Interviewed by Wall Street Journal on keeping investing costs low
June 22, 2010 by Jean Keener, CRPC, CFDP · Leave a Comment
I was recently interviewed for the Wall Street Journal’s website about the importance of keeping investing costs low and how costs affect your long-term investment returns. You can read the article at WSJ.com.
Four Rules for Asset Allocation
May 25, 2010 by Jean Keener, CRPC, CFDP · Leave a Comment
As a special guest blog post, the Motley Fool staff has provided the following article on asset allocation. It’s an excellent summary of some of the most important concepts of investing and asset allocation, and is definitely worth the read. Enjoy!
By The Motley Fool
When it comes to asset allocation, the biggest decisions come down to how much you should have in cash, how much in bonds, and how much in stocks. These four rules for asset allocation will help you slice up your portfolio into these important pieces.
Rule 1: If you need the money in the next year, it should be in cash.
You don’t want the down payment for your vacation home to evaporate in a stock market — or bond market — crash. Keep it in a money market or savings account. And, of course, make sure it’s FDIC-insured.
Rule 2: If you need the money in the next one to five (or even seven) years, choose safe, income-producing investments such as Treasuries, certificates of deposit (CDs), or bonds.
Whether it’s your kid’s college money or the retirement income you’ll need in the not-so-distant future, stay away from stocks.
As with all investments, risk and reward go hand-in-hand when it comes to “safe” assets. So, in order of “safest” to “still safe but technically riskier,” we have Treasury notes and bills, CDs, and corporate bonds. That’s also the order of lowest- to highest-yielding. CDs are still very safe (as long as they’re FDIC insured), can usually be bought commission-free, and you should be able to find some that pay a percentage point above Treasuries. Shop around for the best rates; your local bank may not be the best-yielding option.
As for corporate bonds, the general rule is to choose bond mutual funds if you have less than $25,000 to $50,000 to invest. That’s because buying individual bonds can be tricky. With a stock, you can pull up a quote on your computer and — presto! — you have a good idea of the going price. However, most bonds don’t trade on a centralized exchange. And instead of charging a commission, most brokerages (discount and full-service) embed a “markup” in the price of the bond. This makes it difficult to know what fees you paid.
It is gradually becoming easier (and more cost-effective) to buy individual bonds, so it can be done if you’re willing to put in the effort. The advantage of individual bonds over bond funds is you know exactly how much you’ll get back when the bond matures. However, since bond funds don’t technically “mature,” you don’t know what your investment will be worth when you need the money. In fact, they can lose quite a bit of money, which can be inconvenient if it happens right before you need it.
If you’re going to choose a bond fund, stick with short- to intermediate-term bonds (i.e., bonds that mature in two to five years). And be vigilant about costs — you can find plenty of good funds with expense ratios below 0.50%.
Rule 3: Any money you don’t need for more than five to seven years is a candidate for the stock market.
We Fools are fans of the stock market, and we know our history. According to Ibbotson, large-cap stocks, on average, have returned 10.4% annually from 1926 to 2007, compared to 5.5% for long-term government bonds and 3.7% for short-term Treasury bills.
However, investors in stocks have to keep that “long run” part in mind, since in the short run, no one knows what stocks will do. Make no mistake: Even if you’re in or near retirement, a portion of your money should be invested for the long term. That’s because, according to the Center for Disease Control, a 55-year-old can expect to live another 26 years. A 65-year-old has another two decades. The average 75-year-old lives into her late 80s. A 110-year-old, however, should sell everything and get to Vegas while he still can.
So unless you’re a 95-year-old skydiver who smokes, expect your retirement to last two to three decades. To make sure your portfolio lasts that long, you should …
Rule 4: Always own stocks.
Over the long term, equities are the best vehicles to ensure your portfolio withstands inflation and your retirement spending.
According to Jeremy Siegel’s Stocks for the Long Run, for every rolling five-year investing period from 1802 to 2006 (i.e., 1802-1807, 1803-1808, etc.), stocks outperformed bonds 69% of the time. Stocks beat bonds in 80% of the rolling 10-year periods, and almost 100% of the rolling 30-year periods. For holding periods of 17 years or more, stocks have always beaten inflation, a claim bonds can’t make.
But don’t forget that four-letter word
The bottom line is that when you need your money will partially dictate where you put it. What else determines your asset allocation? Risk.
Most people base their investment strategies on the returns they want, but they have it backward. Instead, focus on managing risk and accept the returns that go along with your tolerance for it. It’d be great if we could get plump returns with no risk at all. But to achieve returns beyond a minimal level, we have to invest in things that involve the possibility that we’ll lose money.
Of course, this isn’t just hypothetical theory for modern investors. The 2000s have brought us two wrenching bear markets, a mere six years apart. (Maybe there was something to all that Y2K hullabaloo after all!). Have you been able to hold on — or did you panic and sell? That’s the true test of an investor’s risk tolerance: the ability to cling to those shares as they become worth less and less, while clinging to the hope (based on history, but nothing more) that they will one day be worth more and more.
So ask yourself: What would you do if your portfolio dropped 10%, 20%, or 40% from its current level? Would it change your lifestyle? If you’re retired, can you rely on other resources such as Social Security or pensions, or would you have to go back to work (and how would you feel about that)? How you answer those questions will lead you to your risk tolerance. The lower your stomach for portfolio ups and downs, the more your portfolio should be in bonds.
As an extra aid in determining your mix of stocks and bonds, consider the following table, from William Bernstein’s The Intelligent Asset Allocator:
|
I can tolerate losing ___% of my portfolio in the course of earning higher returns |
Recommended % of portfolio invested in stocks |
|
35% |
80% |
|
30% |
70% |
|
25% |
60% |
|
20% |
50% |
|
15% |
40% |
|
10% |
30% |
|
5% |
20% |
|
0% |
10% |
So, according to Bernstein, if you can’t stand seeing your portfolio drop 20% in value, then no more than 50% of your money should be in stocks. Sounds like a very good guideline to us.
Copyright © 1995-2010 The Motley Fool. All rights reserved. Used with permission. www.fool.com
May 2010 Newsletter
May 10, 2010 by Jean Keener, CRPC, CFDP · Leave a Comment
The May 2010 newsletter is now available. It includes investing information with perspective on last week’s market plunge and an update on the new reduced fees for trading Vanguard ETFs. For taxes, there’s information on the new 3.8% medicare tax for high income individuals. For cash flow, we cover using a Roth IRA as a back-up emergency fund. For insurance, it includes information on incorporating TX state guarantee association coverage limits and exclusions into your financial planning. Click here to read the newsletter.
Keller Public Library Free Investing Workshop
April 21, 2010 by Jean Keener, CRPC, CFDP · 1 Comment
Common Investing Mistakes and How to Avoid Them
Free Investing Workshop at Keller Public Library on Tuesday, May 18 at 6:30 pm.
This workshop will cover the fundamentals of successful long-term, goals-based investing. Effective investing doesn’t have to be complicated, but with so much information available, it can be difficult to tell fact from fiction. This workshop will reveal common pitfalls and investing myths and share information on how to avoid them. Space is limited and registration is encouraged to ensure your space. RSVP to tchiv@cityofkeller.com.April 2010 Monthly Newsletter
April 15, 2010 by Jean Keener, CRPC, CFDP · Leave a Comment
The April 2010 monthly newsletter is now available. It includes information on how the new healthcare law may affect you as an individual and new student loan and financial aid provisions. Also covered are an investment market update and a discussion on the merits of dollar cost averaging to make investments vs. lump-sum investing. Please click here to view the full newsletter.
Non-Deductible IRA Contributions: Good Idea?
March 25, 2010 by Jean Keener, CRPC, CFDP · Leave a Comment
If your income is over the limit for deductible and Roth IRA contributions, you are faced with a dilemma each year: should you contribute to a non-deductible IRA? Making a non-deductible contribution shouldn’t be an automatic decision. It could be beneficial, or investing the same amount of money in a taxable account could be a superior choice.
Like most decisions in personal finance, there’s not one right answer for everyone.
Non-Deductible IRA contribution benefits:
- Your earnings grow on a tax-deferred basis. This means that you can reinvest all of your dividends and capital gains without paying taxes on them as you go. You are also free to buy, sell, and rebalance investments in your account without tracking each investment’s cost basis, gain, or loss for income tax purposes.
- There’s a psychological benefit to putting money in a retirement account for many people – you may be less likely to tap into the funds if you know there would be penalties.
- Non-deductible contributions create Roth conversion opportunities with less tax owed than if the entire conversion were pre-tax.
Non-deductible IRA contribution drawbacks:
- Your earnings when withdrawn will be taxed at regular income tax rates rather than capital gains tax rates. Right now capital gains rates are 15% for those in the 25% and higher tax brackets and are scheduled to go to 20% next year. So if you’re instead paying 35% or higher income tax on the withdrawals, that’s a big hit.
- Loss of flexibility – if you withdrawal the funds before 59 ½, you will be subject to penalties unless you qualify for an exception.
So how do you decide if it makes sense for you?
First – Consider what your tax bracket is pre-retirement and what it will likely be in retirement.
To do this, you or your financial planner will need to consider your likely sources of income in retirement and their tax status. You also need to make some assumptions about future tax rates — of course no one has a crystal ball, so an educated guess is the best you can do with this aspect.
- If you think your tax bracket will be the same, higher, or just slightly lower in retirement, then non-deductible contributions are likely not a good move for you (unless one of the other benefits applies).
- If your tax bracket will be a lot lower in retirement – like moving from 28% to 15%, then non-deductible contributions should definitely be considered.
After you’ve answered the first question, then you should consider possible Roth IRA conversion opportunities. If you don’t have other assets in traditional or roll-over IRAs, you can make non-deductible contributions and convert them to Roth IRAs with only taxes owed on the growth between contribution and conversion. This can be a very beneficial technique to get assets into a Roth IRA even when your income exceeds the Roth contribution limits. There are very specific rules for conversions, so it’s important to consult with your financial or tax advisor to make sure you follow them correctly.
Lastly, if your decision still isn’t clear, consider the loss of flexibility. Depending on your money personality, this can be a positive or a negative. The positive is less temptation to tap into retirement funds early. The negative is the penalties for doing so. You need to know yourself and know whether the loss of flexibility is good or bad for your situation.
Bottom line, don’t put your non-deductible IRA contribution on auto-pilot. It’s important to do the analysis because your decision can affect how quickly your assets grow and how much income you have in retirement.
March 2010 Newsletter
March 9, 2010 by Jean Keener, CRPC, CFDP · Leave a Comment
The March 2010 Newsletter is now available. It includes an investment market update, Part II in my series on how to tap into your home equity in retirement, considerations in evaluating an early retirement offer, information on 2009 tax deduction for 2010 Haitian relief contributions, 2011 tax rate proposals found in the federal budget, credit card act provisions, and a reminder on the deadline to take advantage of the home buyers credit. Click here to read it.
Partial Roth Conversion Strategy
October 13, 2009 by Jean Keener, CRPC, CFDP · Leave a Comment
When people find out how much tax they would have to pay to convert their IRA from traditional to Roth, it’s often times a conversion show stopper. Even if all the analysis shows that conversion would be clearly beneficial to their after-tax retirement income levels or provide estate planning benefits, there’s a gigantic psychological hurdle with writing a check to the IRS sooner rather than later. However, the conversion decision can become more attractive when you realize it’s not an all or nothing decision. You can choose to convert just part of your traditional IRA balance.
How do you decide how much to convert?
One reasonable way of determining how much to convert is doing enough to take you to the top of your current tax bracket without going into the next one. You might also determine how much of a tax bill you would be willing to pay, and then calculate the conversion amount based on that. For most, one of these two options will create the most appealing results.
There is a third option in the “fancy financial footwork” category.
This third option will result in far too much paperwork for many individuals to want to deal with it, especially for a smaller traditional IRA balance. But if you have a larger IRA – say $50,000 or more – the extra work might be worth the tax savings. Conversion is not an irrevocable decision until you get to the tax filing deadline of the next year (October 15 for most people). This 21-month window from January 2010 until the deadline to “recharacterize” the conversion creates a Roth Segregation Opportunity, pioneered by David Marotta of Marotta Wealth Management in Virginia and written up in a recent Financial Planning Magazine article.
Using the Roth Segregation Strategy, you convert your entire traditional IRA balance in January 2010. Let’s say the balance is $100,000 for easy math. Instead of putting the entire conversion in one account, you put $20,000 in each of 5 accounts. Each of these 5 accounts is invested in a different equity asset class – you might do 20% large cap growth, 20% large cap value, 20% small cap, 20% developed international, and 20% emerging markets. Then, around the beginning of October 2011, you assess which of these asset classes has performed the best. You keep the converted IRA with the best performance and recharacterize each of the other 4 back to traditional IRAs. This limits your tax liability (payable on 2011 and 2012 tax returns) to just the taxes on the $20,000. Of course, if multiple asset classes performed extremely well, you might choose to keep more of the conversions. Or if they all declined in value, you would likely recharacterize them all.
This strategy is not a simple one. It requires a lot of analysis and rigorous tracking of the paperwork to ensure that everything is completed properly. You would also want to ensure that going with such an aggressive equity allocation in your IRA over the 21-month period made sense within the larger context of your portfolio, time horizon, and risk tolerance. And for those that plan to do a full conversion vs. a partial, there’s no benefit to setting up all the different accounts.
But for those of you who relish a little financial creativity and don’t mind complexity, this can be a pretty cool opportunity to analyze and implement – and unique to the 2010 opportunity to spread taxes over 2011 and 2012.
Couples, Investing, and Risk
July 21, 2009 by Jean Keener, CRPC, CFDP · Leave a Comment
It’s pretty common for spouses to be at different points on the risk tolerance spectrum. If you’re one of these couples, you know that these differences can have varying effects on the relationship and your investing behavior.
Sometimes, the more conservative spouse just completely delegates investing decisions to the other spouse and just shuts their eyes when the statement comes. This is not the ideal solution because it’s important for both spouses to be educated on your investments in case something happens to the decision-making spouse. Lack of information can lead to stress and poor decisions with long-term consequences in this situation.
Other times, there’s a constant state of friction and stress whenever investments are discussed. The more conservative investor may veto anything that sounds the slightest bit risky. Or the more aggressive investor may rush to make investing decisions without fully explaining or researching the risk to the more conservative spouse. This approach is also clearly not what you want in your relationship!
The bottom line is … You can have differences in this area and still work quite productively together on investing. In fact, you can use your differences to prompt each other to thoroughly research and discuss each investment option resulting in better investment decisions. So how do you get to this point?
First, define your goals
Making good investment decisions is difficult if you don’t know what you’re investing for. Making sure you’re on the same page–or at least reading from the same book–when it comes to financial goal-setting is the first step toward dealing jointly with investments.
Make sure the game plan is clear
Making sure both spouses know how and (equally important) why their savings are invested in a certain way can help minimize marital blowback if investment choices don’t work out as anticipated. Second-guessing rarely improves any relationship; making sure both partners understand from the beginning why an investment was chosen, as well as its risks and potential rewards, may help moderate the impulse to say “I told you so” later.
If you’re the more aggressive investor …
Take time to understand your spouse’s concerns. You may need to provide additional information to increase his or her comfort level, but you won’t know what to supply if you automatically dismiss any objections. If you’re enthusiastic about an investment, concealing potential pitfalls could make future joint decisions more difficult if your credibility suffers because of a loss. A more cautious spouse may help you remember to assess the risks involved.
Remember that you can make changes in your portfolio gradually; you don’t have to become more aggressive all at once. And if you’re an impulsive investor, try not to act until you can consult your partner.
If you’re the more conservative investor …
If you’re unfamiliar with a specific investment, research it. Though past performance is no guarantee of future returns, understanding how an investment typically has behaved in the past or how it compares to other investment possibilities could give you a better perspective on why your spouse is interested in it.
Consider whether there are investments that are less aggressive than what your spouse is proposing but that still push you out of your comfort zone and might represent a compromise position. For example, if you don’t want to invest a large amount in a single stock, a mutual fund that invests in that sector might be a way to compromise. (Before investing in a mutual fund, carefully consider its investment objective, risks, charges, and expenses, which can be found in the prospectus available from the fund. Read it carefully before investing.)
What if you still can’t agree?
You could consider investing a certain percentage of your combined resources aggressively, an equal percentage conservatively, and a third percentage in a middle-ground choice. This would give each partner equal input and control of the decision-making process, even if one has a larger balance in his or her individual account.
Another approach is to use separate asset allocations to balance competing interests. If both spouses have workplace retirement plans, the risk-taker could invest the largest portion of his or her plan in an aggressive choice and put a smaller portion in an option with which a spouse is comfortable. The conservative partner would invest the bulk of his or her money in a relatively conservative choice and put a smaller piece in a more aggressive selection on which you both agree.
Or you could divide responsibility for specific goals. The more conservative half could be responsible for the money that’s being saved for a house down payment in five years. The other partner could take charge of longer-term goals that may benefit from taking greater risk in pursuit of potentially higher returns. You also could consider setting a predetermined limit on how much the risk-taker can put into riskier investments.
Finally, a neutral third party with some expertise and a dispassionate view of the situation may be able to help work through differences.
If you and your partner have worked through investing differences, I’d love to hear what’s worked for you. Please feel free to post a comment!
Free Financial Webinars
July 10, 2009 by Jean Keener, CRPC, CFDP · 3 Comments
The National Association of Personal Financial Advisors is starting a new series of free webinars on various financial topics including Money 101, Kids & Money, Investing Basics, Protecting What you Have, and more. These sessions are designed to provide a convenient, accessible way to get financial information to help you most effectively manage your finances. Each one is instructed by one of my fellow NAPFA members. The first session is August 7. For the full schedule and to RSVP, visit NAPFA’s website.