Like many of you, we are always looking for a good deal. So when we recieved an offer for 2 nights in a king-bedroom suite for only $69 at a local resort, we took it. In addition, we would receive a $100 gift card good for shopping or fine dining–all we had to do was go to a 90-minute tour and presentation. By my calculations, they were going to pay us $31 for a fun weekend getaway.

Anyone who has attended a timeshare presentation is laughing out loud right now. Because once you’ve been through it, you know the reality is far from the marketing pitch.

Truth #1: 90 minutes takes longer than an hour and a half. In our case it was three hours–and I suspect it would have been longer if the sales rep thought he had any chance of getting us to buy. If you ever choose to hear a timeshare sales pitch, expect to sit for double the time. You also may want to practice your get-up-and-walk-out-of-the-room-while-someone-else-is-talking skills. These sales reps are well prepared to talk around any objection, even “I’m not interested and will not buy.” Getting up and rudely walking out may be your only way out other than being at their mercy for an undetermined amount of time.

Truth #2: A timeshare will not save you money. The first thing our sales rep did was determine how much we spend on hotels per year. We estimated six nights at $100 each, for a total of $600. Multiply that by twenty years, and we will have spent at least $12,000 on hotel accommodations. For that same price we could own a week of timeshare! Sounds good…except for the fact that the yearly maintenance fees alone cost $800, 30% more than we spend right now. And that doesn’t include payments on the property. Not nearly the savings he was trying to make us believe we would get.

It was curious that the price of the timeshare was exactly what we would spend on hotels over 20 years. I wonder what would have happened if we had said we spend $1,000 a year. Would the price have gone up to $20,000 for the timeshare?

Truth #3: You will see a lot of numbers, but not the ones that matter. They gave us a lot of numbers–a white board full of figures floating around. But none really helped us determine if we can afford it. When we asked the sales rep for specifics on costs and fees we were told he would lose his job for disclosing such information. We were told that AFTER we signed we would receive an owners manual with all the details. So we had no way to determine the real cost until it was too late.  ARE YOU KIDDING ME?

After the fact, I came home and jotted down the basic figures we were given. Assuming the numbers he gave me were real and not unrealistically low, I determined that the monthly cost of a timeshare would be at least $225; that’s compared that to the equivalent of $50 a month we spend now!

Truth #4: They want you to finance your “purchase” because it makes the timeshare company more money. The company offered tons of perks and rewards for each year you finance the timeshare through them. Not a surprise since they charge 14.5% interest! Check out these numbers:

• Price: $12,000
• Downpayment: $2000
• Closing costs: $500
• Balance to be financed at 14.5%: $10,000
• Interest paid over the course of the loan: $8993.60
• Principle and interest paid over the course of the loan: $20,993.60

The total cost, including downpayment, closing costs, principle, interest and maintenance fees for 20 years, is $37,494.60.

In the end, you would pay 75% more to finance through them. No wonder they offer perks!

Truth #5: You are investing in vacations, not real estate. Our sales rep kept explaining that we are investing in real estate. True, timeshares sell you a piece of property during a certain period of time each year. You do get some sort of deed for the property. But the real estate comparison ends there. If the value of a timeshare will increase over time and is in such demand, why is it so difficult and expensive to sell a timeshare? As I looked for information online, there was twice as much information on selling timeshares than on buying timeshares.

Truth #6: You are signing up for a one-on-one (or one-on-two, if married) high-pressure sales pitch, not a lovely tour of the property.. When we entered the sales offices, we were impressed by the lavish decor and saw beautiful glassed-in rooms where people were watching sales videos. We also saw sales reps touring people around the property. “That won’t be so bad,” I thought. Well, it turns out the videos and tours must be for people who’ve already purchased or expressed interest in purchasing. In our case they put us in a small office for the entire three hours with no discussion of the resort facilities or amenities. We were exposed to a high-pressure pitch from a sales rep who wouldn’t take no for an answer. It was excruciatingly painful, and I frankly felt a little violated. For an idea of what the experience was like, check out this article about what a timeshare presentation is like and how to avoid pitfalls.

Truth #7 Timeshare presentations are about buying, not about learning. Don’t make the mistake of thinking you can go to a presentation to become informed. You must go prepared to buy, or not buy. Timeshare companies offer incentives that are only good RIGHT NOW, TODAY; tomorrow is too late. You cannot have a night to sleep on it, you cannot consult your accountant or lawyer. Tell me, who makes real estate purchases for tens of thousands of dollars in such a way?! To learn about timeshares, you might want to read a book, like Surviving a Timeshare Presentation, or Timeshare Vacations for Dummies by Lisa Ann Schreier, a former timeshare sales rep who offers an “insider” look.

Truth #8 Timeshare sales reps are friendly, but they are not your friend. And the friendliness only lasts until it’s clear you’re not going to buy. The way our sales rep framed things, buying a timeshare seemed to make so much sense; it was in our best interest; our sales rep was only trying to help us make a sound financial investment. Don’t be fooled! These are highly trained professionals and they are only trying to help themselves out with a nice commission on a sale. All his friendliness abruptly ended towards the end of the three hours when it became clear we wouldn’t purchase TODAY. In fact, it was odd because we expressed interest in the timeshare and said we would consider it, but wanted to have more time. I would think a good sales rep would take our information and follow up in few days. Instead there was no interest in following up; it was as though he knew the deal would crumble under scrutiny.

For an inside look, read sales tips that timeshare sales reps share to help each other out. In this article, entitled Timeshare sales techniques-Warm up the author says that the first step is to make friends with your clients. There’s also an entire blog dedicated to the subject or timeshare sales techniques.

Truth #9 A timeshare will always cost you money, not make you money. Even once you finish making payments on a timeshare, you still have to pay maintenance fees, whether or not you use the timeshare. They explain that one of the great benefits is that you own it forever, and can pass it along to your children. Ironically, it seems that some children don’t want the financial burden that comes with a timeshare. In fact, I found a company called Timeshare Relief that specializes in taking over timeshares – ones that are paid in full – to relieve the owners of the financial responsibility. Among the testimonials is a video testimonial of some “satisfied clients who realized Timeshare Relief was their only answer to receive financial freedom and escape their a life long burden of their Timeshare.”

Truth #10 A timeshare might be a great choice for your family. I won’t argue that timeshares may be a great decision for some people. But making a decision about purchasing a timeshare is not one you want to make while on vacation, under pressure, with no time to think about or discuss it. The package we were offered seemed like it might be a good fit for us–in about three to five years. Right now we take a lot of smaller vacations; long weekends instead of week-long trips. Also, we don’t have an extra $200 per month to dedicate to travel (which does not include the extra gas, airfare, food, and excursion costs). When we are ready and a timeshare makes sense, we will do a lot of research, and then make a purchase if it makes financial sense.

There’s really no reason to make a timeshare purchase decision under pressure. There are plenty of companies that specialize in re-selling time shares. Not only can you purchase them for a fraction of what you’d pay in a high-pressure sales pitch, but you can have the time to browse and find the deal that best meets your needs. I have relatives who have purchased a few timeshares. The first one they purchased under pressure at a sales pitch. Within a couple of days, they saw an ad for a timeshare re-seller and were able to find the exact same timeshare at about half the price. Luckily, they were able to cancel their original purchase and take advantage of the lower-priced offer.

In summary, I won’t say if it’s worth it to take advantage of these great timeshare offers or not. For me personally, having to sit for three hours in a high-pressure situation, wasn’t worth the essentially-free nights stay. On the other hand, I know people who don’t mind going through the process and they will take advantage of such offers regularly. If you know the pitfalls to avoid, more power to you. For me, after sitting for three hours and considering the possibility of spending nearly $40,000 on a timeshare over the next 20 years, a piece of Japanese wisdom rings true: There is nothing as expensive as free.

Resources:

• 7 Timeshare Tips Every Consumer Should Know
• Timeshare Tips (includes FTC article on buying timeshares)
• Is Time-Sharing Ready for Prime Time? and Time-share Tips by Business Week
• Timeshare Buying Tips
• 7 Tips for Buying a Timeshare

Part 3 of the FPU overview covers week 8 of Financial Peace University – Retirement and College Planning. This post will apply to Dave Ramsey’s baby steps #4 and 5. Baby step #4 is: Invest 15% of your income into tax-favored investments (typically Roth IRAs or 401ks). Baby step #5 is : College funding. It is assumed that you won’t start doing either of these steps until you have saved a full emergency fund (3-6 months of expenses) and paid off all your debt except your house.

If you’re joining this series late and want to catch up see the links below for parts 1 and 2:
FPU Overview Part 1
FPU Overview Part 2

Why should I have an emergency fund and no debt before investing for retirement and college?

Dave is very strict about having an emergency fund and paying off debt before investing for retirement. He even says you shouldn’t put money in a 401K with a match (which is when your company matches a portion of what you invest – it’s basically free money). When we attended Financial Peace University we were already contributing to a 401K with a match and decided not to follow his advice on this point. It would have been much more disruptive to stop contributing. We would have lost the match and had to wait until the enrollment period to start up again.

Saving an emergency fund before saving for retirement

I’m aware that many people disagree with Dave’s advice on this point because if you wait to invest, you lose some of the advantages of compound growth. I personally can see it both ways. I tend to agree that you should have an emergency fund first. Otherwise you may have to dip into your retirement savings to cover emergencies and invoke severe tax penalties. If you take funds out of a 401K or IRA before retirement you pay excessively high taxes which would be like kicking you when you’re already down.

Paying off debt before saving for retirement

Having all your debt paid off before saving for retirement is a more tricky argument. Frankly, Dave doesn’t address it much. As far as I can tell, the main reason for doing so is focus. The more you focus ALL available money on paying off debt the more momentum you’ll get. There’s a strong psychological benefit to seeing your debt paid off at an accelerated rate.

From a math perspective, you can argue either way. If the interest rate on your debt is higher than the interest rate you’d get investing (typically about 10-12% if you invest in mutual funds), you’re better off paying down your debt. Otherwise, you’re better off investing. Having said that, even if you think you could earn 10-12% on a mutual fund, you’re not necessarily guaranteed that rate of return whereas you are guaranteed the return by paying off your debt.

In the end, I don’t think it matters much whether you pay off debt first before investing or not. I would do whichever gives you the most motivation and peace.

What investment vehicles should I use to invest for retirement?

During the session, Dave explains many savings vehicles in great detail including IRAs, Roth IRAs, SEPs, 403Bs, 457s, and 401Ks. Rather than explain them all, I’ll hit the highlights. Here is Dave’s basic strategy for investing for retirement:

1. If your company’s 401K offers a match, invest just enough to take advantage of the full match.
2. Next invest in Roth IRAs until you reach your maximum contribution.
3. If you still have money left to invest, go back and invest in company plans (401Ks) or SEPs.

Within IRAs, Roth IRAs and 401Ks, you can choose what stocks, bonds, and mutual funds you want to invest in. For Dave’s advice on how to allocate funds see Financial Peace University Summary Part 1

Now let’s briefly explain the differnt retirement vehicles. Keep in mind that these are the most basic definitions. I’ve included links with more information for those interested.

Types of retirement investment vehicles

IRA

IRA stands for Individual Retirement Account (or Arrangement). An IRA allows you to invest money pre-tax and allows your investment to grow tax free. You then only pay taxes when you withdraw the money at retirement. The IRA itself is really a stock, bond, mutual fund, or other investment that is simply designated as an “IRA.” Even real estate can be used for an IRA. As Dave puts it, the IRA is just a “coat” to keep your investment protected from taxes.

To invest in an IRA you have to have a earned income in that year. In 2007 you can invest up to $4,000 per person if you’re 49 or younger or $5,000 if you’re 50 or older.

Wikipedia entry about IRAs

Roth IRA

A Roth IRA is similar to a regular IRA with one huge difference – with a Roth IRA you invest money post-tax but then your investment grows tax free and you can withdraw it at retirement tax free. In very basic terms, you would typically choose a Roth IRA if you think your income at retirement will exceed your current income. Otherwise, a traditional IRA would make more sense.

Wikipedia entry about Roth IRAs

401K

A 401K acts like an IRA in that you invest money pre-tax and your savings grows tax free. You are then taxed when you withdraw the funds. One of the main differences between an IRA and 401K is simply that a 401K is offered specifically through your employer.

With a 401K you are also more limited in your investment options. The company running your 401K usually provides a pre-selected set mutual funds to choose from.

One benefit of 401Ks is that some employers offer a match – they will match a portion of the amount you save. For example, my current employer matches 100% of my contribution up to 4% of my income and then 50% of my contribution from 4 to 6% of my income. Just to make the math simple, if I made $100,000 and saved 6% of my income, rather than ending up with $6,000 invested I’d end up with $11,000 ($6,000 contribution plus a $5,000 match). It’s basically free money and you should definitely take advantage of a matching program if your employer offers one.

Dave points out some people don’t use the 401K if there is not a match. That’s a mistake. Even though they don’t offer a match you still get the great tax benefits and should still contribute.

The maximum contribution to a 401K for 2007 is $15,500.

Wikipedia entry about 401Ks

403B

A 403B is essentially the same as a 401K but is offered by hospitals, schools, and non-profit organizations rather than corporations.

Wikipedia entry about 403Bs

SEP

Simplified Employee Pension (SEP) plans provide a way for small business owners to provide retirement plans to themselves and their employees. When an employee participates in an SEP, they essentially create an IRA, which in this case is known as an SEP-IRA. SEP-IRAs have the same tax implications as traditional IRAs. Employees can contribute up to 25% of their income. Self employed individuals can contribute up to 18.6% of their net profit.

Wikipedia entry about SEPs

457

The 457 allows you to defer your compensation. Instead of receiving income now and being taxed on it now, you can receive it and be taxed on it later. Rather than receiving the income, you can invest it. Essentially this acts similarly to a 401K. I’m personally not familiar with 457s and Dave didn’t recommend them. Use your company’s 401K instead.

Standard Thrift Plan for government employees

For federal government employees you have the standard thrift plan. Dave recommends putting 40% in C fund (common stock plan, 17% return over 10 years. Modeled after S&P index), 40% in S fund (small company fund [aggressive growth], modeled after Barclays index, averaged 14% return over 10 years), and 20% in I fund (International, 8-9% return, modeled after the Barclays EAFE index).

Rolling out funds

401Ks, 403Bs, and 457s are all offered by your employer. The good news is, you can transfer or “roll out” these investments when you leave the company. You can also roll over IRA accounts. Dave recommends rolling out funds whenever you have the option because you have more flexibility in a non-employer plan – you can invest the funds exactly how you want rather than being forced to choose from a limited selection. 401Ks and IRAs can typically only be rolled when you leave the company. However, 403Bs can be rolled at any time.

When you roll funds, be sure to do a direct transfer rather than bringing the money home first. If you have them cut you a check they have to hold 20% of the money until you decide where to invest it. Then if you don’t reinvest you have taxes of about 40% on those funds.

When you roll out funds, you need to decide if you want to roll them to an IRA or Roth IRA. Dave recommends you roll them to an IRA unless you meet the criteria below, in which case you should roll them to a Roth IRA:
1. You will have saved $700,000 by the age of 65.
2. You can pay your taxes separately out-of-pocket. For example, if you roll $10,000 to a Roth IRA, you have to pay taxes on the $10,000 immediately. If you don’t have the funds to pay the taxes right now, you can roll funds in chunks as you have money to pay the taxes.
3. You have less than $100,000 in income the year of the roll. Rules state that you can’t roll to a Roth IRA if you have $100,000 or more in income that year.

Borrowing against 401K – DON’T DO IT!

Some people ask about borrowing money against your 401K. On the surface it seems like a good idea – you can pay yourself interest rather than the bank. However, you should never borrow against your 401K because there are severe risks. Here are 3 reasons why you shouldn’t borrow against your 401K.

1. You unplug yourself from the stock-like returns.
2. You might leave or be fired. If you leave, that loan is due in full within 60 days or it’s considered an early withdraw.
3. If you die, you are deemed to have left the company and your spouse has to pay back the loan.

Saving for Education

For the seemingly rare few who already have a full emergency fund, all debt paid off, and are saving 15% of your income for retirement, you can move on to baby step #5: Funding your child’s college education. I think this step is appropriately placed in relation to the other goals. You need to make sure you take care of your own financial situation, including retirement, before worrying about your kids’ educations. If you don’t, they will have to take care of you financially when you retire. Of course, I paid for almost all my college education and therefore am biased towards having children pay their own way and/or get scholarships. Regardless of your stance, Dave’s placement of this baby step is prudent and appropriate.

Use ESAs and UTMA/UGMAs to save for your child’s education

Dave’s advice is pretty straight forward – save for your child’s education first using an ESA, then using an UTMA/UGMA if you max out the ESA.

Education Savings Accounts (ESA)

An ESA is essentially an IRA for education rather than retirement.
A parent sets up an ESA for his/her child and acts as the custodian. Contributions to an ESA grow tax-exempt. If the child uses the funds for qualified educational expenses, those distributions can be used tax free. You can make a maximum of $2,000 in contributions each year. You have have an income under $110,000 if filing as a single or $220,000 for married couples to use an ESA.

Investopedia has a nice overview of ESAs

Uniform Transfer to Minors Act (UTMA/UGMA)

If you max out your ESA contributions or you make too much money to contribute to an ESA you can use an UTMA. The Uniform Transfer to Minors Act allows you to open a Mutual Fund account in the name of the child. The parent is custodian of the account until the child is 18. The downside (or upside if you’re the child) is that funds in an UTMA don’t have to be used for education. The child can use funds how they want when they turn 21.

Wikipedia entry about UTMAs

Don’t use 529 plans or use life insurance for college savings

Dave recommends staying away from 529 plans which force you to put the money into pre-defined mutual funds that don’t provide a good enough return. Age-based 529 plans invest the funds more conservatively as the child reaches 18 and give you no control. They are too conservative.

Dave also recommends avoiding the following:

• Using life insurance policies (such as the Gerber Life Insurance policy) to save for college
• Use savings bonds or zero-coupon bonds for college investing
• Using pre-paid college tuition

Conclusion

Please recognize that the above descriptions are not meant to be comprehensive by any means. Dave Ramsey goes into quite a bit more detail in Financial Peace University and even his descriptions are not comprehensive. Hopefully this will give you a base line for understanding your investment options and spur you on to learn more. Stay tuned for part 4.

Other Resources

Retirement Savings or Debt Reduction: Which is the Top Priority? [Get Rich Slowly]
Retirement Savings Or Debt Repayment: Which Is More Important? [The Simple Dollar]
3 Common 401(k) Mistakes [The Consumerist]