Smart Couples Finish Rich, Revised and Updated: 9 Steps to Creating a Rich Future for You and Your Partner

by David Bach

you should really consider putting your dream-basket money into growth-oriented investments. Because you’ve got more time, you can afford to take more risk to get a bigger return. To my mind, that means investing in stock-based mutual funds.

As far as I’m concerned, the first place you should put your long-term dream-basket money is in an index fund. Index funds are simple, inexpensive, easy to set up, and they work.

If you want even broader exposure to the stock market than an S&P 500 index fund, you might consider a Wilshire 5000 Index Fund. As the number suggests, the Wilshire 5000 tracks the performance of 5,000 separate stocks, and as a result represents one of the most diversified market gauges you can find.

ETFs are basically mutual funds that trade like stocks, meaning you can buy and sell them during market hours just as you can buy and sell common stock. What makes these funds so exciting to investors is that they are incredibly liquid, incredibly tax efficient, and extremely low cost. The average ETF has an expense ratio of about 0.20 percent, and sometimes less. And most of these funds sell for less than $100 a share.

Some of the most popular ETFs are the S&P 500 Index Depositary Receipts (known as Spiders, because their trading symbol is SPY), iShares Core S&P 500 (trading symbol IVV), Vanguard Total Stock Market ETF (trading symbol VTI), the Dow Jones Industrial Average Model Depositary Shares (or Diamonds; trading symbol: DIA), the NASDAQ 100 Trust (known as Cubes, after its QQQ symbol), and the S&P MidCap 400 Depositary Receipts (symbol MDY).

Balanced funds and index funds are great places to start, but once your dream basket reaches a really large size—say, when it contains $25,000 or more—it’s time for the two of you to consider building a diversified portfolio of mutual funds. BUILD YOUR PORTFOLIO AROUND “CORE” FUNDS

six types of funds I believe you should consider when building a mutual-fund portfolio. They are listed in the order of what I consider most conservative to most aggressive.

Large-Capitalization Value Funds A large-cap value fund invests in companies with large market capitalizations—that is, companies whose outstanding stock has a total market value of $10 billion or more. Companies of this magnitude tend to be more secure and established than most, and, as a rule, they pay quarterly dividends to shareholders. The “value” part of the name reflects the basic strategy these kinds of funds pursue. Generally speaking, the manager of a value fund looks for high-yielding large-cap stocks that sell at low price-earnings multiples. (That’s a fancy way of saying that these funds like to invest in solid companies whose stock is selling at bargain prices.)

Large-Capitalization Growth Funds These types of funds invest in what are commonly referred to as “growth stocks.” Large-cap funds typically look for stocks with a market value greater than $10 billion. Typically, growth stocks do not pay dividends because growth companies prefer to invest their profits in research, development, and expansion. Some great examples of large-cap growth companies are Apple, Microsoft, Facebook, Google, Oracle, Intel, and Amazon.com.

Medium-Capitalization Funds Otherwise known as “mid-caps,” these funds invest in medium-sized companies—that is, those with a market capitalization of $2 billion to $10 billion, such as Domino’s Pizza, ResMed, and Packaging Corporation of America. The potential for great returns here is high, but so is the risk.

Small-Capitalization Funds It’s getting harder to classify these funds because some small new company can go public these days with no earnings and overnight see its market capitalization suddenly spike to $1 billion or more. Typically, small-cap funds invest in companies with market caps that range from about $250 million to $3 billion. This reflects an ultra-aggressive approach, which can potentially produce great returns. Small-cap investing is a lot like betting on the hare instead of the tortoise.

International or Global Funds As the name implies, these funds invest in stocks from foreign countries. While an international stock fund invests solely in foreign stocks, a global fund will usually have only about 60 percent of its assets invested abroad; the remaining 40 percent will be in domestic stocks. Remember, as big as it is, the United States represents only about a third of the total world economy, and if you invest only in domestic stocks, you’re missing out on a lot of opportunities. I usually recommend that investors keep about 10 to 20 percent of their portfolio in international or global mutual funds.

What I know is this, the next time the market has a significant correction, don’t believe people who tell you, “This time it’s not going to recover—this time is different.” The markets have always recovered. A correction is not fun to go through, but if you don’t panic, you can live through it and thrive.

The mutual fund options I discussed in the previous section work fantastically well for long-term dreams, and I could simply leave it at that, but I want to provide you with all the major investment options, which is why we’re now going to cover annuities.

Here’s a broad definition of an annuity: It’s a contract between you and an insurance company whereby you pay a premium (you invest) in exchange for a variety of guaranteed payout options for a set period of time or for the remainder of your life. There are really two phases of annuities: the first phase, when you save and the contract accumulates and grows. The second phase, when you start to take money out, is called the distribution phase.

Do not buy an annuity until you are clear on the quality of the insurance company.

Fixed indexed annuities, which are often referred to as “FIAs,” are an insurance product that is tax-favored. In lay terms that means the money grows tax-free until you take it out (the technical term being “tax-deferred”).

Fixed indexed annuities offer principal protection, the promise of no downside (i.e., you can’t lose money if the market goes down, and you participate in the market returns when it goes up). The catch to this is that you don’t participate in all of the market upside.

you may earn only 50 percent of the upside with a cap in a given year. This all depends on the individual product you invest in, which means the devil is in the details.

Variable annuities are also insurance contracts. The insurance company basically wraps an insurance policy around mutual funds

The “insurance wrapper,” as it is called, allows the money in the fund to grow tax-deferred, just like in a fixed indexed annuity. The big difference between a variable annuity and a fixed indexed annuity is that your returns are based on your subaccount selection and returns, and these accounts typically do not provide a fixed guarantee.

The upside of annuities is that they are insurance products that can provide principal protection and tax deferral. And in some cases, depending on how you use the annuity, they can provide a guaranteed income stream for life and a long-term care benefit.

Let’s start with one big issue with annuities (both fixed and variable). First, the money grows tax-deferred (that’s really good), but the profits, when they are taken out of the annuity, are taxed as ordinary income as opposed to a long-term capital gain (that’s not so good) because ordinary income can be taxed at a higher rate depending on your income and tax rate. This is a very important point you need to consider before you invest.

Second, when you invest in an annuity you’re locking up your money for the long term. You can’t take the money out before you reach age 59½ without paying a government penalty fee of 10 percent

Third, there are lots of fees involved in getting the benefits and guarantees of the insurance. You must review the ...

Fourth, the insurance is only as good as the insurance c...

Finally, there can be a surrender fee—you must pay if you sell your annuity or take any distributions above a certain level from it within...

make sure, when buying an annuity, to ask the person presenting it to you about all “internal fees” and “back-end” surrender fees or sales charges.

I can tell you that my annuity preference now is for the fixed indexed annuity over the variable annuity. I will happily take part of the upside of the index to protect myself on the downside of the markets. Just as I would choose indexed universal life insurance over variable universal life insurance, I would opt for an FIA vs. a VA today.

MISTAKE NO. 1 Having a 30-year mortgage.

In the example I went over on the $250,000 mortgage at 4.5 percent with a monthly mortgage payment of $1,266 a month, just adding $126 a month EXTRA toward the principal would pay that mortgage off five years sooner, saving you $39,933! Make two extra payments of $126 and you would save $63,421! Reread that. That’s like two months of your Latte Factor! Right? Two months of coffee at home a year, and you’ve paid your home off eight years faster and saved $63,421.

One thing to keep in mind: when you make these extra mortgage payments, pay close attention to your monthly statements.

Believe me, debt-free home ownership is a goal worth striving for—and all it takes is an extra 20 percent on your monthly payment to make it a reality a decade or more early. And you know what else happens when you pay your home off in 15 years instead of 30? You retire earlier—on average, seven to ten years earlier. As your financial coach, that’s an option I would like you and your partner to have.

With this in mind, beware of the brokerage or insurance salesperson who suggests you should pull equity out of your home and “reposition” it in some mutual funds or insurance products where it supposedly can grow faster. Don’t fall for this.

MISTAKE NO. 2 Not taking credit-card debt seriously.

MISTAKE NO. 3 Trying to time the market.

Please seriously listen to me on this: you will not succeed in timing the market. What works when you invest in the market is TIME IN THE MARKET, NOT TIMING THE MARKET.

History shows that the markets ALWAYS RECOVER. There has never, ever been a declining market that has not ultimately recovered.

MISTAKE NO. 4 Buying stocks on margin.

My rule of thumb when it comes to this sort of thing is simple: never buy stocks you can’t afford to pay cash for.

MISTAKE NO. 5 Not starting a college-savings plan soon enough.

before I get into the details, there is an important point I need to stress. You shouldn’t even consider putting aside money for your kids’ college costs unless you are already putting at least 10 percent of your income into a pretax retirement account.

The greatest gift you can give your children is to ensure that you won’t be a financial burden to them. If worse comes to worst, your kids can always get a part-time job when they’re in high school and start putting aside their own money for college. There are also countless scholarships and loan programs for deserving students.

Section 529 plans are how people save for college today. What the 401(k) plan has become to retirement planning, the 529 plan has become for college savings. You should take advantage of these now, before some politician comes along and tries to end them (which has been discussed).

The best place to start your research is www.savingforcollege.com, which offers an incredible library of relevant material. The first thing to do is look at the plans in your state, as there may be a state tax deduction.

Websites for College Planning www.collegeboard.org www.collegeresults.org www.college-insight.org www.finaid.org www.petersons.com www.nasfaa.org www.unigo.com

we should institute a Presidential Financial Fitness program. We should create a mandatory education program, starting in the first grade, to motivate kids to learn about personal finance by offering them the chance to win symbolic awards. Let’s make learning how to be smart about money something that everyone does, not just the children of the rich (who are generally very good about teaching their kids how to become richer).

If you agree with me, go to www.gov.com and let your representatives in the House and the Senate know. This site tells you how to reach your representative. If a hundred thousand of us do this, they’ll have to listen!

You don’t have to be a financial professional to be able to teach your kids about money. You can still talk to them about how you are saving for retirement and why. You can discuss with them how you handle your credit-card debt, what sort of investments you are making, and how you make sure your financial practices reflect your values. A good way to begin the process is by showing your kids the chart. Explain to them how a little saving every month can go an awfully long way. Kids are interested in being rich. And they love learning about money.

committed to training teachers to teach money curriculums in school.