Hodges Offers Financial Tips
A writer for Atlanta Magazine asked Dr. Charles Hodges, professor of business administration and an authority on personal finance, to answer a few finance questions for a future article. The information may be helpful to faculty and staff.
“Here is a general caveat for these answers. Every person’s situation is different, so these general answers may not apply in every case.” Charles Hodges
Q: My 401k has taken a hit, and I’m considering just moving my savings to a CD or something. Should I cash it out or leave it?
The first issue is that you may not have lost as much as you think. Most 401ks have a match associated with them. If your employer’s match is a contribution of $1 for every $1 you contribute, then you have lost very little of your money in the market downturn. The stock market is down about 50% from the October 2007 highs. If you invested $1 and your employer matched $1, then you lose 50 percent you are back to your original $1. Had you invested the $1 in a CD that had no match, you would also have about a dollar. Assuming your 401k had any match, most of the losses were to the employer match, not your original contribution.
The second issue is risk tolerance. For most of us, our most valuable asset is our own human capital. For most of us, it is more important to spend time worrying about how to do well in our career rather than worrying about investments. Thus the most important aspect of investing is to not let your investing adversely affect your job performance. If the volatility of your 401k is affecting your job performance, your social relationships or your ability to sleep at night, then you need to move to a less risky asset.
The third issue is how rational are you. If the 401k money is to fund your retirement and retirement is several years in the future, then a rational person needs to leave the money in stocks. Most 401k plans give you a choice of money market funds, bond funds and stock funds. Over any 10-year period, stocks are the top performing investment choice about 70 percent of the time. It is not rational to quit a bet that you win 70 percent of the time, just because the bet occasionally loses.
A last point on the topic is that you should seek to minimize fees. Over any ten-year period, stock index funds beat about 95 percent of other stock fund choices. Using index funds instead of actively managed funds will improve your returns. You should never pay an advisor to manage your 401k, as it is almost impossible for that person to increase your returns enough to justify their fee.
Q: Just in case I’m in the next round of cuts, how much money should I try to put aside as a rainy day fund?
A rainy day fund is a form of self-insurance. As with any insurance, you should spend the minimum amount to protect yourself. This answer ultimately depends very much on your situation as to how much you have in assets that can be converted to cash, the probability and timing of the expected layoff and how much you have in monthly expenses. Where a layoff is imminent, there is not enough time to create a rainy day fund. Creating a large pool of funds, which you hope to never use, takes years and may not be rational.
Having said the above, one should attempt to prepare for adverse events. Funding emergencies like a layoff, having the ability to purchase assets at a deep discount, being able to flee the country when the revolution comes, are all realistic probabilities. A rainy day fund, as a form of preparation, makes sense. Ideally, you should have access to enough cash to cover several months of expenses.
For most of us, several months of cash available is unrealistic. We should therefore be proactive and innovative in creating our preparedness plans. If you do not have cash, you should try to have an unused credit card for emergencies. If you do not have credit available, then purchase a few extra items of food each week to create a temporary supply of food. You might create an agreement to combine households with a friend or family member. Per person housing and food costs are much lower where many people live in a home. Being proactive would suggest that you combine households before the layoff so that you have some time to build a cash reserve.
An important aspect of your rainy day fund is the mechanism you use for saving. If a person thinks there is a high probability of bankruptcy after their layoff, the person should place the money in their retirement plan or an IRA because retirement funds are (mostly) protected in the event of bankruptcy. A person expecting bankruptcy who places the money in a regular savings account only increases the payoff to their creditors and does nothing to help their own post-bankruptcy standard of living. After one loses their job, they have access to funds in 401ks with a 10 percent penalty. Paying a 10 percent penalty to the government is far better than a 100 percent penalty to creditors.
Also, be aware that you may already have a rainy day fund. 401ks from former employers and IRAs are an emergency source of funds.
Q: The Company is really stressing how much we need to save money in order to not have any more cuts. Should I stop reporting mileage and other expenses?
No, report the true expenses and get your proper reimbursement. Reimbursement is pre-tax money, meaning that income taxes, Social Security and Medicare are not deducted from the payments. A person typically needs a $1.50 in regular income to replace $1 in reimbursements. It may even be smart to suggest to the company that they increase reimbursements in exchange for a pay cut. For the company, both are deductible expenses and the employee receives higher take home pay for reimbursements.
Layoffs generally follow one of two paths. There is the indiscriminate layoff, where whole sections are eliminated. In that case, you would lose your job whether or not you claimed the reimbursement. The second path is a partial layoff within each department. In the partial layoff, firms generally target those who are highly compensated or who make the least contribution to the department’s mission. Again, your reimbursement is not likely to impact whether you get laid off or not.
There are three exceptions to the above advice. One, if you are padding your expenses then quit padding. This type of behavior is much more likely to be discovered when times are bad. If you are terminated for cause, you are not likely to get severance pay and are probably not eligible for unemployment benefits. Two, if there are smarter ways to do you job that will reduce expenses, then be smarter. Behaving smarter makes you more valuable and reduces the chance of termination in the partial layoff. Finally, if everyone has agreed to stop getting reimbursed, be a team player. Not being a team player in stressful times makes it more likely you will be terminated.
Q: I’m worried about being laid off and losing my health insurance. Should I try to get all of my annual appointments out of the way before the next round of cuts?
Yes, you should take all of your appointments and get treatment for acute conditions. You should get prescriptions filled as soon as possible. Setting up treatments that you expect to continue after the layoff is more problematic.
COBRA, the government’s post-layoff health insurance plan, is often far too expensive to be maintained by the unemployed. For many treatments, a partial treatment is worse than no treatment at all. You should discuss the possibility of layoff with your doctor when designing treatment plans.
Be aware that there are alternatives to insurance. For laid-off Georgia residents, your children may be eligible for PeachCare. This low-cost health insurance plan will cover most needed treatments for children though age 18. Some basic medical needs can be met at county health departments and free clinics. Many senior centers have clinics available for seniors. College students can use their student health department. Finally, under federal law, be aware that hospital emergency rooms must provide "stabilizing care" for a patient with an emergency medical condition. The hospital must screen for the emergency and provide the care without inquiring about your ability to pay.
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