Some Popular Questions and What They Mean
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Podcast Title: Some Popular Questions and What They Mean
Podcast Series: Financial Literacy Boot Camp
Video and illustrations available on our YouTube channel here
In episode 44, we discussed “Knowing Your Numbers” and this is a follow-up to that episode on some of the more popular questions I’ve come across.
Questions/Issues We’ll Address on this Episode:
Q) What is a good debt ratio and what is a bad debt ratio? (5:23)
A) Most experts would say for every dollar of income you should have no more than 36 cents of debt. This would be anything you have a payment on (house, car, etc.). As I explained in episode 44 about knowing your numbers, underwriters will use 43% to give you a loan, but this is a really high number. Now let’s talk about some reasons people may want to ask this question. I think it centers around the concept of “delayed gratification”. How much can I afford to consume and not have a negative consequence is essentially what someone is asking when they ask this? So let’s just illustrate the concept of bringing your future consumption to the present. A good example of this is when someone buys a home. You buy the home and of course, you are financing that purchase over a long period of time (e.g. 15-30 years). So you are bringing a considerable amount of your consumption forward into the present. However, when you start to purchase additional items to furnish the house this is when you may tend to go overboard. The level of consumption generally speaking far exceeds what needs to be brought into the present. So try and keep this inside 33%–that would be good. Above 43% would be bad.
Q) Can an individual contribute to both a Roth and a Traditional IRA in the same year? (10:30)
A) Yes; as long the total contribution doesn’t exceed the IRS limit of $5500 ($6500 if over 50) per person. But why would you want to contribute to both versus one or the other? In a lot of cases, the contribution to a Traditional IRA can be deducted from gross income in the tax year you make the contribution. There are some rules around this based on income and whether you participate in your employer’s retirement plan. For instance, if you can’t make a deductible contribution to a Traditional IRA you may want to make the entire contribution to a Roth IRA if you qualify. You also may want to split the contribution between the portion that is deductible since it phases out and contribute the remaining amount to a Roth.
Q) How did the financial crisis affect the banking sector? (14:09)
A) The short version is that lending was constrained because there was a lack of trust in the system. In most cases, you never see a banking crisis because there is always a “lender of last resort”. This is the bank or collection of banks that will always buy a security that is offered as collateral so that the seller can use the cash to continue whatever operation it has. Can this happen again? There is a lot more liquidity in the system because the FED has purchased a lot of treasuries from banks and that cash has been “put” into the system for lending and “cushion”. However whenever a large enough fear can be built into the system because asset prices get too high and form a “bubble”, then you have the makings for uncertainty again.
#financialadvisor #financialplanner #financialquestions #finliteracy #finlit
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Dominique Henderson, CFP® is founder of DJH Capital Management, LLC., a fee-only, registered investment advisory firm specializing in comprehensive financial planning and wealth management.
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