Episode 117: Living a Financially Intentional Life with Naseema McElroy
Naseema is the founder of Financially Intentional, a platform about personal finance and living life intentionally. She discusses how taking control of her finances has enabled her to overcome bankruptcy, divorce, and break the cycle of living paycheck to paycheck. She shares her lessons along her path to help others benefit from the freedoms of financial independence.
Outside of encouraging people to get their financial act together, Naseema is a mother and Labor and Delivery Nurse. Though making six figures for years, she struggled with money. Finally realizing she couldn’t out-earn her financial ignorance, she knew she had to make some changes. By shifting her mindset around money, being consistent and intentional, She has paid off $1 million in debt and grew a six-figure net worth in three years without living in deprivation.
HERE’S WHAT YOU’LL LEARN FROM THIS EPISODE:
How Naseema made a move from nursing to finance
The misconception many people have about finances
Where to start in order to become more financially intentional
Steps to set yourself up for financial success
How Nassema paid off $1,000,000 in debt
The asset she sold to push her back on track financially
Steps you can take to improve your financial life
The flexibility Naseema was able to create by getting her finances in order
How to keep yourself committed to your financial goals
What it looks like to anti-budget
How to keep your financial life in balance
The importance of building a good team around you to continue to drive your passion
How to make legacy building second nature in your life
The benefit of having a financial planner as an accountability partner
Economic and social impacts of the coronavirus are still unfolding and the federal interest rate has moved to near zero. From stressing our healthcare system to millions of layoffs to business closures to mandated social distancing, we haven’t been faced with an economic crisis of this scale since the Great Depression.
In response, the Federal government is doing what it can to keep the economy afloat. On March 15, 2020, the Federal Reserve cut interest rates to near zero in an effort to balance the economy.
So what are federal interest rates? How do they work? In what ways will this “near-zero” rate impact you? Let’s find out.
Breaking Down the Federal Interest Rate
When people refer to interest rates they are often talking about the target federal funds rate or short term interest rates. But what does that really mean?
The federal funds rate refers to the rate that banks charge other banks for lending them money to meet their bottom line.
By law, a bank must have a cash reserve that equals a certain percentage of their deposits. This law is in place to make sure banks have enough money to handle the ebbs and flows of customers’ deposits and withdrawals.
If a bank is concerned about falling short on their reserve requirements, they can get a loan from another bank who anticipates a surplus of cash during that period. The interest rate that the banks charge each other is the federal funds rate, or the fed funds rate.
Who Sets the Fed Funds Rate?
A monetary policy-making body from the Federal Reserve called the Federal Open Market Committee (FOMC) gets together to set the federal funds rate. This group meets eight times each year, and sets the rate based on the economic climate. In extenuating circumstances, the FOMC can meet outside this schedule, which is what they did in March.
But this committee doesn’t have as much power as you think.
The FOMC can’t exactly force banks to charge a certain rate, so they set a target federal funds rate which is a range that they encourage. In March, the target federal funds rate was set from 0%-0.25% which is where the phrase “near-zero” originates.
The actual interest rate that a bank charges is determined through negotiations between the two banks and the weighted average among all transactions of that nature is referred to as the effective federal funds rate.
So how can the FOMC get that into their target range? They may not be able to mandate an exact fed funds rate, but they can have the Federal Reserve system adjust the money supply to sway interest rates in a certain direction by adding or removing money from the financial system. By adding money, they increase supply and drop the effective rate. The opposite is true for taking money out. By doing this, supply decreases which makes the effective fed fund rate rise.
How the Economy is Impacted
The federal funds rate is one of the most important interest rates in our economy because it impacts our financial condition as a country, which causes a ripple effect on other aspects of our economy like employment and inflation.
The Federal Reserve’s ability to add or detract money from the financial system can have a secondary effect on interest rates that we encounter in daily life like auto loans, home mortgages, credit cards, and savings accounts.
Many lenders set their rates based on the prime lending rate, or the rate of interest the bank charges their A+ clients (top credit) which is also impacted by the federal funds rate.
Investors also keep an eye on the fed funds rate as its activity tends to correlate with market trends. The market often reacts strongly to this rate which makes it an area of interest for many investors, brokers, and analysts.
Let’s look a little more at how the addition and subtraction of funds work for the economy at large.
Why Lower Interest Rates?
When the federal funds rate decreases, interest rates tend to fall along with it. This can be a really good thing, especially in terms of debt like auto loans, home mortgages, and credit cards. But this also decreases the amount of interest you can expect to get from your savings account or certificates of deposit (CDs).
For you, this means that when the federal funds rate drops, the government is encouraging spending over saving. By promoting borrowing money with better interest rates, the economy can be filled with some much-needed cash. When the economy needs some help, which it does now, lower interest rates will promote greater economic activity.
Why Raise Interest Rates?
Just like the Fed can decrease rates to bolster the economy, they can also raise rates to help ward off inflation. When the fed funds rate increases, interest rates tend to climb which is good news for your savings accounts and CDs as they will often see a greater return. But it isn’t so wonderful for other loans like credit cards or home mortgages.
When interest rates go up, it benefits people more to save money as opposed to spending it. Why would the government want to slow down spending money? The main reason is to keep inflation at bay and discourage a level of economic growth we couldn’t keep up with.
Practical Ways 0% Interest Impacts You Today
So now that you have an understanding of how the federal interest rate system works, you probably want to know how this “near-zero” situation affects your day to day life. COVID-19 has changed the way our economy has functioned and not for the better.
To incentivize greater economic activity, the government wanted to slash interest rates as close to 0% as possible. This will (hopefully) help promote regular economic activity so businesses can run, pay employees, and give people money to put back into the financial system. Let’s take a look at a few ways these low-interest rates could impact you.
Look Into Refinancing
Since lower interest rates can have a significant impact on your debt, now is a good time to reevaluate the debt you have to see if you can refinance or consolidate any of it for a more lucrative rate.
First, take a look at the type of debt you have, and what interest rate is associated with each. Some interest rates are fixed whereas others are variable. Many variable interest rates on credit cards, for example, might be lower during this time which can help you pay that debt off quicker. For credit card debt, you can also look for 0% balance transfers but be sure to read the fine print as that rate may only be in effect for a short period of time.
If you have multiple private student loans, consider refinancing those to a lower interest rate. In most instances, refinancing federal student loans isn’t as beneficial as they have more flexible repayment options and low-interest rates to begin with.
For those of you with a home mortgage, now is a great time to shop around for other lending options. Even if you closed recently, refinancing to a lower interest rate will impact the amount you pay over the lifetime of your loan.
Most people recommend refinancing if the interest rate is at least a full percentage point lower than your current one, but each person’s needs will be different. Keep in mind that in the refinancing process, you will need to have extra cash on hand for closing costs which can be significant depending on if you need to purchase points to lower the rate, the total amount you have left on the loan (private mortgage insurance) and the lender fees.
The pandemic has caused a lot of turmoil for people’s personal financial health, impeding some from being able to pay their bills and make ends meet. Should you be under tough economic distress, take some time to look at the options available to you.
The first thing will be to take advantage of the CARES Act stimulus check, which is $1,200 for those who filed taxes single and $2,400 for those who filed jointly. As a business owner, be sure to look into other CARES Act relief funds like the payroll protection plan and other provisions designed to help keep your doors open.
If you need to borrow money, now could be the time to do it. Start by looking at all of the options you have available to you: personal loan, credit card, business loan, etc. and start with the one that has the lowest interest rate. Also, look for a fixed interest rate so as not to incur a massive surprise when the fed funds rate increases again. It is always important to borrow money with caution. Do your research and only borrow what you need to.
Know Your Savings Accounts Won’t Grow As Much
Seeing the numbers on your savings account grow from interest payments is a great feeling, but with the fed funds rate so low, don’t anticipate as large of an interest payment as usual.
Many savings accounts’ interest rates have a close relationship with the target federal funds rate. With the current range from 0-.25%, most banks aren’t making any money on the bank to bank loans which doesn’t give them a lot of wiggle room when it comes to interest rates they pay on savings accounts.
The world of federal interest rates can be a bit overwhelming, but know that you don’t have to tackle it all on your own. Our team is here to help you make smart money choices that give you the power to live life on your own terms. Even in these uncertain times, we are here to help you. Get in touch with us today.
Taxes play an important role in your financial life. Their reach extends far beyond the dreaded April 15 (now July 15th for 2020) date and come into play much more than once per year. Taxes are actually involved in nearly every financial decision you make, chief among them being investing.
Taxes are to investing as textbooks are to education—you can’t have one without the other. So how do taxes work when you are investing and in what ways can they impact and inform your investment strategy?
Let’s find out!
What Accounts are Taxable?
Before we dive into the type of taxes to look out for, let’s review what type of accounts generate taxes.
Investment Accounts and Taxes
A taxable investment account, otherwise known as a brokerage account, is an account that is funded by after-tax dollars and allows the account owner to invest in nearly any type of security. Those securities could be
With taxable investment accounts, you will be required to pay taxes on any gain in the year that gain happened. So if you had a capital gain of $5,000 in 2020, that money will need to be claimed on your 2020 tax return.
But what happens if your investments lose money? If you sell an asset at a loss (less than what you paid for it) that is known as a capital loss and doesn’t require any taxes. You can work to balance your tax bill by strategically balancing your capital gains and capital losses in a year as these losses can be used to reduce your taxable gains. In addition, you can deduct up to $3,000 in capital losses each year on your tax return with an option to carry forward the remainder.
Your long savings journey to retirement won’t come without its fair share of tax responsibilities. There are a couple of accounts that are tax-deferred accounts, which means the accounts contribute and accrue gains tax-free until distribution in retirement. The top two tax-deferred accounts are 401(k) and a Traditional IRA.
Both of these accounts are funded with pre-tax dollars. All of the gains continue to grow tax-free and are only subject to tax when you take distributions in retirement as ordinary income.
A Roth IRA and Roth 401(k), on the other hand, requires you to pay taxes when you contribute the money but not when you take it out, making it a vital savings vehicle for retirement. Roth IRAs do have income thresholds so if you make over $139,000 for single filers or $206,000 for married filers your options are limited, but you may be able to still contribute to a Roth by initiating a Roth transfer or backdoor Roth IRA in which you transfer funds from a traditional IRA into a Roth.
What Taxes Will You Owe (And Why)?
If you are earning money on an investment, the IRS will want a portion of that gain. Below are three main types of tax you might deal with when investing.
Capital Gains Tax
Capital gains tax is triggered when you make money, or realize a gain, on an investment. This comes from the sale of an investment at a higher price than what you paid. Sounds simple right? Well, the IRS has come up with a couple of stipulations to determine the percentage of capital gains tax that you will owe.
Length of time you held the investment
These two factors work to determine the percentage of tax you will pay on a capital gain. The first factor is based on your household income and your ordinary tax bracket and this number really informs the second criteria of how long you held the investment.
If you retain an asset for less than a year, that is considered a short-term capital gain and will be taxed at a higher rate, anywhere 10%-39.6% depending on your tax bracket. But, by holding onto your investments for a year or more, you will be eligible for the more favorable long-term capital gains rate, which ranges from 0%-20%, though most people pay about 15%. Again, that percentage will depend on your tax bracket.
Since selling assets costs you money, why is it worth doing? There are many reasons for people to sell assets including
Rebalancing a portfolio
Desire to make a change to investment strategy
Changing risk tolerance
The bottom line here is that your investments aren’t stagnant. They are moving and changing as your needs change. It is important to keep up with your investment strategy and understand what your needs and goals from it are to better create a plan that works for you.
Ordinary Income Tax
The second type of tax that you will need to factor into your investments is the ordinary income tax. This tax comes into play when you earn income through your portfolio in the case of dividends and interest payments.
Dividends are an interesting category and another way for you to experience tax on your investments. Some investments pay quarterly or annual dividends to their individual investors which are basically just a check that goes into your account. Interest works in a similar way. As a shareholder, some investments will pay you regularly, resulting in income.
This income is taxed at your ordinary-income rate. There are, of course, exceptions to this rule. Interest from municipal bonds is exempt from federal tax and for those lucky to live in California, they are exempt from state tax as well. If a dividend meets certain IRS regulations, it can be a qualified dividend that is taxed at the capital gains rate.
How to Keep Taxes in Mind When Investing
Tax planning is an important step to get the most out of your investments. As you can see, they play a major role in your overall profits. When factoring in taxes into your investment plan there are a couple of strategies to keep in mind.
Asset allocation is a strategy that looks at the specific securities that you invest in, like stocks and bonds, as well as the balance between those securities. Based on your aggressive risk tolerance, one account might be allocated to have 80% stock and 20% bonds, as an example.
If asset allocation is the balancing of securities, asset location takes it a step further by determining the best place to house those securities in order to make them as tax-efficient as possible. Believe it or not, where your securities live makes a huge difference in your overall return. Creating a strong plan around the role taxes play in your investments can help you come up with a strong, balanced, comprehensive investment plan.
Your investment goals will change and evolve as you do, so don’t be afraid to make changes when you need to. A situation might happen when you want to rebalance your portfolio or the market fluctuations support a different allocation depending on your risk tolerance and investment horizon.
The most important thing is to remember the investment goals that you set and employ a level of flexibility so that your strategy stays in line with where you are at in your life now.
Episode 106: How to Become a Millionaire with Ariel Ward
This week I sat down again with Ariel Ward, CFP® to talk about how to become a millionaire and some of the small steps you can be taking now to help you down the road.
Ariel Ward, CFP® joined Workable Wealth in 2018 as a Financial Planner and in March of this year, made the move to Abacus Wealth Partners with me as a Financial Planner. She and I work closely together on our clients. She has 11 years of experience in the field of personal financial services and in helping clients develop financial clarity. She is passionate about helping professionals understand their financial lives and make better decisions with their money. Ariel is married to a pilot and spends as much time as possible exploring the US with her husband and 2 children. She enjoys working with clients in the aviation industry to make the most of their employee benefits and map out a plan for personal financial strength. She is a member of NAPFA, the XY Planning Network and the Financial Planners Association.
Ariel works virtually out of Charlotte, NC. She enjoys North Carolina’s mountains, beaches and everything in between. In her free time you can catch her walking to one of Charlotte’s excellent breweries, playing Scrabble or building Lego houses with her kids.
HERE’S WHAT YOU’LL LEARN FROM THIS EPISODE:
The first thing to do to start growing your net worth
The question I like to ask all of my clients to help judge progress
How being debt conscious can be an important step toward millionaire status
How student loans play into your plan of millionaire status
How critical employer-sponsored retirement savings accounts can be
Leveraging a Roth IRA or a backdoor Roth IRA
If you’re paired up, is maxing out two 401(k)s enough for retirement
A few items millionaires have leveraged to get to that status
Other areas to focus on beyond investments when working to become a millionaire
One of your most valuable assets to help you increase your net worth
How lifestyle inflation can delay your ability to become a millionaire
What a $5,000 raise could do to your net worth over 20 years
A fear small business owners have that could be hurting their millionaire status
Where a budget plays into your millionaire goal
The difference between saving a percentage of income vs. a specific dollar amount
One of the fun parts of being a financial planner is getting to discuss some of the money moves we’ve made in our household knowing clients and readers are going through similar things. In these Work Your Wealth episodes I’ll be taking time to address how we approached the different money situations and the results of our decisions. Today I’m talking about the what we are doing as we stay home due to COVID-19 and how we are still managing self-care and family time.
HERE’S WHAT YOU’LL LEARN FROM THIS EPISODE:
What the headlines around COVID-19 are doing to your fears and anxiety
Great resources on COVID-19, benefits to be aware of, etc.
How we are handling the next several weeks in our household
If you have little ones at home, the importance of sticking to a schedule
Ideas for the little ones to keep them occupied while they are at home
Why you should have on hand some creature comforts
The important financial things you should be doing as COVID-19 spreads and the market reacts
At a time like this, why you should be reviewing your current expenses
Adjustments you could make to your personal and retirement accounts
The importance of staying physically active during a “stay-at-home” mandate
How to continue to show gratitude in this challenging time
A few books you could pick up while staying at home
How to teach your little ones about purchasing power and make it fun
Things you should focus on during over the next several weeks and months
Some of the ways the employees at Abacus are practicing self-care