What a week, the dog days of summer are here and the action on Wall Street is hot. This newsletter gives a weekly recap from Vanguard, changing investment sentiment, risk of owning individual stocks, and some trivia for your enoyment. You and your investments need to stay cool for the rest of the summer.
Vanguard Weely Recap
The Commerce Department's report on gross domestic product (GDP) for the second quarter confirmed what many had expected: Although the economy has grown for the fourth straight quarter, the rate of growth has slowed. Moreover, the nation's recovery from recession has been tougher than previously thought, based on revised GDP figures indicating that the economy from 2007 to 2009 was weaker than originally estimated. For the week, the S&P 500 Index fell 0.1% to 1,102 (for a year-to-date total return—including price change plus dividends—of about -0.1%). The yield of the 10-year U.S. Treasury note fell 8 basis points to 2.94% (for a year-to-date decrease of 91 basis points).
Changing Investment Sentiment
As you read in the Vanguard Weekly Recap, this week on Friday, it was stated that the economy did not grow as fast as anticipated in the second quarter. The result was a drop in long term interest rates and the stock market yawned. This is the first time this summer that news like this did not send the VIX skyward and the stock market tumbling.
We have a change in investment sentiment and this is positive for the stock market. How did this happen? Thursday night on Bloomberg TV the Finance Minister for France was interviewed and gave a very upbeat report about the future. The statements were that a double dip recession would not occur, during 2011 the global economy would grow by 4%, and employment would grow worldwide. France is working simultaneously to control debt and grow their economy, something badly needed in the USA. I admit that I live a boring life by watching Bloomberg TV.
Risk of Owning Individual Stocks
This week CommScope reported second quarter financial results with revenue and earnings exceeding expectations. The stock was punished for the next 2 days dropping about 25%. Normally, one would think that good news would be rewarded. So what happened? The revenue for the next quarter was forecasted slightly below expectations and some large investors gave a vote of no confidence and ran for the exits. CommScope had top ratings by several investment guidance services such as the Motley Fool.
This points out a few important points about owning individual stocks:
* It is common for stocks to have much larger up and down swings from the rest of the market. We enjoy the large upswings.
* Results for the previous quarter do not matter, investing is about what will happen in the future. You can not invest by looking backward.
* Investment guidance experts do lots of research and select good companies based upon metrics and they can not predict the future just like trying to predict the weather.
Trivia
"Dog Days" (Latin: diēs caniculārēs) are the hottest, most sultry days of summer. In the northern hemisphere, they usually fall between early July and early September. In the southern hemisphere they are usually between January and early March. The actual dates vary greatly from region to region, depending on latitude and climate. Dog Days can also define a time period or event that is very hot or stagnant, or marked by dull lack of progress. The name comes from the ancient belief that Sirius, also called the Dog Star, was somehow responsible for the hot weather.
Saturday, July 31, 2010
Saturday, July 24, 2010
Financial Derivatives
This blog covers the topic of financial derivates. Also included will be an update on corporate earnings and the weekly update from Vanguard.
Corporate Earnings
My belief has been that corporate earnings will be stronger than anticipated and would be positive for investing in stocks. This week many corporations published earnings and gave guidance on future revenue and earnings. Most corporations exceeded expectations and gave a favorable view of the future stating that an economic recovery was progressing with little concern about a double dip recession. Treasury Secretary Tim Geitner also gave positive comments about economic recovery for the next 18 months. Because of these earnings reports, and an extension of jobless benefits, the stock market did perform well this week. This trend should continue through the earnings season which lasts through about the end of August.
Vanguard Weekly Recap
The speed might resemble that of rush hour traffic, but the economy is still moving. If a breakdown occurs, Federal Reserve Chairman Ben Bernanke said the Fed would take further measures. The news was mostly negative this week, but the long-term recovery still appears to be on course. Both existing-home sales and housing starts were down, mostly because of April's expiration of the federal homebuyer tax credit. The Conference Board's index of leading indicators also fell. For the week, the S&P 500 Index rose 3.5% to 1,103 (for a year-to-date total return—including price change plus dividends—of about -0.1%). The yield of the 10-year U.S. Treasury note rose 6 basis points to 3.02% (for a year-to-date decrease of 83 basis points).
Financial Derivates
A derivative is a financial instrument - or more simply, an agreement between two people or two parties - that has a value determined by the price of something else (called the underlying). It is a financial contract with a value linked to the expected future price movements of the asset it is linked to - such as a share or a currency. There are many kinds of derivatives, with the most notable being swaps, futures, and options. However, since a derivative can be placed on any sort of security, the scope of all derivatives possible is nearly endless. Thus, the real definition of a derivative is an agreement between two parties that is contingent on a future outcome of the underlying.
By contrast, we might speak of primary instruments, although the term cash instruments is more common. A cash instrument is an instrument whose value is determined directly by markets. Stocks, commodities, currencies and bonds are all cash instruments. The distinction between cash and derivative instruments is not always precise, but it is a useful informal distinction.
Referring to derivatives as assets would be a misconception, since a derivative is incapable of having value of its own. However, some more commonplace derivatives, such as swaps, futures, and options, which have a theoretical face value that can be calculated using formulas, such as Black-Scholes, are frequently traded on open markets before their expiration date as if they were assets.
Derivatives are used by investors to
1) provide leverage or gearing, such that a small movement in the underlying value can cause a large difference in the value of the derivative
2) speculate and to make a profit if the value of the underlying asset moves the way they expect (e.g., moves in a given direction, stays in or out of a specified range, reaches a certain level)
3) hedge or mitigate risk in the underlying, by entering into a derivative contract whose value moves in the opposite direction to their underlying position and cancels part or all of it out
4) obtain exposure to underlying where it is not possible to trade in the underlying (e.g., weather derivatives)
create optionability where the value of the derivative is linked to a specific condition or event (e.g., the underlying reaching a specific price level)
The recently passed financial regulation law has placed limits on the use of derivatives for banks and other financial institutions. These institutions are upset as it impacts their ability to make money as well as their ability to hedge against loss in an investment. If financial institutions are using derivatives, how can an individual investor use it?
If an investor is buying individual stocks then an option can be used to cover any loss. This is done by buying a put against the stock that gains in value as the stock declines. I am not a big believer of buying stocks options.
If an investor is buying mutual funds then an Electronically Traded Fund (ETF) can be purchased that tracks the value of future contracts. One such ETF is VXX that tracks the future value of the Volatility Indexes such as the Volatility Index of the S&P 500 (^VIX). A somewhat inverse correlation exists between the S&P 500 and the ^VIX so if one is concerned about future stock prices an individual investor can buy the VXX as a hedge. During the latest recession, while stock prices were dropping by 50% the VXX increased substantially, about 4 times higher.
The use of VXX is something that I am researching as a way to make money when the stock market is in a trading range. A portion of an investment portfolio would be used. This takes advantage of the Warren Buffet statement to be fearful when others are greedy and be greedy when others are fearful. This is how it works:
* when the stock market is acting normally and the ^VIX is low, about 20, VXX would purchased
* when fear hits the stock market and the ^VIX is high about 40, VXX would be sold
* the cycle continues as volatility rises and falls
Corporate Earnings
My belief has been that corporate earnings will be stronger than anticipated and would be positive for investing in stocks. This week many corporations published earnings and gave guidance on future revenue and earnings. Most corporations exceeded expectations and gave a favorable view of the future stating that an economic recovery was progressing with little concern about a double dip recession. Treasury Secretary Tim Geitner also gave positive comments about economic recovery for the next 18 months. Because of these earnings reports, and an extension of jobless benefits, the stock market did perform well this week. This trend should continue through the earnings season which lasts through about the end of August.
Vanguard Weekly Recap
The speed might resemble that of rush hour traffic, but the economy is still moving. If a breakdown occurs, Federal Reserve Chairman Ben Bernanke said the Fed would take further measures. The news was mostly negative this week, but the long-term recovery still appears to be on course. Both existing-home sales and housing starts were down, mostly because of April's expiration of the federal homebuyer tax credit. The Conference Board's index of leading indicators also fell. For the week, the S&P 500 Index rose 3.5% to 1,103 (for a year-to-date total return—including price change plus dividends—of about -0.1%). The yield of the 10-year U.S. Treasury note rose 6 basis points to 3.02% (for a year-to-date decrease of 83 basis points).
Financial Derivates
A derivative is a financial instrument - or more simply, an agreement between two people or two parties - that has a value determined by the price of something else (called the underlying). It is a financial contract with a value linked to the expected future price movements of the asset it is linked to - such as a share or a currency. There are many kinds of derivatives, with the most notable being swaps, futures, and options. However, since a derivative can be placed on any sort of security, the scope of all derivatives possible is nearly endless. Thus, the real definition of a derivative is an agreement between two parties that is contingent on a future outcome of the underlying.
By contrast, we might speak of primary instruments, although the term cash instruments is more common. A cash instrument is an instrument whose value is determined directly by markets. Stocks, commodities, currencies and bonds are all cash instruments. The distinction between cash and derivative instruments is not always precise, but it is a useful informal distinction.
Referring to derivatives as assets would be a misconception, since a derivative is incapable of having value of its own. However, some more commonplace derivatives, such as swaps, futures, and options, which have a theoretical face value that can be calculated using formulas, such as Black-Scholes, are frequently traded on open markets before their expiration date as if they were assets.
Derivatives are used by investors to
1) provide leverage or gearing, such that a small movement in the underlying value can cause a large difference in the value of the derivative
2) speculate and to make a profit if the value of the underlying asset moves the way they expect (e.g., moves in a given direction, stays in or out of a specified range, reaches a certain level)
3) hedge or mitigate risk in the underlying, by entering into a derivative contract whose value moves in the opposite direction to their underlying position and cancels part or all of it out
4) obtain exposure to underlying where it is not possible to trade in the underlying (e.g., weather derivatives)
create optionability where the value of the derivative is linked to a specific condition or event (e.g., the underlying reaching a specific price level)
The recently passed financial regulation law has placed limits on the use of derivatives for banks and other financial institutions. These institutions are upset as it impacts their ability to make money as well as their ability to hedge against loss in an investment. If financial institutions are using derivatives, how can an individual investor use it?
If an investor is buying individual stocks then an option can be used to cover any loss. This is done by buying a put against the stock that gains in value as the stock declines. I am not a big believer of buying stocks options.
If an investor is buying mutual funds then an Electronically Traded Fund (ETF) can be purchased that tracks the value of future contracts. One such ETF is VXX that tracks the future value of the Volatility Indexes such as the Volatility Index of the S&P 500 (^VIX). A somewhat inverse correlation exists between the S&P 500 and the ^VIX so if one is concerned about future stock prices an individual investor can buy the VXX as a hedge. During the latest recession, while stock prices were dropping by 50% the VXX increased substantially, about 4 times higher.
The use of VXX is something that I am researching as a way to make money when the stock market is in a trading range. A portion of an investment portfolio would be used. This takes advantage of the Warren Buffet statement to be fearful when others are greedy and be greedy when others are fearful. This is how it works:
* when the stock market is acting normally and the ^VIX is low, about 20, VXX would purchased
* when fear hits the stock market and the ^VIX is high about 40, VXX would be sold
* the cycle continues as volatility rises and falls
Pension Guarantees
The July AARP Bulletin has an article titled What an Outrage Protector of Pensions on Shaky Ground. This week on CNBC, the Ohio State Attorney General talked about the reasoning for filing a lawsuit against BP and has filed lawsuits in the past against other publicly traded company that saw a dramatic drop in stock price. These are related in that it points to the efforts taken to guarantee a pension. When person receives a pension it is believed to be guaranteed. This is mostly correct and if you are receiving a pension you need to stay current on the status of the pension fund.
Pension Benefit Guaranty Corporation
The Pension Benefit Guaranty Corporation (or PBGC) is an independent agency of the United States government that was created by the Employee Retirement Income Security Act of 1974 (ERISA) to encourage the continuation and maintenance of voluntary private defined benefit pension plans, provide timely and uninterrupted payment of pension benefits, and keep pension insurance premiums at the lowest level necessary to carry out its operations. Subject to other statutory limitations, the PBGC insurance program pays pension benefits up to the maximum guaranteed benefit set by law to participants who retire at age 65 ($54,000 a year as of 2009). The benefits payable to insured retirees who start their benefits at ages other than 65, or who elect survivor coverage, are adjusted to be equivalent in value.
The PBGC is not funded by general tax revenues. Its funds come from four sources:
1) Insurance premiums paid by sponsors of defined benefit pension plans;
2) Assets held by the pension plans it takes over;
3) Recoveries of unfunded pension liabilities from plan sponsors' bankruptcy estates;
4) Investment income.
Currently PBGC pays monthly retirement benefits to approximately 631,000 retirees of 3,800 terminated defined benefit pension plans. Including those who have not yet retired and participants in multiemployer plans receiving financial assistance, the PBGC is responsible for the current and future pensions of about 1.3 million people. It currently protects the pensions of more than 44 million American workers and retirees in more than 29,000 private single-employer and multiemployer defined benefit pension plans.
The PBGC regularly updates its investment strategy. In 2004, it chose to invest heavily in bonds. Under new leadership, the agency shifted a substantial portion of its assets into stocks. Because of the market decline, PBGC's equity investments lost 23% during the year ending September 30, 2008.
The AARP article made the following statements about PBGC:
* did not effectively safeguard assets
* problem with compliance to laws and regulations
* chronically underfunded with shortfalls in the billions of dollars
* this impacts the pensions in 1 out of 6 Americans
Getting to the questions of why the Ohio Attorney General has filed lawsuits against BP, Bank of America, AIG, etc? The answer is that management company for the Ohio state employees pension fund took some risks in order to gain a higher return and invested in individual stocks at a time when certain individual stocks took a dive. Because this pension fund is now underfunded, the citizens in the state of Ohio now have a liability at a time when tax receipts are down. The lawsuits are filed to protect because of: mismanagement, being underfunded, and a liability when tax receipts are down.
It seems that PBGC and Ohio state pension fund have some similarities. Typically, pension funds for corporations are underfunded because corporations prefer to put money into the operation of the company instead of a pension fund. Because of the recent decline in the stock market, both public and private pension funds need the PBGC more than ever.
Bottom Line: Pensions are a great thing and realize that a risk of underfunding always exists, especially when a stock market declines. If you have a pension you need to stay current on the funding and performance. Also, even if you will be covered by a pension you need to also invest for retirement because things outside of your control influence the ability of the pension fund to meet its future obligations.
Pension Benefit Guaranty Corporation
The Pension Benefit Guaranty Corporation (or PBGC) is an independent agency of the United States government that was created by the Employee Retirement Income Security Act of 1974 (ERISA) to encourage the continuation and maintenance of voluntary private defined benefit pension plans, provide timely and uninterrupted payment of pension benefits, and keep pension insurance premiums at the lowest level necessary to carry out its operations. Subject to other statutory limitations, the PBGC insurance program pays pension benefits up to the maximum guaranteed benefit set by law to participants who retire at age 65 ($54,000 a year as of 2009). The benefits payable to insured retirees who start their benefits at ages other than 65, or who elect survivor coverage, are adjusted to be equivalent in value.
The PBGC is not funded by general tax revenues. Its funds come from four sources:
1) Insurance premiums paid by sponsors of defined benefit pension plans;
2) Assets held by the pension plans it takes over;
3) Recoveries of unfunded pension liabilities from plan sponsors' bankruptcy estates;
4) Investment income.
Currently PBGC pays monthly retirement benefits to approximately 631,000 retirees of 3,800 terminated defined benefit pension plans. Including those who have not yet retired and participants in multiemployer plans receiving financial assistance, the PBGC is responsible for the current and future pensions of about 1.3 million people. It currently protects the pensions of more than 44 million American workers and retirees in more than 29,000 private single-employer and multiemployer defined benefit pension plans.
The PBGC regularly updates its investment strategy. In 2004, it chose to invest heavily in bonds. Under new leadership, the agency shifted a substantial portion of its assets into stocks. Because of the market decline, PBGC's equity investments lost 23% during the year ending September 30, 2008.
The AARP article made the following statements about PBGC:
* did not effectively safeguard assets
* problem with compliance to laws and regulations
* chronically underfunded with shortfalls in the billions of dollars
* this impacts the pensions in 1 out of 6 Americans
Getting to the questions of why the Ohio Attorney General has filed lawsuits against BP, Bank of America, AIG, etc? The answer is that management company for the Ohio state employees pension fund took some risks in order to gain a higher return and invested in individual stocks at a time when certain individual stocks took a dive. Because this pension fund is now underfunded, the citizens in the state of Ohio now have a liability at a time when tax receipts are down. The lawsuits are filed to protect because of: mismanagement, being underfunded, and a liability when tax receipts are down.
It seems that PBGC and Ohio state pension fund have some similarities. Typically, pension funds for corporations are underfunded because corporations prefer to put money into the operation of the company instead of a pension fund. Because of the recent decline in the stock market, both public and private pension funds need the PBGC more than ever.
Bottom Line: Pensions are a great thing and realize that a risk of underfunding always exists, especially when a stock market declines. If you have a pension you need to stay current on the funding and performance. Also, even if you will be covered by a pension you need to also invest for retirement because things outside of your control influence the ability of the pension fund to meet its future obligations.
Friday, July 23, 2010
Secrets to a Happy Retirement
I found a good article concerning being happy in retirement written by Sydney Lagier Thursday, July 22, 2010. Happiness is high on my list and I hope you enjoy the article.
Some folks transition seamlessly into a happy retirement and get right to the business of enjoying their new lives. But other people have a tougher time entering the retirement years. Some of these folks may wonder whether they are really cut out for retirement at all. Here are seven traits happy retirees share.
Good health.
Enjoying good health is the single most important factor impacting retiree happiness, according to a 2009 Watson Wyatt analysis. Retirees in poor health are nearly 50 percent less likely to report being happy, trumping all other factors including money and age.
A significant other.
The same study found that married or cohabiting couples are more likely than singles to be happy in retirement. The news gets even better for couples enjoying retirement together. Retirees whose partners are also retired report being happier than those with a working partner, according to research conducted earlier this year at the University of Greenwich.
A social network.
The Greenwich study also found that having friends was far more important to retirement bliss than having kids. Those who have strong social networks are 30 percent happier with their lives than those without a strong network of friends. Having kids or grandkids had no impact on a retiree's level of contentment.
They are not addicted to television.
After you retire you will have lots of time to fill. If you want to be happy in retirement, don't fill that time with endless hours of television. Heavy TV viewers report lower satisfaction with their lives, according to a 2005 study published by the Institute for Empirical Research in Economics in Zurich. The same results were found again in 2008 by researchers at the University of Maryland. In that study, a direct negative correlation was found between the amount of TV watching and happiness levels: unhappy people watched more TV and happy people watched less.
Intellectual curiosity.
Adults over 70 who choose brain-stimulating hobbies over TV watching are two and a half times less likely to suffer the effects of Alzheimer's disease, according to Richard Stim and Ralph Warner's book Retire Happy: What You Can Do Now to Guarantee a Great Retirement. Not only will shunning TV make you happier, it will make you healthier. Good health will in turn make you happier -- a not-so-vicious cycle.
They aren't addicted to achievement.
The more you are defined by your job, the harder it will be to adjust to life without it. According to Robert Delamontagne's book The Retiring Mind: How to Make the Psychological Transition to Retirement, achievement addicts have the most difficulty transitioning to retirement.
Enough money.
Of course you'll need enough money to support your chosen lifestyle in retirement. But beyond that, more money will not make you happier. The Watson Wyatt survey found that the absolute amount of money you have for retirement is less important than how your retirement income compares to your income before retirement. If you have enough to continue your pre-retirement lifestyle, you have enough.
If you don't have the traits necessary for a happy retirement, don't despair. There's good news for you, too. Consider a retirement that includes a little work. Researchers at the University of Maryland found that retirees who go back to work either full or part-time are healthier. The benefits don't depend on how many hours you work. Even temporary work has the same positive impact on health. If you can't find a paying job, don't worry. A growing body of research shows that retirees who volunteer reap the same benefits of health, happiness, and longevity. And since a happy retirement is a healthy retirement, you'll be set up to enjoy both.
Some folks transition seamlessly into a happy retirement and get right to the business of enjoying their new lives. But other people have a tougher time entering the retirement years. Some of these folks may wonder whether they are really cut out for retirement at all. Here are seven traits happy retirees share.
Good health.
Enjoying good health is the single most important factor impacting retiree happiness, according to a 2009 Watson Wyatt analysis. Retirees in poor health are nearly 50 percent less likely to report being happy, trumping all other factors including money and age.
A significant other.
The same study found that married or cohabiting couples are more likely than singles to be happy in retirement. The news gets even better for couples enjoying retirement together. Retirees whose partners are also retired report being happier than those with a working partner, according to research conducted earlier this year at the University of Greenwich.
A social network.
The Greenwich study also found that having friends was far more important to retirement bliss than having kids. Those who have strong social networks are 30 percent happier with their lives than those without a strong network of friends. Having kids or grandkids had no impact on a retiree's level of contentment.
They are not addicted to television.
After you retire you will have lots of time to fill. If you want to be happy in retirement, don't fill that time with endless hours of television. Heavy TV viewers report lower satisfaction with their lives, according to a 2005 study published by the Institute for Empirical Research in Economics in Zurich. The same results were found again in 2008 by researchers at the University of Maryland. In that study, a direct negative correlation was found between the amount of TV watching and happiness levels: unhappy people watched more TV and happy people watched less.
Intellectual curiosity.
Adults over 70 who choose brain-stimulating hobbies over TV watching are two and a half times less likely to suffer the effects of Alzheimer's disease, according to Richard Stim and Ralph Warner's book Retire Happy: What You Can Do Now to Guarantee a Great Retirement. Not only will shunning TV make you happier, it will make you healthier. Good health will in turn make you happier -- a not-so-vicious cycle.
They aren't addicted to achievement.
The more you are defined by your job, the harder it will be to adjust to life without it. According to Robert Delamontagne's book The Retiring Mind: How to Make the Psychological Transition to Retirement, achievement addicts have the most difficulty transitioning to retirement.
Enough money.
Of course you'll need enough money to support your chosen lifestyle in retirement. But beyond that, more money will not make you happier. The Watson Wyatt survey found that the absolute amount of money you have for retirement is less important than how your retirement income compares to your income before retirement. If you have enough to continue your pre-retirement lifestyle, you have enough.
If you don't have the traits necessary for a happy retirement, don't despair. There's good news for you, too. Consider a retirement that includes a little work. Researchers at the University of Maryland found that retirees who go back to work either full or part-time are healthier. The benefits don't depend on how many hours you work. Even temporary work has the same positive impact on health. If you can't find a paying job, don't worry. A growing body of research shows that retirees who volunteer reap the same benefits of health, happiness, and longevity. And since a happy retirement is a healthy retirement, you'll be set up to enjoy both.
Thursday, July 22, 2010
3 Ways Your Credit Score Impacts Retirement Readiness
I found an important article written by Ryan Guina, Wednesday, July 21, 2010, on how a credit score impacts retirement readiness. I hope you find it useful.
Your credit score can be an important component of your financial planning. While it's possible to make it through life without ever taking out a loan, most people can't afford to buy a home or pay for college with cash. A good credit score can help you take on an affordable loan to tackle these large expenses. Your credit score can also be an important indicator of financial health. Here are three ways your credit score might be affecting your retirement readiness.
1. Low credit scores are often a reflection of too much debt. Debt is the number one roadblock to a comfortable retirement and one of the leading causes of a poor credit score. Your credit utilization ratio, the amount of debt you have versus the amount available on your credit limits, makes up 30 percent of your credit score. Too much debt affects your cash flow and takes money away from other important goals, such as contributing to retirement accounts and investing. Reducing the total amount of debt you have not only improves your credit score, but, more importantly, improves your cash flow and financial health.
2. A low credit score means you pay higher interest rates. If you have a poor credit score and need to take out a loan for a mortgage or other big ticket item, you can expect to pay hundreds and perhaps thousands more over the life of the loan than if you had a high credit score. Improving your credit score means you can qualify for lower interest loans and better mortgage rates and use those savings for more important things like opening a Roth IRA or funding your 401(k) plan.
3. Your credit score can affect your ability to get a high paying job. Some employers use credit scores as a screening tool to help them determine which job candidates are most trustworthy. These companies believe your credit score can be a reflection of your ability to handle money and therefore your trustworthiness. Several states have proposed legislation that would prohibit this action, but for now this is a real threat for many job seekers. Improving your credit score may help you land a higher paying job. You can use the additional income for more important things, such as paying down debt, investing for retirement, and having fun.
Steps to Take
Improving your credit score will help you in many aspects of your financial life. Here are some ways you can improve your score:
• Understand how your credit score works. The first step is understanding how your credit score is calculated.
• Make on time payments. Your payment history makes up the largest percentage (35 percent) of your credit score.
• Pay extra on your loans. Your credit utilization makes up 30 percent of your credit score. Paying extra on your loan reduces your credit utilization and decreases the amount of interest you pay and the time it takes to become debt free.
• No new lines of credit. The average age of your credit accounts and the number of lines of credit you have open affect your credit score.
• Time. Follow these steps and practice good credit habits and you will see your credit score climb.
These steps require time and discipline, but they are worth the effort. Understanding how your credit score works and improving your score can put you on a successful financial path to retirement.
Your credit score can be an important component of your financial planning. While it's possible to make it through life without ever taking out a loan, most people can't afford to buy a home or pay for college with cash. A good credit score can help you take on an affordable loan to tackle these large expenses. Your credit score can also be an important indicator of financial health. Here are three ways your credit score might be affecting your retirement readiness.
1. Low credit scores are often a reflection of too much debt. Debt is the number one roadblock to a comfortable retirement and one of the leading causes of a poor credit score. Your credit utilization ratio, the amount of debt you have versus the amount available on your credit limits, makes up 30 percent of your credit score. Too much debt affects your cash flow and takes money away from other important goals, such as contributing to retirement accounts and investing. Reducing the total amount of debt you have not only improves your credit score, but, more importantly, improves your cash flow and financial health.
2. A low credit score means you pay higher interest rates. If you have a poor credit score and need to take out a loan for a mortgage or other big ticket item, you can expect to pay hundreds and perhaps thousands more over the life of the loan than if you had a high credit score. Improving your credit score means you can qualify for lower interest loans and better mortgage rates and use those savings for more important things like opening a Roth IRA or funding your 401(k) plan.
3. Your credit score can affect your ability to get a high paying job. Some employers use credit scores as a screening tool to help them determine which job candidates are most trustworthy. These companies believe your credit score can be a reflection of your ability to handle money and therefore your trustworthiness. Several states have proposed legislation that would prohibit this action, but for now this is a real threat for many job seekers. Improving your credit score may help you land a higher paying job. You can use the additional income for more important things, such as paying down debt, investing for retirement, and having fun.
Steps to Take
Improving your credit score will help you in many aspects of your financial life. Here are some ways you can improve your score:
• Understand how your credit score works. The first step is understanding how your credit score is calculated.
• Make on time payments. Your payment history makes up the largest percentage (35 percent) of your credit score.
• Pay extra on your loans. Your credit utilization makes up 30 percent of your credit score. Paying extra on your loan reduces your credit utilization and decreases the amount of interest you pay and the time it takes to become debt free.
• No new lines of credit. The average age of your credit accounts and the number of lines of credit you have open affect your credit score.
• Time. Follow these steps and practice good credit habits and you will see your credit score climb.
These steps require time and discipline, but they are worth the effort. Understanding how your credit score works and improving your score can put you on a successful financial path to retirement.
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