended up filing six months late with a tax balance payable of $5,000, your failure-to-file penalty (excluding interest) would be $1,250. Your total cost of procrastination in this case would be $1,250 plus any interest or other penalties assessed by the IRS. That should be sufficient inducement to avoid procrastinating on your taxes in future years. (For more, check out Next Season, File Taxes On Your Own.)
5. Procrastinating on Major Financial Decisions
While the preceding cases can cost in the thousands, procrastinating on major financial decisions can ultimately cost you the most.
For most people, the necessity to make major financial decisions – the ones that involve relatively large sums of money – tends to coincide with personal milestones such as buying a residential property or saving up for retirement. It is highly advisable in such cases to begin learning at the earliest opportunity about the finer details of the upcoming financial milestone and the factors that need to be considered in making a decision concerning it. As an example, when buying a residential property, the prospective buyer needs to evaluate numerous factors, including:
Procrastinating on major financial decisions may lead to a number of pitfalls such as:
•Making hasty decisions without adequate research
•Having insufficient time to read and analyze the "fine print" in contracts
•Not having adequate insurance coverage or assets in times of need
Buying an overpriced condo without assessing its investment merits; being unaware that one's adjustable-rate mortgage will reset to an interest rate that is twice the teaser rate; being struck down with a debilitating illness when one does not have long-term disability insurance. These are all examples of unfortunate financial situations that can wipe out a massive chunk of one's bank balance and net worth. However, doing one's homework and taking prompt action can help avert or at least mitigate these losses. (For more, see Are You Living Too Close To The Edge?)
Conclusion
Time is indeed money when decisions have to be made and actions taken with regard to your personal finances and investments. In this regard, prompt action needs to replace financial procrastination, since the costs associated with the latter can be very steep.
by Investopedia Staff, (Contact Author | Biography)
Investopedia.com believes that individuals can excel at managing their financial affairs. As such, we strive to provide free educational content and tools to empower individual investors, including thousands of original and objective articles and tutorials on a wide variety of financial topics.
http://www.investopedia.com/articles/pf/09/costs-of-financial-procrastination.asp?viewed=1
- missed deadlines,
- wasted opportunities and
- sub-standard work as a result of insufficient time.
Broadly speaking, we can classify the costs of financial procrastination in five main areas:
- Delays in investing
- Putting off routine investment decisions
- Tardiness in organizing personal finances
- Late filing of taxes
- Procrastinating on major financial decisions
Delays in putting your money to work through investments can eventually end up costing you a lot.
Consider the case of two hypothetical investors, Ms. A. Lacrity and Mr. D. Lay, who begin investing $2,000 annually at ages 30 and 40 respectively in a tax-deferred account such as an individual retirement account (IRA).
- Let's assume that the long-term average annual rate of return earned by both investors on their investments is 5%.
- By the time they turn 60, A. Lacrity's IRA would have grown to about $132,878, twice the size of D. Lay's IRA, as Table 1 shows.
5.00%
5.00%
30
20
$2,000
$2,000
$60,000
$40,000
$132,878
$66,132
$72,878
$26,132
$26,746
- But a substantial part of the difference – or $26,746 – can also be attributed to the compounding effect of the $20,000 for the additional 10 years that A. Lacrity has been investing.
- Another way of looking at this from D. Lay's viewpoint is that this $26,746 in incremental growth represents his "cost of procrastination" for the 10-year period (recall that he commenced investing at age 40, rather than at 30). (Learn more in Accelerating Returns With Continuous Compounding.)
Annual Rate of Return
8.00%
8.00%
30
20
$2,000
$2,000
$60,000
$40,000
$226,566
$91,524
$166,566
$51,524
Putting off investment decisions until the market "improves," or consciously delaying investing in a bid to "time the market," can also cost thousands of dollars over the long term. Many professionals view market timing as an exercise in futility, primarily because missing the market's best days can erode returns significantly.
Getting your financial house in order is a vital area that may tend to get overlooked in the hustle and bustle of daily life. In some cases, this tardiness may have a direct opportunity cost - for example,
- a $50 gift card that you delayed using for two or three years until it was well past expiry.
- In other cases, procrastination may have a relatively minor effect at first, but may have a cascading impact that gets magnified over time.
Since the tendency to procrastinate is directly proportional to the unpleasantness of the task, it is not surprising to note the large number of people who miss the deadline for filing their tax returns every year. By that token, April 15 must probably rank as one of the most dreaded dates for procrastinators in the U.S. But it makes sense to file taxes by the due date, because penalties and interest can make late filing an expensive proposition.
While the preceding cases can cost in the thousands, procrastinating on major financial decisions can ultimately cost you the most.
- the mortgage amount that can be comfortably serviced,
- arranging for the down payment,
- deciding on whether to opt for a fixed-rate or adjustable-rate mortgage,
- deciding how much to bid for a desirable property etc.
•Having insufficient time to read and analyze the "fine print" in contracts
•Not having adequate insurance coverage or assets in times of need
Buying an overpriced condo without assessing its investment merits; being unaware that one's adjustable-rate mortgage will reset to an interest rate that is twice the teaser rate; being struck down with a debilitating illness when one does not have long-term disability insurance. These are all examples of unfortunate financial situations that can wipe out a massive chunk of one's bank balance and net worth. However, doing one's homework and taking prompt action can help avert or at least mitigate these losses. (For more, see Are You Living Too Close To The Edge?)
Time is indeed money when decisions have to be made and actions taken with regard to your personal finances and investments. In this regard, prompt action needs to replace financial procrastination, since the costs associated with the latter can be very steep.
What do people mean when they say debt is a relatively cheaper form of finance than equity?
What do people mean when they say debt is a relatively cheaper form of finance than equity?
--------------------------------------------------------------------------------
In this case, the "cost" being referred to is the measurable cost of obtaining capital.
For example, if you run a small business and need $40,000 of financing, you can either take out a $40,000 bank loan at a 10% interest rate or you can sell a 25% stake in your business to your neighbor for $40,000.
Of course, the advantage of the fixed-interest nature of debt can also be a disadvantage, as it presents a fixed expense, thus increasing a company's risk.
Companies are never 100% certain what their earnings will amount to in the future (although they can make reasonable estimates), and the more uncertain their future earnings, the more risk presented.
(For more on the costs of capital, see Investors Need A Good WACC.)
http://www.investopedia.com/ask/answers/05/debtcheaperthanequity.asp
In this case, the "cost" being referred to is the measurable cost of obtaining capital.
- With debt, this is the interest expense a company pays on its debt.
- With equity, the cost of capital refers to the claim on earnings which must be afforded to shareholders for their ownership stake in the business.
- Suppose your business earns $20,000 profits during the next year. If you took the bank loan, your interest expense (cost of debt financing) would be $4,000, leaving you with $16,000 in profit.
- Conversely, had you used equity financing, you would have zero debt (and thus no interest expense), but would keep only 75% of your profit (the other 25% being owned by your neighbor). Thus, your personal profit would only be $15,000 (75% x $20,000).
- From this example, you can see how it is less expensive for you, as the original shareholder of your company, to issue debt as opposed to equity.
- Taxes make the situation even better if you had debt, since interest expense is deducted from earnings before income taxes are levied, thus acting as a tax shield (although we have ignored taxes in this example for the sake of simplicity).
- Going back to our example, suppose your company only earned $5,000 during the next year.
- With debt financing, you would still have the same $4,000 of interest to pay, so you would be left with only $1,000 of profit ($5,000 - $4,000).
- With equity, you again have no interest expense, but only keep 75% of your profits, thus leaving you with $3,750 of profits (75% x $5,000).
- So, as you can see, provided a company is expected to perform well, debt financing can usually be obtained at a lower effective cost.
- However, if a company fails to generate enough cash, the fixed-cost nature of debt can prove too burdensome. This basic idea represents the risk associated with debt financing.
- Thus, companies in very stable industries with consistent cash flows generally make heavier use of debt than companies in risky industries or companies who are very small and just beginning operations.
- New businesses with high uncertainty may have a difficult time obtaining debt financing, and thus finance their operations largely through equity.
What is GDP and why is it so important?
- It represents the total dollar value of all goods and services produced over a specific time period - you can think of it as the size of the economy.
- Usually, GDP is expressed as a comparison to the previous quarter or year.
- For example, if the year-to-year GDP is up 3%, this is thought to mean that the economy has grown by 3% over the last year.
- either by adding up what everyone earned in a year (income approach), or
- by adding up what everyone spent (expenditure method).
The expenditure method is the more common approach and is calculated by adding total consumption, investment, government spending and net exports.
- For example, when the economy is healthy, you will typically see low unemployment and wage increases as businesses demand labor to meet the growing economy.
- A significant change in GDP, whether up or down, usually has a significant effect on the stock market.
- It's not hard to understand why: a bad economy usually means lower profits for companies, which in turn means lower stock prices.
- Investors really worry about negative GDP growth, which is one of the factors economists use to determine whether an economy is in a recession.
Is The U.S. Government Too Big To Fail?
Is The U.S. Government Too Big To Fail?
by Marv Dumon
When considering whether the U.S. government is too big to fail, it's helpful to look at historical precursors and ask yourself: Was the Roman Empire too big to fail? How about Genghis Khan and his Mongolian Empire, or Alexander the Great and the Macedonians? Can we find an everlasting civilization in the ancient Egyptians or the early Chinese? History not only teaches, but shows, that civilizations and species are only as fragile as one non-adaptive and careless generation.
Most people believe that incomprehensibly large systems are simply beyond demise, or are somehow invincible. Compared to other nation states and empires that once dotted the globe, America is a fairly young country, at a little over 200 years old. The U.S. boasts the world's biggest economy, which helps to fund and support its gargantuan bureaucracy. Massive amounts of liabilities on the government balance sheet, however, threaten significant cuts on important programs that are aimed at keeping the country strong.
Programs such as education, defense and homeland security, and technological research are reliant on adequate funding (along with effective implementation and execution) for the continuing long-term prosperity of the U.S. Significant fiscal pressures placed on the U.S. government may well reduce future funding of these critical programs - especially if belt tightening becomes the only option for fiscal responsibility. Lack of funding, along with lack of effectiveness of the funded programs, heightens the country's economic, geo-political and defense risks. (Learn more in our Credit Crisis Tutorial.)
Financial Metrics
The U.S. economy is the world's largest, with a gross domestic product (GDP) of approximately $14.5 trillion as of the end of 2008. This economy supports a massive governmental bureaucracy with a budget of $2.9 trillion for 2008. This budget represents annual expenditures spent on defense, homeland security, education, health services, infrastructure and other programs. The latter half of the 2000s saw severe economic pressures on ordinary citizens, the federal government, as well as state and local governments. (Mutual funds devoted to keeping roads, structures and communities safe can make you money, read Build Your Portfolio With Infrastructure Investments.)
A Decade of Missteps
As of the latter half of the decade ending 2010, the federal government and markets underwent the following:
The war on terror cost hundreds of billions of dollars in 2008, and was projected to rise in 2009. Since 2001, the total cost of the war has exceeded $2 trillion.
The years from 2000-2008 brought in the five biggest budget deficits in America's history. In 2008, the federal budget deficit exceeded $450 billion – an all-time high at the time. In 2009, the budget deficit is expected to exceed $700 billion. That deficit figure was highly unforeseeable (if not unimaginable) merely a decade earlier.
2008 saw the U.S. hit a 53-year high for national debt as a percentage of GDP. In the fourth quarter of 2008, the national debt clock in Times Square ran out of space, and had to eliminate the dollar sign in order to add another zero to the government's debt. As of October 2008, the national debt exceeded $10 trillion for the first time. Merely three months later, the national debt exceed $10.6 trillion, and at the time, some were expecting the national debt to increase by $1 trillion within the next year. (Learn more in The Treasury And The Federal Reserve.)
To facilitate the national debt, the federal government had to borrow more money, much of which came from foreign sources including the Middle East, Europe, China and others. Additional liabilities on the balance sheet means that the government has to set aside interest payments that could otherwise be spent on education, healthcare, infrastructure and military programs. Interest payments are essentially a zero sum expenditure with high opportunity costs. (Find out more about these debt obligations in Buy Treasuries Directly From The Fed and Where can I buy government bonds?)
U.S. taxpayers, with their periodic payroll checks, have been funding Social Security and Medicare in anticipation of benefits as they get older and retire. Congress had been spending hundreds of billions of dollars of trust fund money on various spending programs, as opposed to setting it aside for the taxpayers' retirement benefits. In 2008, Congress "borrowed" $674 billion in Social Security trust funds. Social Security and Medicare have been regarded as unfunded liabilities. That is because only a portion of the monies provided by taxpayers are actually set aside. They are also regarded as generational liabilities, which is when a current generation borrows money, and when they die, the bill is handed off to future generations – while the current generation benefits from the current spending. As the U.S. approaches the end of the 2000s, some economists and government accountants estimate that these unfunded liabilities would exceed $80 trillion. (For more, check out Introduction To Social Security.)
A U.S. and global economic recession not seen since World War II was placing financial stress on citizens, affecting the lower, middle, and upper classes. Wall Street's poorest performance since the Great Depression of the 1930s saw stock market wealth worth $6.9 trillion wiped out during 2008.
Over one million jobs were eliminated in the U.S. in 2008, which contributed to the unemployment rate approaching 8%. With U.S. per capita earnings of $48,000, one million layoffs translate to approximately $48 billion in eliminated payroll and earnings for working families. These statistics do not include under-employment figures in the country – it is estimated that one out of nine Americans are underemployed. As of 2007, approximately 12.5% of Americans lived below the poverty line. (From unemployment and inflation to government policy, learn what macroeconomics measures and how it affects everyone in Macroeconomic Analysis and Economic Indicators To Know.)
The housing collapse was expected to require government intervention and action on mortgages that require over $1 trillion. American homeowners saw over $1.9 trillion in home values wiped out in 2008. A frozen credit market forced the government to spend several hundred billion dollars through a stimulus package. Continued frozen credit facilities through 2009 made the economic downturn of 2008-2009 more protracted and more costly for the government.
Future Opportunities
The U.S. continues to be the most technologically advanced nation in the world, with the best research universities. New developments and advances can bring a wave of economic stimulus simultaneously ushering in a new age in commerce activity.
These areas could become the economic rallying cry to uplift the economy and refill government coffers:
•clean / alternative energy and fuel efficiency
•infrastructure building and repair
•nanotechnology
•robotics
•healthcare advances
Parting Thoughts
The ruins of ancient Rome, and numerous other civilizations centuries ago, serve as warning to national leaders against taking rash actions on behalf of their people or on behalf of future generations. Such gambles can spell disaster, and risk the very existence of the state. Fiscal irresponsibility may not bring about such a rapid decline as that of Napoleon's charge on Russia, or Germany's multi-front wars, but it can lead to a longer-term protracted decline similar to ancient Rome's nagging and continued multi-front wars and internal discord.
Fiscal decline is a slower process of reduction in flexibility, which forces leaders to make choices in proportional constriction. Affected citizens encounter reduction in economic wealth and quality of living. The philosophy of monetary and resource conservatism has endured over the millennia, from agricultural to hunter-gatherer societies, for a reason. There is a time when corrective measures in the form of resource conservatism, temperament and an urgency in common sense, are the clarion call of the times. (Learn about the series of events that triggered the Great Depression and other crashes in The Crash Of 1929 - Could It Happen Again? and our Market Crashes Tutorial.)
by Marv Dumon, (Contact Author | Biography)
Marv Dumon serves as a mergers and acquisitions advisor for a middle-market financial services firm specializing in industrial and energy companies. He maintains established relationships with more than 500 mid-market private equity firms. He also serves as a national business and finance columnist for Examiner.com. Dumon's background includes experience in consulting, finance and operations with several organizations including two S&P 500 companies. He received a Bachelor of Arts, a Bachelor of Business Administration and a Master of Accounting from the University of Texas at Austin.
http://www.investopedia.com/articles/economics/09/us-government-too-big-to-fail.asp
by Marv Dumon
When considering whether the U.S. government is too big to fail, it's helpful to look at historical precursors and ask yourself: Was the Roman Empire too big to fail? How about Genghis Khan and his Mongolian Empire, or Alexander the Great and the Macedonians? Can we find an everlasting civilization in the ancient Egyptians or the early Chinese? History not only teaches, but shows, that civilizations and species are only as fragile as one non-adaptive and careless generation.
Most people believe that incomprehensibly large systems are simply beyond demise, or are somehow invincible. Compared to other nation states and empires that once dotted the globe, America is a fairly young country, at a little over 200 years old. The U.S. boasts the world's biggest economy, which helps to fund and support its gargantuan bureaucracy. Massive amounts of liabilities on the government balance sheet, however, threaten significant cuts on important programs that are aimed at keeping the country strong.
Programs such as education, defense and homeland security, and technological research are reliant on adequate funding (along with effective implementation and execution) for the continuing long-term prosperity of the U.S. Significant fiscal pressures placed on the U.S. government may well reduce future funding of these critical programs - especially if belt tightening becomes the only option for fiscal responsibility. Lack of funding, along with lack of effectiveness of the funded programs, heightens the country's economic, geo-political and defense risks. (Learn more in our Credit Crisis Tutorial.)
Financial Metrics
The U.S. economy is the world's largest, with a gross domestic product (GDP) of approximately $14.5 trillion as of the end of 2008. This economy supports a massive governmental bureaucracy with a budget of $2.9 trillion for 2008. This budget represents annual expenditures spent on defense, homeland security, education, health services, infrastructure and other programs. The latter half of the 2000s saw severe economic pressures on ordinary citizens, the federal government, as well as state and local governments. (Mutual funds devoted to keeping roads, structures and communities safe can make you money, read Build Your Portfolio With Infrastructure Investments.)
A Decade of Missteps
As of the latter half of the decade ending 2010, the federal government and markets underwent the following:
The war on terror cost hundreds of billions of dollars in 2008, and was projected to rise in 2009. Since 2001, the total cost of the war has exceeded $2 trillion.
The years from 2000-2008 brought in the five biggest budget deficits in America's history. In 2008, the federal budget deficit exceeded $450 billion – an all-time high at the time. In 2009, the budget deficit is expected to exceed $700 billion. That deficit figure was highly unforeseeable (if not unimaginable) merely a decade earlier.
2008 saw the U.S. hit a 53-year high for national debt as a percentage of GDP. In the fourth quarter of 2008, the national debt clock in Times Square ran out of space, and had to eliminate the dollar sign in order to add another zero to the government's debt. As of October 2008, the national debt exceeded $10 trillion for the first time. Merely three months later, the national debt exceed $10.6 trillion, and at the time, some were expecting the national debt to increase by $1 trillion within the next year. (Learn more in The Treasury And The Federal Reserve.)
To facilitate the national debt, the federal government had to borrow more money, much of which came from foreign sources including the Middle East, Europe, China and others. Additional liabilities on the balance sheet means that the government has to set aside interest payments that could otherwise be spent on education, healthcare, infrastructure and military programs. Interest payments are essentially a zero sum expenditure with high opportunity costs. (Find out more about these debt obligations in Buy Treasuries Directly From The Fed and Where can I buy government bonds?)
U.S. taxpayers, with their periodic payroll checks, have been funding Social Security and Medicare in anticipation of benefits as they get older and retire. Congress had been spending hundreds of billions of dollars of trust fund money on various spending programs, as opposed to setting it aside for the taxpayers' retirement benefits. In 2008, Congress "borrowed" $674 billion in Social Security trust funds. Social Security and Medicare have been regarded as unfunded liabilities. That is because only a portion of the monies provided by taxpayers are actually set aside. They are also regarded as generational liabilities, which is when a current generation borrows money, and when they die, the bill is handed off to future generations – while the current generation benefits from the current spending. As the U.S. approaches the end of the 2000s, some economists and government accountants estimate that these unfunded liabilities would exceed $80 trillion. (For more, check out Introduction To Social Security.)
A U.S. and global economic recession not seen since World War II was placing financial stress on citizens, affecting the lower, middle, and upper classes. Wall Street's poorest performance since the Great Depression of the 1930s saw stock market wealth worth $6.9 trillion wiped out during 2008.
Over one million jobs were eliminated in the U.S. in 2008, which contributed to the unemployment rate approaching 8%. With U.S. per capita earnings of $48,000, one million layoffs translate to approximately $48 billion in eliminated payroll and earnings for working families. These statistics do not include under-employment figures in the country – it is estimated that one out of nine Americans are underemployed. As of 2007, approximately 12.5% of Americans lived below the poverty line. (From unemployment and inflation to government policy, learn what macroeconomics measures and how it affects everyone in Macroeconomic Analysis and Economic Indicators To Know.)
The housing collapse was expected to require government intervention and action on mortgages that require over $1 trillion. American homeowners saw over $1.9 trillion in home values wiped out in 2008. A frozen credit market forced the government to spend several hundred billion dollars through a stimulus package. Continued frozen credit facilities through 2009 made the economic downturn of 2008-2009 more protracted and more costly for the government.
Future Opportunities
The U.S. continues to be the most technologically advanced nation in the world, with the best research universities. New developments and advances can bring a wave of economic stimulus simultaneously ushering in a new age in commerce activity.
These areas could become the economic rallying cry to uplift the economy and refill government coffers:
•clean / alternative energy and fuel efficiency
•infrastructure building and repair
•nanotechnology
•robotics
•healthcare advances
Parting Thoughts
The ruins of ancient Rome, and numerous other civilizations centuries ago, serve as warning to national leaders against taking rash actions on behalf of their people or on behalf of future generations. Such gambles can spell disaster, and risk the very existence of the state. Fiscal irresponsibility may not bring about such a rapid decline as that of Napoleon's charge on Russia, or Germany's multi-front wars, but it can lead to a longer-term protracted decline similar to ancient Rome's nagging and continued multi-front wars and internal discord.
Fiscal decline is a slower process of reduction in flexibility, which forces leaders to make choices in proportional constriction. Affected citizens encounter reduction in economic wealth and quality of living. The philosophy of monetary and resource conservatism has endured over the millennia, from agricultural to hunter-gatherer societies, for a reason. There is a time when corrective measures in the form of resource conservatism, temperament and an urgency in common sense, are the clarion call of the times. (Learn about the series of events that triggered the Great Depression and other crashes in The Crash Of 1929 - Could It Happen Again? and our Market Crashes Tutorial.)
by Marv Dumon, (Contact Author | Biography)
Marv Dumon serves as a mergers and acquisitions advisor for a middle-market financial services firm specializing in industrial and energy companies. He maintains established relationships with more than 500 mid-market private equity firms. He also serves as a national business and finance columnist for Examiner.com. Dumon's background includes experience in consulting, finance and operations with several organizations including two S&P 500 companies. He received a Bachelor of Arts, a Bachelor of Business Administration and a Master of Accounting from the University of Texas at Austin.
http://www.investopedia.com/articles/economics/09/us-government-too-big-to-fail.asp
Current Account Deficits: Government Investment Or Irresponsibility?
by Reem Heakal
The current account is a section in a country's balance of payments (BOP) that records its current transactions. The account is divided into four sections:
- goods,
- services,
- income (such as salaries and investment income) and
- unilateral transfers (for example, workers' remittances).
- When a current transaction enters the account, it is recorded as a credit; when a value leaves the account, it is marked as a debit.
- Basically, a current account deficit occurs when more money is being paid out than brought into a country.
What a Deficit Implies
When a current account is in deficit, it usually means that a country is investing more abroad than it is saving at home. Often, the logic dictating a country's investment decisions is that it takes money to make money. - In order to try and boost its gross domestic production (GDP) and future growth, a country may go into debt, taking on liabilities to other countries. It then becomes what is termed as a "net debtor" to the world.
- However, a problematic deficit can result if a government has not planned out a sound economic policy and used its debts for consumption purposes, not future growth. (For more insight, see What Fuels The National Debt?)
In other words, other countries are essentially financing the economy, and hence sustaining the deficit.
When determining the economic health of a nation, it is important to understand
- where the deficit stems from,
- how it's being financed and
- what possible solutions exist for its alleviation.
To do so, we need to look at not only the current account, but also the other two sections of the BOP,
- the capital account and
- the financial account.
Foreign funds entering a country from the sale or purchase of tangible assets - as opposed to non-physical assets such as stocks or bonds - are recorded in the capital account of the BOP. (Again, money entering the account is noted as a credit, and money leaving the account is a debit.)
Financial transactions such as money leaving the country for investment abroad are recorded in the financial account.
Together, these two accounts provide financing for a current account deficit.
Why Is There a Deficit?
Is a current account deficit simply a matter of a government's bad planning and/or uncontrollable spending and consumption?
- Well, sometimes.
- But more often than not, a deficit is planned for the purpose of helping an economy's development and growth.
- It can also be a sign of a strong economy that is a safe haven for foreign funds (we'll explain this below).
- When an economy is in a state of transition or reform, or is pursuing an active strategy of growth, running a deficit today can provide funding for domestic consumption and investment tomorrow.
Here are some of the types of deficits, both planned and unplanned, that countries experience.
With the long-term in mind, a country may run a deficit by importing more than it's exporting, with the ultimate goal of producing finished goods for export. In this scenario, the country will plan to pay off the temporary excess of imports at a later time with proceeds made from future export sales. The proceeds made from these sales would then become a current account credit. (To Learn more, read In Praise Of Trade Deficits.)
Instead of saving money now, a country could also choose to invest abroad in order to reap the rewards in the future. The outing funds would be recorded as a debit in the financial account, while the corresponding incoming investment income would eventually be earmarked as a credit in the current account. Often, a current account deficit coincides with depletion in a country's foreign reserves (limited resources of foreign currency available to invest abroad).
When foreign investors send money into the domestic economy, the latter must eventually pay out the returns due to the foreign investors. As such, a deficit may be a result of the claims foreigners have on the local economy (recorded as a debit in the current account).
Sometimes governments spend more than they earn, simply due to ill-advised economic planning. Money may be spent on costly imports while local productivity lags behind. Or, it may be deemed a priority for the government to spend on the military rather than economic production. Whatever the reason, a deficit will ensue if credits and debits do not balance.
Financing the Deficit
Funding channeled into the capital and financial accounts (remember, these accounts finance the deficits in the current account) can come from both (1) public (official) and (2) private sources.
- Governments, which account for official capital flows, often buy and sell foreign currencies. Credit from these sales is recorded in the financial account.
- Private sources, whether institutions or individuals, may be receiving money from some sort of foreign direct investment (FDI) scheme, which appears as a debit in the income section of the current account but, when investment income is finally received, becomes a credit.
To avoid unnecessary extra risks associated with investing money abroad, the financing of the deficit should ideally rely on a combination of long-term and short-term funds rather than one or the other.
- If, for example, a foreign capital market suddenly collapses, it can no longer provide another country with investment income.
- The same would be true if a country borrows money and political differences cut the credit line.
- However, by planning to receive recurrent investment income over the years, such as by means of an FDI project, a country could intelligently finance its current account deficit.
In times of global recession, the financing of a deficit can sometimes be traced to capital flight, that is, private individuals and corporations sending their money into "safe" economies.
- This money is recorded as a credit in the current account but, in reality, it is not a reliable source of financing.
- In fact, it is a strong indication that the world economy is slowing and may not be able to provide financing in the near future.
- In order to determine whether a country's economy is weak, it is important to know why there is a deficit and how it is being financed.
- A deficit can be a sign of economic trouble for some countries, and a sign of economic health for others.
- To support the current account deficits of countries around the world, the global economy must be strong enough so that exports can be bought and investment income repaid.
- Often, however, a current account deficit cannot be sustained for too long - it is widely debated whether the consumption of today will result in chronic debt for future generations.
by Reem Heakal, (Contact Author | Biography)
What is a trade deficit and what effect will it have on the stock market?
What is a trade deficit and what effect will it have on the stock market?
--------------------------------------------------------------------------------
A trade deficit, which is also referred to as net exports, is an economic condition that occurs when a country is importing more goods than it is exporting. The deficit equals the value of goods being imported minus the value of goods being exported, and it is given in the currency of the country in question. For example, assume that the United Kingdom imports 800 billion British pounds worth of goods, while exporting only 750 billion pounds. In this example, the trade deficit, or net exports, would be 50 million pounds.
Measuring a country's net imports or net exports is a difficult task, which involves different accounts that measure different flows of investment. These accounts are the current account and the financial account, which are then totaled to help form the balance of payments figure. The current account is used as a measure for all of the amounts involved in importing and exporting goods and services, any interest earned from foreign sources, and any money transfers between countries. The financial account is made up of the total changes in foreign and domestic property ownership. The net amounts of these two accounts are then entered into the balance of payments. (To learn more, see What Is The Balance Of Payments?, Understanding The Current Account In The Balance Of Payments and Understanding The Capital And Financial Accounts In The Balance Of Payments.)
In terms of the stock market, a prolonged trade deficit could have adverse effects.
http://www.investopedia.com/ask/answers/03/110603.asp
- If a country has been importing more goods than it is exporting for a sustained period of time, it is essentially going into debt (much like a household would).
- Over time, investors will notice the decline in spending on domestically produced goods, which will hurt domestic producers and their stock prices.
- Given enough time, investors will realize fewer investment opportunities domestically and begin to invest in foreign stock markets, as prospects in these markets will be much better. This will lower demand in the domestic stock market and cause that market to decline.
What Is The Balance Of Payments?
What Is The Balance Of Payments?
by Reem Heakal
The balance of payments (BOP) is the method countries use to monitor all international monetary transactions at a specific period of time.
The Balance of Payments Divided
The BOP is divided into three main categories:
The Current Account
The current account is used to mark the inflow and outflow of goods and services into a country. Earnings on investments, both public and private, are also put into the current account.
The Capital Account
The capital account is where all international capital transfers are recorded. This refers to the acquisition or disposal of
The capital account is broken down into the monetary flows branching from
The Financial Account
In the financial account, international monetary flows related to investment in
Also included are government-owned assets such as
/div>
The Balancing Act
The current account should be balanced against the combined-capital and financial accounts. However, as mentioned above, this rarely happens.
When a country has a current account deficit that is financed by the capital account, the country is actually foregoing capital assets for more goods and services. If a country is borrowing money to fund its current account deficit, this would appear as an inflow of foreign capital in the BOP.
Liberalizing the Accounts
The rise of global financial transactions and trade in the late-20th century spurred BOP and macroeconomic liberalization in many developing nations. With the advent of the emerging market economic boom - in which capital flows into these markets tripled from USD 50 million to USD 150 million from the late 1980s until the Asian crisis - developing countries were urged to lift restrictions on capital and financial-account transactions in order to take advantage of these capital inflows.
by Reem Heakal, (Contact Author | Biography)
http://www.investopedia.com/articles/03/060403.asp
Also read:
http://www.investopedia.com/terms/c/currentaccountdeficit.asp
by Reem Heakal
The balance of payments (BOP) is the method countries use to monitor all international monetary transactions at a specific period of time.
- Usually, the BOP is calculated every quarter and every calendar year.
- All trades conducted by both the private and public sectors are accounted for in the BOP in order to determine how much money is going in and out of a country.
- If a country has received money, this is known as a credit, and, if a country has paid or given money, the transaction is counted as a debit.
- Theoretically, the BOP should be zero, meaning that assets (credits) and liabilities (debits) should balance.
- But in practice this is rarely the case and, thus, the BOP can tell the observer if a country has a deficit or a surplus and from which part of the economy the discrepancies are stemming.
The Balance of Payments Divided
The BOP is divided into three main categories:
- the current account,
- the capital account and
- the financial account.
The Current Account
The current account is used to mark the inflow and outflow of goods and services into a country. Earnings on investments, both public and private, are also put into the current account.
- Within the current account are credits and debits on the trade of merchandise, which includes goods such as raw materials and manufactured goods that are bought, sold or given away (possibly in the form of aid).
- Services refer to receipts from tourism, transportation (like the levy that must be paid in Egypt when a ship passes through the Suez Canal), engineering, business service fees (from lawyers or management consulting, for example), and royalties from patents and copyrights.
- When combined, goods and services together make up a country's balance of trade (BOT).
- The BOT is typically the biggest bulk of a country's balance of payments as it makes up total imports and exports.
- If a country has a balance of trade deficit, it imports more than it exports, and if it has a balance of trade surplus, it exports more than it imports.
- Receipts from income-generating assets such as stocks (in the form of dividends) are also recorded in the current account.
- The last component of the current account is unilateral transfers. These are credits that are mostly worker's remittances, which are salaries sent back into the home country of a national working abroad, as well as foreign aid that is directly received.
The Capital Account
The capital account is where all international capital transfers are recorded. This refers to the acquisition or disposal of
- non-financial assets (for example, a physical asset such as land) and
- non-produced assets,
The capital account is broken down into the monetary flows branching from
- debt forgiveness,
- the transfer of goods, and financial assets by migrants leaving or entering a country,
- the transfer of ownership on fixed assets (assets such as equipment used in the production process to generate income),
- the transfer of funds received to the sale or acquisition of fixed assets,
- gift and inheritance taxes,
- death levies, and,
- finally, uninsured damage to fixed assets.
The Financial Account
In the financial account, international monetary flows related to investment in
- business,
- real estate,
- bonds and stocks
Also included are government-owned assets such as
- foreign reserves,
- gold,
- special drawing rights (SDRs) held with the International Monetary Fund,
- private assets held abroad, and
- direct foreign investment.
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The Balancing Act
The current account should be balanced against the combined-capital and financial accounts. However, as mentioned above, this rarely happens.
- We should also note that, with fluctuating exchange rates, the change in the value of money can add to BOP discrepancies.
- When there is a deficit in the current account, which is a balance of trade deficit, the difference can be borrowed or funded by the capital account.
- If a country has a fixed asset abroad, this borrowed amount is marked as a capital account outflow. However, the sale of that fixed asset would be considered a current account inflow (earnings from investments). The current account deficit would thus be funded.
When a country has a current account deficit that is financed by the capital account, the country is actually foregoing capital assets for more goods and services. If a country is borrowing money to fund its current account deficit, this would appear as an inflow of foreign capital in the BOP.
Liberalizing the Accounts
The rise of global financial transactions and trade in the late-20th century spurred BOP and macroeconomic liberalization in many developing nations. With the advent of the emerging market economic boom - in which capital flows into these markets tripled from USD 50 million to USD 150 million from the late 1980s until the Asian crisis - developing countries were urged to lift restrictions on capital and financial-account transactions in order to take advantage of these capital inflows.
- Many of these countries had restrictive macroeconomic policies, by which regulations prevented foreign ownership of financial and non-financial assets.
- The regulations also limited the transfer of funds abroad.
- But with capital and financial account liberalization, capital markets began to grow, not only allowing a more transparent and sophisticated market for investors, but also giving rise to foreign direct investment.
- For example, investments in the form of a new power station would bring a country greater exposure to new technologies and efficiency, eventually increasing the nation's overall gross domestic product by allowing for greater volumes of production.
- Liberalization can also facilitate less risk by allowing greater diversification in various markets.
by Reem Heakal, (Contact Author | Biography)
http://www.investopedia.com/articles/03/060403.asp
Also read:
http://www.investopedia.com/terms/c/currentaccountdeficit.asp
Understanding The Current Account In The Balance Of Payments
by Reem Heakal
The balance of payments (BOP) is the place where countries record their monetary transactions with the rest of the world. Transactions are either marked as a credit or a debit. Within the BOP there are three separate categories under which different transactions are categorized:
- the current account: goods, services, income and current transfers are recorded.
- the capital account: physical assets such as a building or a factory are recorded.
- the financial account: assets pertaining to international monetary flows of, for example, business or portfolio investments, are noted.
The balance of the current account tells us if a country has a deficit or a surplus. If there is a deficit, does that mean the economy is weak? Does a surplus automatically mean that the economy is strong? Not necessarily. But to understand the significance of this part of the BOP, we should start by looking at the components of the current account: goods, services, income and current transfers.
Now that we have covered the four basic components, we need to look at the mathematical equation that allows us to determine whether the current account is in deficit or surplus (whether it has more credit or debit). This will help us understand where any discrepancies may stem from, and how resources may be restructured in order to allow for a better functioning economy.
M = Imports of goods and services
NY = Net income abroad
NCT = Net current transfers
Theoretically, the balance should be zero, but in the real world this is improbable, so if the current account has a deficit or a surplus, this tells us something about the state of the economy in question, both on its own and in comparison to other world markets.
Analyzing the Current Account
Exports imply demand for a local product while imports point to a need for supplies to meet local production requirements. As export is a credit to a local economy while an import is a debit, an import means that the local economy is liable to pay a foreign economy. Therefore a deficit between exports and imports (goods and services combined) - otherwise known as a balance of trade deficit (more imports than exports) - could mean that the country is importing more in order to increase its productivity and eventually churn out more exports. This in turn could ultimately finance and alleviate the deficit.
- The volume of a country's current account is a good sign of economic activity.
- By scrutinizing the four components of it, we can get a clear picture of the extent of activity of a country's industries, capital market, services and the money entering the country from other governments or through remittances.
- However, depending on the nation's stage of economic growth, its goals, and of course the implementation of its economic program, the state of the current account is relative to the characteristics of the country in question.
- But when analyzing a current account deficit or surplus, it is vital to know what is fueling the extra credit or debit and what is being done to counter the effects (a surplus financed by a donation may not be the most prudent way to run an economy).
- On a separate note, the current account also highlights what is traded with other countries, and it is a good reflection of each nation's comparative advantage in the global economy.
by Reem Heakal, (Contact Author | Biography)
What's the difference between absolute P/E ratio and relative P/E ratio?
What's the difference between absolute P/E ratio and relative P/E ratio?
The simple answer to this question is that absolute P/E, which is the most quoted of the two ratios, is the price of a stock divided by the company's earnings per share (EPS). This measure indicates how much investors are willing to pay per dollar of earnings. The relative P/E ratio, on the other hand, is a measure that compares the current P/E ratio to the past P/E ratios of the company or to the current P/E ratio of a benchmark. Let's look at both absolute and relative P/E in more detail.
The nominator of this ratio is usually the current stock price, and the denominator may be
- the trailing EPS (from the trailing 12 months [TTM]),
- the estimated EPS for the next 12 months (forward P/E) or
- a mix of the trailing EPS of the last two quarters and
- the forward projected EPS for the next two quarters.
For example, if the price of the stock today is $100, and the TTM earnings are $2 per share, the P/E is 50 ($100/$2).
Relative P/E
Relative P/E compares the current absolute P/E to
- a benchmark or
- a range of past P/Es over a relevant time period, such as the last 10 years.
Relative P/E shows what portion or percentage of the past P/Es the current P/E has reached.
- Relative P/E usually compares the current P/E value to the highest value of the range, but investors might also compare the current P/E to the bottom side of the range, measuring how close the current P/E is to the historic low.
- The relative P/E will have a value below 100% if the current P/E is lower than the past value (whether the past high or low).
- If the relative P/E measure is 100% or more, this tells investors that the current P/E has reached or surpassed the past value.
Suppose a company's P/Es over the last 10 years have ranged between 15 and 40.
- If the current P/E ratio is 25, the relative P/E comparing the current P/E to the highest value of this past range is 0.625 (25/40), and the current P/E relative to the low end of the range is 1.67 (25/15).
- These value tell investors that the company's P/E is currently 62.5% of the 10-year high, and 67% higher than the 10-year low.
- There is, however, a lot of discretion that goes into interpreting relative P/E.
- Fundamental shifts in the company such as an acquisition of a highly profitable entity can justifiably increase the P/E above the historic high.
- Continuing with the example above where we have a current P/E ratio of 25, suppose the P/E of the market is 20.
- The relative P/E of the company to the index is therefore 1.25 (25/20).
- This shows investors that the company has a higher P/E relative to the index, indicating that the company's earnings are more expensive than that of the index.
- A higher P/E, however, does not mean it is a bad investment. On the contrary, it may mean the company's earnings are growing faster than those represented by the index.
- If, however, there is a large discrepancy between the P/E of the company and the P/E of the index, investors may want to do additional research into the discrepancy.
Absolute P/E, compared to relative P/E, is the most-often used measure and is useful in investment decision making; however, it is often wise to expand the application of that measure with the relative P/E measure to gain further information.
http://www.investopedia.com/ask/answers/05/051005.asp
The 2007-08 Financial Crisis In Review
by Manoj Singh
When the Wall Street evangelists started preaching "no bailout for you" before the collapse of British bank Northern Rock, they hardly knew that history would ultimately have the last laugh. With the onset of the global credit crunch and the fall of Northern Rock, August 2007 turned out to be just the starting point for big financial landslides. Since then, we have seen many big names rise, fall, and fall even more. In this article, we'll recap how the financial crisis of 2007-08 unfolded. (For further reading, see Who Is To Blame For The Subprime Crisis?, The Bright Side Of The Credit Crisis and How Will The Subprime Mess Impact You?)
Like all previous cycles of booms and busts, the seeds of the subprime meltdown were sown during unusual times. In 2001, the U.S. economy experienced a mild, short-lived recession. Although the economy nicely withstood terrorist attacks, the bust of the dotcom bubble, and accounting scandals, the fear of recession really preoccupied everybody's minds. (Keep learning about bubbles in Why Housing Market Bubbles Pop and Economic Meltdowns: Let Them Burn Or Stamp Them Out?)
But, every good item has a bad side, and several of these factors started to emerge alongside one another. The trouble started when the interest rates started rising and home ownership reached a saturation point. From June 30, 2004, onward, the Fed started raising rates so much that by June 2006, the Federal funds rate had reached 5.25% (which remained unchanged until August 2007).
There were early signs of distress: by 2004, U.S. homeownership had peaked at 70%; no one was interested in buying or eating more candy. Then, during the last quarter of 2005, home prices started to fall, which led to a 40% decline in the U.S. Home Construction Index during 2006. Not only were new homes being affected, but many subprime borrowers now could not withstand the higher interest rates and they started defaulting on their loans.
Problems in the subprime market began hitting the news, raising more people's curiosity. Horror stories started to leak out.
It became apparent in August 2007 that the financial market could not solve the subprime crisis on its own and the problems spread beyond the United State's borders. The interbank market froze completely, largely due to prevailing fear of the unknown amidst banks. Northern Rock, a British bank, had to approach the Bank of England for emergency funding due to a liquidity problem. By that time, central banks and governments around the world had started coming together to prevent further financial catastrophe.
The subprime crisis's unique issues called for both conventional and unconventional methods, which were employed by governments worldwide. In a unanimous move, central banks of several countries resorted to coordinated action to provide liquidity support to financial institutions. The idea was to put the interbank market back on its feet.
- The financial crisis of 2007-08 has taught us that the confidence of the financial market, once shattered, can't be quickly restored.
- In an interconnected world, a seeming liquidity crisis can very quickly turn into a solvency crisis for financial institutions, a balance of payment crisis for sovereign countries and a full-blown crisis of confidence for the entire world.
- But the silver lining is that, after every crisis in the past, markets have come out strong to forge new beginnings.
The Dangers of Unmanaged Growth: What Lessons Should You Learn?
Let's say you get a huge promotion and raise at work. You look at everything you own and think about upgrading your lifestyle. Should you get a bigger house, hire a personal trainer, or replace all your clothes in one Neiman Marcus shopping spree?
- Before you adjust your lifestyle, you should think about how long the raise could last. Maybe you should wait a year or two and see if your higher income persists.
- And even if your company does well, what happens to your job when the rest of the country cuts back on expenses?
Just as with Iceland, in a globalized world, no person, company or even country is a self-contained and independent entity. Therefore, Iceland's troubles showed that thinking ahead, even in the best of times, is an important survival strategy.
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