Avoid These 10 Insurance Mistakes
Few people enjoy thinking about their insurance needs, shopping for coverage, or reading through a policy’s fine print. Once they do buy a policy, many people rarely think about it again, other than when they pay the premiums. But that tendency to avoid thinking about insurance can lead to mistakes that can put a person’s assets at risk. Below are some of the most common insurance mistakes:
Expecting the best — Some people may think they can skip various types of essential insurance (like car or health insurance), because it won’t happen to them.
Or they may buy a bare-bones policy thinking they won’t ever need to make a claim. But the reality is that accidents and injuries can happen to anyone. A comprehensive insurance plan protects you when they do.
Not shopping around — If you’re in the market for a new policy, shop around and compare prices to get the best deal. But make sure you’re comparing equivalent policies and coverage — an ultracheap policy may offer skimpy benefits.
Buying too much insurance — While insurance is a valuable part of your overall financial plan, there is such a thing as being overinsured. If you’re paying high premiums for insurance coverage you don’t really need, you’re wasting money. What types of insurance might you skip? Extended warranties, cell phone insurance, insurance that covers specific diseases (like cancer), rental car insurance, and mortgage life insurance are usually not worth the premiums you'll pay.
Not negotiating on insurance rates — Here’s a little-known tip: The premium price you’re quoted isn’t set in stone. Depending on the type of coverage you need, you may be able to get discounts based on your profession, the age of your car, installing an alarm system in your home, choosing a higher deductible, and more. Bundling — buying several policies through the same carrier — can also lead to premium price breaks.
Forgetting to pay the premium — It’s a simple but potentially devastating mistake. Missing premium payments could cause your policy to lapse leaving you without coverage. Reduce the risk of this happening by automating your payments.
Dropping coverage to save money— When your budget is tight, dropping insurance coverage may seem like a good way to save cash. But while you may save money in the short term, you could end up worse off in the long term if you need to make a claim. If premium payments are straining your budget, consider raising your deductible or asking your insurer if you’re eligible for any discounts.
Forgetting to update life insurance beneficiaries —
As your life changes, so should the people named as beneficiaries on your life insurance policy. Divorce, remarriage, the death of a spouse, or the birth or death of a child are all times you should update these designations. If you fail to take this simple step, your life insurance may not do its job when you need it most. After all, do you want your insurance benefits to go to your ex-spouse or have one child receive a generous insurance payment while the other receives nothing? Keeping your beneficiary designations up to date can help you avoid those outcomes.
Having coverage gaps — Everyone faces different risks and, thus, has different insurance needs. Sometimes, it’s easy to overlook a risk until it’s too late. For example, if you live in an earthquake-prone area, you likely need separate earthquake insurance. If you serve on a nonprofit board of directors, you may need personal liability coverage. If you own ATVs, snowmobiles, or other vehicles, you may need special policies to protect yourself in case of damage to the vehicle or a lawsuit. The list of possible risks goes on and on.
Not researching an insurance company before you buy — Not every insurance company is created equal, and what looks like a great deal today may be less appealing tomorrow when you are struggling to get a claim processed quickly. Before you buy, get multiple quotes, read the policy’s fine print, review the insurer’s complaint record with the state department of insurance, and check the company’s ratings with agencies like Fitch, Moody’s, and A.M. Best.
Not thinking about insurance as part of your overall financial plan — Insurance isn’t something you should think about in isolation. In fact, it’s an essential part of your overall financial plan. A solid risk management strategy protects your hard-earned wealth and your family’s future.
Control Your Spending
If you’re trying to increase savings, remember that savings are directly tied to spending — the less you spend, the more you have to save. Some tips to help you clamp down on your spending include:
- Analyze your spending for a month. Are you surprised by how much you spend on dining out, groceries, entertainment, or clothing? Give serious thought to your purchasing patterns, looking for ways to reduce spending. Clean out your closet and really assess whether you need new clothes.
Cut back on how often you dine out or at least dine at less-expensive restaurants. Rent a movie instead of going to the theater. Make a list before grocery shopping and don’t deviate from it. Look for coupons and sales before shopping. You may scoff at these ideas for saving money, thinking you can’t possibly add much to your savings. After all, you’re just spending a few dollars here and there. But over a long time period, even modest amounts can grow to significant sums.
- Go over major expenditures also. When was the last time you comparison shopped your auto or homeowners insurance? Have you checked mortgage rates lately to see if you should refinance? Have you reviewed strategies to reduce your income taxes?
- Make a spending plan and put it in writing. Budget for all major expenditures and resolve not to purchase items that aren’t in your budget.
- Throw out your credit cards (or at least hide them for a while). Most people find it more difficult to spend cash than to charge a purchase. So for the next couple of months, only purchase items with cash.
- Don’t purchase items over a fairly low dollar amount until your second shopping trip. How often have you purchased something on impulse, only to realize when you got home that you really didn’t need it? To control those impulses, compare price and value on your first shopping trip. Then go home, think about whether you really need the item, and purchase it on another trip.
- Think carefully before making major purchases. Often, upkeep and maintenance will add to your costs. Consider a less-expensive or used car. Keep your car for four or five years instead of getting a new one every two or three years
- Figure out the maximum amount you can afford for a house and then buy one substantially less expensive than that. Not only will you save on your mortgage payment, other costs associated with owning a home will be lower. Living well within your means is one of the best ways to ensure you have money left over for saving.
Withdrawal Strategies Are as Important as Planning Strategies
Like your parents, you worked hard and saved hard, and now it is finally time to reap the rewards. Unlike your parents, you probably don’t have a pension, Social Security benefits are uncertain, and healthcare costs are higher than ever. Today’s retirees live longer and need to use more personal savings than previous generations. Like the planning that got you here, you also need to develop a withdrawal plan that will give you the best chance of not outliving your assets.
Where to Start — You want a plan that ensures you can meet your expenses and has the potential to keep growing, all while weathering inflation, market volatility, and taxes. The best place to start is to determine how you want to live in your retirement years. Define what expenses are nonnegotiable, like housing and expenses that are discretionary, such as traveling. One withdrawal strategy may be to use your reliable income such as Social Security for essential expenses and your investment income for things you want to do.
Keep it Growing — Building a strategy for growth is very different in retirement than it was when you were saving for retirement. You will need an asset allocation strategy that uses a target asset mix of investments aligned with your risk tolerance, which will probably be different at this stage of your life.
Monitoring and Rebalancing — Just like during your saving years, you’ll need to monitor your portfolio on a regular basis. It may be wise to rebalance your portfolio due to market conditions or other factors that impact your life. While in the early years of your retirement you may take more risk; as you age, you may want to be more conservative.
Help Beneficiaries Avoid IRA Mistakes
While annual contributions to IRAs are still relatively modest, the ability to roll over 401(k) balances to an IRA can result in significant IRA balances. Thus, in addition to retirement planning vehicles, IRAs are becoming estate-planning tools for individuals who won’t use the entire balance during their lifetimes. If you are in that situation, help your beneficiaries avoid these common IRA mistakes:
- Using the IRA balance too quickly. After an IRA is inherited, a traditional deductible IRA still retains its tax-deferred growth and a Roth IRA retains its tax-free growth. Your beneficiaries’ goal should be to extend this growth for as long as possible.
If the IRA has a designated beneficiary that includes individuals and certain trusts, the balance can be paid out over the beneficiary’s life expectancy. Spouses have additional options that can stretch payments even longer. Your beneficiaries can also elect to take the entire balance immediately, paying any income taxes due. You should stress the importance of taking withdrawals as slowly as possible.
- Not splitting the IRA when there are multiple beneficiaries. When there are multiple beneficiaries, it is typically best to split the IRA into separate accounts by December 31 of the year following the original owner’s death. If the account is not split, distributions must be taken by all beneficiaries over the life expectancy of the oldest beneficiary. By splitting the IRA into separate accounts, each beneficiary can take distributions over his/her own life expectancy. This is especially important for a surviving spouse who can only roll over the IRA to his/her own account if he/she is the sole beneficiary. With the rollover IRA, the surviving spouse can name his/her own beneficiary, thus extending the IRA’s life, and can defer distributions until age 70½. When other than an individual or qualifying trust is named as one of the beneficiaries, the IRA must be distributed within five years when the owner dies before required distributions begin, or over the owner’s life expectancy when the owner dies after required distributions begin. Separating the account or paying out the nonindividual’s portion then allows the individual beneficiaries to take distributions over their own life expectancies.
- Rolling the balance over to a spouse’s IRA too quickly. Once a spouse rolls over the balance to his/her own IRA, some planning opportunities are eliminated. While the IRA balance can typically be spread out over a longer period when the balance is rolled over, the spouse may need distributions. Spouses under age 59½ can take withdrawals from the original IRA without paying the 10% federal income tax penalty. Once the account is rolled over, withdrawals before age 59½ would result in a 10% tax penalty. Also, spouses who are older than the original owner can delay distributions by retaining the original IRA. The surviving spouse is not required to take distributions until the deceased spouse would have attained age 70½, even if the surviving spouse is past that age. The spouse may want to disclaim a portion of the IRA, which must be done within nine months of the original owner’s death. If the account is rolled over, that disclaimer can’t be made. Thus, it is typically best for the surviving spouse to determine his/her financial needs before rolling over the IRA balance.
- Not properly establishing the inherited IRA. An inherited IRA must be retitled to include the decedent’s name, the words "individual retirement account," and the beneficiary’s name. The IRA cannot simply remain in the decedent’s name. The beneficiaries should also designate beneficiaries for their own IRAs.
Using Portfolio Losses
To help minimize your capital gains tax bill, you should actively harvest any losses in your portfolio. Some strategies to consider include:
Recognize losses to offset at least $3,000 of ordinary income. Capital losses offset capital gains, and an excess of $3,000 of capital losses can be offset against ordinary income. If you are holding stocks with losses in your portfolio, you should probably take advantage of this tax rule.
If you still want to own the stock with the loss, you can sell the stock, recognize the tax loss, and then repurchase the stock. You just need to make sure to avoid the wash sale rule.
This rule states that you must repurchase the shares at least 31 days before or after you sell your original shares to recognize the loss for tax purposes. You can also purchase a similar stock, perhaps of a competitor, to replace the sold stock. Since it isn’t the same stock, you don’t have to wait 31 days to purchase it.
Consider recognizing all, or a substantial portion, of any losses in your portfolio. Since you can only offset an excess of $3,000 of capital losses against ordinary income, you might wonder why you should incur excess losses that can’t be used currently, even though you can carry them forward to future years. There are a couple of advantages to this strategy.
First, it gives you an opportunity to totally reevaluate your portfolio. If you are convinced all your investments are good ones, you can sell them, recognize the tax loss, and then repurchase the stocks, being sure to avoid the wash sale rule. But it’s probably more likely you own some investments you wish you didn’t or you think won’t recover as quickly as other investments.
Second, it gives you more flexibility when recognizing gains in the future. Until you use all your capital losses, you can recognize capital gains without worrying about paying taxes.
Use stock losses to offset other capital gains. You don’t have to match stock losses with stock gains. If you have capital gains from the sale of another type of asset, such as a business or real estate, stock losses can be used to offset those gains.
Don’t gift stocks with losses. If you are planning a large charitable contribution, it may make sense to donate appreciated stock held for over a year. You deduct the fair market value as a charitable contribution, subject to limitations based on a percentage of your adjusted gross income, and avoid paying capital gains taxes on the gain. If the stock has a loss, however, you should first sell it and then send the cash to the charity. That way, you get the charitable deduction and recognize a tax loss on the sale.
Active vs. Passive Bond Investing
A great many investors are aware of only one way to manage their bonds: buy them and hold them until they mature, reinvesting the redeemed funds in more bonds to hold until they mature. Not surprisingly, this is called a buy-and-hold strategy, and it’s considered a form of passive management. But there is another way to approach a bond portfolio. It’s called active management and routinely involves selling bonds before they mature. Before considering active management, however, it’s important to understand some bond fundamentals.
Bond Income vs. Capital Gains
Everyone knows that bonds generate income in the form of interest payments. But many people don’t realize that bonds can also generate capital gains in the secondary market — the market where investors buy and sell existing bonds. Interest rates are the result of prices that investors are willing to pay to receive the fixed-income streams from existing bonds. Whenever potential buyers of existing bonds decide that the bonds’ annual income isn’t enough relative to its price, they’ll bid bond prices lower. As a result, the bonds’ current yield, their effective interest rate, will rise. The result is that at any given time, the market value of a bond could be higher or lower than its face value, its original price, or its previous transaction price. Individual bond prices can also change as a result of changes in their credit ratings. If a major bond agency reduces the rating of a bond, its price will normally go down; if the rating goes higher, the price will ordinarily go up. In either case, the price is bound to be different from its price when you bought it.
Selling to Capture Premiums or Higher Yield
Bonds whose prices are higher than their face value — something that often happens when interest rates have been falling for some time — are called premium bonds. If you’re holding a premium bond to maturity, one thing is certain: no matter what happens to interest rates in the future, you’re never going to benefit from this temporary increase in your bond’s market value — unless you sell it. So in the right circumstances, it can make sense to sell a premium bond. In certain circumstances, it can make sense to sell a bond that’s fallen to a lower price than its purchase price. Why? First, selling a bond at a loss generates a potential tax advantage — a capital loss that come tax time, can be used to offset capital gains taken elsewhere. Second, in a market in which bond prices are falling, bond interest rates are rising. So investors can increase their net income if they sell a lower-yielding bond to purchase a higher-yielding bond.
Using the Yield Curve
Professionals know that the bond markets are more inefficient than the stock markets. One of the results is that anomalies frequently occur in what’s known as the yield curve, the line on a graph that shows yield by maturity dates. In theory, there is a gradual and proportional relationship between time to maturity and yield. On a normal yield curve, the line rises a bit steeply from left to right over the first few years and then begins to flatten out, with yields continuing to rise as the maturity gets longer. In practice, however, abnormal relationships can emerge in which the yield for a slightly shorter maturity is higher than the yield for a longer maturity (an inverted yield curve). In this case, a premium may have developed for the longer maturity that could disappear once the market becomes fully aware of it. In such cases, active managers may decide to sell the longer maturity and buy the shorter one to book that capital gain.
6 Questions to Ask before Investing
An educated investor is an empowered investor. Whether you’ve been investing for decades or are dipping a toe in the stock market for the first time, you should approach every investment opportunity with an open mind, as well as some healthy skepticism. Gathering as much information as you can before you choose an investment will protect you and your money. To help you do that, here are six questions everyone should ask before they invest.
1. Do I understand this investment?
Never invest in something you can’t understand. Before deciding to invest, make sure you’re clear on what you’re investing in, how it makes money (will you be paid interest, earn dividends, or make money via capital gains, for example), and how easy it is to sell. This is one reason it’s good to work with a financial advisor, since he/she will be able to explain more complicated investment opportunities.
2. What’s the potential reward, and am I prepared to accept the risk involved to get it?
All investing involves both risk and reward, and smart investors know how to balance the two to best achieve their goals. Usually, an investment that comes with a big potential reward also comes with a big risk. That doesn’t necessarily mean it’s a bad choice, but it does mean you should go into it fully informed.
3. What’s the cost of this investment?
The cost of an investment isn’t just the upfront purchase price. You should also find out if there are fees and expenses associated with it. Also important are the taxes you’ll have to pay when you sell, as well as any potential penalties. For example, do you have to hold the investment for a certain amount of time to avoid paying a penalty?
4. Does this investment fit with my goals?
Investing will be easier if you go into it with specific goals in mind. Shorter-term goals, like saving for a down payment on a house or accumulating funds for a child’s college education, require a different investment strategy than if you’re investing for a retirement that may be 20 or 30 years away. Lower-risk investments are usually more appropriate for shorter-term goals, while riskier investments can be fine for longer-term goals. A financial advisor can help you determine which investments fit with your particular goals.
5. How easily can I get out of this investment?
Money you’ve invested isn’t liquid. In the case of stocks, you can always sell without too much difficulty, but you may take a loss. But with other investments, like real estate and certain types of life insurance, it’s harder to get your money out. If you think you’re going to need to access your investment in the near future, make sure you know how easy it is to access those funds.
6. What is this investment’s history?
Some investments have a long history that you can look to when making a decision about whether to get involved. For example, the U.S. has never defaulted on its debt and there’s little chance that it will in the future. That long history allows you to make certain informed predictions about the future performance of this investment. Likewise, certain companies have a solid history of strong performance. While past performance is no guarantee of future results, it is useful information to consider. Newer companies and investments obviously don’t have a clear history for investors to study. That doesn’t mean they’re always bad investments, but it does mean you should be skeptical of any claims of outsize returns.
Straightening Out Your Financial Accounts
It’s not uncommon to accumulate things over the years without taking time to straighten them out periodically. That applies to our finances as well as to our possessions. How many credit cards do you carry? How many stocks and bonds, brokerage accounts, and individual retirement accounts (IRAs) do you own? It’s not just a matter of finding time to keep track of all these different financial assets.
Often, these assets are acquired without a clear-cut strategy, so you may own assets with similar investment objectives or that are not compatible with your financial goals. If you feel it’s time to straighten out your finances, consider these steps:
- Make a list of all your assets and debts. List each one individually, so you have a sense of how many different accounts you’re dealing with.
- Go through each one of your investments. Make sure you understand why you own each one. Are you really adding diversification to your portfolio, or do you have overlapping investments? Assess the prospects of each investment and decide whether you should continue to own it.
- Look for ways to consolidate accounts. Try to get down to one bank account, one brokerage account, and one IRA. This can significantly reduce the time needed to review and reconcile accounts.
- Assess your outstanding debts. Do you really need all those credit cards? Consider keeping only one or two cards, so it’ll be easier to monitor balances. Look for ways to reduce the cost of your borrowing. Is it time to take another look at refinancing your mortgage?