Frequently Asked Questions
- How long should I keep copies of my tax returns?Generally, you should keep your tax returns and supporting information (i.e., receipts, W-2 forms, bank statements) for six to seven years. The IRS has three years to audit a return, or two years after you have paid the tax, whichever is later. However, if income was under-reported by at least 25 percent, the IRS can look back six years, and there is no time limit for fraudulent tax returns.
- How can I figure out my net worth?
To figure out your net worth, add up the current value of all of your assets, then add up the current amount of all of your liabilities. Subtract your total liabilities from your total assets. The amount you end up with is your net worth. Assets can include cash, checking accounts, certificates of deposit (CDs), mutual funds, stocks, bonds, IRAs, 401(k) plans, automobiles, and real estate. Liabilities can include debt from credit cards, student loans, mortgages, home equity loans, 401(k) loans, and car loans.
If you are married, take this a step further. List your assets and liabilities under the name of the owner, so you can then calculate net worth values for you, your spouse, and the two of you as a couple.
The first step in the financial planning process should be to calculate your net worth. Once you determine your net worth, you will know exactly what you have and what you owe, enabling you to begin mapping out your financial future. Keep in mind that your net worth constantly changes. As a result, you should calculate your net worth annually and make adjustments as needed to ensure that you are meeting your financial goals.
- How much money should I keep in a savings account for emergencies?Without an adequate emergency fund, a period of crisis could be financially devastating. Many financial professionals suggest that you set aside three to six months' worth of living expenses for emergencies. The actual amount, however, should be based on your individual circumstances. Do you have a mortgage? Do you have short-term and long-term disability protection? Other factors you need to consider include job security, your health and income. Be sure to review your cash reserve periodically. Since personal and financial circumstances often change, you'll want to make sure your cash reserve fits your current needs/situation.
- How can I reduce my spending?To reduce your spending, you first need to know where your money goes. Start out by keeping track of all of your expenses for a month. None are too small or insignificant: the daily newspaper, coffee on the way to work, an extra gallon of milk, that burger at the fast-food outlet. Next, categorize the expenses so you can see what you spend and where you spend it. Be sure to factor into your monthly expenses a prorated portion of the annual cost of your irregular expenses (e.g., clothes, gifts, car maintenance, insurance premiums). Expenses generally fall into two categories. Essential expenses are ones you can't avoid (e.g., rent, utilities, groceries, car insurance). Discretionary expenses are ones you choose to incur (e.g., eating out, entertainment, gifts, cigarettes, videos). Discretionary expenses are the ones over which you will have the most control. Do you buy a lot of books? Try the library instead. Take coffee or lunch to work rather than buy it once you get there. Limit eating out to once a week rather than twice. Quit smoking, or at least begin to cut back on the number of packs you smoke each week. Although essential expenses are fixed, there may be ways to reduce them. Make sure you shut off the lights and TV when you leave the room. E-mail your distant friends and relatives rather than call them long-distance. Change the oil in your car on a regular basis to avoid more costly repairs due to neglect. Review your insurance policies: Can you save on your premiums by taking a nonsmoker discount or increasing your deductibles? Clip the grocery store coupons, always shop from a list, and avoid the impulse items at the end of the aisles. Pick a realistic goal for your monthly spending reduction and try not to make too many changes all at once. To see how big a difference this can make, do the math. If you start by committing to reduce your spending by $2 a day, that's $730 a year! Set the saved money aside, perhaps in a savings account for your planned vacation, or use it for a specific purpose, such as reducing debt faster.
- Should I invest my extra cash or use it to pay off debt?
To answer this question, you must decide how your money can work best for you. Compare the money you might earn on other investments with the money you would pay on your debt. If you would earn less on investments than you would pay on debts, you should pay off debt.
Let's assume that you have $1,000 in a savings account that earns an annual rate of return of 4 percent. Meanwhile, your credit card balance of $1,000 incurs annual interest at a rate of 19 percent. Your savings account thus earns $40, while your credit card costs $190. Your annual net loss is 15 percent, or $150, the difference between what you earned on the savings account and what you paid in interest on the credit card balance. It's even worse when you consider the tax effect. The interest on the savings account is taxable, and you have to use after-tax dollars to pay your credit card bill.
In the above example, it would be best to use your extra cash to pay down the high-interest debt balance. The same principle would apply if you were to invest your extra cash in a certificate of deposit (CD), mutual fund, or other investment.
Note: All investing involves risk, including the possible loss of principal, and there is no guarantee that any investment strategy will be successful.