Costco Connection - September 2006

AskSuze Orman

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Suze Orman’s latest book is The Money Book for the Young, Fabulous & Broke. The Suze Orman Show airs Saturday nights on CNBC. Suze can be contacted at www.suzeorman.com.

LINDA, YOU NEED A smart place to save, not invest. There’s a very big difference. An investment is something you do not need to touch for at least seven to 10 years, and ideally much longer.

KIE TH LATHROP

With a long time horizon, stocks are a good investment: You have time to ride out market rough patches, which brings an opportunity to earn more when the markets rise. But you never want to invest in stocks or other volatile investments for your emergency fund.

Your main goal is to keep your money safe. That means a bank savings account or a money market mutual fund.

Thanks to more than two years of the Federal Reserve raising its benchmark short-term interest rate—the federal funds rate—you can earn nearly 5 percent in a safe savings account.

Money market deposit accounts and money market mutual funds will give you the most flexibility: You can write checks against the account at any time, though often a minimum check amount of $200 or so is required.

FINANCIALconnection

Here’s one investment

you should avoid

What’s the best way to invest $5,000

or more in an account that could be accessed quickly in case of an emergency? I am 58.

—Linda Katrick, via fax

out while you are alive, there’s no guarantee you’ll get at least your original deposit back.

Even worse is that the supposed tax advantage is really an albatross. Sure, your money grows tax deferred while it is invested. But if you withdraw it, you are going to owe income tax, not capital-gains tax, on your earnings. The highest income-tax bracket is 35 percent; the highest capital-gains rate is 15 percent. See my point?

You can easily create a tax-efficient investment on your own: Invest in index mutual funds and there’s little likelihood you will be hit with a tax bill until you sell. To guarantee there’s no tax bill, opt for an exchange-traded fund (ETF), which is an index fund that trades like a stock. Then, when you do sell, you will simply owe capital gains on your earnings, as long as you have owned the index fund or ETF for at least a year.

Let’s think about your kids for a minute. With a VA, if they withdraw all the funds immediately upon inheritance (which most kids do), they will owe tax on all the earnings. With a mutual fund or ETF, if they withdraw all the funds immediately they probably won’t owe a penny of tax.

To learn more about why I dislike VAs, check out the “Resources” page at www.suzeorman.com.

My financial planner wants to put a large sum of my money ($400,000) in a flexible premium variable annuity. I am a bit skeptical and am not real crazy about the large ( 6 percent to 8 percent) surrender charges. What are your thoughts?

—Sandy Sandweg, San Diego

I am 65 and my husband is 69, and through bad investments we lost everything and are now renting an apartment. We get $1,650 a month from Social Security; I can get my hands on about $20,000. Should we try to buy a home? Or maybe lease?

—Jacqueline Hart, Atlanta

HOW CAN I SAY this politely? Actually, I can’t. So let me just be blunt: This is horrible financial advice. Variable annuities (VAs) are at the top of my list of worst investments. You are absolutely right to be skeptical about the surrender charge (the fee you pay if you dare to want to cash out in the first seven years or so that you own the VA), but that’s just the tip of the scary iceberg.

Financial advisers love VAs because these investments earn a fat commission and they are easy to sell. Consumers fall for the sales pitch of getting tax-deferred savings by investing in mutual funds through a VA as well as the promise that they won’t ever get less out of the VA than they put in.

Here’s what the adviser doesn’t tell you: You will pay an extra fee each year that hovers around 1. 3 percent to give you that asset protection, which kicks in only if you die. If you take all your money

YOU MAY HAVE LOST all your money—and I know how wrenching that is—but let’s get something clear: You have not lost everything. You have your husband, a nice Social Security payout and $20,000.

If you can buy a place for $150,000, a 10 percent down payment ($15,000) would leave you $5,000 for an emergency cash fund, which I think is important. A 30-year fixed-rate mortgage for $135,000 will run you about $835 a month, which is about half your Social Security payment. Buy only if you can afford the 30-year fixed—don’t take on a risky adjustable-rate mortgage on your fixed income.

Of course, you will also have the additional costs of property tax and insurance to contend with, as well as private mortgage insurance the lender will insist on if you make less than a 20 percent down payment. If, after you add up those costs, you don’t have enough money left to cover your other living expenses, you must either lower your purchase price or just keep renting. C