As a Certified Financial Planner™, I work with a lot of widows trying to navigate the tricky world of Social Security benefits after their spouse passes away. Social Security provides you, as a widow, with a choice between your own Social Security benefit based on your work history, and a survivor…
Jane M. Young, CFP, EA
When investing in mutual funds it is important to be aware of the associated fees. High fees can significantly impact your total investment return. All mutual funds have operating expenses and some have sales fees, commonly known as a load. When you invest in mutual funds you have a choice between load and no-load funds. A mutual fund load is basically a commission charged to the investor to compensate the broker or sales person. As the name implies, no-load funds do not charge a sales fee.
The first type of load fund is an A share fund, where you pay a front end sales charge plus a small annual 12b-1 fee. A 12b-1 fee is a distribution fee that covers marketing, advertising and distribution costs. The typical front-end load is around 5%, but can go as high as 8.5%. Class A shares offer breakpoints that provide you with a discount on the sales load when you purchase larger quantities or commit to making regular purchases. The 12b-1 fee associated with most A shares is generally about .25% annually.
The second type of load fund is a B share, where you pay an annual fee of around 1% plus a contingent deferred sales charge (CDSC), if you sell before a specified date. The CDSC usually begins with a fee of 5% that gradually decreases over five years. After five years or so the fund converts to an A share fund. The actual percentages and timeframes may vary between fund families. Most mutual fund companies have stopped offering B share funds because they are usually the most expensive option for the investor and the least profitable option for the mutual fund company.
The third type of load fund is a C share that charges a level annual load, usually around 1%. This is on-going fee that is deducted from the mutual fund assets on an annual basis.
Generally, any given mutual fund can offer more than one share class to investors. There is no difference in the underlying fund. The only difference is in the fees and expenses that the investor pays.
All load and no-load mutual funds charge fees associated with the operation of the fund. The most significant of these expenses is usually the management fee which pays for the actual management of the portfolio. Other operations related fees may include administrative expenses, transaction fees, custody expenses, legal expenses, transfer agent fees, and 12b-1 fees.
These annual fees are combined and calculated as a percentage of fund assets to arrive at the fund’s expense ratio. The expense ratio is an annualized fee charged to all shareholders. The expense ratio includes the fund’s operating expenses, management fees, on-going asset based loads(C shares) and 12b-1 fees. The expense ratio does not include front-end loads and CDSCs. According to Morningstar the average mutual fund expense ratio is .75%.
Jane M. Young CFP, EA
It’s time to move but you hate to sell your house when the market is down. Maybe you should rent your house for a few years? Or, on second thought, maybe not.
There are many factors to consider before deciding to rent your home. Do you have the temperament and the time to be a landlord? Are you comfortable with the idea of having someone else living in your home? Do you want to manage the rental yourself or do you plan to hire a property manager? If you manage the property yourself do you have time to learn about fair housing laws, code requirements, lease agreements, escrow requirements and eviction procedures? Who will take care of repairs and maintenance and are you ready for tenant calls in the middle of the night? If this sounds a bit daunting, a property manager may be your best option. A property manager will cost you about 10% of the rent. Be sure to include this in your cash flow analysis.
Before renting your home do a realistic cash flow analysis. Add up your projected expenses and deduct them from your projected rental income to see if renting will result in a profit or a loss. If you project a loss, does your projected appreciation on the home while it’s rented compensate you for the time and money it will cost you? Do you have funds to cover a negative cash flow? Your expenses may include your mortgage payment, property taxes, insurance, home owner’s association dues, maintenance and repairs, legal and accounting fees and property management fees. A rule of thumb for maintenance and repairs is about 1 – 2% of the market value of your home, depending on the home’s condition. You may need to spend money up front to attract good quality tenants.
When calculating your rental income, you need to decrease your projected rental income by about 8% to allow for vacancies. In Colorado the average rental vacancy rate has been around 7-9 percent over the last five years, based on U.S. Census data. When a renter moves or is evicted it can take several months to get a new renter in place.
If you rent you can take a tax deduction for depreciation against your rental income. To calculate your annual depreciation, take the value of your home, on the date you begin renting, less the value of land and divide it by 27.5. Unfortunately, this is just a temporary gift from the IRS. When your home is sold you must recapture all of the depreciation at 25%.
Other potential drawbacks to renting your home include the possibility of major damage inflicted by a tenant, drawn out eviction processes, negligence or safety lawsuits and costly maintenance issues.
An additional consideration, if you have a capital gain on your home, is the loss of the capital gain exemption of $250,000 for individuals and $500,000 for a couple if you haven’t lived in your home for 2 or the last 5 years.
Jane M. Young
As we approach retirement, there is a common misconception that we need to abruptly transition our portfolios completely out of the stock market to be fully invested in fixed income investments. One reason to avoid a sudden shift to fixed income is that retirement is fluid; it is not a permanent decision. Most people will and should gradually transition into retirement. Traditional retirement is becoming less common because life expectancies are increasing and fewer people are receiving pensions. Most people will go in and out of retirement several times. After many years we may leave a traditional career field for some well-deserved rest and relaxation. However, after a few years of leisure we may miss the sense of purpose, accomplishment, and identity gained from working. As a result, we may return to work in a new career field, do some consulting in an area where we had past experience or work part-time in a coffee shop.
Another problem with a drastic shift to fixed income is that we don’t need our entire retirement nest egg on the day we reach retirement. The typical retirement age is around 65, based on current Social Security data, the average retiree will live for another twenty years. A small portion of our portfolio may be needed upon reaching retirement but a large percentage won’t be needed for many years. It is important to keep long term money in a diversified portfolio, including stock mutual funds, to provide growth and inflation protection. A reasonable rate of growth in our portfolio is usually needed to meet our goals. Inflation can take a huge bite out of the purchasing power of our portfolios over twenty years or more. Historically, fixed income investments have just barely kept up with inflation while stock market investments have provided a nice hedge against inflation.
We need to think in terms of segregating our portfolios into imaginary buckets based on the timeframes in which money will be needed. Money that is needed in the next few years should be safe and readily available. Money that isn’t needed for many years can stay in a diversified portfolio based on personal risk tolerance. Portfolios should be rebalanced on an annual basis to be sure there is easy access to money needed in the short term.
A final myth with regard to investing in retirement is that money needed to cover your retirement expenses must come from interest earning investments. Sure, money needed in the short term needs to be kept in safe, fixed income investments to avoid selling stock when the market is down. However, this doesn’t mean that we have to cover all of our retirement income needs with interest earning investments. There may be several good reasons to cover retirement expenses by selling stock. When the stock market is up it may be wise to harvest some gains or do some rebalancing. At other times there may be tax benefits to selling stock.