Real-World Number Crunching

Question of the week:I recently received an inheritance big enough to pay down my home mortgage. I have a great mortgage interest rate and monthly payments I can afford comfortably. I have no other large debts to deal with because I keep my credit cards clear and I don't plan on having children. Should I pay off my house? Or should I invest it? --Gus B. Dear Gus, Yours is certainly a nice dilemma to have, and you're to be congratulated for considering your two very attractive alternatives so seriously. We recently asked members of the Armchair Millionaire community to weigh in with what they would do if they were in your shoes. Here are just a few of the comments we heard: "Pay down the mortgage early. It's a guaranteed savings, risk-free, and if necessary, the money is there to borrow against at a later time." --Craig "Do both. Put 25 percent of the extra cash towards paying down the mortgage and invest the remaining 75 percent in stocks and bonds. Consider your home a partial 'investment.'" --Jeff "Invest, especially if you can do it through an IRA. You'll get the tax advantage of the IRA and still have the tax advantage of the mortgage." --Gregory As you can see, people hold widely varying opinions. Who's right? Actually, everyone. Because everyone is in a different financial situation, there's no single answer that works for everyone. This means that you'll need to do some thinking and run some numbers. At the heart of it, you need to do a cost-benefit analysis--something every MBA student learns inside and out. But don't be put off by the fancy term. It's really just means figuring the benefit of a particular course of action, subtracting the costs, and deciding if it's worth it to you. In your case, the benefit in paying off your mortgage would be the interest you would save and the peace of mind you'd achieve from being mortgage-free. The cost would be the lost opportunity of not investing your money elsewhere. Would the benefit outweigh the cost? That's for you to decide. My guide will help you crunch the numbers. The Armchair Millionaire's Guide to Crunching the Numbers State the alternatives clearly. Break your choices down into manageable parts that you can assess individually. Define each possible outcome and look at all the factors that will impact each. For your decision, some of the factors to consider will be the rate of return you might get on an investment, how long your money might remain invested, the interest rate you're paying on your mortgage, your job security, and any other financial goals you might have. Look for the hidden costs and benefits. Don't overlook the impact of both taxes and inflation. For example, you receive a bit of a tax break when you pay mortgage interest (assuming you itemize your deductions). Likewise, when figuring how an investment might grow, remember that inflation erodes that value of a dollar over time. For example, to have $100,000 in today's dollars, you'd need to have $134,000 in ten years (assuming 3 percent annual inflation). Be sure to include these factors in your calculations. Be realistic about investment returns. Many people look at average annual returns of a major market index like the S&P 500 and assume that they can earn the same returns over time. In the real world, though, most people actually earn less. A better way to estimate what your returns might be over the next ten years would be to look at what your returns actually were over the last ten years. Honor the intangibles. The major challenge in working any cost-benefit analysis is accounting for the intangibles--the things you can't measure in dollars. For example, how do you figure the value of the feeling you'd get from knowing your mortgage is paid off? For some people, it would be worth a great deal; for others, much less. Leverage online tools. There are plenty of online calculators that will do the math for you as you run different mortgage pay-off and investment scenarios. Good places to start are www.cnnmoney.com and www.bankrate.com. THE BOTTOM LINE: There's emotion involved in any big financial decision, but you also need to be clear-headed about the math. Be as rational as possible in considering all the variables and you'll have a great basis for making a sound decision.

Putting Every Penny to Work

Question of the week:I was lucky enough to get a nice holiday bonus of $2,000 this year. Any suggestions on how to make the most of this extra cash? --J.S. Dear J.S., Lucky you are, given that most businesses these days do not give their employees holiday bonuses. In fact, according to a survey last year by American Express, just 43 percent of business owners planned to give bonuses. That's all the more reason to make the most of your extra cash. When we asked Armchair Millionaire community members about how they planned to use their holiday bonuses, we heard from some with generous--and not so generous--employers: Baby bucks. "I got a $100 bonus, or basically, one day's pay. Since I was getting new glasses the same week (I used my last pair for 6 years!), I just put the money toward those. After the way my stocks have performed lately, I'm ready to take a second job and can't afford to put any 'bonuses' toward luxuries." --Erin Big bucks. "I got a $15,000 (pre-tax) bonus. Breakdown of where it's going: $3,000 into an IRA, $4,000 to pay down personal debt (almost done!), $2,000 towards a new (used) car we need and the rest into a new PC and home repairs." --Bob Regardless of the amount of your bonus, you still want to leverage the money in the best ways possible. My checklist provides my top recommendations for putting your money to work. The Armchair Millionaire's Checklist for Turning Casual Cash into Serious Bucks Zap your consumer debt. Carrying a balance on your credit cards? Use that extra cash to get rid of it, or at least to put a big dent in it. If you have a $2,000 credit card debt charging 18 percent interest, it will take you more than seven years and over $1,700 in interest to pay if off if you just make the minimum payments. But pay it all off now, and that's like cash back in your pocket. Secure your retirement. Ready to get your retirement plan on track? Consider putting that cash into an Individual Retirement Account. You can put up to $3,000 into an IRA this year, money that will grow on a tax-advantaged basis right up until you withdraw it during retirement. If you put $2,000 each year into your IRA over the next 25 years, and it grows at an average annual rate of 10 percent, you'll end up with about $233,000. While most people are eligible to contribute to an IRA, check with your tax advisor to make sure you are. Save for college. Have a college-bound child? An annual contribution of $2,000 to a college fund earning an average return of 10 percent will grow to just over $36,000 in 10 years. There's a nice range of college savings programs now available, most of them offering substantial tax advantages. One of my favorite Web sites for learning about your college savings choices is www.savingforcollege.com. Pay off your mortgage early. Want to get out from under the mortgage burden? An extra $2,000 payment each year on a $200,000 30-year mortgage with seven percent interest will knock off more than eight years of payments--and save you nearly $90,000 in interest. THE BOTTOM LINE: Creating a real and positive difference future your financial future doesn't require you to be a money whiz or even to have a huge amount to begin. Just commit to a plan and get started.

Teach Your Children Well

Question of the week:My parents were terrible teachers and role models when it came to money. I have my own kids now and don't want to make the same mistakes. What should I be teaching them about money? --C.P.

Dear C.P.,

Given the complexity of personal finance and investing nowadays, it's a constant challenge for parents to prepare their kids well to manage money on their own. Unfortunately, it seems that many young adults are really not prepared at all--according to the Consumer Bankruptcy Project, a staggering 94,000 people under the age of 25 declared bankruptcy in 2001.

We asked members of the Armchair Millionaire community for their opinions on what's most important to teach kids about money and heard a wide range of ideas. Here are just two:

"Children need to learn about delayed gratification and goal setting, and to be given money choices early in life." --Ken

"Teach your children that they only need ONE credit card. And teach them how to use it wisely and pay it off each month." --Michelle

Kids today--and especially teens--have more money than ever before. That means it's more important than ever to instill sound financial habits from an early age. My guide provides some of the basics you should be teaching your children at every age level.

The Armchair Millionaire's Guide to the Important Financial Lessons

• Preschoolers. By the age of three, most kids start to become curious about money and how it works. This makes it an ideal time to model good spending habits. For example, when you take your preschooler along to the grocery store, show them that you plan what you're going to spend by using a shopping list. Many older preschoolers will want to start saving money. Help them get started by setting up a savings account for them. Many banks will waive their fees for children's accounts.
• Elementary school age. By this age, your child will be keenly interested in money and how to get more of it. Provide an allowance so that they can have an income of their own in order to learn their own real-life money management lessons. Let them make mistakes-they can't do a lot of damage at this age. They'll learn just how far a dollar goes, and will begin to learn how to prioritize their spending. Many older kids in this age group will want to start earning their own money. Help them out with simple money-earning ideas.
• Pre-teens. By the time they hit middle school, kids these days have become full-fledged consumers and are ready to start learning how to make good spending choices. If you think your child is ready at this age, provide a monthly clothing and entertainment allowance. They will either learn how to make a budget, or learn to do without that pair of hip new sneakers. It also gives you an opportunity every month to talk over their financial successes and mistakes.
• Teens. This is your last good opportunity to prepare your child with financial life lessons. Make sure they don't leave home for good without knowing how to balance a checkbook, what using a credit card really costs, the power of compounding interest and the basics of common sense investing.

THE BOTTOM LINE: Kids learn about money in two different ways: though their own experience and from watching their parents. Set your children up for financial success by grounding them in positive experiences and by being the good model they need.

A Hand for Mom and Dad

Question of the week:My parents are in their late 70s and I'm worried about their finances. Any advice on how I could give them some help taking care of their money? --W.B.

Dear W.B.,

People are living longer, so they need to make their money stretch longer and manage it to an older age than ever before. According to the Census Bureau, there are 35.6 million Americans over the age of 65 (and 4.5 million over the age of 85).

You're not alone. When we asked about the state of their elderly parents' finances, we found plenty of worried Armchair Millionaire community members. This was a typical response:

Dark days ahead for mother-in-law. "I believe that my parents will have a comfortable retirement. They don't have big expectations about traveling the world so they'll be able to get by. Now, my mother-in- law is a completely different story. She has no retirement savings, no life insurance and no health care. We have tried numerous times to get her to 'see the light' but she lives in a bubble that I am worried is going to burst sooner rather than later. She lives in a different country so I don't think she can come to live with us but I am worried we are going to get stuck paying her medical bills and subsidizing the dog food she will have to eat in retirement." --mdonalds

As people grow older, they face a new set of financial issues, including Social Security, pensions, different insurance polices and wills and trusts. This challenge is compounded if they also have the stress of living on a fixed income or of health worries. However, there's plenty you can do to help your parents age with grace financially. My guide will get you started.

The Armchair Millionaire's Guide to Lending Parents a Financial Hand

• Tread carefully. Money is deeply connected to our feelings of personal independence and dignity. Any steps towards taking over control of that money naturally threatens those feelings. At the same time, you're likely to feel uncomfortable bring up the subject with them, as well. However, you need to overcome this to help your parents avert problems in the future. If they don't want to discuss the topic with you, provide them with the names of several reputable financial advisors, preferably ones who specialize in the finances of retired people.
• Organize paperwork. Know where they keep their financial documents, including insurance policies, bank and investment account information, tax records, and will or trust, so that you can easily find them if there's an emergency. If their paperwork is incomplete or unorganized, help them get it shipshape.
• Make it easier. Save your parents some banking chores by arranging to have their Social Security and pension checks deposited automatically and bills paid automatically. Less stress for everyone. If your parents are no longer up to taking care of their day-to-day financial tasks, and they're not something you can do, either, consider hiring a Daily Money Manager, a professional who can take care of bill paying, balancing the checkbook and organizing records. You can find one through the Web site of the American Association of Daily Money Managers at www.aadmm.com.
• Help them protect themselves. Older people are a favorite target of scam artists. Encourage your parents to never give out any financial information (such as credit card or checking account numbers) to anyone calling them on the phone, as well as take steps necessary to safeguard their identities.
• Consider power of attorney. Encourage your parents to look ahead to a time when they may no longer be able to manage their finances, and to designate someone to act on their behalf if the need arises. A power of attorney document can be created inexpensively by your parents' lawyer.

THE BOTTOM LINE: Just as your parents helped you when you were young, the time may come when you need to help them as they age. Go slowly and respectfully, and your help will be much appreciated.

Putting Your Finances on Auto Pilot

Question of the week:My employer is encouraging everyone to start receiving their paychecks through direct deposit. Call me old-fashioned, but I really like getting that check in my hands, and I'm not sure I trust the direct deposit technology. What do you think? --Geri G. Dear Geri, It's time to join the 21st century. A survey by the American Payroll Association found that more than half--56 percent--of all workers in the U.S. receive their pay through direct deposit. I strongly suspect that once you join their ranks, you'll never want to go back to paper checks again. For starters, you needn't worry about the technology. Banking statistics tell us that the chance of having a problem with a check is 20 times greater than with direct deposit. And the advantages of direct deposit are numerous: You'll get the money in your account sooner, won't have to ever worry about a check being lost or stolen, and won't have the hassle of waiting in line at the bank. Because it saves banks money, many offer free or low-cost checking when you have your pay directly deposited with them. And most employers will allow you to have your pay split up and deposited into more than one account, making it easy to set up a savings system. But perhaps the most compelling thing about direct deposit is how much it can help you begin to gain firm control over your financial life by automating your savings and spending. Members of the Armchair Millionaire community recently told us how this works for them: One check, many baskets. "My paycheck is deposited automatically and then divided into several areas. A fixed amount is deposited into several mutual funds for paying myself first and the rest goes to bills, my emergency account and for spending. All my spending is based on a preset, fixed amount, which ensures that my expenses are within the preset limit. Any excess is goes to my charity account." --Jonathan Like clockwork. "I have my paycheck deposited in my credit union checking account, but before I get my check, I have the maximum contribution withdrawn for my 401(k) account. Then every payday I pay off my credit card balances. I always put some money into my money market account, and try to maintain the equivalent of six months' take home pay in this account. As the money accumulates there, I move it to my Internet savings account to get higher interest without risking principal." --Elizabeth M. As you can see, directly depositing your paycheck is just a first step in a chain of events that will ensure your financial security. My guide will show you how to automate the rest of your financial life. The Armchair Millionaire Checklist for Putting Your Finances on Autopilot Direct deposit all your payments. Your paycheck is not the only payment that can be directly deposited. You can also have dividend and interest payments, annuities, pension payments, government benefit payments and tax refunds all made by direct deposit. Pay bills by automatic funds transfer. Chances are that every single company that bills you regularly--such as your utility, insurance and mortgage companies--allows you to have those bills paid by automatic withdrawals from your checking account. You'll never have to worry about paying bills on time again. Invest automatically. Having a portion of your take-home pay (I recommend 10 percent) automatically withdrawn from your checking account and deposited into an investment account once a month is the smartest, least painful way to save there is. That money will be gone before you have a chance to spend it and, by investing regularly, you'll take advantage of dollar cost averaging. Build an automatic portfolio. Tracking and regularly re-balancing a portfolio is not everyone's idea of fun. If you don't want to be bothered with it, choose mutual funds that will take care of the chore for you. Lifestyle funds maintain a specific mix of investments right for your age and risk tolerance, and thus are designed to be the only fund your need to hold in your portfolio. And index funds that cover the entire market are also available. THE BOTTOM LINE: You'll never become financially secure if you don't control your cash. One of the best ways to do this is to have the that paycheck sent straight to your checking account, and then doling out that cash automatically according to your needs and long-term goals.

Saying "I Do" with a Prenup in Hand

Question of the week:Our daughter recently got engaged and will be married this winter. We have been wondering about when a prenuptial agreement might be called for. Any guidance on this issue? --Miami Dad

Dear Miami,

A prenuptial agreement defines the financial obligations and responsibilities of two people about to get married. Its primary intent is to reduce heartache and conflict later on if the marriage doesn't work out. Given that, according to the Census Bureau, about half of all marriages end in divorce, a prenuptial agreement can definitely be useful for many couples.

When we asked members of the Armchair Millionaire community their thoughts about prenups, the comments we heard showed how much it depends on each couple:

Burned once. "I did not have one but would have been more than willing to sign one if my husband wanted. He had been in a bad divorce before I met him which consumed his assets, including an inheritance from his grandmother." --Jennifer

Just common sense. "We didn't have a prenup when we got married--we were young and had nothing to fight over, except a little debt. I think prenups make sense for people who go into their marriage with sizeable assets, or for second or third marriages. It might take away the romance, but it's common sense!" --Gina

People most often think that prenuptial agreements are needed when one party has substantially greater assets than the other. While that certainly the case, there are actually many other circumstances when a prenup might be in order. Here are some examples:

• If one or both parties have children from a prior marriage. In this case, a prenuptial agreement can ensure that certain assets go to the children in the event of their parent's death.
• If one or both parties own their own businesses, and don't want the business assets to be part of any divorce proceeding.
• If one party will be giving up their career once married, or will be supporting the other through graduate school. In such a case, a prenup can define the spousal support (alimony) this partner would receive in the event of divorce.

If you think your daughter might benefit from having a prenuptial agreement going into her marriage, my guide will help her get started.

The Armchair Millionaire Guide to Drafting Prenuptial Agreements

• Ensure that it's needed. Sit down with your spouse-to-be and outline exactly what each of you would want to accomplish with a prenuptial agreement. State laws already cover how property is divided during divorce, so it usually only makes sense to have a prenuptial when both parties want a different outcome.
• Get legal assistance. Prenuptial agreements are legal, enforceable contracts and the laws governing them vary from state to state, so this is one time you should not try to do it yourself. To ensure an agreement that addresses your particular needs and is fair to everyone, each party should consult with their own family lawyer.
• Make full disclosure. Both sides need to disclose all of the assets and liabilities they are bringing to the marriage. Failing to so will usually void the agreement.
• Keep it strictly financial. Courts will only uphold agreements that are monetary in nature. So don't try to sneak in anything about requiring your future spouse to take out the trash every week.
• Plan ahead. While there's nothing to stop you from drafting this kind of agreement after you're already married, I recommend doing it before--when you're madly in love and have your partner's best interests at heart.

THE BOTTOM LINE: Drafting a prenuptial agreement certainly isn't romantic, but in some cases it can be very wise and extremely practical.

Exploring Financial Cyberspace

Question of the week:After much pestering from our granddaughter, we have finally started using email and the Internet. Now we're considering online banking. Any pointers on how to get started? --Ohio Grandparents

Dear Grandparents,

Congratulations on making the leap over the digital divide! Like you, lots of people these days are interested in e-banking. The Pew Internet Project found that about one-third, or 32 percent, of Internet users were doing their banking online in 2002, up from 17 percent in 2000.

When we recently asked members of the Armchair Millionaire community about their online banking experiences, we found that folks are taking full advantage of it. Here are several comments:

Stay ahead of the curve. "I use online banking to pay ALL of my bills. Traditional banking is going the way of the Dodo bird … If you don't jump on the bandwagon you will be left behind. --mdonalds

Go automatic. "After setting up every automatic bill paying option that was available to me, I discovered that I could schedule recurring automatic payments even for those companies that don't offer the service themselves. Combine that with money management software (like Money or Quicken) and soon you'll find yourself on autopilot." --Jerry

Pay on time. "I use my credit union's bill pay service (which is free!). It's not only convenient, but is a real time saver. I always found it hard to find the time to pay bills so quite often they used to be late. Now my credit rating has also increased because the bills are paid automatically on time."--lM

Online banking, which allows you to take care of all your bills and monitor your accounts from your computer, offers terrific advantages over traditional banking. Payments are processed quickly, never lost in the mail, and can be scheduled in advance, so bills are paid while you're away on vacation. It's a money saver--no more stamps or envelopes for paying bills, and fewer paper checks. But perhaps best of all, it saves time. There's no more sitting down to the kitchen table to write out checks and, because transactions are recorded online, no more having to file away all the records.

Online banking is offered by thousands of banks and credit unions around the country, and getting started is easy--just visit your bank's Web site and sign up.

But online banking is only the tip of the iceberg. If you really decide to go hog wild on managing your money with the Internet, you'll find that there's much, much more waiting for you in cyberspace. My guide will get you started.

The Armchair Millionaire Guide to Online Money Management Tools

• Calculators ask you for a couple pieces of information, do some quick math, and then deliver the result. They will answer your questions on everything from how much you should be saving for your kid's college to whether it makes sense to refinance your mortgage. Planners provide you with specific recommendations for reaching your goals. For example, retirement planners will figure how much you'll need for retirement, and recommend savings strategies and asset allocations for getting there. Another popular type, debt reduction planners, map out the most effective route for paying off your debt.
• Investment research tools. Screeners allow you to sift through thousands of stocks and funds to locate those that meet your criteria. Looking for a domestic large-cap index fund with an expense ratio of less than .5 percent? A screener will turn up a list in seconds. And that's just the beginning. The Web can provide you all the information on particular stocks and funds that you could possibly use, including earnings reports and estimates, annual reports, price charts, company and fund news and much more.
• Portfolio trackers. These nifty tools let you enter the number of shares and ticker symbols of the stocks and funds you own, and then keep your portfolio up to date. Every time you log in, you'll get current quotes and values for all your investments.
• Account managers. Many brokers and fund companies allow you to manage your investment accounts online. You can check your account status, place buy and sell orders, or make transfers between accounts, all with the click of your mouse.

THE BOTTOM LINE: With all the tools available on the Internet, you no longer need to rely solely on your financial advisor to get your questions answered. While it will never replace that human touch, it can absolutely make you a better, more-informed manager of your own money.

Your Retirement Vs. Their College

Question of the week:We have a son in high school and want to be able to pay for his college education. However, our retirement accounts have been so beaten up that we also need to save as much as possible to shore them up. We don't think we can manage both, so where is it best to concentrate? --CPI

Dear CPI,

Given the sky-high cost of funding retirement and rocketing college tuition, your dilemma is shared by many. We asked the Armchair Millionaire community about whether retirement or college should be the priority for parents, and heard from both sides:

Take care of yourself. "During the pre-flight routine, we're always told that if oxygen is necessary, secure your mask first then help your children. Same goes for finances. Fund your retirement first, then help the kids." --Steven

Take care of the kids. "In a decision between your retirement or your kids' education, the kids' education wins, no questions asked. Children owe nothing to their parents, while parents owe the world to their children." --billmac

In my own opinion, when you can't do both, you should focus on your retirement. After all, there are no student loans, scholarships or work study programs available for your retirement years. And the last graduation present your kid would want is a pair of financially destitute parents.

But if you don't have a dime saved for your kid's college, don't despair. Even if your child doesn't qualify for financial aid, there are still many other strategies that will help bring college within reach. My guide tells some of the best.

The Armchair Millionaire Guide to Alternative College Funding

• Get a scholarship. Scholarships are generally reserved for students with special qualifications (like academic, athletic or artistic talent), who are interested in particular studies or who demonstrate financial need. They are not often awarded out of the blue, so it pays to seek them out. Scholarship reference books (found at your local library or from your child's high school counselor) are a good place to start. There are also a number of searchable online databases. Pass up on search services that charge a fee to locate scholarships--they won't turn up anything that you can't find yourself.

• Be of service. AmeriCorps, a government-run, domestic volunteer program, offers an education award of $4,725 to pay for college or re-pay student loans. Participants can also defer their student loans while serving. In addition, there are a number of government programs that forgive student loans in exchange for teaching, practicing medicine and other activities in economically disadvantaged areas. Since these are fairly specific, the best source of information may be your child's college financial aid office.

• Be in the service. For military-minded people, plenty of help is available:
  • Montgomery GI Bill. This program provides an educational benefit for up to 36 months of college for veterans who served on active duty.
  • Reserve Officer Training Corps (ROTC). This program offers generous scholarships that pay up to the full cost of college. However, ROTC scholarships are not available for every school or for every field of study and carry a substantial service obligation upon graduation.
  • Service academies. West Point, the Air Force Academy, Naval Academy and Coast Guard Academy all provide a free college education in exchange for a commitment to serve after graduation.

• Consider community colleges. These are the last great education values. A student can attend for two years while paying rock-bottom tuition, then go on to finish up a bachelor's degree at a four-year college.

THE BOTTOM LINE: With a bit of forethought and flexibility, both you and your child can be winners in the struggle between retirement and college.

What to Do with a Windfall

Question of the week:We've just received an unexpected windfall of $10,000. My wife says that we should invest it, but I want to pay down some debt. Which do you think is best? --Russell from Tampa

Dear Russell,

Yours is one of the classic dilemmas in personal finance. We posed your question to members of the Armchair Millionaire community. Some advocated paying down debt, others the investing route. And others, like this one, advised a little of both:

"I would break it down into four buckets of $2,500 each. I would pay some credit card debt, put $2,500 in my emergency fund, invest $2,500 in either individual stocks or a stock mutual fund and I would spend $2,500 on something fun for me." --Mattchiavo

Either way, you'll get a return on your investment. The question is which offers the best return. To run the numbers, you'll need to look at the interest rate on your debt and figure what you would save in interest, as well as assume an annual rate of return on the investment you might make. And you'll also have to figure in the impact of the taxes (if any) that you would have to pay on your investment returns.

Here's an example. Let's assume you're paying 15 percent annual interest on credit cards, and that it would take you another five years to pay them off with your current payments. By using your windfall to pay them off immediately, you'll save $4,274 in interest over the next five years. On the other hand, if you invest that money in a tax-deductible account and receive an average annual return of eight percent over the same five years, you'd earn $4,898. Keep that investment over the next 20 years, however, and you'd earn $39,268.

However, the numbers don't tell the entire story. The best alternative will depend entirely on your own situation. My guide will help you make the right choice.

The Armchair Millionaire Guide to Choosing Debt Reduction or Investing

• What kind of debt is it? Some kinds of debt are better than others. A mortgage, for example, is a far cry from high-interest credit card debt. The interest rate is lower, the interest may be tax deductible, and that debt allowed you to buy an asset that's likely to increase in value over the years. On the other hand, credit cards have high, non-deductible interest and are often used for one-time purchases, like dinner out or a tank of gas--things that are gone long before we even pay for them.

• Do you have a plan for avoiding future debt? If you pay down your debt but then immediately run up your credit cards again or take out a new loan, you'll have gained little for the long term and will have lost a great opportunity to invest.

• Do you have a good place to invest the money? If the stock market doesn't look attractive to you right now and your investing alternatives are a low-yielding money market fund or CD, you're probably better off paying off the debt. But if an investment in the stock market looks good to you, this could be the better route.

• Can you make the money go even further by investing it? If you can tuck your extra money away in a 401(k) or tax-deductible IRA over the next couple of years, you'll enjoy a nice tax break in addition to your investment returns. You'll do even better if you employer matches some portion of your 401(k) contribution.

THE BOTTOM LINE: Financial windfalls are as rare as blue moons, so act carefully. Take time to weigh your options and arrive at the one that will have the best impact on your long-term financial health.

Navigating the Student Loan Maze

Question of the week:My high school age son is starting to think about college, and I'm starting to get nervous about paying for it. Can you provide some guidance on student loans? --Andrew G.

Dear Andrew,

Given the high cost of college these days, your worry is quite understandable. According to Nellie Mae, one of the leading national providers of college loans, the average undergraduate student loan debt today is $18,900.

But the news really may not be all bad. When we asked members of the Armchair Millionaire community recently about how they are handling their student loans, many told us how they are making lemonade from lemons. This story was typical:

"My parents helped me as much as they could to pay for college, but I still have a lot of loans. Recently, I consolidated my loans to lock in a fixed rate of less than 4 percent interest and a slightly longer term. I intend to pay off the minimum through an automatic debit system (which also lowers my rate) and invest extra money I would put toward the loans in a Roth IRA." --Jason

Before you (and your son) plunge into debt for college, you should have a very clear understanding of your student loan options. My guide provides the basics on the most common choices.

The Armchair Millionaire Guide to College Loans

• Stafford student loans. These are federal loans with low interest rates, extended and flexible repayment terms, and that do not require collateral. They also offer options for deferment. The loans may be made either from a private source, like your bank, credit union, or savings and loan (in this case, the loan is guaranteed by the government), or else directly from the federal government. The interest rate is variable, but capped at 8.25 percent. For the 2002-2003 school year, the interest rate is 4.06 percent. There are two different kinds of Stafford loans:
  • Subsidized. The government pays the interest on the loan while the student is in school, and repayment does not start until six months after graduation or leaving school. These loans are need-based.
  • Unsubsidized. The student is responsible for the interest during school, although he or she can defer the payments until after college. These loans are not need-based, so anyone, regardless of income, is eligible.
  Undergrads who are dependents can borrow up to $2,625 their freshman year, $3,500 their sophomore year, and $5,500 for each of the final two years. Some students end up with a combination of both subsidized and unsubsidized loans to make up the maximum.

• Parent Loans for Undergraduate Students (PLUS). As you can guess from the name, these are for mom and dad. Like the Stafford, the PLUS is a federal loan, and is available either from private lenders or directly from the federal government.

  The PLUS has a much higher limit than the Stafford--up to the entire cost of the child's education, minus other financial aid. Interest rates are variable, but capped at 9 percent, with repayment starting 60 days from the time the loan is given. For the current school year, the interest rate on PLUS loans is 4.86 percent. Unlike the Stafford, PLUS loans are in the name of the parents, and are their responsibility.

• Private loans. If you need still more borrowing choices, you can turn to a private loan from a bank. Your bank may offer a lower interest rate or other favorable options when the money will be used for education than for regular consumer loans. Parents are generally the borrowers, although the student can apply, too (assuming that he or she is credit worthy.) The terms for these loans will vary considerably from one lender to the next, so compare several to find the best interest rate and most convenient repayment arrangements.

THE BOTTOM LINE: Sending a child to college without incurring debt is simply not an option for many parents. But by choosing your loans wisely, you can minimize the pain.