CFP Board eNewsletter
September 2007
In Case of Emergency ... Use This Fund!
Health Savings Accounts and You
Financial Alerts
Portrait of an Investment Fraud Victim
Survey: Have You Experienced Financial Fraud?
About This Newsletter

In Case of Emergency ... Use This Fund!

I recently spent some time at the dentist. For months, I had been unable to chew on the left side of my mouth because of an extremely sensitive molar there. The dentist told me that the tooth needed a root canal treatment. I was expecting maybe a filling at the worst, so the root canal news came as a shock. I was even more shocked when he told me how much it was going to cost — upwards of $1,500.

Reclining in the dentist’s chair, feeling like my mouth was a roadside excavation site, lots of thoughts crossed my mind, none of them pleasant. I was worried about the expense of this treatment, and wondered how much it would cost if we suddenly discovered that one (or two, or even all three!) of my kids needed braces. One unpleasant thought led to another, and I remembered the leaky roof. Would it survive another wet autumn? And what about the warning lights that keep blinking on and off on the car dashboard? The mechanic says it’s just an electrical fault. But what if the transmission is about to implode? Even through the numbness of the anesthetic, I was starting to feel some pretty serious financial pain. That’s when an emergency fund — a sum of money put away for just such unpleasant surprises — started to seem like a really good idea.

Any large, unexpected expense — a dentist’s bill or some other health-related cost, major home maintenance, an expensive car repair — can pose enormous financial challenges. It can be difficult enough to afford one such emergency at a time. What would happen if two or more emergencies happened at once? What would I do, for example, if in addition to my root canal treatment I needed a new roof and a new transmission, too? And, since we’re dealing in worst-case scenarios here, what if I lost my job or became too ill to work just as all these bills were coming due?

Many financial advisors suggest keeping an emergency fund for exactly these kinds of situations. The idea is to figure out your basic living expenses for an average month, then set aside several months’ worth of money to tide you over should something unexpected happen. If disaster did strike, the emergency fund could cover the unexpected expenses; in case of job loss, it could keep you afloat until you got back on your feet again. Without an emergency fund, you might be forced to use credit cards or some other form of borrowing just to pay for basic necessities.

Advice varies on how many months’ savings to set aside; some say three months, some say six, some say nine. Mary Claire Allvine, CFP® and Christine Larson, authors of The 7 Most Important Decisions You’ll Ever Make: What Happy Couples Do to Achieve Their Dreams (some editions of the book are called The Family CFO), suggest keeping “no less than two months’ and no more than twelve months’ worth of operating expenses in cash. If you have more than a year’s worth of expenses in the bank, you risk losing a lot of value to inflation over time. If you have less than two months, you don’t have much wiggle room for emergencies.”

How much you set aside will depend on a variety of personal factors, such as how confident you are about your health, how secure you feel in your job, and how many dependents you support. A single individual in good health, for example, can probably afford to keep a smaller emergency fund than, say, a homeowner with a leaky roof, a creaky transmission, and three young children with bad teeth… Whatever you decide, two important questions are: How do I save, and where do I save it?

Saving for emergencies can be hard, especially when just paying the monthly bills can seem like a series of mini-emergencies in themselves. But having enough cash stashed away to meet your basic needs — mortgage, rent, insurance premiums, transportation, food — for a few months can provide a valuable sense of security. The financial information site Bankrate.com has an article, “22 Ways To Build an Emergency Fund,” with helpful savings tips. Two of the 22 ideas are: “Treat saving as a bill; consider having the amount transferred automatically from your checking account or paycheck” and “Just paid off a big debt such as a car loan or child’s tuition? Keep making the payments — this time to yourself.” Ideas like this are important when building an emergency fund, and they are important for re-building it in the event that you should ever have to use it.

To make sure your emergency fund is only used in emergencies — not for vacations, nights out, or new shoes — it’s best to keep it separate from your other money. And there’s no reason the funds shouldn’t be growing through investments or interest, as long as you can access the money quickly in case of need. Here is a list of savings and investment options that many advisors recommend for emergency funds:

  • Savings Accounts: Savings accounts normally earn higher interest rates than checking accounts, but the rates are still pretty low. Online savings accounts often offer more attractive rates.
  • Money Market Accounts: These savings accounts earn higher interest rates than traditional savings and often allow transactions like check-writing, though some limits apply.
  • Money Market Funds: A money market fund is not a money market savings account but a type of conservative investment. They tend to offer higher rates of return than savings accounts but, as with any investment, you can also lose money in a money market fund, although the risk is considered very low.
  • Certificates of Deposit (CDs): In a CD, you deposit a specific amount of money in a bank for a fixed period, usually between three months and five years. Your money earns a fixed rate of interest over that term; the longer you leave the money in, the higher the return. There are usually penalties if you withdraw funds early.

As always, it’s wise to seek qualified professional advice before making any financial decisions.

Emergency funds have their critics, too. Liz Pulliam Weston, a personal finance columnist for MSN Money and author of Deal with Your Debt: The Right Way to Manage Your Bills and Pay Off What You Owe, argues that what really counts is not the size of your emergency fund but “your overall financial flexibility — the resources you can command to help you withstand a crisis, even one that’s unexpectedly severe or long-lasting.”

In “The $0 Emergency Fund,” she highlights some of the problems with emergency funds. They take a long time to accumulate, for example, and they may prevent you from paying other bills or making other, more profitable investments. Weston suggests that, in some cases, borrowing may be a better way to deal with emergencies. She cites home equity lines of credit (HELOC) as one potential source of emergency money. Weston warns, though, that borrowing should never be an excuse for not saving, and "If you're a chronic over-spender who can't be trusted with credit, you're better off going the all-cash route."

Each individual or family will make a personal decision about whether to start an emergency fund and, if they do, how much to put in it. Remember, though, there is no substitute for qualified professional advice. As for me, I intend to keep some money socked away — and to start taking better care of my teeth.

— James Geary
 
Health Savings Accounts and You

Paying for health care can be one of the biggest financial challenges an individual or family can face. Health Savings Accounts (HSAs) might be able to help. HSAs have only been around since 2003, so they are still relatively unfamiliar to many people. But if you are concerned about providing health care for yourself and your loved ones, they might be worth a closer look. Here is an overview of how they work.

If you have an Individual Retirement Account (IRA) or a 401(k) plan, then you already know the basics of how HSAs work. You and/or your employer can contribute to an HSA, just as with a 401(k). And the money in your HSA can grow tax-free through investment and interest earnings, just as with an IRA. You can use the money saved in an HSA to pay for qualified medical and health care expenses. To open an account, though, you must first be covered under a high-deductible health plan (HDHP), a type of insurance that normally does not reimburse you for the first several thousand dollars in expenses (an amount known as the “deductible”).

The advantage of an HDHP is that monthly premiums drop as deductibles rise. A policy with a $3,000 deductible, for example, will be less expensive than a policy with a $1,000 deductible. That’s because the higher the deductible, the less an insurer will have to pay in case of a claim. The flip side is, of course, that the higher your deductible, the more you will have to pay from your own funds before your insurance kicks in.

Say, for example, that the deductible on your HDHP is $2,000. You face medical bills of $6,000. Your HDHP covers everything above the $2,000 deductible; in this case, that amounts to $4,000. But you still have to pay that first $2,000 yourself. This is where your HSA comes in. You can use the money saved in your account to pay these bills, as well as other expenses that may not be covered at all under your HDHP.

HSAs can only be used for “qualified” medical expenses. That means that the money can pay for broken bones, but not for Botox injections. If you use the funds in your HSA for anything else, watch out: The money will be taxed. And, unless you are disabled or over the age of 65, you will also be hit with a 10% penalty. If you are in any doubt about what expenses qualify, consult Publication 502 on the Web site of the Internal Revenue Service.

Once you reach the age of 65, you are permitted to use the funds in your HSA for non-medical expenses, but the money then becomes subject to tax. If you are already enrolled in Medicare, you are not eligible for an HSA. But if you had an HSA before enrolling in Medicare, you can still use it, though you can no longer make fresh contributions after you begin taking Medicare benefits. If you designate your spouse as the beneficiary of your HSA, then it will be transferred to his or her name after you die.

Just as with a traditional savings account, you decide how much money to deposit in your HSA, how to invest it, and how to spend it. (There is an upper limit on how much you can contribute in any one year. For 2007, this is $2,850 for individuals and $5,650 for families. Those aged 55 and over can make extra “catch-up” contributions, up to $800 for 2007.) If you don’t use the funds in your HSA at all in any single year, the money rolls over into next year — and continues to grow, tax-free.

Not everyone thinks HSAs are a good idea. Critics have said that HSAs favor those with high incomes, who are already more likely to have health insurance than those on low incomes. Another criticism is that the tax benefits are too small to make the accounts attractive to low-income individuals, who are also least able to set aside money every month for an HSA. Before deciding whether an HSA is right for you, be sure to consult a qualified financial advisor.

If you would like to know more, the Consumer Guide To Health Savings Accounts, from the National Association of Health Underwriters contains full details on how HSAs work and what you need to do to open an account. The U.S. Department of the Treasury has a comprehensive list of Frequently Asked Questions that address many of the details related to setting up and managing HSAs.

Online Resources
HSAs are available from banks, credit unions, and insurance companies. Here is a selection of Web sites that feature information on how to set up an HSA. Be sure to consult a qualified financial advisor before deciding whether an HSA is right for you.

HealthDecisions.org
America’s Health Insurance Plans (AHIP), a national trade association representing nearly 1,300 health insurance companies, manages this Web site, which has a section devoted entirely to Health Savings Accounts. The HealthDecisions.org HSA Learning Center provides information on the basics of HSAs and how to open an account.

HSAFinder.com
Marketing and media firm Information Strategies, Inc. manages this Web site, which features a wide range of information on HSAs for both individuals and employers. The site has a state-by-state guide to obtaining HDHPs as well as a comparative list of banks offering HSAs.

HSA Information Center
The Council for Affordable Health Insurance (CAHI), an advocacy group for market-oriented health care solutions, manages this Web site, which has a broad range of resources for both consumers and employers. It also features links to HSA-related material on the Web sites of the Internal Revenue Service and the U.S. Department of the Treasury.

HSA Insider
Healthcare and financial services firm Canopy Financial manages this Web site, which offers HSA quotes from a range of providers. The site’s HSA Knowledgebase has an extensive list of questions and answers about HSAs.
 
Financial Alerts

Generosity is a trait many of us aspire to. Unscrupulous salespeople and scam artists understand this and have come up with ways to use generosity to their benefit. Some make themselves look generous by masking sales pitches with “free” offers. Others develop ways to trick people into sharing their generosity with them. The North American Securities Administrators Association (NASAA) and the Federal Trade Commission (FTC) have issued alerts to help consumers protect themselves from investment fraud and charity fraud.

Financial Seminars with “Free” Meals

We all know there’s no such thing as a free lunch, but that doesn’t stop some financial salespeople from filling newspapers and mailboxes with invitations to financial seminars that include a “free” meal. NASAA urges seniors to be aware that “free meal seminars” usually come with a large serving of high-pressure investment sales pitches. If you decide to take up an offer for a “free” meal, take time beforehand to learn what to watch out for and how to protect yourself from investment fraud at: www.nasaa.org/Investor_Education/Investor_Alerts___Tips/7181.cfm

Giving Wisely: Avoid Fraudsters Seeking to Divert Your Donations

Many have opened their hearts and wallets to help those affected by the earthquake that shook the central coast of Peru on August 15. Unfortunately, there are also fraudsters ready and willing to divert your charitable contributions to their own pockets. For those considering donations to international relief organizations that assist earthquake victims, the FTC has put together tips to help make sure your generosity reaches the people who need it. Learn more about how to give wisely at: www.ftc.gov/bcp/edu/pubs/consumer/alerts/alt165.shtm

Read more financial alerts.
 
Portrait of an Investment Fraud Victim

Scam artists and unscrupulous investment salespeople seem to find more and more ways to take advantage of investors. Regulators and researchers know this, and they’re taking action to discover how scam artists operate and how to best help people resist fraudulent sales practices. Last year, the NASD Investor Education Foundation (now called the FINRA Investor Education Foundation), with the assistance of WISE Senior Services and the Consumer Fraud Research Group, conducted an Investor Fraud Study that examined consumer fraud targeted at Americans over the age of 45. In addition to reviewing the methods fraudulent salespeople use to persuade people to invest, the study also conducted a survey of individuals who had been victimized by investment fraud. The study’s findings create a portrait of the type of American most likely to succumb to investment fraud.

The NASD study shows that investment fraud victims are most likely to be male and are likely to be married and living with one or more persons. They are also more likely than the general population to have a college degree and bring in a higher-than-average income. They tend to have experienced significant negative life events, such as legal problems, physical conditions, or financial challenges related to their home.

In addition to the demographic similarities, the group of investment fraud victims shared some similar personality traits. The study found them to be more optimistic than the general population, believing that they’re in control of their lives and that their fate is up to them.

With their optimistic traits and faith in their own ability to discern between quality and dubious investments, investment fraud victims were also found to be more open to hearing investment pitches, even if those pitches came from questionable sources. The survey results showed they are more likely to attend that “free lunch” seminar that may be pitching risky or high-commission investments, to read investment advertisements that appear in their mailboxes, or to listen to unsolicited phone calls touting investment opportunities. While they believe they can distinguish the difference between a legitimate investment opportunity and a scam, they seem to make themselves available to listen to the end of possibly fraudulent sales pitches. Unfortunately, listening to dubious sales presentations only increases a person’s exposure to fraud and gives a perceptive salesperson more chances to find the right pitch to hook the listener.

Perhaps the most surprising finding was that victims of investment fraud scored higher on a series of questions designed to measure financial literacy. They understood things such as how interest works, what investment types historically perform better over long periods, and what risk factors are associated with certain investment types. One would expect people who scored higher on financial literacy to be better prepared to realize when an investment is too good to be true. Instead, it appears that their knowledge of financial matters made them over-confident.

Investment fraud victims were found more likely to rely on their own experience and knowledge when making investment decisions. Rather than establish a relationship with a trusted financial advisor who could be a reliable source of legitimate investment options, or a sounding board for evaluating investment options discovered through the news media or other means, investment fraud victims tended to display independence when approaching investments.

Another unfortunate finding of the study was that people who fall prey to investment fraud were unlikely to seek help even after they experienced fraud. All of the people surveyed had verifiable losses of at least $1,000. Nevertheless, they often failed to report being taken in by fraud, with less than 24% even admitting that they had lost money.

If this portrait of an investment fraud victim resembles a friend or family member, or if you recognize yourself in the portrait, you can take steps to prevent being taken in by a fraudulent salesperson:

  • Take time to learn about the latest scams so you can identify the type of schemes to avoid.
  • Ask questions about a potential investment until you’re certain you have a clear understanding of all important aspects of the investment.
  • Walk away when anything about an investment opportunity makes you uncomfortable.
  • Learn about the regulators and authorities you can turn to when you need objective information about investment types or when you want to report fraudulent activities.
  • Develop a relationship with a trusted financial professional who can provide you with competent and ethical advice before you invest your money.

Online Resources
If you encounter an investment pitch that you believe is misleading or fraudulent, there are several regulatory bodies you can turn to for assistance.

U.S. Securities and Exchange Commission (SEC)
An important part of the SEC’s mission is to protect investors, and the SEC’s Office of Investor Education and Advocacy was created to serve individual investors. They encourage investors to let them know about the concerns and problems they encounter, so that they are alerted to bad brokers or firms and about unfair practices in the securities industry that might need to be changed. To file a complaint with the SEC, visit their Web site at: https://tts.sec.gov/acts-ics/do/complaint.

Financial Industry Regulatory Authority (FINRA, formerly NASD)
FINRA is the largest non-governmental regulator for all securities firms doing business in the U.S., and it oversees nearly 5,100 brokerage firms, about 173,000 branch offices and more than 669,000 registered securities representatives. Their Web site includes an extensive Investor Information section. If you believe you have been the subject of unfair or improper business conduct by a brokerage firm or broker, you can file an investor complaint through FINRA’s Web site at:

http://www.finra.org/InvestorInformation/InvestorProtection/InvestorComplaintCenter/index.htm.


North American Association of Securities Administrators (NASAA)
NASAA is an organization of the securities administrators from each state, province and territory in North America. Securities administrators are typically responsible for licensing securities firms and investment professionals, registering certain securities offerings, reviewing the financial offerings of small companies, auditing branch office sales practices and record-keeping, promoting investor education, and enforcing state securities laws. If you encounter a solicitation for a securities investment that appears to be a scam, contact your state’s securities administrator and share your concerns. NASAA’s Web site includes links to each state’s securities administrator at: http://www.nasaa.org/QuickLinks/ContactYourRegulator.cfm.

National Association of Insurance Commissioners (NAIC)
The sale of insurance products in the U.S. is regulated by each individual state. NAIC is an organization of insurance regulators from each state to further the public interest. If you encounter a solicitation for insurance that sounds fraudulent, don’t hesitate to contact your state’s insurance department. In addition to insurance-related consumer alerts, the NAIC Web site provides links to each state’s insurance commissioner at: http://www.naic.org/state_web_map.htm.

Certified Financial Planner Board of Standards Inc. (CFP Board)
Financial planners who have attained CFP® certification are required to abide by CFP Board’s Code of Ethics and Professional Responsibility and Financial Planning Practice Standards. CFP Board takes those ethical standards seriously, and it investigates allegations of unethical conduct brought against CFP® professionals. When appropriate, CFP Board issues public discipline against those who violate CFP Board’s ethical standards. To learn more about CFP Board’s disciplinary procedures, or to file a complaint against a CFP® professional, visit: http://www.CFP.net/learn/complaint.asp.

 
Survey: Have You Experienced Financial Fraud?

There are many financial services professionals across the country who provide objective advice and act in the best interest of their clients. Unfortunately, there are also unscrupulous financial salespeople and fraudulent investment schemes out there. Let us know if you’ve ever experienced financial fraud.

Take Our Survey
 
About This eNewsletter

CFP Board's "It's Your Turn" eNewsletter is sent monthly to those who have subscribed through CFP Board's Web site, www.CFP.net/learn. CFP Board exists to make people aware of the benefits of financial planning and to encourage people to seek out individuals who can help them apply the financial planning process to improve their financial lives. This eNewsletter is designed to provide information about financial planning, financial planning tools and resources, consumer alerts and more. Suggestions and feedback are welcome at mail@CFPBoard.org.