Switching to Cash May Feel Safe, but Risks Remain

By RON LIEBER

It’s a question we’ve all asked in our darker moments of late: Why not just put all of our investments in cash, 100 percent, just for a little while, until things calm down?
Some people already seem to be acting on that instinct. In the first six days of October (through Monday), investors pulled $19 billion out of mutual funds that invest in United States stocks, matching the outflows for the entire month of September, according to TrimTabs Investment Research.
“What clients are looking for is safety,” said John Bunch, president of retail distribution at TD Ameritrade. “They are seeking solutions that are backed by the federal government. Specifically, F.D.I.C-insured money funds and certificates of deposit. All of it is under the umbrella of, ‘Am I safe and insured?’ ”
By fleeing for the comfort of safe and insured, however, investors with a time horizon beyond a few years may be doing real damage to their long-term finances. If you’re tempted to make a big move to cash right now, you’re doing something called market timing. It’s an implied statement that you’ve figured out the right moment to get out of stocks — and will also know the right time to get back in.
So let’s dispense with the first part straightaway. The right time to move out of stocks was a year or so ago, before various stock indexes the world over fell by one-third or more.
If you missed that opportunity, you’re hardly alone.
But if you sell now, you’ll be locking in your losses. And once you’re in cash, there isn’t much upside. In fact, with interest rates low, you’re likely to lose money in cash, because inflation will probably eat up the after-tax returns you earn from a savings or money-market account.
A guarantee of a small loss may sound good right now. But if you’re not bailing out of stocks once and for all, how will you know when it’s time to get back in? The fact is, any peace of mind you gain by being on the sidelines now will turn into a migraine once you see how much you can harm your portfolio over time by missing just a bit of any rebound.
H. Nejat Seyhun, a professor of finance at the Ross School of Business at the University of Michigan, put together a study in 2005 for Towneley Capital Management, where he tested the long-term damage that investors could do to their portfolios if they missed out on the small percentage of days when the stock market experienced big gains.
From 1963 to 2004, the index of American stocks he tested gained 10.84 percent annually in a geometric average, which avoided overstating the true performance. For people who missed the 90 biggest-gaining days in that period, however, the annual return fell to just 3.2 percent. Less than 1 percent of the trading days accounted for 96 percent of the market gains.
This fall, Javier Estrada, a professor of finance at IESE Business School in Barcelona, published a similar study in The Journal of Investing that looked at equity markets in 15 nations, including the United States. A portfolio belonging to an investor who missed the 10 best days over several decades across all of those markets would end up, on average, with about half the balance of someone who sat tight throughout.
So moving to cash right now is just fine as long as you know precisely when to get back into stocks (even though you didn’t know when to get out of them).
At some point, stocks will indeed fall enough that investors will remove the money from their mattresses and put it to work, causing prices to rise significantly. But, as Bonnie A. Hughes, a certified financial planner with the Enrichment Group in Miami, put it to me, there won’t be an e-mail message or news release that goes out when this is about to happen. It will be evident only afterward, on the few days when the market surges.
And it gets worse for those who think they won’t have any trouble investing in stocks again later. Medium- or long-term investors who are considering a big move into cash right now are probably making an emotional decision, at least in part. For those who follow through, the same instincts will probably hurt when trying to figure out when to reinvest in stocks.
“The emotional forces that drove them out of the market aren’t likely to let them back in ‘until things are better,’ ” Dan Danford of the Family Investment Center in St. Joseph, Mo., said in an e-mail message. “And for most people, things won’t feel better again until the market has already moved back up.” In fact, he added, plenty of people may not allow themselves to get back in until the market has already risen significantly.

That situation is worth considering if you think your mood, or returns, can’t get any worse. “People feel worse missing out on the bounce-back that will inevitably come than they do hanging in there through the down period,” said Elaine D. Scoggins, a certified financial planner with Merriman Berkman Next in Seattle.
The truly downbeat do not see the bounce as inevitable. This outlook is essentially a bet that our current predicament is so different that the equity markets won’t bounce back at all, even though they survived 1929, the Great Depression, 1987 and a major terrorist attack. I do not believe that the markets are in some kind of permanent decline, and I haven’t found an expert who does.
That said, some retirees, or those close to leaving the work force, may be well-off enough to leave stocks behind for now. If the tumult in the economy and the decline in the markets have altered your risk tolerance, then it may make sense to move to a portfolio of Treasury bills, certificates of deposit and money market funds.
Michael G. Coli, 56, of Crystal Lake, Ill., decided to take his 401(k) money out of the market in February. As an investor in his sons’ pizza restaurants, he noticed that an increasing number of customers were relying on credit cards. And as the owner of a winter home in Naples, Fla., he witnessed the housing market dive. Taken together, he decided to pull his retirement money, which he would need in five years, from the Vanguard Balanced Index Fund and move it all into certificates of deposit.
“I had the feeling the economy was not on real firm ground,” Mr. Coli said. “I decided to get out and put it all in C.D.’s, and that is where I’ve been ever since.”
If you can’t afford to live off the proceeds of cash investments (or dividends from your investment in your kids’ pizza joints), you may have no choice but to hold on to whatever stocks you have left. Then, you can hope for a rebound that will allow you to live out your later years more comfortably. Selling now and moving to cash could mean guaranteeing a lower standard of living for the rest of your life, because you’d be locking in your losses.
But if you’re a bit younger, try to think of your investment portfolio in the same way you consider the value of your home, if you own one. After all, if you’re not moving anytime soon, your home is a long-term investment, too.
“Today’s price is not your price. Your price is 10 or 20 years from now,” said Thomas A. Orecchio, of Greenbaum & Orecchio, a wealth management firm in Old Tappan, N.J. “Unfortunately, stock market investors don’t always see things that way.”

Your Money: Keeping It Safe

by Money Magazine Staff

Scared yet? The Dow Jones industrials suffered a decline of more than 875 points on Monday and Tuesday, and Federal Reserve Chairman Ben Bernanke predicted that the global financial markets crisis is likely to restrain the economy well into next year.
Americans' retirement plans have lost as much as $2 trillion in the past 15 months, according to Congress' top budget analyst.
It's okay to feel the fear. But it's not okay to react to it. Panicking and making big changes in your accounts is likely to do a heck of a lot more damage than a recession ever could.
Sticking to some tried-and-true principles can help you get through the bad times with your sanity and your savings intact.
"Don't panic, stay the course," said Allan Roth, a financial planner in Colorado Springs. "If you can't be right at least be consistent. We're allowed to feel the emotions, but how we react to them is going to be far more important than any short-term swings."
An Early Start
If you're just starting to think about saving for retirement, don't delay. Despite the upheaval of the past few months — and the past few weeks in particular — it would be a mistake for someone in their 20s or 30s to hold off on investing now.
The key here is the long-term prospects for stocks. Ultimately, stock values hinge on the productivity of U.S. workers and the earnings power of American companies. And it's not as if those engines of long-term growth are about to disappear.
The country may need some time to work through the detritus of the housing bubble and lending excesses. And stock returns could very well be anemic as that happens. But history shows that some of the best long-term gains go to investors willing to buy stocks when they're reviled, as in the years following major setbacks like the 1929 crash and the 1973-1974 bear market.
Of course, the long view may not seem particularly relevant to you at the moment. But remember: the money that you contribute to accounts such as a 401(k) is going to be invested for many years.
The real question isn't whether you should be contributing to a 401(k). It's how you should be investing the money you contribute, as well as the money that's already there.
If you're in your 20's or 30s, you still want most of your 401(k) money in stocks, say between 80% and 90%. That may be a tough sell emotionally in these uncertain times. But the important thing isn't what your 401(k) is worth over the next few years — it's what its value will be in 2040 and beyond.
Mid-Career
Even if you're older, you should still think of the money you're contributing now as a long-term investment. But you also need to give some consideration to preserving the assets you've already accumulated.
That means dialing back your stock exposure somewhat, although you don't want to hunker down completely in bonds and cash. Lightening up on stocks will give you more short-term stability. But if you get too conservative, you run the risk of stunting the eventual size of your nest egg — and your lifestyle in retirement.
But before you go tinkering around with your portfolio, keep in mind that while bear markets can hurt a portfolio, how you react to downturns can make matters worse, said Roth. He points out that investing in stocks when they're hot and then running to bonds when they're not has a name: performance chasing.
"When you move in and out, you're actually increasing risk while decreasing your returns," Roth said. Over time, market timing can cost investors around 1.5% a year in returns, according to Roth.
'The Danger Years'
The decade before you quit the work force, along with the five years immediately after, is the most sensitive period in an entire lifetime of retirement planning. The saving, investment and career decisions you make during this time will dictate in a major way whether you'll spend the next 30 to 40 years enjoying the life you've always looked forward to or eating the early-bird special at Denny's.
"It's natural to have a queasy feeling at this time in your life, wondering if your retirement will happen as planned," says Joseph Chadwick of the Longevity Alliance, a financial services firm that specializes in retirement products. "But there's no need to panic."
Stocks held for the long term can be counted on to bounce back eventually. But if you need to sell shares just as they're dropping in value — exactly the scenario many newly minted retirees have faced recently — you run a sharply higher risk that your money will someday run out. That's because when the market does recover, you'll have less money invested to benefit from renewed growth.
Fortunately, there's a minor tweak that can dramatically cut your risk.
Typically, to ensure your nest egg lasts as long as you do, you should withdraw no more than 4% of your savings for living expenses in your first year of retirement. In year two, you might take a little more to account for inflation.
The bear-market adjustment? Give up on the inflation increase until stocks recover.
A study by T. Rowe Price concludes that this simple step cuts the odds of running out of money over a 30-year period in half, from 22% to 11%, on a sample portfolio invested 55% in stocks and 45% in bonds.
Worried that forgoing your inflation raise will bust your budget? Pull a Brett Favre and go back to work part time to make up the "lost" income. You probably won't need to put in more than a few hours a week — a 3% increase on a $75,000 annual withdrawal equals only $200 a month.

Early Retirement Is Not Just A Daydream

Anna Vander Broek

Imagine living a life in which your suit is one for swimming, your only appointment is walking the dog and the most important report of the day is on the Weather Channel.
Actually, this life isn't that hard to picture because this is how many American's view their retirement.
Now imagine living this life before turning 50.
It may sound fantastical, but there are ways to retire young without winning the lottery or having valuable options to cash out. Savvy investing, smart spending and very strict saving can pave the road for the average American to find a way to live out the dream of early retirement.
When planning for early retirement, you must first understand just how much money you are going to need. If you retire at age 50, you could very well have another 35 years or more left to live. Americans in their 20s probably won't have Social Security or pension plans to lean on.
"Your portfolio will have to finance everything," emphasizes Alyce Zollman, a financial adviser with Charles Schwab (nasdaq: SCHW - news - people ).
In Pictures: 15 Ways To Retire Early
To understand how much money you'll need after you say good bye to your nine-to-five, take your pre-retirement income and multiple it by 35 (assuming you'll live to age 85). For example, if you are living off $100,000 now, you'll need about $3,500,000 when you retire. Not a small sum.
Saving is essential for most people who want to retire early. Max out your 401(k) and consider an IRA. Put money into safe, long-term investments, and don't gamble on the stock market.
To retire in your younger years, you'll have to work for it in your much younger years. In order to retire young without an income of hundreds of thousands of dollars, you'll have to live below your means, not within your means--and it's not going to be fun.
Don't buy a new car--or even own a car--or designer brands. Skip eating out, smoking cigarettes and traveling. Even consider lifestyle decisions like not having children or only marrying someone with your same financial goals.
If being painfully frugal isn't your ideal way of life during your youth, you could start your own business, which is one way to manage early retirement. Hire someone else to run the company while you kick back and relax--still bringing in cash. Even if it's a small sum, if you're able to continue "earning" your spending money even after you're done working, your savings will stretch farther. However, there are never any guarantees in business. It may be difficult to predict how successful your idea will be and, if it is, how long that success will last.
Not everyone has entrepreneurial instincts. Instead, live out that childhood dream of becoming a firefighter. Many government jobs still offer pensions that usually continue to pay a percent of your wages after retirement and, in many cases, kick in after just 10 to 20 years of service.
Unfortunately, as you grow older, your body does too, which greatly increases your chances of incurring health expenses. If you're not working, it's up to you to pay for poor health. Zollman explains that a couple looking to retire at age 65 would need to spend about $200,000 during their retirement on health care costs. Even this estimate is considered conservative. "It's vital to make sure you understand all of the potential challenges that could occur over a 40 or 50 year retirement," she says.
Your chances of pulling a Mark Zuckerberg, the 24-year-old who created the networking Web site Facebook and is now worth $1.5 billion, are slim. And many of us are not ready to join the police force for a pension plan.
So, if you want security after the checks stop coming, emulate oilman John D. Rockefeller and start being prudent. Albeit a billionaire, Rockefeller carried around a little red book and wrote down every single thing he spent his money on. You may have a lot to save before you can say good bye to the working world, but at least it's a start.

Is Your Money Safe?

by Ron Lieber and Tara Siegel Bernard

For all of you on Main Street who have been watching the turmoil on Wall Street for the last few weeks, Monday's shockwaves rattled even the most steadfast.
The day began with the announcement that another big bank -- Wachovia -- had been taken over, just days after Washington Mutual collapsed and was sold. In early afternoon, the House rejected the bailout package for the financial industry. Stocks plunged, with the Dow ending the day down nearly 778 points in the worst single-day drop in two decades.
What is a regular investor to make of it all? What about people who have money in bank accounts? Below are some answers to questions that are probably on your mind.
Q. Why did the stock market fall so far so fast on Monday?
A. The element of surprise surely didn't help, since everyone was expecting the bailout bill to pass. There may have been a bit of investor disgust thrown in, too, a sense that our representatives in Washington just don't get it.
Fear may be the biggest driver, however -- the worry that it may be weeks or longer before companies can get the affordable, short-term loans they need to finance their operations. Without easy access to that money, it's hard to run a profit-making operation on a day-to-day basis, let alone grow over the long haul. The professional investors who often drive big market moves don't want to hold onto stocks to see if things will really get that bad.
Q. What's likely to happen in the markets over the next few days?
A. It's possible that Monday's market moves will spook members of the House of Representatives enough that they will be willing to change their votes with only a modest amount of compromise. Or, there may be hasty efforts to write a new bill from scratch. This will take days, however, not hours, since Tuesday is the Jewish holiday of Rosh Hashana. Stocks may rebound, at least somewhat, if another similar bill emerges. But much will depend on the revisions.
Q. Is any investment truly safe right now?
A. As long as you trust the United States government, sure. Plenty of banks, like HSBC Direct and Capital One are offering online savings accounts paying more than 3 percent. These accounts have all the normal Federal Deposit Insurance Corporation protections of at least $100,000. Also, the Treasury Department is currently insuring investors who had holdings in money market mutual funds as of Sept. 19, as long as the fund company pays to participate.
Q. What about Treasury bills?
A. Treasuries are issued and backed by the United States government. But since throngs of investors have rushed into these investments, it has pushed their yields down. Way down. Some Treasuries, with maturities in the one-week to three-month range, are yielding less than 1 percent, anywhere from 0.10 percent to 0.50 percent. Clearly, many investors are willing to accept paltry yields as long as they know their money is secure.
Another government offering is Treasury Inflation-Protected Securities, or TIPS, which protect investors against rising inflation. That may be one result of any big government bailout.
Q. My retirement portfolio has been wrecked by this. How should I respond?
A. Continue to save. Big losses mean you'll need that much more time, or good news, to bring your balances back to where they need to be for you to retire comfortably. If your employer matches your contributions, this is a great time to take advantage of the largess.
As for whether you should pile into beaten down stocks, no one knows how much further the markets will fall or how long they'll take to bounce back. But people who move their savings to ultrasafe investments and then leave them there usually miss out on the gains when the markets come back. If you need to do that to sleep at night or avoid stomach ulcers, then do what you have to do. But it may cost you in quality of life come retirement time.
Q. But what if I am about to retire? Then what?
A. Leaving the work force at a time like this creates big problems. Not only is your portfolio down, but you need to start withdrawing from it. So you are essentially locking in your losses.
If your portfolio has taken a big hit, it may be time to seriously consider delaying retirement. Working just a few years more can make a big difference. Or, a part-time job may keep you from having to dip into your portfolio before it recovers. To get a better idea of how much you can afford to withdraw, you can test different amounts with a retirement income calculator on the Web, like T. Rowe Price's.
Q. With things looking increasingly gloomy, though, why not allocate extra cash to other types of savings or paying down debt?
A. If you're saving for a downpayment, you could put enough money in your retirement account to match any employer contribution. Then, use whatever money you have left for the downpayment fund, which should be in an ultrasafe account. The same logic goes for a teenager's college fund, which ought to be mostly in steady investments by now. There are nice tax breaks on 529 college savings accounts, too.
Yes, paying down debt, especially high-interest credit card debt, is always a good idea, though it's probably best to take advantage of employer matches on retirement savings first.
Q. Is it time to buy stocks?
A. Like gambling? This is a great time to make bets on the wide price swings that we're seeing in some stocks and entire sectors of the market. Just be prepared to lose big, as plenty of professionals have done of late.
Q. I'm worried sick about my parents, who rely on stock dividends for their income. What will happen to them?
A. It's not a great time to be relying on dividends. We've seen plenty of companies cut them. (Citibank did so on Monday as part of its acquisition of Wachovia's banking operations.) Still, if your parents were planning all along to keep their shares until they die and live only off the dividends and Social Security, perhaps now is the time to encourage them to be selfish. They could sell some shares and live well now, even if it means you'll get less later when they pass on.
Q. I'm a long-term investor and prefer not to see my retirement balances as real numbers for now. So the crisis doesn't feel like it has hit me financially yet. Should I be doing anything defensively?
A. It's not yet clear how much more the crisis will affect employment levels. Still, this seems like the best moment in years to have a few months of cash set aside in one of those online savings accounts just in case you lose your job or face some large expense that you haven't predicted.
Q. What's the next shoe to drop?
A. It seems certain that it will be harder for consumers to borrow money in the next year or two than it was earlier this decade. How much harder isn't clear yet. It will be more difficult for people who need jumbo mortgages than for those whose lenders can simply sell off their loans to Fannie Mae or Freddie Mac. Home-equity lenders are already cutting plenty of people off, while credit card companies are lowering credit limits on others.
Q. What about more bank failures?
A. They will happen. In recent days, we've seen the F.D.I.C. getting out in front of troubles at big banks like Wachovia and Washington Mutual, by arranging for other banks to take over their consumer accounts. What's less clear, however, is how many healthy institutions are left to take in other big banks that may run into trouble.
As always, stay within F.D.I.C. deposit limits. Then, the worst-case scenario is that it will take a couple of days to extract your funds from a failed bank.

Ditch the Gas Guzzler? Well, Maybe Not Yet

By RON LIEBER and TARA SIEGEL BERNARD

Your neighbors may turn up their noses, but keeping your gas-guzzling sport utility vehicle, or buying one coming off a lease, may be a smart move.

The fact is that not many people want your big vehicle right now, if Friday’s new auto sales data are any indication. Total S.U.V. sales were down 43.3 percent this July from a year ago, according to Autodata, an automotive information services company in Woodcliff Lake, N.J.

As for used vehicles, while they almost always fall in value over time, Jack Nerad, executive editorial director and executive market analyst at Kelley Blue Book, says that the rate of depreciation on large S.U.V.’s over the last six to eight months has been about twice what is normal.

Given the plummeting demand for big vehicles and the rise in gas prices that is responsible for the market turmoil, it is probably tempting to ditch your own large vehicle and trade down to something smaller.

But many experts suggest sitting tight, for a variety of reasons.

Here are some questions to consider if you are tempted to get rid of your gas guzzler, and some tips for figuring out whether it may be more financially sensible to hang onto it for a little longer.

WHAT IS THE TRUE COST OF A TRADE-IN? If fuel prices are behind your urge to drive a smaller vehicle, here is what you need to consider if you own a bigger one that you want to get rid of.

First, how much does fuel cost you now, and how much would it cost with a new car? Then, how much could you get for your old vehicle — and how much more money would you need to come up with to acquire a new one?

Philip Reed, senior consumer advice editor at Edmunds.com, was on the tennis court a month ago when a friend asked him what he ought to do about his Ford Escape S.U.V. “I said, ‘You probably don’t want to hear this, but your best thing is to keep driving it,’ ” he said.

Mr. Reed and his colleagues huddled to come up with a way to help consumers do the math, and the result is the new “Gas Guzzler for Gas Sipper” trade-in calculator at edmunds.com/calculators/gas-guzzler.html.

You select the vehicles in question, your location, the local price for gas and the number of miles you drive a month, and the calculator tells you how many months it will take for the fuel savings to equal the money you would need to acquire the new vehicle.

The calculator may actually underestimate how often it makes sense to hang onto a gas guzzler, since it does not account for sales taxes or the immense hassle of having to deal with all of the registration paperwork.

IS A SMALL CAR PRACTICAL? You will be tempted to play with the Edmunds.com calculator by swapping your hulking Chevy Suburban for a tiny Honda Fit or an itty-bitty hybrid of some sort. But let’s get back to reality for a moment. It is nice to fantasize about tripling your fuel economy, but you might have a trailer to tow or perhaps you are larger than average and are not comfortable in small cars.

Say you need to haul three rows of people but still want to save on gas costs. So you trade in your 2005 Ford Expedition for a 2008 Toyota Highlander hybrid with a third row. It will take more than 15 years to break even on that deal, driving 1,500 miles a month, according to the Edmunds.com calculator. The numbers may work better if you get a used car instead.

Tex Pitfield, whose company, the Saraguay Petroleum Corporation, delivers fuel to gas stations, airports and elsewhere, has done the math himself on his 2003 Lincoln Navigator. “I can’t justify trading it in,” he said. “It’s going to cost me more to trade it in than it will to keep driving it.”

WHAT IS YOUR LARGE VEHICLE WORTH? The answer is, probably much less than you think. About 36 million S.U.V.’s were sold in the United States in the last decade, according to Autodata. Plenty of people are blindly putting them up for sale or trading them in right now.

Used S.U.V. prices were down 12 percent for the months of May and June, compared with the same period a year earlier, according to J. D. Power and Associates data. But certain models had even sharper declines. For instance, the price of the Ford Excursion was down 27 percent, Hummers fell 25 percent, while Suburbans dropped 24 percent.

Take a standard 2005 Ford Explorer in good condition with 50,000 miles on it, for instance. According to Kelley Blue Book, a dealer might give you a stunningly low $6,740 when trading it in now. Selling it to a private party might net you $10,000, if you are lucky. In theory, a dealer would spiff it up and try to sell it for $14,315. But a bargain hunter might be able to find a sales lot full of Explorers coming off a lease and pay many thousands less.

By that same token, if your lease is up on that Explorer, you may be able to negotiate a rock-bottom price if you want to buy it.

The only good news on the falling value of your S.U.V.? “It seems to correlate with the rise in fuel prices,” said Mr. Nerad at Kelley Blue Book. “So it’s probably mitigating somewhat even as we speak.”

If you still owe money on the loan on your vehicle, there is also the ugly possibility that you may owe more on the loan than the vehicle is actually worth. You will want to check the residual value of it on sites like Kelley Blue Book to see.

WHO ELSE WANTS A SMALL CAR? Lots of people. Sales of vehicles with four-cylinder engines represented 47.2 percent of all new vehicle sales during June, up from 38.4 percent of all new sales compared with the year-earlier period. “They would be even higher if they were available,” said Charlie Vogelheim, vice president of automotive development at J. D. Power and Associates.

Take the Honda Civic: On average, there was a 16-day supply of these vehicles at the end of June, versus a 32-day supply a year ago (meaning it would take 16 days to sell existing inventory off a dealer’s lot), according to Autodata. There was a nine-day supply for the Toyota Prius, down from a 17-day supply last year. There was a 41-day supply for all new cars in June, down from 49 days last year.

“The consumer can expect to pay a higher price today for a compact or subcompact than they would have a few months ago,” said Ron Pinelli, president of Autodata. “There is more demand. The dealers aren’t discounting as much, if at all."

EMOTIONAL OR RATIONAL DECISION? “If you’re selling an S.U.V. or trading it in, you’re selling an asset at the low ebb in its value and trying to buy an asset that’s been bid up in value,” says Mr. Nerad of Kelley Blue Book. “In stock market terms, this wouldn’t be a propitious time to make that kind of trade.”

As for fuel costs, the way Mr. Nerad sees it, people tend to view the cost of a fill-up as their cost of owning the car. So if filling the tank has gone up to $75 from $50, it seems as if the cost of owning the vehicle is up 50 percent.

Do not fall into this trap. Your insurance bill has probably stayed the same. So has your car payment. Maintenance costs do not change when fuel prices do, either. Take a deep breath and consider staying put, no matter what your neighbors may think.

5 steps to building an emergency fund

By Joe Light, Money Magazine staff reporter

(Money Magazine) -- Lindsay and Patrick Heineke seem to be doing everything right, financially speaking. The Whitinsville, Mass. couple are aggressively paying down mortgage debt and are saving for retirement at a pace that would put most of their twentysomething peers to shame.
There's just one thing Lindsay, 26, and Patrick, 27, are missing. And in today's turbulent economic climate, it might be the most vital investment of all: a sufficient emergency fund.
This cash account is a kind of insurance policy against financial calamity. When you're suddenly faced with a bill you couldn't possibly have budgeted for, the money is there. In a worst-case scenario, like a computer replacing your job, the fund can cover your family's living expenses while you look for work.
The Heinekes - who only have $2,500 in cash - aren't alone in being underprepared: A third of Americans have no emergency savings, according to the National Foundation for Credit Counseling; 57% of those who have a fund don't have enough in it.
Surprisingly, Lindsay and Patrick have made a conscious decision not to have rainy-day savings. "We just feel confident that we won't need it," Patrick said when the couple first spoke to Money. They felt that their $116,000 income - from his job in custom manufacturing and hers in event marketing - was secure. And if they ever did face a disaster, they figured, they had $19,000 available on a home-equity line of credit (HELOC) to carry them over.
Dave Fernandez, a Scottsdale, Ariz. financial planner, says the Heinekes' sense of financial invulnerability is misguided - though it doesn't make them unusual. "Everyone feels secure in their jobs until they get handed a pink slip," he says. "But putting the job aside, what if their furnace or AC unit breaks? Big costs like that are always a possibility."
What's more, the HELOC may not be the guaranteed safety net the Heinekes thought it was. With home prices having dropped 9% in the past 12 months, according to Fiserv Lending Solutions, lenders have been freezing or reducing these lines in the areas that have taken the biggest hit.
Meanwhile, the real estate slump is supposed to get worse before it gets better; Fiserv projects that home values will plummet 10% in the twelve months ahead. And the job market is suffering too. Unemployment has edged up to 5.5%, the highest in almost four years, following some big layoffs. And job seekers are spending an average of 4.5 months handing out résumés, the Bureau of Labor Statistics reports. The message of the markets: Right now you can't afford not to have an emergency fund. Protect yourself by taking these steps.

1. Chart your expenses
To figure out how much you need to save, you first need to calculate how much you spend every month. As tedious as it may seem, it pays off to go over the past three months of bills to get a monthly average of your expenses. At a minimum, include:

• Mortgage payments
• Utilities, including bills for cable, Internet, landline and cell-phone service
  Groceries
• Insurance premiums, including home, auto and life. Add in at least $400 for individual health insurance - $1,000 for a family - in case the partner whose work provides it is the one to get laid off.
• Other car expenses including gas and loan payments
• Property tax (if not included in the mortgage payment)
• Discretionary spending Allow yourself some fun money. And be realistic: While there are certainly things like dinners out that you can cut back on in a pinch, don't delude yourself into thinking you can slash spending drastically.

Lindsay and Patrick calculate that their expenses are $4,750 a month. With only $1,000 in a savings account and a $1,500 buffer in their checking account, "we'd be through our savings before the month was out if one of us lost a job," admits Lindsay.
2. Measure your need
The rule of thumb is that you should have three to six months of living expenses in the bank. But your personal target depends on how stable your income is, says Tim Maurer, a Baltimore financial planner. With two salaries - which Lindsay and Patrick have - a three-month emergency fund may be sufficient in good times.
When finding a new job is tough, as it is now, it's a good idea to push that up to six months. If your family depends on a single income or if one or both of you rely heavily on commissions or bonuses, shoot for a six-month fund in safe times. And daunting as it sounds, aim for a year in uncertain times.
You can reduce the fund if you are guaranteed a severance package, but never dip below three months of cash - a lost job isn't the only potential emergency. Also, keep in mind that your fund may not be just for you. If your parents or grown-up children are likely to call on you in a crisis, you might need to tap your savings to support their emergency in addition to yours.
3. Find a place to put it
Often, the safest accounts offer interest rates that don't even keep up with inflation. "But the emergency fund isn't about yield," says David Greene, a financial planner in Fairfax, Va. Above all, you need an account that won't tumble in value and that's as liquid as cash.
Taxable stock and mutual fund accounts, while relatively easy to get at, fail the first test. When the economy is in trouble, chances are stocks are as well, making it the worst time to cash out.
The past six months have shown that home equity fails the second test. Lindsay and Patrick's HELOC is still intact. (Condo prices in Massachusetts are down only 2.6% year over year.) But since lenders have been changing the rules on HELOC equity, the Heinekes shouldn't view their line as guaranteed.
For the best combination of access, safety and yield, you have three options: a bank money-market account, a high-yield savings account and a money-market mutual fund. The first two have the benefit of being FDIC-insured for up to $100,000. And while money-market mutual funds are not insured, no individual investor has ever lost money in one.
Among these ultrasafe categories, pick the one with the highest yield. Go to bankrate.com to compare rates.
4. Build it up
Starting from scratch? Save fast. You don't want to be one emergency away from debt. Halt retirement savings - except to get your employer's full 401(k) match - and extra payments on low-interest loans until you have the target amount in the bank, says Maurer. Then resume retirement contributions.
Today, Lindsay and Patrick put $2,000 a month toward their 6% HELOC (they used $19,000 of their $38,000 line for home improvements and wedding costs). They could divert most of that to an emergency fund - still making $300 minimum payments on the HELOC. Combined with the $1,000 in their savings account, they'd be able to build a decent three-month cushion of $15,000 in nine months.
5. Look but don't touch
Once you've got the fund built, revisit it once a year and consider upping the amount if life events - like a new baby, new house or new salary - have increased your spending. Resist the temptation to use the fund for anything other than unbudgeted necessary expenses.
Hearing the planners' advice has made Patrick and Lindsay realize that they weren't as secure as they'd thought. They've decided to split their extra cash between their emergency fund and the HELOC, and they plan to move their savings from a bank account yielding a low 0.2% to a high-yield money-market account. Says Lindsay: "We've really had our eyes opened to how much risk we've had all this time."

Getting a Millionaire's Mindset

by Glenn Curtis

Let's face it; we all don't make millions of dollars a year, and the odds are that most of us won't receive a large windfall inheritance either. However, that doesn't mean that we can't build sizeable wealth — it'll just take some time. If you're young, time is on your side and retiring a millionaire is achievable. Read on for some tips on how to increase your savings and work toward this goal.

Stop Senseless Spending
Unfortunately, people have a habit of spending their hard-earned cash on goods and services that they don't need. Even relatively small expenses, such as indulging in a gourmet coffee from a premium coffee shop every morning, can really add up — and decrease the amount of money you can save. Larger expenses on luxury items also prevent many people from putting money into savings each month.
That said, it's important to realize that it's usually not just one item or one habit that must be cut out in order to accumulate sizable wealth (although it may be). Usually, in order to become wealthy one must adopt a disciplined lifestyle and budget. This means that people who are looking to build their nest eggs need to make sacrifices somewhere — this may mean eating out less frequently, using public transportation to get to work and/or cutting back on extra, unnecessary expenses.
This doesn't mean that you shouldn't go out and have fun, but you should try to do things in moderation — and set a budget if you hope to save money. Fortunately, particularly if you start saving young, saving up a sizeable nest egg only requires a few minor (and relatively painless) adjustments to your spending habits.
Fund Retirement Plans ASAP
When individuals earn money, their first responsibility is to pay current expenses such as the rent or mortgage expenses, food and other necessities. Once these expenses have been covered, the next step should be to fund a retirement plan or some other tax-advantaged vehicle.
Unfortunately, retirement planning is an afterthought for many young people. Here's why it shouldn't be: funding a 401(k) and/or a IRA early on in life means you can contribute less money overall and actually end up with significantly more in the end than someone who put in much more money but started later.
How much difference will funding a vehicle such as a Roth IRA early on in life make?
If you're 23 years old and deposit $3,000 per year (that's only $250 each month!) in a Roth IRA earning an 8% average annual return, you will have saved $985,749 by the time you are 65 years old due to the power of compounding. If you make a few extra contributions, it's clear that a $1 million goal is well within reach. Also keep in mind that this is mostly interest — your $3,000 contributions only add up to $126,000.
Now, suppose that you wait an additional 10 years to start contributing. You have a better job and you know you've lost some time, so you contribute $5,000 per year. You get the same 8% return and you aim to retire at 65. When you reach age 65, you will have saved $724,753. That's still a sizeable fund, but you had to contribute $160,000 just to get there — and it's nowhere near the $985,749 you could've had for paying much less.
Improve Tax Awareness
Sometimes, individuals think that doing their own taxes will save them money. In some cases, they might be right. However, in other cases it may actually end up costing them money because they fail to take advantage of the many deductions available to them.
Try to become more educated as far as what types of items are deductible. You should also understand when it makes sense to move away from the standard deduction and start itemizing your return.
However, if you're not willing or able to become very well educated filing your own income tax, it may actually pay to hire some help, particularly if you are self employed, own a business or have other circumstances that complicate your tax return.
Renting Versus Buying
At some point in our lives, many of us rent a home or an apartment because we cannot afford to purchase a home, or because we aren't sure where we want to live for the longer term. And that's fine. However, renting is often not a good long-term investment because buying a home is a good way to build equity.
Unless you intend to move in a short period of time, it generally makes sense to consider putting a down payment on a home. (At least you would likely build up some equity over time and the foundation for a nest egg.)
Buying Expensive Cars
There's nothing wrong with purchasing a luxury vehicle. However, individuals who spend an inordinate amount of their incomes on a vehicle are doing themselves a disservice — especially since this asset depreciates in value so rapidly.
How rapidly does a car depreciate?
Obviously, this depends on the make, model, year and demand for the vehicle, but a general rule is that a new car loses 15-20% of its value per year. So, a two-year old car will be worth 80-85% of its purchase price; a three-year old car will be worth 80-85% of its two-year-old value.
In short, especially when you are young, consider buying something practical and dependable that has low monthly payments — or that you can pay for in cash. In the long run, this will mean you'll have more money to put toward your savings — an asset that will appreciate, rather than depreciate like your car.
Don't Sell Yourself Short
Some individuals are extremely loyal to their employers and will stay with them for years without seeing their incomes take a jump. This can be a mistake, as increasing your income is an excellent way to boost your rate of saving.
Always keep your eye out for other opportunities and try not to sell yourself short. Work hard and find an employer who will compensate you for your work ethic, skills and experience.
Bottom Line
You don't have to win the lottery to see seven figures in your bank account. For most people, the only way to achieve this is to save it. You don't have to live like a pauper to build an adequate nest egg and retire comfortably. If you start early, spend wisely and save diligently, your million-dollar dreams are well within reach.

10 Things Millionaires Won't Tell You

by Daren Fonda

1. "You may think I'm rich, but I don't."
A million dollars may sound like a fortune to most people, and folks with that much cash can't complain — they're richer than 90 percent of U.S. households and earn $366,000 a year, on average, putting them in the top 1 percent of taxpayers. But the club isn't so exclusive anymore. Some 10 million households have a net worth above $1 million, excluding home equity, almost double the number in 2002. Moreover, a recent survey by Fidelity found just 8 percent of millionaires think they're "very" or "extremely" wealthy, while 19 percent don't feel rich at all. "They're worried about health care, retirement and how they'll sustain their lifestyle," says Gail Graham, a wealth-management executive at Fidelity.
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Indeed, many millionaires still don't have enough for exclusive luxuries, like membership at an elite golf club, which can top $300,000 a year. While $1 million was a tidy sum three decades ago, you'd need $3.6 million for the same purchasing power today. And half of all millionaires have a net worth of $2.5 million or less, according to research firm TNS. So what does it take to feel truly rich? The magic number is $23 million, according to Fidelity.

2. "I shop at Wal-Mart..."
They may not buy the 99-cent paper towels, but millionaires know what it is to be frugal. About 80 percent say they spend with a middle-class mind-set, according to a 2007 survey of high-net-worth individuals, published by American Express and the Harrison Group. That means buying luxury items on sale, hunting for bargains — even clipping coupons.
Don Crane, a small-business owner in Santa Rosa, Calif., certainly sees the value of everyday saving. "We can afford just about anything," he says, adding that his net worth is over $1 million. But he and his wife both grew up on farms in the Midwest — where nothing was wasted — and his wife clips coupons to this day. In fact, most millionaires come from middle-class households, and roughly 70 percent have been wealthy for less than 15 years, according to the AmEx/Harrison survey. That said, there are plenty of millionaires who never check a price tag. "I've always wanted to live above my means because it inspired me to work harder," says Robert Kiyosaki, author of the 1997 best seller Rich Dad, Poor Dad. An entrepreneur worth millions, Kiyosaki says he doesn't even know what his house would go for today.

3. "...but I didn't get rich by skimping on lattes."
So how do you join the millionaires' club? You could buy stocks or real estate, play the slots in Vegas — or take the most common path: running your own business. That's how half of all millionaires made their money, according to the AmEx/Harrison survey. About a third had a professional practice or worked in the corporate world; only 3 percent inherited their wealth.
Regardless of how they built their nest egg, virtually all millionaires "make judicious use of debt," says Russ Alan Prince, coauthor of "The Middle-Class Millionaire." They'll take out loans to build their business, avoid high-interest credit card debt and leverage their home equity to finance purchases if their cash flow doesn't cut it. Nor is their wealth tied up in their homes. Home equity represents just 11 percent of millionaires' total assets, according to TNS. "People who are serious about building wealth always want to have a mortgage," says Jim Bell, president of Bell Investment Advisors. His home is probably worth $1.5 million, he adds, but he owes $900,000 on it. "I'm in no hurry to pay it off," he says. "It's one of the few tax deductions I get."

4. "I have a concierge for everything."
That hot restaurant may be booked for months — at least when Joe Nobody calls to make reservations. But many top eateries set aside tables for celebrities and A-list clientele, and that's where the personal concierge comes in. Working for retainers that range anywhere from $25 an hour to six figures a year, these modern-day butlers have the inside track on chic restaurants, spa reservations, even an early tee time at the golf club. And good concierges will scour the planet for whatever their clients want — whether it's holy water blessed personally by the Pope, rare Mexican tequila or artisanal sausages found only in northern Spain. "For some people, the cost doesn't matter," says Yamileth Delgado, who runs Marquise Concierge and who once found those sausages for a client — 40 pounds of chorizo that went for $1,000.
Concierge services now extend to medical attention as well. At the high end: For roughly $2,000 to $4,000 a month, clients can get 24-hour access to a primary-care physician who makes house calls and can facilitate admission to a hospital "without long waits in the emergency room," as one New York City service puts it.

5. "You don't get rich by being nice."
John D. Rockefeller threatened rivals with bankruptcy if they didn't sell out to his company, Standard Oil. Bill Gates was ruthless in building Microsoft into the world's largest software firm (remember Netscape?). Indeed, many millionaires privately admit they're "bastards in business," says Prince. "They aren't nice guys." Of course, the wealthy don't exactly look in the mirror and see Gordon Gekko either. Most millionaires share the values of their moderate-income parents, says Lewis Schiff, a private wealth consultant and Prince's coauthor: "Spending time with family really matters to them." Just 12 percent say that what they want most to be remembered for is their legacy in business, according to the AmEx/Harrison study.
Millionaires are also seemingly undaunted by failure. Crane, for example, now runs a successful company that screens tenants for landlords. But his first business venture, a real estate partnership, went bankrupt, costing him $20,000 — more than his house was worth at the time. "It was the most depressing time in my life, but it was the best lesson I ever learned," he says.

6. "Taxes are for little people."
Most millionaires do pay taxes. In fact, the top 1 percent of earners paid nearly 40 percent of federal income taxes in 2005 — a whopping $368 billion — according to the Internal Revenue Service. That said, the wealthy tend to derive a higher portion of their income from dividends and capital gains, which are taxed at lower rates than wages (15 percent for long-term capital gains versus 25 percent for middle-class wages). Also, high-income earners pay Social Security tax only on their first $97,500 of income.
But the big savings come from owning a business and deducting everything related to it. Landlords can also depreciate their commercial properties and expenses like mortgage interest. And that's without doing any creative accounting. Then there are the tax shelters, trusts and other mechanisms the superrich use to shield their wealth. An estimated 2 million Americans have unreported accounts offshore, and income from foreign tax shelters costs the U.S. $20 billion to $40 billion a year, according to the IRS. Indeed, "an increasing number of people want to establish an offshore fund," says Vernon Jacobs, a certified public accountant in Kansas who specializes in legal foreign accounts.

7. "I was a B student."
Mom was right when she said good grades were the key to success — just not necessarily a big bank account. According to the book "The Millionaire Mind," the median college grade point average for millionaires is 2.9, and the average SAT score is 1190 — hardly Harvard material. In fact, 59 percent of millionaires attended a state college or university, according to AmEx/Harrison.
When asked to list the keys to their success, millionaires rank hard work first, followed by education, determination and "treating others with respect." They also say that what they absorbed in class was less important than learning how to study and stay disciplined, says Jim Taylor, vice chairman of the Harrison Group. Granted, 48 percent of millionaires hold an advanced degree, and elite colleges do open doors to careers on Wall Street and in Silicon Valley (not to mention social connections that grease the wheels). But for every Ph.D. millionaire, there are many more who squeaked through school. Kiyosaki, for one, says the only way he survived college calculus was by "sitting near" the smart kids in class — "we cheated like crazy," he says.

8. "Like my Ferrari? It's a rental."
Why spend $3,000 on a Versace bag that'll be out of style as soon as next season when you can rent it for $175 a month? For that matter, why blow $250,000 on a Ferrari when for $25,000 it can be yours for a few weekends a year? Clubs that offer "fractional ownership" of jets have been popular for some time, and now the concept has extended to other high-end luxuries like exotic cars and fine art. How hot is the trend? More than 50 percent of millionaires say they plan to rent luxury goods within the next 12 months, according to a survey by Prince & Associates. Handbags topped the list, followed by cars, jewelry, watches and art. Online companies like Bag Borrow or Steal, for example, cater to customers who always want new designer accessories and jewelry, for prices starting at $15 a week.
For Suzanne Garner, a millionaire software engineer in Santa Clara, Calif., owning a $100,000 car didn't make financial sense (she drives a Mazda Miata). Instead, Garner pays up to $30,000 in annual membership fees to Club Sportiva, a fractional-ownership car club in San Francisco that lets her take out Ferraris, Lamborghinis and other exotic vehicles on weekends. "I'm all about the car," she says. And so are other people, it seems. While stopped at a light in a Ferrari recently, Garner received a marriage proposal from a guy in a pickup truck. (She declined the offer.)
9. "Turns out money can buy happiness."
It may not be comforting to folks who aren't minting cash, but the rich really are different. "There's no group in America that's happier than the wealthy," says Taylor, of the Harrison Group. Roughly 70 percent of millionaires say that money"created" more happiness for them,he notes. Higher income also correlates with higher ratings in life satisfaction, according to a new study by economists at the Wharton School of Business. But it's not necessarily the Bentley or Manolo Blahniks that lead to bliss. "It's the freedom that money buys," says Betsey Stevenson, coauthor of the Wharton study.
Concomitantly, rates of depression are lower among the wealthy, according to the Wharton study, and the rich tend to have better health than the rest of the population, says James Smith, senior labor economist at the Rand Corporation. (In fact, health and happiness are as closely correlated as wealth and happiness, Smith says.) The wealthy even seem to smile and laugh more often, according to the Wharton study, to say nothing of getting treated with more respect and eating better food. "People experience their day very differently when they have a lot of money," Stevenson says.
10. "You worry about the Joneses — I worry about keeping up with the Trumps."
Wealth may go a long way toward creating happiness, but the middle-class rich still can't afford the life of the billionaire next door — the guy who writes charity checks for $100,000 and retreats to his own private island. "What makes people happy isn't how much they're making," says Glenn Firebaugh, a sociologist at Pennsylvania State University. "It's how much they're making relative to their peers."
Indeed, for all their riches, some 40 percent of millionaires fear that their standard of living will decline in retirement and that their money will run out before they die, according to Fidelity. Of course, it may not help if their lifestyle is so lavish that they're barely squeaking by on $400,000 a year. "You can always be happier with more money," says Stevenson. "There's no satiation point." But that's the trouble with keeping up with the Trumps. "Millionaires are always looking up," says Schiff, "and think it's better up there."

Millionaires in the Making

by Paul Keegan

John and Gina Rodrigues have always been good with numbers. John is a software engineer who manages a team at Microsoft, and Gina spent years processing mortgages at Wells Fargo and Countrywide Home Loans. But the numbers they are especially good at are the kind with dollar signs in front of them.

At age 27, John and Gina already earn a combined $174,000 a year, save half of what they make and have built a formidable portfolio of $380,000 in stocks, mutual funds and cash. Their goal: to become millionaires and retire by the time they turn 40, just 13 years from now.

To make that dream a reality, they have become black-belt practitioners of an art rarely practiced in America these days: While others with their earning power might indulge in fancy dinners, luxury vacations and designer wardrobes, the Rodrigueses live like young couples did before the era of easy credit. They rent the house where John grew up in the San Francisco Bay Area for a mere $650 a month; rarely travel; split an entrée on the rare occasions they eat out; and spend almost nothing on clothes (John wears free Microsoft T-shirts, while Gina gets hand-me-downs from her sister).

They are driven by a fierce determination to control their own fate. John yearns to quit his job to indulge his passion for the outdoors, and Gina plans to cut back her hours at the boutique they own to work with animals and, possibly, raise a family.

Can the couple do it? The outcome depends on the answers to three key questions: Will they be able to keep up their spartan lifestyle? (Anxious for a home of their own, they are now shopping for a house in one of the priciest areas of the country.) Will they invest wisely? (Among their goofs so far: They snatched up three properties near the height of the real estate bubble.) And even if they do, is 13 years really enough time to amass the huge sums required to retire at 40 - enough money to last them for the ensuing 50 to 60 years?

A Great Start

John learned the importance of saving early. When his father quit his job as a retail store manager to follow his dream of becoming a high school special-ed teacher, the family's income took a big hit. They squeaked by thanks to their rainy-day funds, but there wasn't much left for extras. When John, then 12, wanted the latest video-game system, his parents told him to earn it. So he raked leaves and mowed lawns for nine months until he'd scraped together the $150 he needed.

Later, when John saw his high school classmates tooling around in expensive cars, he worked long hours at a computer store so he could buy a used Honda Prelude. "I don't need my mom or dad to buy me a $60,000 Mercedes," he recalls thinking. "I can do it on my own."

John and Gina met at that computer store, where she was a cashier. They began dating and spent money like typical teenagers, going out to dinner and the movies, shopping at the mall. But starting in his sophomore year as an information systems major at the University of California at Santa Cruz, John had to pay his own tuition (his grandfather had paid for the first year). He saw a stark choice: take out loans like his friends or get a job and live frugally. He chose the latter, working 30 hours a week while packing his schedule with extra classes. "People said it was too hard; I wanted to prove them wrong," says John, who graduated with highest honors in just three years, free of debt.

Gina was slower to embrace John's money-saving ethic. Midway through college, as their relationship got serious, she revealed that she had $5,000 in credit-card debt. "I loved shopping," she remembers. "If I had a tough day, I'd go to the mall to make myself feel better." John was not pleased, but Gina devised a plan to dig out. Shortly after graduating, she got her real estate license and paid off the debt with the $9,000 commission she made selling her first home.

About a year after they began their careers - John at Microsoft, Gina at Wells Fargo - John proposed. But first he drove to Oregon (12 hours each way) to buy Gina's engagement ring, thereby avoiding $1,500 in California sales tax. They married in 2004 and moved into a two-bedroom condo in Dublin, Calif. that they bought for $377,000, putting down 5% of the price and financing the rest.

Within a year the condo had appreciated to $535,000. Tempted by their success, John and Gina decided to buy an investment property, settling on a $141,000 three-bedroom house in Phoenix, where friends had invested. They put down 10% and hired a property manager. Within 18 months the home's value had shot up to $240,000. They refinanced, taking out a $190,000 mortgage to free up cash for more properties. In late 2005 they bought two $150,000 homes near San Antonio with a 20% down payment.

Not that the Rodrigueses were relying on real estate alone to build their fortune. They were also saving furiously, putting 15% to 20% of their income in a mix of stock and cash investments. By the time they turned 24, when many of their peers were struggling with student loans and crushing credit-card bills, Gina and John already had nearly $70,000 set aside for retirement, plus their real estate equity.

Buckling Down

Then came a stumble, followed by an epiphany. John decided he could use tips from a financial adviser. After picking one he deemed astute and trustworthy, he bought a pair of variable life insurance policies at the planner's suggestion, only afterward looking at the fine print to find that the policies were loaded with fees and cancellation penalties. John stormed into the adviser's office demanding an explanation, then realized it was his own fault for not being more careful. "I was so angry that I didn't catch it," he says.

It wasn't just the $5,000 it cost to cancel the policies that had John steaming. His very identity - the financial whiz kid with a chip on his shoulder who could shut up those who doubted him in high school and college - was shaken. So he gave himself a crash course in finance, spending weekends with Gina poring over investment magazines and books. One day, he says, they hit upon a stunning realization about the power of compounding: "If we just push as hard as we can for another 10 years or so, there could be an explosion of financial growth at the end for us."

The Rodrigueses vowed to yank their belts even tighter. Like Tiger Woods restructuring his swing after winning the Masters a decade ago, they took their already phenomenal savings game to a new level. They sold their condo in late 2006, netting $110,000, and moved to John's childhood home, which they rented from his parents (his mom and dad had moved to a house nearby). They cut back on eating out to once a month, going to cheap chain restaurants and sharing a meal. They vowed to drive their cars until they died. Their clothes budget dropped to $300 a year.

Their new minimalist approach caused a few problems socially. Gina recalls awkward moments going out to eat with her family or friends when she would order only an appetizer and tap water and didn't think it was fair to split the check equally. John had to "respectfully decline" when buddies invited him to fly to Las Vegas for the weekend. "We're kind of boring," says Gina.

Their restricted lifestyle sometimes chafes, both admit. Living in John's boyhood home, furnished with his parents' stuff, is tough. "It's hard to see other couples living in their own houses the way they want," says Gina. And yes, she sometimes resents John's constant admonitions to save, save, save: "I'd say, 'We could die in a car crash tomorrow, so let's enjoy ourselves now!' " John, though, revels in his thriftiness: "I'm okay with people calling me cheap."

Over time they've learned to compromise. They eat out two or three times a month now and recently splurged on tickets to the show Jersey Boys (it was their anniversary). Gina convinced John to buy something he'd been craving for years - a $30,000 Subaru WRX STI to indulge his hobby of rallycross racing. And John has promised Gina they'll buy a home of their own as soon as they find a suitable one (they're looking in the $350,000-to-$450,000 range).

The Rodrigueses still manage to save more than half of their income, which is spread among different investments. John aggressively buys discounted Microsoft shares through an employee stock-purchase plan and contributes nearly the max to his 401(k). Additional savings go into a diversified mix of stock funds and cash accounts.

Bumps in the Road

But they have a long way to go before they're millionaires. And the Rodrigueses have run into a few snags that underscore how hard the path to wealth can be even for the most dedicated savers.

For one thing, owning real estate so far away has turned into a headache. Make that a migraine: One house stood empty for nine months because of a dispute with a former tenant, and their Phoenix property has dropped so sharply in value that they now owe nearly as much as the house is worth. Carrying costs for the properties exceed the rental income they generate by $9,000 a year. Given the downturn in real estate prices, if they sold all three homes today, they'd barely break even.

The Rodrigueses have also seen how a blip in their careers can undermine their saving efforts, even temporarily. Last year Gina quit the mortgage underwriting business - the hours were too long, she says, and the work wasn't creative enough. During the year she was out of work, the amount the couple were saving dropped by 20%. Then, earlier this year, Gina found a boutique called La Lavande, which sells imported soaps and handbags, for sale in nearby Walnut Creek. The Rodrigueses took out a $75,000 loan to buy the store - and Gina had found her calling.

Eventually, though, the Rodrigueses both hope to stop working altogether. Their plan is to move away from the Bay Area to a less expensive locale like Arizona by age 40. They want to buy a ranch where outdoorsman John can go hiking and camping while Gina starts a small farm, raising sheep and chickens and maybe a family. "I'd like a really simple life where John and I can just spend more time together," says Gina.

The Advice

Money asked California financial planners Eric Toya of Redondo Beach and Mike Chamberlain of Santa Cruz to assess the Rodrigueses' chances of retiring by 40 and recommend steps to help them reach that goal. Their suggestions:

Rethink that exit date. If John and Gina maintain their current rate of saving, they'll build an impressive nest egg over the next 13 years. Assuming they get raises of 4% annually and their portfolio averages gains of 6% a year, Toya estimates they'll have $2.9 million at age 40. Combined with the income they might earn from any ventures they pursue in retirement (John's thinking about buying more investment properties or starting a small business), that might be enough to last them the following 50 to 60 years.

Toya, however, stresses that making projections for such a long period is inherently risky because the unknowns are so great: What path will their careers take? Will either one develop a health problem? Might the financial markets go through a protracted downturn? To compensate for those risks, Toya says, "the younger you retire, the more conservative your withdrawal rate should be." But even if the Rodrigueses draw down their portfolio at a 3% rate vs. the 4% typically recommended for retirees, they'll run out of money before age 80.

What to do? Delaying retirement by just five years will greatly increase the chances that their money will last their lifetime, Toya says. When they're 45, their portfolio will be worth $4.75 million, according to his calculations. They could tap their savings at an even lower 2.5% annual rate - giving them an extra cushion for bad market years and big expenses like raising kids and paying for college - and they'll still likely have enough to live comfortably to age 100.

Dump the company stock. The Rodrigueses have 37% of their portfolio in Microsoft. That's far too much in a single stock, especially since they're also dependent on the company for most of their income. Chamberlain advises selling the shares in increments every two weeks or so to get the stock down to 5% of their portfolio.

John strongly disagrees. "Frankly, I think it's dumb to sell low," he says. "I think it's a safe investment to hold until the market comes up." Replies Chamberlain: "I don't care what the stock is: To diminish risk, you need more diversification in your portfolio."

Add a few bonds. Gina and John scored off the charts for risk tolerance in a questionnaire Chamberlain gave them. But even for fearless investors, having 99% of a 401(k) in stocks and just 1% in fixed-income assets is too aggressive, warns Chamberlain, who suggests a 90/10 split. Best bet: intermediate-term bonds, which historically have returned about 5% a year.


Consider a real estate sale. The Rodrigueses are losing about $750 a month on their three investment properties. If they sell one or two of the homes now, they can stop the bleeding and probably break even on their purchase. If they're forced to sell later on and the market is still in a free fall, they stand to lose a lot more money.

But John is adamantly against a sale, an odd position for a man who splits entrées at a restaurant to save a few bucks. Chamberlain believes John has developed an emotional attachment to the properties - or he may simply be unwilling to admit that they made a mistake. John counters: "I think those properties are going to come back eventually. Even if they don't, our retirement plan is not based on any return from those properties anyway."

After meeting with Chamberlain, John and Gina are relieved to know they're on the right track. They do understand that life is uncertain - that John could lose his job and that investment returns could keep shrinking. If that happens, they say, they're prepared to work past 40 and retire later.

But John remains optimistic about their chances of reaching their goal. "I get tired of the naysayers around me," he says. "Sure, it gets lonely sometimes, but look, I have a beautiful wife, I'm happy, I've got good friends...." He pauses, as though hearing a cash register ringing. "Well, I don't need a hundred friends. That usually means a hundred gifts a year."

For President

Ivy Leaguers' Big Edge: Starting Pay

by Sarah E. Needleman

Where people go to college can make a big difference in starting pay, and that difference is largely sustained into midcareer, according to a large study of global compensation.

In the yearlong effort, PayScale Inc., an online provider of global compensation data, surveyed 1.2 million bachelor's degree graduates with a minimum of 10 years of work experience (with a median of 15.5 years). The subjects hailed from more than 300U.S. schools ranging from state institutions to the Ivy League, and their incomes show that the subject you major in can have little to do with your long-term earning power. PayScale excluded survey respondents who reported having advanced degrees, including M.B.A.s, M.D.s and J.D.s.

Even though graduates from all types of schools increase their earnings throughout their careers, their incomes grow at almost the same rate, according to the survey. For instance, the median starting salary for Ivy Leaguers is 32% higher than that of liberal-arts college graduates -- and at 10 or more years into graduates' working lives, the spread is 34%, according to the survey.

One reason why Ivy Leaguers outpace their peers may be that they tend to choose roles where they're either managing or providing advice, says David Wise, a senior consultant at Hay Group Inc., a global management-consulting firm based in Philadelphia. By contrast, state-school graduates gravitate toward individual contributor and support roles. "Ivy Leaguers probably position themselves better for job opportunities that provide them with significant upside," says Mr. Wise, adding that this is the first survey he's seen that correlates school choice to a point later in a career.

Also, more Ivy League graduates go into finance roles than graduates of other schools, and employers pay a premium for them, says Peter Cappelli, a professor of management and director of the Center for Human Resources at the Wharton School of the University of Pennsylvania. "Dartmouth kids get paid more for the same job than kids from Rutgers are [doing]," he says.

Which school pays off the most? According to the survey, graduates of Dartmouth College, an Ivy League college, earn the highest median salary -- $134,000.

Of all Ivy League graduates surveyed, those from Columbia earn the lowest midcareer median salary -- $107,000. Meanwhile, the highest-paid liberal-arts-school graduates, from Bucknell University, earn slightly more -- $110,000.

Mr. Wise called the data thought-provoking. "These results, to some extent, confirm suspicions that many people have about the importance of a person's college choice in giving them better pay opportunities down the line," says Mr. Wise. "What we still don't know is whether or not it's the training or education the school provides that drives these pay differences, or if the people from those schools are just wired to self-select into jobs that are likely to be paid more."

The survey also looked at how much salaries increased over time. Liberal-arts-school graduates see their median total compensation grow by 95% after about 10 years, to $89,379 from $45,747. Meanwhile, graduates of "party schools" (as defined by the 2008 Princeton Review College Guide) aren't that far behind, with their incomes increasing 85% during that time to $84,685 from $45,715.

At the bottom: Engineering-school grads, who earn the highest starting salaries, yet see their paychecks expand just 76% by their career midpoints to $103,842 from $59,058.

Contrary to what many parents tell their children majoring in subjects like political science or philosophy, these degrees won't necessarily leave you in the poorhouse. It can depend on what career path you choose to pursue with that degree. History-majors-turned-business-consultants earn a median total compensation of $104,000, similar to their counterparts who pursued a business major like economics -- whose grads earn about $98,000 overall at midcareer, the PayScale study shows.

English majors in all career paths who graduate from Harvard University earn a median starting salary of $44,500, compared with $35,000 for those with English degrees from Ohio State University -- a 27% difference. And that disparity widens even more after 10 years. By then, English majors from Harvard reported earning $103,000 in median pay, 111% more than their counterparts from Ohio State.

"With a liberal art's degree, it's what you make of it," says Al Lee, director of qualitative analysis at PayScale. "If you're motivated by income, then there are certainly careers in psychology that pay as well as careers out of engineering."

Bullet Art

Numb What?

10 Secrets of Breakthrough Companies

by Keith McFarland

Why do some companies "break through" while so many others do not? Author and business consultant Keith McFarland has spent years researching thousands of private companies in an attempt to answer that very question. After studying the performance of more than 7,000 companies that have appeared on the Inc. 500 list of America's fastest-growing private companies, McFarland, a former Inc. 500 CEO himself, wrote the best-selling book The Breakthrough Company: How Everyday Companies Become Extraordinary Performers. Here are 10 secrets to long-term entrepreneurial growth:

1. The sexiest businesses don't always win.

In fact, the most interesting companies often don't operate in the markets that Wall Street and the business press consider interesting or "cool." Many of the breakthrough companies began in market segments experts considered unattractive at the time. We certainly didn't expect to find a nuts-and-bolts distributor, a snowmobile maker, a payroll processor, or even a niche real estate business on our list of top performing growth companies. But we did.

2. It's not all about the entrepreneur.

They're the ones that grab the headlines, right? And in fact, in the earliest stages of development, the quality of the entrepreneurial team tends to swamp all the other variables in predicting firm success. But as soon as the business gets on its feet, the best entrepreneurial leaders are too smart to let the company make it "all about them." Breakthrough leaders understand that no one wants to serve a king. These leaders work hard to put the company's vision -- and not their own personality -- at the center of things.

3. Entrepreneurs aren't always risk takers.

Over a five-year period, we administered a psychological inventory to more than 4,000 entrepreneurial leaders. We discovered that contrary to conventional wisdom, entrepreneurs are actually distributed evenly across the risk-taking spectrum. Even more important, there is evidence that as they achieve success, some entrepreneurs actually become more risk averse -- "playing tight" (as they say in poker) at the very time when they should be upping the ante.

4. Founders don't need to let go.

Conventional wisdom holds that entrepreneurial companies fail to reach their full potential because founders just won't "let go." So we were surprised to learn that in eight of nine top-performing companies in our study founders stayed deeply involved -- usually for decades. It turns out that, rather than letting go, founders and founding teams need to redefine their roles as the business grows.

5. You don't necessarily have to stick to your knitting.

Sticking to your knitting is fine, as long as your competitors stick to theirs as well. But competitors rarely behave the way you want them to. To achieve breakthrough performance, companies need to be constantly scanning the changing needs of the customer and developments in the industry so they can spot the most important opportunities to advance the business.

6. You don't need OPM (other people's money).

We've all heard the professional investor's pitch: "Sure you can grow your business on your own, but you can grow it faster with our money." So we were surprised by the fact that not one of the breakthrough companies were funded by venture capital in their start-up years -- not even several high-tech ventures (one company accepted venture money just before going public because the founder wanted some sharp VCs on his board, not because he needed the money). The right investor at the right time can be crucial, but outside money is far from a requirement.

7. It's not all about hiring the right people.

So much has been written about the importance of hiring the "right people" that we expected the top-performing Inc. 500 companies to have some really innovative techniques for attracting the best and the brightest in the industry. Instead, we found that these companies focus more on making the people already in the company productive through intense training and education. In the words of one breakthrough CEO, we have succeeded because we have built a place where ordinary people can do extraordinary things."

8. It doesn't matter where you went to school.

In our study of the top performing Inc. 500 companies over a 22-year period, we found that it's not about where (or even whether) you went to school. One company was run by a Ph.D in statistics and former college professor; another was run by a person who hit the bricks right out of high school.

9. You don't have to let the MBAs take over.

Many business people divide the world into two groups -- entrepreneurial firms and "professionally managed" firms. But reality is not that simple. Many small firms are very well managed -- though probably not in a way that most bureaucrats in giant companies would recognize. And in many big companies, it is easy for the "professional management" tail to start wagging the company dog. Companies large and small alike should strive to create an entrepreneurial enterprise that combines the quickness and customer focus of an entrepreneurial firm with the systems and processes of a more mature organization. MBAs are optional.

10. Strategy isn't just the job of the CEO.

The most successful companies recognize that strategy is a firm's "source code" -- the fundamental set of assumptions upon which everything else in the business is based. So they strive to get people throughout the organization thinking about and debating strategy. They nurture an environment that includes "insultants" -- people willing to take a full swing at the issues, even if it means questioning the fundamental assumptions upon which the firm is based.

Ways to Make Saving a Habit

by Andrea Coombes

What's your excuse? When it comes to the sorry state of our finances, we've all got one.
Maybe your raise at work never materialized, or you charged that unexpected car-repair bill -- or that plasma TV -- to your credit card. Whatever the reason, for many of us, personal balance sheets could look better. Half of U.S. workers report less than $25,000 in savings.
Even if you've saved more, is it enough to sustain you through a decades-long retirement?
Sure, plenty of consumers now are easing back on spending, thanks to sticker shock at the grocery store and gas station. But soon enough retailers and restaurants will be pushing hard-to-resist "recession deals" -- will you be able to restrain yourself? And, what happens to your budget-minded ways when the economy recovers?
It's time to shake off the "consumer" mantle that politicians and economists are so happy to drape around our shoulders. Resist their calls for consumers to save the economy, and resist the advertisements enveloping us in the idea that we need more and more things.
The only thing most of us need more of is financial security. A lot more.
How to get there? Think thrift. For some, it's a familiar idea. For others, thrift implies denial and deprivation, and that makes for a tough call-to-arms.
So, how to save money without scrimping, be thrifty without feeling miserly -- and maintain those habits after our economy picks up speed?
It won't be easy. Expect discomfort, says Kathleen Gurney, a psychologist and chief executive of Financial Psychology Corp. Keep going, even when it's uncomfortable -- the rewards are worth it, and once this economic slowdown ends, you'll have financial habits in place to support you for a lifetime.

1. Spend less time feeling poor. Flipping through catalogs and going to the mall will make you feel like you need things, Ms. Gurney notes. Sure, you can afford some of that stuff, but the main message is: Most of this is out of your reach. Instead, do things that offer a sense of well-being. Invite friends over. Walk in the park.
2. Retrain your brain. Depriving ourselves of current pleasure is nigh impossible if we're not driven by a sense that the future will be more fulfilling, says Ms. Gurney. When you start to feel that "I'm deserving so I'm buying" feeling, visualize a smaller credit-card bill or higher savings-account balance.
3. Look around you. Are you happy with what your hard-earned dollars bought? If not, shift your spending to those things that bring greater long-term satisfaction, including retirement savings.
4. Choose your extravagances. Here's mine: I eat out about once a week. An extravagance I do without: Cable television.
5. Assess weaknesses. "If you were thrifty, how would you look different?" says Gary Buffone, a financial psychologist in Jacksonville, Fla. Identify what you want to change; then shoot for specific targets, such as a six-month hold on buying new tech gadgets.
6. Make trade-offs. Substitute small, free pleasures for those that cost. Have a movie night at home with friends -- you'd be surprised how many people are equally eager to cut costs.
7. Set goals. Meet weekly with family to discuss the spending plan (don't call it a budget) for the months and years ahead. This may involve tough choices, such as forsaking a family vacation. But think of the guilt-free trip you can take after saving the necessary cash. Good memories last longer, Ms. Gurney notes, when not trammeled by large credit-card bills.
8. Resist your children. They're going to find it hard to change their expectations. How can you help? Stand firm. The next time they clamor for the latest videogame, remind them of the bigger prize (that family vacation), and tell them their choices here and now are, say, a picnic or a movie rental. Offer options, but don't give in to their push for more consumer goods.
9. Enlist other people. Many people are reticent to talk about money worries, but almost everyone has them, so open up and tap your allies. Hold a contest with friends to see who can save the most in a month, or agree with your spouse to talk before spending more than $100, Mr. Buffone suggests.
10. Post it. Remind yourself by putting post-it notes on your wallet, mirror or steering wheel with the mantra of your choosing: "I want to go to Hawaii in January." "I want to pay off credit-card debt."
11. Automate it. Divert money monthly from your checking account to savings. It will force you to budget, based on what's left in your checking account.
12. Rethink rewards. What are some of your happiest memories? Those are the true rewards. Next time you're about to buy something because you deserve it, ask yourself whether there isn't something you deserve more, such as time at home cooking with your teenager, or a stroll with your husband or best friend.
"We've been conditioned to think that spending the money on clothes, at a restaurant, is going to be the reward," Ms. Gurney says. "But what is the ultimate reward that we want from working hard, in the end?"