Bonds May Not Be The “Safe” Investment You Think

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

Many investors consider bonds the "safe" investment.  But in considering a bond "safe" you may be failing to manage some very real risks that bond investing presents. These risks are why bonds, like equities, require ongoing oversight and active management.
  

For starters, there is a difference between a bond fund and a bond.

An individual bond is a promise to pay ongoing interest over the life of the bond and your principal at maturity.
You have three risks with an individual bond. The first is the risk of default. The second is the risk that you will need your principal prior to maturity and be forced to sell a bond at a loss. The third risk is that when your bond matures, you will be unable to replace it with another bond paying comparable interest.

The value of a bond over its lifetime is directly related to (1) the perceived risk of default and (2) current interest rates. If you purchase a bond during a period when 6% interest rates are the norm, and interest rates subsequently fall, your bond could be worth more than its face value. If interest rates were to go up, the value of your bond, if sold prior to maturity, would fall because an investor could purchase other bonds offering higher returns.

A bond fund is a collection of bonds with differing maturities and interest rates. The manager buys and sells bonds with the goal of increasing the value of the fund. The investor receives diversification across multiple bond issues, professional selection of bonds with an eye toward reducing the risk of default, and laddering of bonds of different maturities and returns typically with the goal of creating a stable flow of income (but no guarantee).

Unless the bond fund is a Unit Investment Trust (UIT,) it has no maturity and thus no obligation to return your principal. If a bond fund falls in value, there is no option of simply holding it until maturity to recapture your principal. The value of your investment in a bond fund will change in response market conditions and interest rates. On the other hand, you gain liquidity through the ability to sell virtually all bond funds at the current fund value (NAV).

The problem with bond funds, and with bonds you might want to sell before maturity, is the future direction of interest rates. The chart below shows the change in interest rates over the last 10 years. With every drop in rate, the value of a good bond increases if sold today. It's a good ride and one you want to stay on as long as it lasts.

The catch is that we don't know how long interest rates will remain at their current lows. The Federal Reserve has indicated that it sees no need for increases in the Fed Funds rate in the near future. The economy still struggles to recover and low rates are a good thing for the greatest debtor in our country - the U.S. Government. What we do know is that when rates begin to rise, they will affect the value of a bond portfolio. That's when risk management needs to be a part of the portfolio.

Feel free to email me with any questions or comments at Paul@investfortomorrow.com.

Until next time…

Paul Schatz

Heritage Capital LLC

http://www.InvestForTomorrow.com

http://RetirementPlanningConnecticut.com/

Follow us on Facebook at www.facebook.com/heritagecapital and on Twitter @Paul_Schatz 

With Federal Reserve Rates Near 0%, What's Happening to Your Credit Card?

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

Kudos to the credit card companies for doing their best to help Americans reduce their credit card debt.

Although, that might not be their intent or desired result. Many credit card holders have received notices in the last few months of dramatic increases in their interest rates and fees, more than one might expect in a financial environment where the federal government is trying to hold interest rates to a minimum.

The reason is a law passed by Congress last May, limiting the ability of banks to adjust credit card rates and fees. Many credit card issuers decided their best mode of defense is to raise rates and fees in advance of the law taking effect in February. Lower rates can then be offered as "special promotions."Credit card issuers are also well aware of predictions that the next credit collapse will be the credit card market, as unemployment continues in the double digits and depressed real estate prices make consolidating debt in a home loan less feasible.

What should individuals do to avoid being hit with higher fees and 28% (or higher) interest rates on their credit cards?

Number one is to avoid carrying a balance on your card on which you will have to pay interest. Only use credit cards with a grace period and pay off balances within the grace period.

Number two is to never miss a payment.
Missed payments not only incur late fees (which have jumped to $50 and more at some credit companies) but also could trigger increases in your interest rate. To make certain you never miss a payment, set up an automatic minimum balance payment from your checking account to your credit card. There's no charge to do so and it could save you considerable funds if a particularly crazy month or travel results in overlooking a bill's due date.

Remember: Credit cards have always been a poor way to borrow money. The rates and calculation of interest charges are set up to benefit the credit issuers, not the consumer. While using a credit card has a number of benefits, including fraud protection and the ability to earn points and cash back, you should only use a credit card for charges you can afford to pay.

Please feel free to email me with any questions or comments at Paul@investfortomorrow.com.

Until next time…

Paul Schatz

Heritage Capital LLC
http://www.investfortomorrow.com/

Shopping for Credit Cards: Don't Look for East Street

December and January usually are the most active months for submitting credit card applications.

But in the wake of stiff industry restrictions ushered in by the Credit Card Accountability, Responsibility and Disclosure (CARD) Act and new U.S. Federal Reserve rules, consumers will have a harder time getting approved.

Bill Hardekopf, chief executive officer of LowCards.com and author of The Credit Card Guidebook, said applicants may be disappointed in the credit card offers they receive from issuers.

"Shopping and applying for cards is not as easy as it used to be. Consumers should now expect higher rates and lower credit limits. Approval is no longer a sure thing," he said. "Issuers are struggling to keep profitable, and they are trying to generate new revenue from their cardholders who are finding it difficult to make their card payments."

Still, getting a card with a lower rate can save money on interest and can be worth the effort.

Here are some tips for shopping for a credit card:

1. Start with your credit score.
Lenders make their judgment about your credit worthiness based on your credit score. A FICO score of 700 or more is considered very good; over 760 will usually qualify you for the best rates (up from 720 several years ago). A consumer with a score less than 640 will receive high interest rates and limited credit options.
Issuers will also use your credit score to determine the features of your card such as the credit limit and balance transfer terms. If you are surprised by your credit score, check it for errors. Correcting mistakes is the fastest way to raise a credit score.

2. Honestly assess how you will pay off the credit card.
You need to take a hard look at yourself to determine what kind of credit card customer you are. Will you pay off the entire balance each month on time or will you carry a balance? This will determine the type of card you need.
If you pay off your balance each month, consider a rewards card with no annual fee. Cash back reward cards are usually the best because you can use cash to purchase anything. Know that issuers have cut back on reward offers - 1% is now the standard amount for rewards of points or cash.
Also, pay attention to the reward tiers. Even though the issuer advertises a 1% cash rebate, it may take a certain level of spending to reach the 1% level. If you carry a balance most months, apply for a card with the lowest possible rate. The less you pay for interest, the more you pay toward your balance and the faster you can pay off that balance. Do not pay a higher rate just to get rewards.

3. Transfer your balance to a card with a lower rate.
Transferring balances between low rate cards was once an easy and profitable game for many cardholders. However, this lost money for issuers and the offers for 0% interest on your balance for twelve months have almost dried up. This year, balance transfer fees jumped from 3% to 4% and, in some cases, 5%.
"This is discouraging news for consumers who are placing hope in balance transfers. However, if your APR has been increased significantly, your issuer may be forcing you to try to find another card with a lower rate," Hardekopf said. "Before you begin the process of transferring your balance to another card, contact your issuer and ask them to lower your current rate. This doesn't happen as often as it used to, but it doesn't hurt to ask."

4. Pick one card and apply for it.

Compare three or four cards. Study the terms and conditions of these cards, then select the best one and submit an application. "Limit the number of applications that you submit because each application is recorded as a credit inquiry on your credit report. Multiple applications are a red flag that can lower your credit score because people actively seeking credit are typically a higher risk to lenders than people who are not seeking credit," Hardekopf said.

5. Avoid store cards.
Do not apply for a store card just because the store gives you an immediate discount on your purchase. The interest rates are usually much higher than an average card, often above 20%. If you don't pay off the balance in full the first month, you could pay much more in interest than the money you saved.

6. Pay attention to your rate.
Most rates are now variable and they will increase in the future as the Federal Reserve raises the prime rate.

7. Only apply for credit if you need it.
Do you really need a new card, or can you work with the cards that you have? Most consumers carry too many credit cards which leads to further temptations to spend.

LowCards.com simplifies the confusion of shopping for credit cards. It is a free, independent website that helps consumers easily compare credit cards in a variety of categories such as lowest rates, rewards, rebates, balance transfers and lowest introductory rates.

New Credit Card Protections Taking Effect

Phases of federal legislation known as the CARD Act (Credit Card Accountability, Responsibility and Disclosure), signed by President Barack Obama in May, take effect Aug. 20 that change rules related to notification to consumers.

Credit card issuers must give card holders 45 days notice, up from 15, before any increases to interest rates, fees or finance charges; and before any other significant changes to an account. The present requirement is 15 days.

If you get such a notice, you may shop around for better rates or, under the CARD Act, you are allowed to reject the rate increase by closing down the credit card account. A caveat is that you would have to pay off the balance within five years at your existing interest rate.

There is another consumer benefit kicking in.

Card holders must receive their monthly billing statements 21 days before the due date in order for credit card companies to charge a late fee, rather than the current leeway of only 14 days.

“The new rules of the road established by the Credit CARD Act will shield credit cardholders from widespread abusive practices. New protections will give American families more time to pay their credit card bills every month, and time to shop around for a better deal if their rate is being raised,” U.S. Senate Banking Committee Chairman Christopher Dodd, D-Conn., said in a statement.

Dodd introduced the legislation to Congress.

Credit card companies, however, have been trying to offset likely drops in revenue that would result from the CARD Act provisions by eliminating fixed rates and implementing variable interest rates only; introducing annual fees on cards that did not charge them; and raising other charges such as balance-transfer fees, said Bill Hardekopf, chief executive officer of Lowcards.com and author of the Credit Card Guidebook.

Lowcards.com is a Web site that allows consumers to compare terms and rewards offered by various credit card companies and to keep up to date on credit card industry news.

Hardekopf hosted a live chat with the New Haven Register on Aug. 12 about the legislation and how credit card industry changes affect consumers.

Dodd said the first set of provisions are "important first steps" for American consumers. “Unfortunately, some credit card companies are trying to squeeze their customers before the clock runs out on ‘any time, any reason’ rate increases. These companies will be held accountable for rate hikes when the full Credit CARD Act takes effect.”

The CARD Act will go into effect fully in February 2010.

Dodd has asked Federal Reserve Chairman Ben Bernanke to enforce a provision that requires credit card companies to review accounts every six months if they raised the interest rate. If the credit card holder has improved his or her credit standing and the circumstances causing the increase no longer exist, then companies must reduce the rate.

Click here for a summary of the CARD Act.

Interest-ing

Credit Card Interest Rates Rising Ahead of Rule Changes

There are about six weeks left before some provisions of the new Credit Card Accountability, Responsibility and Disclosure (CARD) Act go into effect. The federal legislation was sponsored by U.S. Sen. Christopher Dodd, D-Conn., and signed by President Barack Obama in May.

One of the key regulations to kick in Aug. 20 applies to interest rate hikes. Credit card issuers will then be required to give consumers 45 days notice before going up on rates, a substantial increase from the 15 days required now.

Bill Hardekopf, chief executive officer of Lowcards.com, said the 45-day mandate will give approximately two cycles' worth of time for consumers to shop around and change cards if they desire.

This may be small comfort to the many cardholders who have experienced interest rate hikes over the past year, as issuers seem to be raising rates before new rules are implemented, he said.
"Issuers realized that change was coming and they have raised rates, cut limits and changed practices quickly and frequently in advance of the regulations going into effect, just as they said they would do," said Hardekopf, also author of The Credit Card Guidebook.

As of Aug. 20, credit card companies also must start mailing or delivering periodic statements 21 days or more before the payment due date in order to charge a late fee.

Lowcards.com reviewed some of the practices that credit card companies have initiated in advance of the new law.

One of the "harshest" changes reported by Lowcards.com was recently announced by JP Morgan Chase, increasing the minimum payment percentage from 2% to 5% for some cardholders, which more than doubles their monthly payment.

For example, if the balance is $8,000, then the minimum payment at 2% is $160. The payment jumps to $400 at 5%.

While a higher minimum payment forces cardholders to pay off their debt faster and thus saves them money in the long run, this increase could make the minimum payment unaffordable for some consumers and could damage their credit scores.

"If this is effective and reduces risk for one issuer, expect other issuers to follow," Hardekopf said.

Dodd, who is chairman of the Senate Banking Committee, on Thursday sent a letter to the heads of key regulatory agencies directing them to write and enforce robust rules requiring credit card companies to review rate increases imposed on their customers since January 1st of this year.

Most of the provisions of the CARD Act take effect after Jan. 1, 2010. Among other changes, the law bans practices such as universal default and sets parameters on the issuance of cards to college students.

Here are some other changes, already implemented by card companies, noted by Lowcards.com:
* Simmons Visa Platinum is moving from a fixed rate to a variable rate. The current annual percentage rate or APR will remain at 7.25%, but it will now be variable. In addition, Simmons is moving from an 8.95% fixed rate to a 9.25% variable rate. Both changes take effect today, July 10.
* IberiaBank has received attention for having one of the lowest rates available. However, the bank raised its low rate from 6.25% to 8.25%, effective June 26.
* Bank of America increased the balance transfer fee from 3% to 4% on June 1.
* Chase increased its balance transfer fee and cash advance fee to 5% effective in August. Both fees are the highest in the industry.
* Both Bank of America and Chase announced that they will be moving a number of their cards from fixed rates to variable rates.
* At the beginning of June, Chase restructured its rewards program. It launched the Ultimate Rewards, a program where cardholders earn one point per $1 spent, with no earnings cap or expiration date.

This will replace versions of its Freedom card, some of which have offered more generous cash-back rewards and bonus opportunities. The Freedom cardholders who want to keep a fixed 3% bonus for spending in grocery, gas and fast-food categories, will pay a $30 annual fee for the card.

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Credit Defaults: Don't Wait -- Negotiate

Credit card default rates are now above 10 percent for several major issuers, meaning some banks might not get paid back on more than 10 percent of their credit card loans, which are unsecured.

To cut their losses, issuers have been be more willing to negotiate a payment plan or settle accounts with card holders.

"While settlement and payment plans may relieve a bit of the pain for issuers and cardholders, this is not an ideal solution. It is merely a way out to avoid total loss. For cardholders, it means their financial situation is so difficult that they can't pay anything on their loans," said Bill Hardekopf, CEO of Lowcards.com and author of The Credit Card Guidebook.

"They probably already have a poor credit score and settling their debt could make it worse, but it does remove some of the weight from the burden of the debt. For issuers, they are losing money on loans, but at least it isn't a total loss," he said.

LowCards.com simplifies your shopping for credit cards. It is a free, independent Web site that helps consumers compare credit cards across a variety of categories such as lowest rates, rewards, rebates, balance transfers and lowest introductory rates. It also gives an unbiased ranking and review for each card.

Hardekopf said cardholders struggling to meet payments should be proactive and try to work out a solution that avoids more serious financial problems.

Bank of America, the largest bank in the U.S., reported that its default rate jumped to 12.5 percent in May, up from 10.5 percent in April. American Express said its default rate rose to 10.4 percent from 9.9 percent.

Defaults are expected to climb as the recession lingers.

That trend is troublesome for card issuers, Hardekopf said, because they have to write the balance down to zero once a person has been delinquent for six months. They may continue to try to collect the debt through a collection agency, but they must post the loss on their books.

If you are having financial difficulties and can't make your credit card payments, now is the time to contact your issuer, explain your situation and work out a payment plan, he said.

Here are some steps to consider:

*Start with trying to adjust interest rates and fees.

If you can make some monthly payment, ask the issuer to lower your rate and waive your fees. That could make a big difference in how much of your debt gets paid off. If you are in danger of missing a payment, contact your creditors as soon as you realize you have a problem.

The sooner you contact them, the more willing they may be to work with you. If the first person you speak with can't help lower your rate or make adjustments to your account, ask to speak with a supervisor. Document all conversations, including whom you spoke with, the date, time, and the results.

Remember: persistence, persistence, persistence.


*If you are already in default, DON'T ignore the problem and hope it goes away.

A good place to start is "Help With My Credit," a service started by financial institutions and credit card issuers to educate and assist cardholders who are struggling to make their credit card payments. The service can be reached toll free at 1 (866) 941-1030.

Operators will provide information about contacting credit card issuers and accredited credit counseling agencies. Consumers can also get help and information through a website, HelpWithMyCredit.org.

*If you are close to or over 90 days past due on your account with no hope of paying it off, talk directly with your credit card issuer about debt settlement.

Credit card companies might be able work out a settlement whereby the account is closed and you pay a portion of the amount that is due.

Keep in mind that there are negatives to arranging a settlement for debt. Closing an account due to settlement will affect your credit score for several years.

Also, income taxes must be paid on any forgiven debt greater than $600. You would need to file Form 1099-C with the IRS.

*Do not respond to ads from debt settlement companies promising to cut your debt in half.

They charge high fees, much of it due up front, for services that you can sometimes do yourself with about the same success. In some cases, scammers have disappeared with the funds, making the situation worse.

A non-profit accredited counseling agency can help you get lower interest rates and develop a debt management plan. The National Foundation of Credit Counselors is a good place to start, Hardekopf said.

The foundation has a Debt Management Plan for paying down outstanding balances through monthly deposits to a credit counseling agency, which would then distribute the funds to creditors.

It takes approximately 36 to 60 months to repay debts through such a plan, but once finished, it can help re-establish a positive credit history. Fees include a $25 counseling fee and a $10 to $25 monthly fee for administering the plan.