Money in the Bank...How Does It Get There?

Financial fitness is a lot like physical fitness: We all know what we should be doing—eliminating credit card debt, saving for emergencies, socking away dizzying amounts in a retirement fund—but finding a plan that works for the average person isn't easy. Even if we buy little notebooks, track every dollar spent and every painful dollar saved, swear off lattes and the stupendous but $28 control-top tights, there's still that small, tinny voice asking, "Are we covered for flooding?"..."Did I pick the right 401(k)?"..."Will I ever be able to pay for my kids' college education?"

We realized we needed nothing less than a dream team of experts to go beyond the financial basics, so we enlisted the aid of Eric Tyson (author of Let's Get Real About Money!), Susan Burke (founder of the investment management firm Beechtree Capital), and John Claghorn (senior vice president and wealth management adviser at RBC Dain Rauscher). To answer thorny questions about insurance and home buying, we turned to J. Robert Hunter, director of insurance, and Allen Fishbein, director of housing and credit policy, both at the Consumer Federation of America. And, of course, we grilled O's own Suze Orman for black-belt debt-paying tactics and investment advice. Here, they tackle the bewildering questions and intimidating calculations that stand in the way of real financial serenity.

Tell me something I don't know about paying off credit card debt.

You know that the first thing you have to do is get rid of any debt—and you probably also know to start by tackling the highest-interest credit cards first. But Suze Orman, O columnist and author of Women & Money: Owning the Power to Control Your Destiny, recommends that you don't close the newly paid-off accounts: Keep them open but inactive. "About 30 percent of your credit rating (FICO score) is based on your debt-to-credit ratio," she explains. Closing the accounts will reduce your amount of available credit and hurt your FICO score. When you've cleared all the debts, cancel one card each year, starting with those that have annual fees, then those with the lowest credit limit to highest. (She recommends you keep only two cards.) As you're paying off credit card debt, you might be tempted to transfer balances to a card with an introductory 0 percent interest rate. That's a good idea only when the cost of transferring is less than the interest you would've paid on the old card. Some cards cap the transfer fee at $75; some charge 3 percent of the entire transfer amount. (Bankrate.com has a "real cost of debt" calculator to help you figure this out.)

Do I really have to stash away six months of living expenses?

It depends, says syndicated financial columnist Eric Tyson, who suggests you have enough put away to cover...

• Three months' expenses, if you have family who will loan you money, your employment situation is stable, and you have accounts such as a 401(k) that you can withdraw from—though you might have to pay a 10 percent penalty.
• Six months, if you can't turn to family or friends and your employment situation is wobbly.
• Twelve months, if your income fluctuates wildly or if you are at high risk for job loss. 
  

Our experts recommend putting the cash in a high-yield savings account, money market deposit account (MMDA), or a money market mutual fund (MMMF). An MMDA is insured by the government; an MMMF is not, but it is very low risk and generally pays better interest than a typical savings account.

When should a person like me use a financial adviser?

The best way to find a good adviser is to ask friends whose financial acumen you respect—or contact the National Association of Personal Financial Advisors (NAPFA.org) or the American Institute of Certified Public Accountants (AICPA.org) to find a list of fee-based advisers in your area. "Commission-based advisers are not evil, but they tend to be salespeople," explains Susan Burke. Eric Tyson recommends you ask the following questions (and look for the following answers) when you meet an adviser for the first time: 

• What is your educational experience? (Business or finance.) 
  
• Do you sell life insurance, options, futures, or commodities? (No, no, no, and no.)
  
• Will you provide me with personal references from clients? (Yes.) 
  
• Do you have liability insurance? (Of course.) 
  
• Will you provide specific strategies I can implement on my own? (Absolutely.)

How will I ever be able to buy a house?

Home ownership: the impossible dream, especially for people contributing to a 401(k) or living in seemingly recession-proof housing markets—or both. But as long as you have not maxed out your 401(k) or IRA, "don't put money in a special savings account for a house," says John Claghorn. "Contribute as much as you can to your 401(k) and retirement accounts at work, which have tax and employer-matching benefits. You can withdraw $10,000 penalty-free from a traditional or Roth IRA for a first-time home purchase, and many employers allow you to borrow against retirement account balances." (Keep in mind that retirement account loans usually have to be paid back within a certain number of years.) Once you've made all your retirement contributions, Claghorn suggests opening a money market mutual fund (which invests low-risk, short- or medium-term investments such as treasury bills, bonds, and commercial paper) to start saving for a down payment. Eric Tyson suggests putting the cash into index funds that are managed by a computer; over 10 years, they outperform about 75 percent of the funds chosen by humans. Also, the best-performing index funds are the ones with the lowest expense ratios. Find out which those are by visiting MorningStar.com.

What kind of insurance do I actually need?

One in four Americans is underinsured for health crises, and about 60 percent of American homes are underinsured. "Most people need to consider five kinds of insurance: health, homeowner's, car, life, and disability," says J. Robert Hunter, director of insurance for the Consumer Federation of America. "Other kinds—from cancer policies to buyer-protection plans—are only worth it if you can't sleep at night without them." First on our list of questions: Who needs disability insurance? "It's only important to have if you are single or if your family is dependent on your income," says Hunter. Most people are best served by a policy that pays out 60 percent of their annual salary, because disability payments are not taxed.

My pal says his idea will be bigger than Google. Should I invest?

Your great-grandfather made a loan to his neighbor. When the young man offered to repay the loan in cash or stock in his new firm, your grandfather took the money. The company turned out to be IBM. If you don't want to make the same mistake, Eric Tyson says you can certainly consider funding someone else's business if you're investing in a small, privately held company and the amount you're putting in is less than 20 percent of your total financial assets; if you read and understand and totally believe in the company's business plan (it should explain the concept, the business objective, exactly how it will be implemented and at what cost, the background of principals, and how this product or service will better meet customer needs); and if you review a study of model companies in the same field. Finally, if you can afford to lose everything you invest, then, sure, go ahead.

How will I be able to afford my child's college tuition?

Don't save for your children's college fund, says Suze Orman, until you've met every one of your own financial goals—you're free of credit card debt, own a home, and are on track for retirement—because (1) you don't want to be a burden to your kids when you're old, and (2) you can withdraw money from an IRA without penalty to pay for tuition. Under the current financial aid system, investing in a 529 plan or education savings account can reduce your eligibility. These accounts may, however, have certain tax advantages. Find out more at SavingforCollege.com. 

Are you doing the very best thing with your money?