May
14
January 23, 2008
NEW YORK (AP) - With the stock market standing on shaky legs, financial advisers are working to bolster clients’ psyches as well as their portfolios.
Relationships between advisers and their clients can grow strained when markets head south, as investors want to hastily sell their positions or change their investment strategies on the fly. To stem the lack of confidence, financial advisers are developing strategies to create recession-resistant portfolios and soothe client concerns before they, too, become volatile.
Calming clients may require listening to their worries, rather than simply citing investment theory and history. Portfolios can be adjusted with a number of tools, including the newfangled (inversely performing exchange-traded funds) and the old fashioned (bonds, cash, gold bullion).
Clients “want to get out of the way of a train wreck,” says Bob Phillips. “But these are the worst times for them to make decisions about their portfolios,” says the managing partner at Spectrum Management Group of Raymond James & Associates Inc., a unit of Raymond James Financial Inc.
To pre-empt some of those impulses, many advisers will send reassuring e-mails to clients when market news turns inordinately bad; Phillips sent one such e-mail Tuesday morning, when the Dow Jones Industrial Average started the day down more than 460 points, or more than 3.8 percent.
Market jitters can affect the wealthy as well as the mass affluent. “I have clients worth tens of millions of dollars who will lose sleep over a 3 percent decline,” says Gary Schatsky, a financial adviser and founder of Financial Planning firm ObjectiveAdvice.com.
“But it’s not for the adviser to say ‘You’re ridiculous,’ ” he says.
Since advisers are well-versed in theories of investing and behavioral finance, it can be tempting to respond to clients’ fears with academic theories and statistics of past market declines. But advisers could end up hurting more than helping their relationships with clients if they keep the discussion abstract.
“An adviser can’t be a shrink, but the worst thing they can do is not listen,” says Dr. Brett Steenbarger, clinical associate professor of psychiatry and behavioral sciences at SUNY Upstate Medical University who works with professionals in financial services. “There’s a real value in the venting, and a real value in someone feeling like they’re being heard.”
May
13
From News-Wave: 5 Mistakes That Will Sink Your Retirement
Mistake No. 1: The biggest blunder is cutting back on contributions to a 401(k) plan, since most companies offer matching funds—the ultimate cash freebie. In general, 401(k) plans are set up so that the employer adds 50 cents to each dollar a worker contributes, typically up to 6 percent of the worker’s salary. That’s an immediate 50 percent return on investment. Yet nearly one quarter of American workers don’t contribute to their 401(k), according to the Profit Sharing/401k Council of America, a nonprofit association. And of those who do contribute, many don’t toss in enough to get the full company match.
If you are nearing retirement, don’t make the mistake of easing off your savings. It’s time to juice them up. Many older boomers didn’t save as much as they should have in the early days of their working lives. The cost of the kids’ braces, tennis lessons, and college tuition understandably took a toll on personal savings. The thought of contributing 10 percent of gross income, let alone 15 percent, was a pipe dream.
But it’s not too late. From age 57 to 65 is typically the peak earnings time for most people. “This is when you can do some extraordinary saving,” says Financial Planner Mary Malgoire, president of the Family Firm. “You’re finally freed up to focus on socking it away for retirement. It’s now or never.”
And the IRS will lend a hand. If you are 50 or older, you can make catch-up contributions to your workplace savings plan and IRA. This year, while most workers are eligible to defer up to $15,500 to a 401(k) plan, those eligible for catch-up contributions can toss in an extra $5,000. Employers are not required to provide for catch-up contributions, but most do. The same catch-up provisions apply to 403(b) plans, 457 plans, and SAR-SEP retirement accounts. You can also contribute an extra $1,000 to a traditional or Roth IRA. So, while younger savers can put $5,000 a year into an IRA, people 50 and older can save $6,000.
Mistake No. 2: Using your retirement money as a bank is a major no-no. Yes, it’s reassuring to know you can always borrow from your 401(k). But even when times are tight, that’s bound to be trouble. If you take a loan and then get laid off or bought out, you’ll probably have to pay back the loan right away. If you can’t repay the loan, it will be treated as an early withdrawal. That means you’ll owe income taxes, plus a 10 percent penalty.
Even if you do pay back the loan, it’s a bad idea to tap your retirement funds. After dipping into the account once, you’ve crossed a psychological line and might be more inclined to do it again. Plus, by withdrawing funds, you sacrifice compounding investment earnings.
Mistake No. 3: When you see your retirement account balances falling, it’s reasonable to want to avoid losses by reinvesting in safer bets, as Fuchs contemplated. Don’t. As gut-wrenching as it might be, it pays to hold your ground. “Managing your retirement money has nothing to do with predicting the markets,” says Susan Stewart, president of Charter Financial Group in Bethesda, Md. “Moving money from stocks into more stable investments like money funds or CDs to avoid losses and ride out the downturn assumes you have a special crystal ball.”One danger, if you get out of equities, is that you’ll miss the upturn when markets turn around. That’s costly. “History tells us that timing the market this way doesn’t work and that you’d be a fool to even try doing it,” Stewart says. “So stop stressing out about it. Downturns do end, and if you stay in the market, you’ll be there when things turn around.”
Another problem with dashing for the cover of “safe” investments is that stocks still offer the surest shot at long-term growth, so conservative investing can take its toll eventually. There’s also the lost opportunity of sitting on the sidelines when stocks are cheaper than they used to be. Your 401(k) contributions buy more shares of stocks when prices are lower, so when the markets come back, you’ll see a bigger boost.
To forestall knee-jerk reactions when the market dives, allocate your portfolio among stocks—both domestic and international—bonds, and cash. “Set your mix,” says Stewart, “and stick with it when it’s hardest for you to do so—when the market has fallen for a few days or weeks.” Then rebalance annually.
If you’re getting close to retirement, or are already retired, the right asset allocation is more important than ever. Sagging markets, combined with pulling funds out for living expenses, can really wreak havoc on your portfolio. At age 65, it’s probably smart to put half your holdings in stocks or equity funds and the rest in cash and bonds, then slowly reduce equities to a third of your portfolio by the time you are in your 80s. “There is no magic number,” Stewart says. “You need to be comfortable with your risk level, but you still want the growth that stocks can offer over a 10- or 15-year period.”
Mistake No. 4: One fast way to undo all your good retirement planning and squash your future nest egg is cashing out your 401(k) balance when switching jobs or being ushered out the door with an early-retirement plan. Even if you don’t intend it to be a cash distribution, it might be considered one.
Chances are, when you leave your employer, you’ll want to transfer your accumulated retirement savings to a self-directed IRA that offers you more investment choices. But timing is important, and this is where it’s easy to get tripped up.
After you receive the funds from your employer plan, you have 60 days to complete the rollover to an IRA or other tax-deferred plan. If you don’t complete the rollover within the time allowed or receive a waiver or extension of the 60-day period from the IRS, the amount is considered ordinary income. That means you are required to include the amount as income on your tax return, where any taxable amounts will be taxed at your current ordinary income tax rate. Plus, if you had not reached age 59½ when the distribution occurred, you’ll face a 10 percent penalty on the withdrawal.
Mistake No. 5: This is an important error: not creating a post-retirement plan. As you approach retirement, you should know all your sources of income, ranging from pensions to investments to Social Security. Also, consider the amount of equity you have in your home. Then establish a plan for how you’ll spend those funds in retirement. In general, you’ll want to tap into your tax-deferred savings last.
Failing to plan for life’s nasty little surprises can torpedo your retirement plans, even if you’ve been saving faithfully for years. While it goes without saying that regular retirement contributions are critical, living well in your golden years also depends on far more than a healthy portfolio. “Saving is the heart of it,” says Gary Schatsky, a financial adviser in New York, “but you can’t ignore insurance, taxes, and debt management.”
Most corporate health plans, for example, cover you until age 65, when Medicare kicks in. Retire early (whether you want to or have no choice), and you’ll probably need to scout for an individual plan. Your most affordable option may carry a high deductible of $2,500 to $5,000 a year. So plan ahead. Another smart move is paying down your mortgage and slashing your credit card and other consumer debt before you leave the workforce, which will help stretch your retirement savings.If possible, delay taking your Social Security check until age 70. For retirees born in 1943 or later, Social Security benefits increase by about 7 percent each year you delay taking them from age 62 through 66 and by 8 percent until age 70, says Laurence Kotlikoff, an economics professor at Boston University. Plus, your actual payment will be indexed for inflation. So, if inflation is running at 3 percent, your benefit will increase at 10 or 11 percent for each year you delay taking it. Not bad for a little patience.
Good retirement planning does require patience—and fortitude. Though she was on the verge of cashing out, Fuchs, the Washington attorney, decided to stay put. “Part of it was inertia,” she says, “but the other part was my 82-year-old father’s voice in my head, constantly reminding me that investing was something you did for the long term.” That’s one voice in your head worth heeding.
May
13
Risk of Chasing Yields
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May 12, 2008 5:12 p.m.
Municipal bonds, let’s face it, could make anyone snooze. “They’re complicated and boring,” says Donald Cummings, principal of Blue Haven Capital, a fee-based wealth-management firm in Geneva, Ill. When he brings up the subject at cocktail parties, he says, people walk away.
These days, Cummings may find it easier to grab listeners’ attention. Over the past two months, municipal bond yields have consistently exceeded Treasury yields, even before factoring in the tax advantage. As of May 7, 30-year Treasurys yielded 4.61%, while AAA-rated (the highest credit quality) municipal bonds of the same maturity hit an average 4.88%. Since interest earned on munis is tax free, that’s the equivalent of a taxable investment yielding 7.3% for someone in the 33% tax bracket, or 6.5% for someone taxed at 25%. Shorter-maturity Treasurys were also close, or lower than AAA-rated munis on a pretax basis, while munis rated AA or lower exceeded Treasury yields on all fronts. “I’ve been in institutional trading and sales of municipal bonds since the late 1980s and I’ve never seen such a run,” says Cummings. “Never all through the curve and never for so long.”
Normally, municipal bonds yield less than Treasurys, with the tax-free interest making up the difference for investors in the highest tax brackets. But the credit crunch and concerns with bond insurers’ downgrades caused many institutional investors to sell off munis and other securities not guaranteed by the government. “There was a flight to quality in the past 12 to 15 months where investors sold anything with risk and bought Treasurys,” explains Scott Berry, senior fund analyst with research firm Morningstar. The selloff suppressed muni prices and, consequently, pushed yields up. Increased demand had the opposite effect on Treasurys.
As a result, investors as low as the 25% tax bracket may be compelled to shift a part of their fixed-income portfolios to municipal bonds. And given the paltry returns of money-market funds and savings accounts these days, munis may even sound like a good place to park your extra cash.
For most investors, however, the risks outweigh the returns. “Right now the yields look fantastic and juicy, but they’re juicy for a reason,” says Michael Boone, a fee-only certified Financial Planner in Bellevue, Wash.
Housing-bust spillover
Thanks to low default rates, municipal bonds have historically been considered extremely safe. But the weakening economy and plummeting housing prices have put the health of some municipalities at risk, raising questions about their ability to repay debts. “The overall feeling is that as the economy weakens, a lot of these municipalities may not be in good shape, so there’s a fear that their credit quality may decrease,” says Boone.
If a municipality relies largely on collecting real estate taxes, for example, falling property values would cut into revenues — a problem that many municipalities have not had to deal with in recent history. Just this week, the Northern California city of Vallejo declared Chapter 9 bankruptcy, allowing it to continue providing services while freezing its debts. When a municipality declares bankruptcy, the bond insurer would typically take over payments of principal and interest, Boone explains. But should the number of such bankruptcies increase, investors now question the ability of insurers to take over the financial burden.
Hence, the importance of location, Boone warns. “A real estate-led decline, unlike other struggles in the economy, is very much localized. When we build a portfolio for clients, we consider geographic diversification just as important as maturity diversification and credit diversification.”
For a combination of high yields and safety, Cummings recommends pre-refunded or escrowed-to-maturity bonds. These are bonds that municipalities have refinanced into Treasurys at some point in the past to take advantage of lower interest rates. Since they continue making the original coupon payment, investors get higher yields for a security backed by the government.
Liquidity concerns
Municipal bonds trade infrequently, which makes pricing difficult, says Jeff Tjornehoj, research manager at financial research firm Lipper. “Your broker may buy it from you and execute the trade as quickly as possible, but if the last bond sold six months ago, how do you know [you’re getting] the right price?” A lack of buyers could mean that you take a hit on your original investment.
That makes buying individual bonds with your emergency cash a bad idea, says Gary Schatsky, a fee-only certified Financial Planner in New York. “An emergency fund is something you could liquidate right away without having your arm cut off,” he says.
Inflation risk
With yields exceeding 4% on AAA-rated bonds, those 20- or 30-year munis may be hard to resist. But locking your money in for a long period of time in today’s low-interest-rate environment exposes you to inflation risk. “A lot of people say if you hold a bond to maturity you have no risk, but that’s a lie,” Schatsky says. “If you’re getting 5% for 20 years and everyone else is getting 6% for 20 years, you’re kidding yourself if you think you’re not losing money.”
Steve McLaughlin, director of business analytics at Municipal Market Advisors, recommends three- to five-year bonds. Faced with lack of demand for so-called adjustable-rate securities, or long-term bonds with floating rates adjusting every seven, 28 or 35 days, municipalities are now forced to restructure them into bonds that mature in three to five years. That causes an oversupply that suppresses prices and, therefore, increases yields, McLaughlin explains.
Hidden costs
Individual bonds are purchased through brokers, whose commissions can be exceptionally high, Schatsky says. That’s why he warns investors with less than $100,000 to spend to stay away from individual bonds. “For more modest purchases, I am inclined to look at no-load, low-cost, diversified muni bond funds,” he notes.
Morningstar’s Berry recommends looking into the tax-exempt funds offered by Vanguard, Fidelity or T. Rowe Price. “You get really good management and low cost,” he notes. But don’t expect impressive yields: The average municipal bond fund has actually lost 1.31% year-to-date, according to Lipper.
Cost-conscious investors may also look into muni bond ETFs, such as the iShares S&P National Municipal Bond or State Street’s SPDR Lehman Municipal Bond funds. Since they track an index, ETF yields are also on the lower side, McLaughlin says. For many investors, however, the pros — lower costs, liquidity and diversification — may outweigh the cons.
May
12
Wall Street Chaos
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Wall Street chaos: How to plan your money
Planners advocate prudence - and a cash cushion - to get you through volatile times.
NEW YORK (CNNMoney.com) — The phrase “run on the bank” is really something you never want to hear. Yet that’s what best describes Bear Stearns’ swift demise - and it has caused investors to wonder if such a run could happen elsewhere.
From the average person’s perspective, it’s a little hard to know how worried, if at all, to be about your money right now.
While certified Financial planners are concerned about the financial news coming out of Wall Street these days, they are far from running scared on behalf of their clients. In fact, they’re still encouraging them to stay invested in a well-allocated portfolio.
But they do see value in taking certain prudent measures - many of which make solid sense even when the financial markets aren’t as rocky as they are now.
Consider the money you’ve got in the bank. The Federal Deposit Insurance Corp. will insure your money in checking, savings, certificates of deposit and money market deposit accounts up to $100,000. That’s per depositor, per institution. In some instances, you may qualify for more coverage, but generally speaking $100,000 is the cut-off for deposit accounts.
So if you have more than $100,000 combined in all your accounts at one bank, you might consider moving some of it to another institution. “That’s a good general rule of thumb,” said Jim Whiddon of JWA Financial Group in Dallas.
If you’re not willing to move money because you’d sacrifice convenience or possibly some yield, “then pay attention to the credit quality of the underlying bank,” said Gary Schatsky of Independent Financial Counselors in New York.
Having access to a cash cushion, wherever you park it, is a big plus.
“In a recession, the secret to getting through it is having cash,” said Mari Adam of Adam Financial in Boca Raton, Fla.
Adam would typically recommend having access to enough money to cover three months’ worth of expenses. But now an even better idea is six months’ worth, she said. That doesn’t mean you need to keep every spare dollar in your bank accounts - access to a line of credit or some liquidity in your portfolio will do the trick.
Keeping an eye out for yield and return is always smart. But you may find it in some surprising places these days, especially given the hit savings rates have taken from all the Fed rate cuts. Adam said she is getting a better return on her short-term CDs (1 year or less) than on the 10-year Treasury.
The hunt for value
If you’re an optimistic contrarian, you’re probably thinking - correctly, many experts say - that some companies are getting punished unfairly in this environment and that long-term they’re solid bets. After all, whatever happens with the mortgage mess, everyone is still going to need toilet paper, right?
But rather than placing your bets on an individual stock or sector to find long-term winners, Schatsky recommends looking for a solid value fund and let the fund manager do all the research on undervalued companies for you.
The same goes for bonds. If you’re looking to expand the bond portion of your portfolio, he recommends looking for a fund that is more focused on shorter-term, high-quality bonds such as Vanguard Short-Term Investment Grade Bond Fund (VFSTX).
The personal finance self-exam
There are still a lot of unknowns about the Bear Stearns fallout. But the biggest opportunity it presents for the perplexed investor and saver is to get smart about their investment exposure.
“It’s a wake-up call to look at your portfolio. How is the overall portfolio allocated?” said Schatsky. Don’t just consider your 401(k) or your brokerage account in isolation.
Consider the allocation across all accounts and figure out if the breakdown between stocks and bonds is right for you. “Markets like this truly test risk tolerance,” Schatsky noted.
Then, Adam said, do what you you should have been doing all along: get rid of any investment that is toxic regardless of the events surrounding the mortgage meltdown on Wall Street.
May
12
Retirement Planning: The I.R.A.
Filed Under Fee-only Financial Planning, Retirement Planning | Leave a Comment
WITH so much contradictory advice floating around, it is sometimes hard to figure out the best way to save for retirement.
Financial experts say that one often-overlooked resource is the humble Individual Retirement Account, or I.R.A., which has been a part of the personal finance landscape for so long that many of us take it for granted.
More than 90 percent of the money that flows into traditional I.R.A.’s is being rolled over from retirement plans at work, like 401(k)’s. On the other hand, only 14 percent of American households that were eligible to make direct I.R.A. contributions did so in 2006, according to the most recent data from the Investment Company Institute, the mutual fund industry trade group.
The rules for some I.R.A. contributions are so complex that many Americans may not realize they are eligible to make them, said Brian Reid, the chief economist at the Investment Company Institute. Indeed, the I.R.A. rules fill a 108-page brochure on the Internal Revenue Service Web site.
And while investors often fund a 401(k) at work before contributing to an I.R.A., particularly if employers offer matching contributions, many people don’t have a 401(k) or other workplace option. Alicia H. Munnell, director of the Center for Retirement Research at Boston College, said that 57 percent of “prime working-age Americans,” defined as 25 to 64 years old, had no retirement plan at work. Contributing to an I.R.A. makes sense for such people, she said.
In a nutshell, the main flavors of I.R.A. — traditional and Roth — have one big difference. You may be able to deduct the money you put into a traditional I.R.A. on your taxes, but you will pay income taxes on all withdrawals in retirement. Contributions to Roth I.R.A.’s are not deductible up front, but there are no taxes on money withdrawn in retirement.
Some I.R.A. rules are simple. Say you are single, do not have a retirement plan at work — like a 401(k) or a traditional pension — and want to contribute to a traditional I.R.A. Whatever your income, you can make the maximum contribution, all of it deductible. (The maximum total contribution for all I.R.A.’s is $5,000 this year, or $6,000 if you are 50 and above.)
But the rules can quickly become more convoluted. If you are single but eligible for a retirement plan at work, you may make the maximum tax-deductible contribution so long as your adjusted gross income is $53,000 or less. The deductible amount whittles away to zero as your income climbs from $53,000 to $63,000.
If you are married and filing taxes jointly, and both of your employers offer retirement plans, both of you can make the maximum deductible contribution so long as adjusted gross household income doesn’t exceed $85,000. The deductible amount phases out at higher incomes, falling to zero at $105,000. And the list goes on.
If you’re considering a Roth I.R.A., it doesn’t matter if you have an employer plan at work. But a single person, for example, can make the full contribution only if income is less than $101,000. The eligible contribution phases out as income climbs to $116,000.
The government slapped income limits on I.R.A.’s in the 1980s to prevent high-income taxpayers from redirecting savings to tax-deferred accounts, said Ms. Munnell at the Center for Retirement Research. “A lot of evidence suggested that higher-income people were simply rearranging their finances,” she said.
A third form of I.R.A., the traditional nondeductible version, is less popular. There are no income limits, and it does not matter whether you have a retirement plan at work. Contributions are not deductible, and you will pay income taxes on investment profits withdrawn in retirement.
Gary Schatsky, a Financial Planner in New York, said the nondeductible I.R.A. was not compelling for most investors. As is the case with all I.R.A.’s, you cannot write off investment losses on your taxes, and you lose the benefit of capital gains tax rates, which are generally lower than income tax rates. If you are eligible to contribute to either a 401(k) or an I.R.A., Mr. Schatsky said, in most cases you are better off choosing the 401(k), especially if your employer offers matching contributions.
Statistically, few people take full advantage of 401(k)’s. Roughly three of four qualified workers participate, but among those who do, only 10 percent contribute the maximum, according to the Center for Retirement Research.
Labor Department rules issued last fall make it easier for companies to automatically enroll workers in 401(k) plans. Now there is talk in Washington about making enrollment in I.R.A.’s automatic for workers who don’t have 401(k)’s, said James Poterba, the head of the economics department at the Massachusetts Institute of Technology.
Mr. Poterba, who is to become president of the National Bureau of Economic Research this summer, said the issues were more complex for automatic I.R.A. enrollment. For instance, he said, employers choose default investments for the 401(k), but he asked, “Who picks the default investment for an I.R.A.?”
While these issues are being worked out, people without employer plans would benefit by opening I.R.A.’s on their own, Ms. Munnell said, adding that they should find motivation in projected shortfalls for the Social Security trust fund.
The government has already been raising the age when most Social Security applicants can retire at full benefits. For those born from 1938 to 1943, full retirement age rose gradually from 65 to 66. It stays at 66 for those born through 1954, and gradually climbs again, to 67, for those born in 1960 or later.
“Those are the changes that are already baked into the cake,” Ms. Munnell said. If the Social Security projections worsen, she said, future retirees may regret not having saved more.
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