Investing is Not a Competition Between Stocks and Bonds

Jane Young, CFP, EA

Many investors think of investing as a competition between investing in the stock market, interest earning investments and real estate.  Too many people take a strong stance for or against one of these three broad categories rather than embracing the advantages that each one can bring to their portfolio.  A well balanced portfolio should include some of all three with each serving a very different purpose.

All three categories will have their day in the sun depending on the investment climate.  Due to low rates, interest earning investments such as CDs, bonds and savings accounts aren’t getting much love right now.   Despite the current low rates of return, interest earning investments provide a relatively safe place to keep your short term money.  This is money needed to cover living expenses or emergencies over the next several years.  Interest earning investments provide a buffer against more volatile investments in the stock and real estate markets.   Keeping a portion of your portfolio in safer, fixed income investments can give you greater peace of mind and help you stick to your long term plan when the stock market gets rocky.  However, avoid putting too much in interest earning investments; this can make it difficult to keep up with inflation and earn the growth needed to support your retirement goals.

On the other hand, when the stock market is doing well everyone wants to get a piece of the action. Avoid overloading your portfolio with stock when the market is skyrocketing.   Investments in the stock market can provide you with long term growth and a hedge against inflation.  Historically, the stock market has trended upward and over long periods of time has outperformed other investment categories.  However, in the short term the stock market can be very unpredictable and volatile and should only be used for long term needs – money that isn’t needed for five to ten years.  Keep your short term money in interest earning investments.

Real estate serves a dual purpose for most investors, it gives us a place to live and it provides us with an asset that usually appreciates over time.   In addition to your home, as your portfolio grows, you may want to consider additional real estate investments in mutual funds or rental property.  Like the stock market, real estate should be treated as a long term investment.  The real estate market can experience extreme downturns and commonly lacks the liquidity needed to cover short term needs.

These three categories of investments have their advantages and disadvantages.  Focus on the role the asset plays in your financial plan and avoid becoming overly comfortable and confident with a single category – it’s all about balance.  The appropriate amount in each category will vary over time and is dependent on your age, your financial goals, your cash flow needs and your risk tolerance.

401k Options When You Change Jobs

Jane Young, CFP, EA

In addition to the other commotion related to changing jobs, you need to decide what to do with your 401k account.  You have four possible options; leave it with your employer, transfer it to your new employer’s plan (if allowed), transfer it to a Rollover IRA or cash it out.  Unless you’re in a dire situation, avoid withdrawing your 401k funds.  Cashing out your 401k will result in taxation of the full amount at regular income tax rates as well as a 10% early withdrawal penalty if you leave your job prior to age 55 and don’t qualify for an exception.  Additionally, you will forfeit the opportunity to earn tax deferred, compounded growth on the hard earned money you have put away.

If you have at least $5,000 in your 401k account, you should be able to leave it with your old employer.  The decision to transfer your 401k or leave it in place largely depends on the quality and variety of investment options and the fees charged by the plan.  Some 401k plans provide access to low cost institutional funds that have lower or comparable fees to those available in an IRA.  If the fees are high and your choices are limited consider moving your account.  Another downfall to leaving your 401k with your old employer can be the danger of neglecting or forgetting about it, resulting in the failure to monitor and rebalance your account.

When changing jobs you may want to consider transferring your 401k to your new employer’s plan. Again, this should only be considered if they have a wide variety of low cost investment options.  You also may find it more convenient to have all of your funds in one place.  A disadvantage to this choice is once you transfer your 401k to a new employer’s plan you may lose the option to later move it to another plan or custodian.  You are locked in if the new plan administrator makes changes to the investment offerings or fees that you don’t agree with.  Alternatively, some advantages of a 401k over an IRA include the ability to borrow against your account, as long as you remain employed, and a 401k may offer greater protection against creditors than an IRA.

Your final option is to transfer your 401k to a Rollover IRA.  A Rollover IRA can provide you with the greatest variety of investment options including mutual funds, individual stocks, bonds and CDs.  You have the freedom to choose from a wide variety of custodians including discount brokerage firms and mutual fund companies to get the best quality, selection, service and cost.  If you decide to transfer your 401k to an IRA; select a custodian, open an IRA account, and ask your 401k administrator to process a direct transfer to your new account.  To avoid negative tax consequences be sure the check is payable to the custodian, not directly to you.

Mutual Funds Best Option for Most Investors

Jane Young, CFP, EA

Jane Young, CFP, EA

There are three primary ways to invest in the stock market; mutual funds, exchange traded funds (ETFs) and individual stocks.   With mutual funds and ETFs your money is pooled together with money from other investors and is professionally managed in accordance with a predefined objective.   Some major benefits of investing in mutual funds and ETFs include diversification, professional management and time savings.  Some disadvantages of mutual funds may include management fees and less control on when gains become taxable.

An essential factor in effectively managing your portfolio is diversification and it’s difficult to maintain a diversified portfolio without investing a significant amount of money.  A diversified portfolio should be comprised of a combination of fixed income investments and stock market based investments.  The stock based investments should be comprised of small, medium and large companies in a variety of different industries in both the United States and abroad.    Investing in a wide variety of companies and industries can spread out your risk.  Mutual funds allow you to easily diversify your portfolio by pooling your funds with those of other investors.  Instead of buying 10 individual stocks you can by 5 to 10 mutual funds in different areas of the market, each of which may contain hundreds of companies.

Although managing your finances should be a priority, most investors lead busy lives and don’t have the time to research and monitor individual stocks.   Mutual funds can be a good alternative to doing your own research.   Most mutual fund companies have entire teams of highly skilled analysts who visit companies, analyze data, assess the competition and monitor industry trends.  It would be difficult to attain this level of knowledge and understanding on your own.  Additionally, professional management provides the methodology and discipline to keep emotions out of investment decisions.  When investing in individual stock, investors can become emotionally attached to a company whose stock has performed well.  This can result in dangerously high concentrations in a few individual companies.

Mutual funds and ETFs use a broad approach that generally tracks more closely to the entire stock market or a specific index.  Individual stocks, on the other hand, can provide the opportunity to break away from market performance to make a significant profit, if you select a winner.  However, you many also experience a significant loss if the stock is a loser.

Some potential disadvantages of mutual funds in comparison to individual stocks include management fees and less control over when you pay capital gains tax, within non-retirement accounts. With individual stocks and ETFs you don’t pay capital gains until you sell your shares.  However, when a mutual fund manager sells stock within a fund, gains earned on the stock are passed through to the shareholder as a taxable gain.  This gain is added to the investor’s basis in the mutual fund to avoid double taxation when the fund is eventually sold.

Key to Financial Success is Understanding and Managing Your Spending

Jane Young, CFP, EA

Jane Young, CFP, EA

Sometimes the simple things can make the biggest impact on our lives.  One of the most important steps toward achieving financial success is to fully understand where you spend money.   Increasing your awareness of how much you have available to spend and where you spend this money helps you become more intentional in your spending.

Studies have found that many of our actions are based on habit rather than conscientious decisions.  This is true with the food we eat, our daily routines and our spending habits.  By tracking your expenses you may discover spending patterns that are preventing you from achieving your financial goals.

This may seem obvious, but if it’s been a while since you took a serious look at your spending habits, it may be time to track and evaluate your spending.  You don’t need an expensive software package, just a pen, paper, and a calculator.  Review your credit card statements and bank statements over the last 6 months and track your monthly expenses.  If you spend a lot with cash you may need to keep a journal, for a month, to monitor where you are spending your cash.  Don’t leave out the quarterly and annual expenses in your review.  Compare your expenses to your net income to determine how much is left at the end of each month.

This exercise should be enlightening and you will probably be surprised at the amount you spend in certain areas.  Think about your financial goals and evaluate how you are actually spending money in the context of your goals.  Are you maintaining an emergency fund and saving money to meet long term goals such as retirement, a new home, a new car or college education for your children?  Create a spending plan that supports your financial goals.

You may find it helpful to systematically set aside or invest money to build an emergency fund, invest for retirement or save for college tuition.  If this money is put aside, it may be easier to become accustomed to living on the remaining funds.

Regardless of your income level, the secret is truly understanding how much you can spend and being intentional about how and why you spend your money.   Budgeting is about setting financial goals and priorities, not keeping you from doing what you love.   If it’s a priority to spend a lot of money on eating out, taking a vacation or buying a new car and it fits within your financial plan, then enjoy yourself.   Alternatively, if you are spending too much in one area consider enjoyable alternatives.   For example, meet friends for happy hour rather than dinner at an expensive restaurant.

Being aware of your spending helps you spend more intentionally and weigh the trade-offs of every purchase.  The simple act of reviewing your past spending habits will make you stop and think before making spending decisions in the future.

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