How to Pick an IRA That’s Right for You (via Credit.com)

One of the most common questions I hear from clients is whether they should invest in a traditional IRA or a Roth IRA. Let’s start with an understanding of the difference between the two. The biggest difference between a traditional IRA and a Roth IRA is when you pay taxes. I like to think of it…


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Understanding Mutual Fund Fees

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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%.

 

 

Stock Can Be a Good Option in Retirement

 

 

 

 

 

 

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.

 

Mutual Funds May be Your Best Option

 

 

 

 

 

 

Jane M. Young

Generally the typical investor is better off investing in stock mutual funds than in individual stocks. A mutual fund is an investment vehicle where money from a large number of investors is pooled together and invested by a professional manager or management team.  Mutual fund managers invest this pool of money in accordance with a predefined set of goals and guidelines.

One of the primary benefits of investing in stock mutual funds is the ability to diversify across a large number of different stocks.  With mutual funds, you don’t need a fortune to invest in a broad spectrum of stocks issued by large and small companies from a variety of different industries and geographies.  Diversification with mutual funds reduces risk by providing a buffer against extreme swings in the prices of individual stocks.   You are less likely to lose a lot of money if an individual stock plummets. Unfortunately, you are also less likely to experience a huge gain if an individual stock skyrockets.

Another benefit of stock mutual funds over individual stocks is that less time and knowledge is required to create and monitor a portfolio.  Most individual investors do not have the time, expertise, or resources to select and monitor individual stocks.  Mutual funds hire hundreds of analysts to research and monitor companies, industries and market trends.   It is very difficult for an individual to achieve this level of knowledge and understanding across a broad spectrum of companies.  Mutual fund managers have the resources to easily move in and out of companies and industries as investment factors change.

Most individual investors appreciate the convenience of selecting and monitoring a diversified portfolio of mutual funds over the arduous task of selecting a large number of individual stocks.   Stock mutual funds are a good option for your serious money.  However, if you really want to play the market and invest in individual stocks, use money that you can afford to lose.

For diehard stock investors, there are some advantages to investing in individual stocks.  Many stock mutual funds charge an annual management fee of between .50% and 1% (.25% for index funds).  With individual stocks, there is a cost to buy and sell the stock but there is no annual management fee associated with holding stock.

Another advantage of individual stocks is greater control over when capital gains are recognized within a non- retirement account.  When you own an individual stock, capital gains are not recognized until the stock is sold.   In a high income year, you can delay selling your stock, and recognizing the gain, to a year when it would be more tax efficient.   On the other hand, when you invest in a stock mutual fund you have no control over capital gains on stock sold within the fund.  Capital gains must be paid on sales within the mutual fund, before you actually sell the fund.  Mutual funds are not taxable entities, therefore all gains flow through to the end investor.

Are Your Bonds Safe?

 

 

 

 

 

 

Jane M. Young

Let’s compare some differences between stocks and bonds.  When you buy a bond you are essentially lending money to a corporation or government entity for a set period of time in exchange for a specified rate of interest.  When you invest in the stock market you assume an ownership position in the company whose stock you are purchasing.  As a result, the value of your investment will fluctuate based on the profit or loss of the underlying company.  With the purchase of a bond the value of your investment hould not fluctuate based on the financial performance of the issuer, assuming it remains solvent.  You will continue to receive interest payments according to the original terms of the agreement until the bond matures.  Upon maturity the amount of your original investment (principal) will be returned to you along with any interest that is due.   As a general rule, stocks are inherently more risky than bonds, therefore investors expect to receive a higher return.

Bonds may appear to be safe but they are not without risk. Currently, there is some risk associated with low interest rates that may not keep up with inflation.  This is especially true with many government bonds. Two additional risks typically associated with bonds include default risk and interest rate risk.

Default risk is the risk that the issuer goes bankrupt and is unable to return your principal.  Most bond issuers are assigned a rating to help investors assess the potential default risk of a bond.   Generally, investors are compensated with higher interest rates when taking a risk on lower rated bonds and receive lower interest rates on higher rated bonds.

Interest rate risk is based on the inverse relationship between interest rates and the value of a bond.  When interest rates increase the value of a bond will decrease and when interest rates decrease the value of a bond will increase. If you hold an individual bond until maturity your entire principal should be returned to you.  You have the control to keep the bond until maturity and avoid a loss.  However, if you need to sell before maturity you may lose some principal. The loss of principal is greater for longer term bonds.  This needs to be weighed against the benefit of a higher interest rate paid on longer term bonds.

Bond mutual funds can provide diversification and reduced default risk because your money is pooled with hundreds of other investors and invested in bonds from a large number of different entities.  If one or two entities within the mutual fund go bankrupt there will be minimal impact on each individual investor.  However, with mutual funds you have less control over interest rate risk.  When interest rates increase, bond fund managers often experience a high rate of withdrawals forcing them to sell bonds at an inopportune time.  This usually results in a loss of principal, the severity of which is greater for longer term bond funds.

Here Are Three Simple Secrets to Investment Success

Jane M. Young, CFP, EA

Build a Portfolio to Support Your Investment Timeframe

Investment timeframe is a major consideration in developing an investment portfolio.  Start with an emergency fund covering about four months of expenses in a cash account with immediate access.  Next, put aside money that is needed over the next few years into fixed income vehicles such as CDs, bonds or bond funds.  Invest long term money into a combination of “stock based” mutual funds and fixed income investments based on your tolerance for investment risk and volatility.  Historically, stock has significantly out-performed fixed income investments but can be volatile during shorter timeframes.  Stock is a long term investment; avoid putting money needed within the next five years in the stock market.

Diversify, Diversify, Diversify

Once your emergency fund is established and funds have been put away for short term needs, it’s time to create a well-diversified investment portfolio.   We cannot predict the next hot asset class but we can create a portfolio that will capitalize on asset categories that are doing well and buffer you from holding too much in asset categories that are lagging.  Think of the pistons in a car, as the value of one asset is increasing the other may be falling.  Ideally, the goal of a well-diversified portfolio is to have assets that move in opposite directions, to reduce volatility, while following a long term upward trend.  It is advisable to diversify based on the type of asset, investment objective, company size, location and tax considerations.

Avoid Emotional Decisions and Market Timing

The best laid plans are worthless if we succumb to our emotions and overreact to short term economic news.  Forecasting the short-term movement of the stock market and trying to time the market is fruitless.   We can’t control or predict how the stock market will perform but we can establish a defensive position to deal with a variety of outcomes.  This is accomplished by maintaining a well-diversified portfolio that supports our goals and investment time horizon. 

The stock market can trigger our emotions of fear and greed.  When things are going well and stock prices are high we become exuberant and want a piece of the action.   When things are bad and stock prices are low we become discouraged and want to get out before we lose it all.  The stock market is counterintuitive, generally the best time to buy is when the market is low and we feel disillusioned and the best time to sell is when the market is riding high and we feel optimistic.  We need to fight the natural inclination to make financial decisions based on emotions.   Don’t let short term changes in current events drive your long term investment decisions.

No one knows what the future holds so focus on what you can control.  Three steps toward this goal are to create a portfolio that meets your investment time horizon, create and maintain a diversified portfolio and avoid emotional decisions and market timing.

 

 

Should I Invest in Variable Annuities?

Jane M. Young CFP, EA

Due to the high costs, lack of flexibility, complexity and unfavorable tax treatment variable annuities are not beneficial for most investors.  Traditional retirement accounts and Roth IRAs meet the tax deferral needs for most investors.  In some instances a variable annuity may be attractive to a high income investor who has maximized all of his traditional retirement options and needs additional opportunities for tax deferral of investment gains.  This is especially true for an investor who is currently in a very high tax bracket and expects to be in a lower tax bracket in retirement.

Generally, money in retirement accounts should not be invested in variable annuities.  The investor is already receiving the benefits of tax deferral.

A variable annuity may also be an option for someone who is willing to buy an insurance policy to buffer the risk of losing money in the stock market.  For most investors, due to the long term growth in the stock market, this guarantee comes at too high a price.  However, some investors are willing to pay additional fees in exchange for the peace of mind that a guaranteed withdrawal benefit can provide.  A word of warning, guaranteed minimum withdrawal benefits (GMWB) can be very complex and have some significant restrictions.  Do your homework, make sure you understand the product you are buying and read the contract carefully.

According to a study conducted by David M. Blanchett – the probability of a retiree actually needing income from a GMWB annuity vs. the income that could be generated from a taxable portfolio with the same value is about 3.4% for males, 5.4% for females and 7.1% for couples. The net cost is about 6.5% for males, 6.1% for females and 7.4% for couples.

Advantages and Disadvantages of Variable Annuities

 

Jane M. Young, CFP, EA

 

What is a Variable Annuity?


A variable annuity is a contract with an insurance company where you invest money into your choice of a variety of sub-accounts, similar to mutual funds. Non-qualified, variable annuities provide tax deferral on gains until the funds are withdrawn. Upon distribution your gains are taxed at regular income tax rates as opposed to capital gains rates. Variable annuities generally charge fees twice those charged by mutual funds. Additionally, you will be to subject to substantial early withdrawal charges if you purchase an annuity from an advisor who is compensated through commissions. Most variable annuities provide the option to buy a guaranteed death benefit option and/or a Guaranteed Minimum Withdrawal Benefit. These do not come without a cost and can be very complex.  Below are some advantages and disadvantages of Variable Annuities.
Advantages and Disadvantages of Variable Annuities:

Advantages:

  • Tax Deferral of gains, beneficial if you have maximized limits on other retirement vehicles such as 401ks and IRAs.
  • No Required Minimum Distribution at 70 and ½ as with traditional retirement accounts. There is no Required Minimum Distribution on Roth IRAs.
  • Death benefit and Guaranteed Lifetime Withdrawal Benefits (GLWB) riders can be purchased for additional fees. However, the death benefit is rarely instituted due to long term growth in the stock market. GLWBs can be very complex and not without risk.
  • Trades can be made within annuity without tax consequences – this is also true within all retirement accounts.
  • Non-taxable transfers can be made between companies using a 1035 exchange.
  • No annual contribution limit. Traditional retirement plans have annual contribution limits.

Disadvantages:

  • Gains taxed at regular income tax rates as opposed to capital gains rates on taxable mutual funds.
  • Higher expense structure –Mortality and Expense fees substantially higher than mutual funds.
  • Substantial surrender charges for up to 10 years on commission products
  • 10% penalty on withdrawals prior to 59 ½, this is also true with most traditional retirement accounts.
  • Complex insurance product
  • Lack of liquidity due to surrender charges and tax on gains
  • No step-up in basis, taxable mutual funds and stocks have a step-up in basis upon death
  • Loss of tax harvesting opportunities

Join us for a Fireside Chat on Annuities vs. Mutual Funds on May 16th

Please join us for lunch and an interactive discussion on annuities vs. mutual funds at Pinnacle Financial Concepts, Inc. on May 16th. Our Fireside Chat will run from 11:30 to 1:00. Please call 260-9800 to RSVP. There is no charge and our Fireside chats are always purely educational!!!

Stay The Course! Ten Steps to Help You Through Uncertain Financial Times

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Jane M. Young, CFP, EA

1. Don’t react emotionally! This will result in a constant cycle of buying high and selling low. Once you sell, you lock in your losses. Stay the course and focus on what you can control.

2. Make sure you have an emergency fund of three to six months of expenses.

3. Evaluate your asset allocation to be sure it is consistent with the timeframe in which you need to withdraw money. The stock market is a long term investment; you should never have short term money in the stock market. Make adjustments to your allocation based on your long term goals and need for liquidity not on fear.

4. Maintain a well diversified portfolio.

5. Pay-off credit cards and high interest consumer debt. Be wary of variable rate loans, lines of credit and mortgages. The downgrade in the U.S. credit rating could hasten an increase in interest rates.

6. Get your personal finances in order. It’s always a good idea to understand your spending and keep expenses in line with your income and financial goals. This is a good time to tighten your belt to be prepared for unexpected emergencies.

7. Use dollar cost averaging to invest new money into the stock market. Volatility in the stock market creates great buying opportunities.

8. Don’t get caught up in the media hype. They are in the business to sell newspapers, magazines and television commercials. Avoid the new hot asset class they are trying to promote this week. Sound investment advice is boring and doesn’t sell newspapers.

9. Take steps to secure or improve your income stream. Are you performing up to speed at work? Are you getting along with co-workers? Should you take some classes to keep your skills current? Are you underemployed or under paid for your education and experience? Consider a second job to pay down excess debt.

10. Stay calm, be patient and focus on making sure your financial plan meets your long term goals and objectives. Stay the course, this too shall pass.

O’Connor: Investors urged not to panic as U.S. default looms

Last Updated: July 27. 2011 1:00AM

Brian J. O’Connor

O’Connor: Investors urged not to panic as U.S. default looms

Many doubt leaders, in the end, will fail to act, trigger default

With the deadline to raise the federal debt ceiling drawing closer by the day — and the risk that the U.S. could default on its sovereign debt growing — individual financial planners are fielding lots of calls from worried investors.

A failure to raise the debt ceiling that prompts a U.S. default would cause stock and bond prices to plummet, interest rates to rise, credit for mortgages, cars and other debt to pucker up, and knock the wobbly economic recovery flat on its face. Federal Reserve Chairman Ben Bernanke himself has warned that letting the federal government run out of money would be “catastrophic.”

Nonetheless, advisers say individual investors should stick to their investment strategies for three good reasons:

First, most planners doubt that even the kinds of people who get elected to Congress these days will really allow the U.S. to default on its debt.

Second, in the case of a cataclysmic financial disaster, the traditional safe havens, such as U.S. Treasuries and even greenbacks, would take a hit.

And third, most individual investors just bungle it when they try to time when to enter and exit the stock market. “You’ve got to know when to sell but when to buy back in, too,” says Lyle Wolberg, a certified financial planner with Telemus Capital Partners in Southfield. “So you’ve got to be right twice. And that’s hard to do.”

Financial experts all agree that a U.S. debt default would be a serious, serious issue. But would it be as big as the worst global crash since the Great Depression? After all, the Dow Jones index has recovered nearly 90 percent of its record high from late 2007, at the peak of the real estate bubble. So unless you’re sure a possible U.S. default would create another great recession, it may not be worth the cost and worry to start rearranging your investments.

And even if it is, a well-structured investment portfolio already is positioned to ride out those kinds of losses.

“The diversification we’ve had in place is to address all these issues, so there really are no moves to make,” says Bill Mack, a certified financial planner who runs William Mack & Associates in Troy. “If you’re in inappropriate investments now, especially if you’re too heavy into equities, I’d be concerned. But this is a short-term event and your portfolio should be geared toward long-term objectives.”

With bonds, stocks and even U.S. Treasuries taking a hit in a default, investors really don’t have many places to run. Some analysts have suggested Swiss francs, an investment that’s well beyond the means and expertise of most folks trying to protect a 401(k) or Individual Retirement Account. Other strategies — from the popular but very risky choice of gold, to moving from long-term to short-term bonds or switching to high-dividend-yielding blue-chip stocks — are common suggestions.

But those strategies have been in place for more than year now, as investors anticipated rising interest rates, more inflation or looked for safe income to replace low-yield Treasuries.

“There isn’t a whole lot you can do that hasn’t been covered by the markets,” says Karen Norman, a certified financial planner with Norman Financial Planning in Troy. “Positioning yourself other than running for cash is tremendously difficult.”

Even cash would lose some value as the dollar would decline after a default, making it more expensive to buy imported goods, including gasoline. The advantage would be that a switch to cash now would leave an investor positioned to go bargain-hunting when stocks slide after a default. But individual investors who make regular contributions to a 401(k) or IRA already buy more shares with every deduction from their paychecks or automated payment from the checking accounts, so they’re already positioned to buy low once stocks hit the skids, just as they’ve done throughout the entire downturn.

The reason to go to cash now, says Nina Preston, a certified financial planner with the Society for Lifetime Planning in Troy, is if you need a stable stash to cover your short-term income requirements, such as retirees who are counseled to hold three to five years worth of needed income in cash or equivalents. But if you need to do that, you’re already holding too much stock.

“If you need to flee to cash,” Preston says, “you should have been in cash to start with.”

The final drawback to moving your money around — even to cash — is that you’ll probably do the wrong thing, warns Mack.

“If people are adamant about going to cash, if they feel it in their bones that the world is coming to an end, at what point do they say, ‘It’s time to get back in?'” he asks. “Don’t tell me its when you feel better because that’s too late. It just doesn’t work to follow your gut feelings.”

The bottom line is that investors need a strategy that lets them ride out short-term economic woes, even if they’re self-inflicted by our own leaders.

“We’ve looked ahead and positioned ourselves the best way we can,” Norman says. “Now we need these folks in Washington to do their duty. That’s what we’re paying them to do.”

Which means that your best investment option is a very easy one — picking up the phone and placing a call to your congressman or congresswoman.

boconnor@detnews.com

 http://detnews.com/article/20110727/OPINION03/107270346/O-Connor–Investors-urged-not-to-panic-as-U.S.-default-looms#.TjMnDLApgnQ.email

Watch Out for These Pitfalls with Social Security and IRA Rollovers

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Jane M. Young, CFP, EA

Here are a couple issues on Social Security and IRA Rollovers that frequently catch people by surprise.

Think twice about taking your Social Security at 62 or before your regular retirement age, if you plan to work during this timeframe. In 2011, if you earn more than $14,160, Social Security will withhold $1 for every $2 earned above this amount. However, all is not lost, when you reach full retirement age Social Security will increase your benefits to make up for the benefits withheld. Once you reach your full retirement age there is no reduction in benefits for earning more than $14,160. However, the amount of tax you pay on your Social Security benefits will increase as your taxable income increases. This may be a good reason to wait until your full retirement age or until you stop working to begin taking Social Security.

If you are thinking about moving your IRA from one custodian to another I strongly encourage you to do this as a direct transfer and not as a rollover. We frequently use these terms synonymously but I assure you the IRS does not! A transfer is when you move your IRA directly from one IRA trustee/custodian to another – nothing is paid to you. A rollover is when a check is issued to you and you write a second check to the new IRA Trustee/Custodian. This must be done within 60 days or the transaction is treated as a taxable distribution. You can do as many transfers as you desire in a given year. However, you can only do one rollover per year, on a given IRA. This is a very stringent rule and there are very few exceptions even when the error is out of your control. Whenever possible be sure to use a direct transfer not a rollover to move your IRA Account.

Solve the Deficit Problem by Cutting Government Spending – You Don’t Stop the Spending by Refusing to Increase the Debt Ceiling

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Jane M. Young, CFP, EA

A few clients and friends have asked me if they should be making changes to their investment allocations based on the uncertainty around raising the debt ceiling. While we don’t want to bury our heads in the sand we should not over react to something that probably won’t come to pass. In my opinion the political stakes are way too high for all parties concerned to allow the U.S. to default on its obligations. At the moment everyone is playing chicken but at the end of the day, neither party can afford the political fallout that would result in a failure to raise the debt ceiling. This does present a great opportunity for the media to get attention with sensationalistic, doomsday headlines to help them sell newspapers or television spots. This is also a great opportunity for political posturing on the part of both Democrats and Republicans. It is my projection that on August 2nd we will still have a huge deficit problem and a higher debt ceiling.

The debt ceiling is an indication of a much bigger problem with federal government spending. The problem is not solved by changing the debt ceiling; the problem was created when congress approved spending resulting in the need to raise the debt ceiling. Failure to raise the debt ceiling is like trying to close the barn door after the horse has gotten out. Refusing to raise the debt ceiling is a meaningless gesture, with regard to our deficit. However, it carries a catastrophic impact on the perceived safety of U.S. debt which would ripple down through all aspects of our financial lives. This is clearly not an acceptable course of action. The real issue is getting a handle on government spending and the deficit which will require major reforms to Social Security and Medicare. Our economy and prosperity are being held back by a looming black cloud caused by fear and uncertainty with regard government spending and the federal deficit.

10 Tips for Financial Success

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Jane M. Young CFP, EA

1. Set Goals –
Review your personal values, develop a personal strategic plan, establish specific goals for the next three years and identify action steps for the coming year.

2. Understand Your Current Situation –
Review your actual expenses over the last year and develop a budget or a cash flow plan for the next 12 months. Compare your expenses and your income to better understand your cash flow situation. Are you’re spending habits aligned with your goals? Can or should you be saving more?

3. Have sufficient Liquidity –
Maintain an emergency fund equal to at least four months of expenses in a fully liquid account. Additionally, I recommend having a secondary emergency fund equal to another three months of expenses in semi-liquid investments. Increase your liquidity if you have above average volatility in your life due to job instability, rental properties or other risk factors.

4. Always save at least 10% of your income –
Regardless of whether you are saving to fund your emergency fund or retirement you should always pay yourself first by saving at least 10% of your income. Most of us need to be saving closer to 15% to meet our retirement needs.

5. Pay-off Credit Cards and Consumer Debt –
Learn the difference between bad debt (credit cards) and good debt (fixed-rate home mortgage). Avoid the bad debt and take advantage of the leveraging power of good debt.

6. Take Advantage of the Leveraging Power of Owning Your Home –
Once you have established an emergency fund and have paid off your bad debt start saving for a down payment to purchase your own home.

7. Fully Fund Your Retirement Accounts be a tax smart investor –
Participate in tax advantaged retirement programs for which you qualify. Maximize your Roth IRA and 401k contribution take full advantage of any company match on your 401k. If you are self-employed consider a SEP or Simple plan. Always select investment vehicles that provide the most beneficial tax solution while meeting your investment objectives.

8. Be an Investor, Not a Trader. Don’t time the market and don’t let emotions drive your investment decisions –
Investing in the stock market is a long term endeavor, forecasting the short-term movement of the stock market is fruitless. Avoid emotional reactions to headlines and short-term events. Don’t overreact to sensationalistic journalists or chase the latest investment trends. You can establish a defensive position by maintaining a well diversified portfolio custom tailored to your unique situation. Slow and steady wins the race!
“Far more money has been lost by investors in preparing for corrections, or anticipating corrections, than has been lost in the corrections themselves.”  -Peter Lynch, author and former mutual fund manager with Fidelity Investments

9. Don’t Invest in anything you don’t understand and be aware of high fees and penalties –
If it sounds too good to be true and you just can’t get your head around it, don’t invest in it! If you want to invest in complicated products, read the fine print. Be aware of commissions, fees and surrender charges. Be especially wary of products with a contingent deferred sales charge. There is no free lunch, if you are being promised above market returns there is probably a catch. Keep in mind that contracts are written to protect the insurance or investment company not the investor.

10. Diversify, Diversify, Diversify – rebalance annually –
It is impossible to predict fluctuations in the market or to select the next great stock. However, you can hedge your bets by maintaining a well diversified portfolio. Establish an asset allocation that is aligned with your goals, investment timeframe and risk tolerance. You should have a good mix of fixed income and equity based investments. Your equity investments should be spread over a wide variety of large, small, domestic and international companies and industries. Re-balance your portfolio on an annual basis to stay diversified and weed out any underperforming investments.

New Normal

By Bert Whitehead, MBA, JD

A number of clients have expressed alarm at the recent clamor of commentators who have been predicting a cataclysmic economic change worldwide. These pundits claim that we are facing an economic “New Normal” and express concern that the ‘old’ economic rules on which we rely no longer operate.

Their conclusions? Drastic changes are needed in our lives and investments to accommodate the “New Normal!”

Usually they question the viability of the U.S. dollar and offer the possibility that China, or perhaps a block of other nations, are somehow positioned to ‘take over’ the U.S. because they hold so many U.S. bonds. Another variation of this calamity centers on the recent collapse of the real estate market, the precipitous drop in the stock market, and extraordinarily low interest rates. Taken together, these developments presage the end of American prosperity for our children and ourselves.

Of course these apocalyptic pronouncements are more effective if they are tied to some political viewpoint, the more extreme the better. More often than not, far right political viewpoints proclaim that doomsday is the certain result of left-wing politics. Leftist views generally emphasize the inevitable revolution that suppression of the masses will cause.

(Note to “Investment Advice” file: Never let your politics drive your investments!)

It’s time to confront these ridiculous assertions. Yes, it is true that the investment and economic travails of the past decade have been severe and have impacted many people worldwide. Some of these changes have not occurred before during many of our lifetimes. It is enticing to point the finger of blame and shame at our financial, economic, investment and political leadership. But that is not the whole story
The power of momentum in democratic economies is easily underestimated. Although dramatic from time to time, the impact of severe financial shifts must be kept in proportion and viewed within a broader historical perspective. We need to recognize that most extreme economic shifts are self-correcting.

Even with unemployment at over 9%, over 90% of our citizens are employed. Real estate crashes, weather-related disasters, stock market crashes, low interest rates, etc. have all happened before. Indeed the damage done by seismic economic shifts during the Great Depression, the severe stagflation in the 1970’s, and the collapse of S. & L.’s in the 1980’s were all worse than we have seen today…and all of these are relatively minor when compared to the disruption of the financial markets in the 19th century. And whatever happened to the “New Economy” theory that gave rise to the ‘dot-com’ frenzy of the 1990’s?

It is folly to fret about how much of our debt is owned by the China (interestingly, Japan owns nearly as much U.S. debt as China, even though that fact is not usually noted). What can the Chinese do with our debt? They can’t dump it on the White House lawn and demand to be paid off with gold. They can’t go on the world markets and exchange dollars for Euros or Yen, or even buy gold. Any of these moves would be self-defeating because dumping huge amounts of money in any market would decrease the value of their remaining dollars. Actually, their only realistic option is to spend it in the U.S.!

There is a concern that the U.S. dollar is at a “tipping point” and will soon lose its status as the world’s reserve currency. But no other currency is in a position to take its place. The Euro’s stability is much too questionable. The Yuan doesn’t have a long enough history to be relied upon, especially when a dictatorial government can arbitrarily determine its value. Neither these nor other ‘respectable’ currencies such as the Yen, the British Pound, the Swiss Franc, etc. have enough depth to support a global economy.

Those who espouse extreme economic outcomes are invariably selling something. Usually it is their newsletter or book, or some strategy to beat the market, or gold itself. The most eminent economists in the world have never been able to predict any economic cycle with a meaningful consensus. Why should you believe the extreme voices of charlatans who use their advanced marketing techniques to dupe the fearful?

What can you do? I suggest that you sit back and follow sensible advice. The Functional Asset Allocation model, which is used by nearly 200 fee-only members of ACA (Alliance of Cambridge Advisors), focuses on the basics.

Consider this…there are only three possible economic scenarios: we can have inflation, deflation, or prosperity. It is a waste of time to try to determine which is coming next. The prudent approach is to be prepared for all three possibilities. As the ancient wisdom of the Torah exhorts: “Invest a third in land, a third in business, and a third in reserves!”

Today, that translates into a balanced portfolio of real estate, equities (i.e. stocks in companies), and cash and bond reserves. Trying to market-time and pick the next ‘hot investment’ is foolhardy. If you allow the vagaries of global economics, i.e. exogenous factors, to be the focus of your attention, you risk making decisions based on emotion rather than rational thought. In truth, it is the ‘endogenous factors’ in your life that determine your financial future.

As Pogo once said, “We have met the enemy, and he is us!” Instead of dithering about what will happen in the Mideast, or where interest rates are headed, or when will real estate level off, look at the things in your life that make a difference. Are you saving at least 10% of your gross income? Are you living within your means? Do you have enough liquidity to ride out a financial setback? Do you have a long-term fixed rate mortgage to protect you from inflation? Do you have government bonds to weather another bout of deflation.

Obsessing about the various complexities and possible outcomes in today’s global economy inevitably leads to rash and unwise leaps. Keep an eye on the issues within your reach! It is the key to a confident journey and a serene financial future.

I appreciate the editorial review contributed by Chip Simon, CFP®, an ACA colleague in Poughkeepsie, NY.

You Are Invited to our 1st Fireside Chat of 2011 on Thursday, February 10th

Please join us at Pinnacle Financial Concepts, for our first Fireside Chat of 2011. This is a great opportunity to join us in a very relaxed atmosphere to ask questions, and get prepared for filing your tax return. On Thursday, February 10, from 7:30 to 9:00 a.m. our topic will be “There’s No Such Thing as a Stupid Investment Question” with a bonus (apologies to David Letterman) of “The Top 10 Things to Think About During Tax Season”. We’ll have a basic overview of investment definitions and things to know about investments to spur a discussion on the topic.

Please call 260-9800 x2 to reserve your spot at this chat. There is no charge, but we will limit the number of available seats and schedule an overflow date if needed.   Free coffee and donuts will be served and, as always, this is purely educational, no selling!!

Almost Whole

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Jane M. Young

I am continually surprised by questions from financial reporters who are still asking how my clients are faring after losing half of their retirement savings or by individual investors who are still fretting over losing half of their nest egg. If you followed our advice, as about 95% of our clients did, to stay the course and avoid selling during the drop in the market you would be close to break even now. If your risk tolerance precluded you from staying in the market, you may have realized a greater loss. This is a good reminder that we need to avoid acting on emotional reactions to the stock market. The stock market is cyclical and you can’t recover from a loss if you aren’t in the market. The stock market is counter intuitive – generally, the best time to buy is when you feel like selling and the best time to sell is when you feel like buying.

Here are some figures that will illustrate the actual change in the market over the last three or four years. The S&P 500 hit an all time high of around 1561 in October of 2007 and dropped about 56% to around 683 by March of 2009. Since March of 2009 the market increased by about 88% to 1286 on January 31, 2011. While it hasn’t reached the peak of 1561 it has returned to the 1200-1300 level where the market hovered throughout the summer of 2008 – before the significant drop in September 2008. The NASDAQ hit an all time high of around 2810 in October of 2007 and dropped about 54% to around 1293 by March of 2009. Since March of 2009 the NASDAQ has increased by about 109% to 2706 on January 31, 2011.

Attend a Financial Fireside Chat with Jane and Linda on December 2nd to discuss “Year End Financial Planning Tips and Money Saving Ideas for the Holidays”

 

You and a guest are invited to a Financial Fireside Chat with Jane and Linda at our office, from 7:30 – 9:00 am on Thursday, December 2nd to discuss “Year End Financial Planning Tips and Money Saving Ideas for the Holidays.”

A Financial Fireside chat is an informal discussion over coffee and donuts, where our clients and guests can learn about various financial topics in a casual non-threatening environment. This is free of charge and purely educational. There will be absolutely no sales of products or services during this session. We will provide plenty of time for informal discussion.

The Fireside Chat will be held at the Pinnacle Financial Concepts, Inc. offices at 7025 Tall Oak Drive, Suite 210. Please RSVP with Judy at 260-9800.

We are looking forward to seeing you on Thursday, December 2nd to learn about and discuss some great year end financial planning ideas.

Living Dangerously in the World of Fixed Income

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Jane M. Young CFP, EA

It is important for us to stay diversified and keep a prudent amount of our portfolio in fixed income investments – but where? We can avoid interest rate risk and default risk with CDs; however, we may sacrifice on return. Currently most short term CDs are paying less than one percent. We can get a slightly better return for a longer term CD but does this make sense in such a low interest rate environment? With CDs, the biggest downfall is the lost opportunity for a higher return.

If you want a higher return and you are willing to take some additional risk, consider short term bond funds. A short term bond fund that invests primarily in treasuries and government agency bonds has a very low default risk. However, there is some interest rate risk. Interest rate risk is due to the cause and effect relationship between bonds and interest rates. When interest rates rise, after the purchase of a bond or a bond fund, the value of the bond will decrease. For example, you purchase a $20,000, 10 year bond that pays 3% interest. A few years later interest rates go up to 5% and you decide to sell your bond that only pays you 3%. When you try to sell your bond you can’t get $20,000 for it because it pays 2% less than the market rate. However, several buyers may be willing to buy your bond for a discounted value to make up for the lower than market interest rate. If you hold your bond until maturity it should sell for the full purchase value of $20,000. The inverse is also true, if interest rates go down your bond will be worth more than what you paid. The degree to which this occurs is magnified by the term or duration of the bond. Short term bonds have less interest rate risk than do long term bonds.

Default risk is the risk that the company or entity issuing the bond will be unable to pay you back. In essence a bond is a loan made to a company or a government entity for a specified interest rate over an agreed upon period of time. US Government bonds and bonds backed by the US Government have an extremely low risk of default. Corporations, Municipalities, and other governmental entities have varying degrees of risk depending on their financial stability. Most bond issuers are assigned a rating to help investors assess the potential default risk of a bond.

A mutual fund has less default risk than an individual bond because you are buying an ownership share in several different bonds. However, you have less control over interest rate risk. If you own an individual bond you can hold it until maturity. If you own a mutual fund, the fund manager may be forced to sell bonds at an inopportune time due to a high rate of withdrawals. If the fund manager could hold all of the bonds to maturity there would not be an actual drop in value. However, bond funds must reflect a share price based on the current value of the bonds held in the portfolio.

If you want a higher return you may want to consider intermediate term bonds but be prepared for a corresponding increase in the level of interest rate risk. If you want to maximize return you could consider high yield or junk bonds. However, be very careful in this arena because high yield bonds are subject to both interest rate risk and default risk. In the current environment, interest rate risk and default risk are very high. Unless you are an expert in high yield bonds, this is a lot of risk to take on the portion of your portfolio that is designed to be less risky and serve as a buffer against the stock market.

Most of my clients are best served by investing in a combination of CDs, high quality short term bonds, and some high quality intermediate term bond funds. Unfortunately, there are few really good options in the current fixed income market.

Are You Paying Too Much for Financial Planning and Advice? by Jane Bryant Quinn

Here is a great piece by Jane Bryant Quinn.
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Are You Paying Too Much for Financial Planning and Advice?
By Jane Bryant Quinn | Sep 21, 2010 | 5 Comments

How much are you paying for the financial-planning advice you get? Some investors don’t know. Others think they know but don’t. “Fee-only” planners and registered investment advisors state their fees up front. “Fee-based” advisors appear to do the same but might be charging you in other ways. Brokerage house advisory accounts charge the most and can entangle you in costs you didn’t expect.

In short, a stated fee isn’t always what it seems. For that matter, neither is an advisor. I recommend fee-only planners but I’ve found some who are so new to the business or so limited in their skills that I wouldn’t go near them.

So how do you go about assessing what you’re paying for advice and what the potential conflicts or trouble spots might be? Here’s a rundown:

Fee-only advice. This is my choice, always. These advisors give you a price list up front, for work by the hour, by the task, or for ongoing management of your money. They don’t take sales commissions, so they’re not primed to push products. They sell only their planning and investment expertise.

Within this world, however, there’s a lot of variation.

A fee-only planner, with a CFP designation (for Certified Financial Planner) helps you establish your priorities and goals, create budgets, set savings targets, test your insurance safety net, establish retirement savings accounts, project future retirement income, plan for taxes, and make basic investment decisions. By “basic,” I mean simple asset allocation and picking no-load (no sales charge) mutual funds. That’s all that most families need. You can find some of these fee-only planners through the Garrett Planning Network, the Alliance of Cambridge Advisors, or the Financial Planning Association (when you search the FPA site, click on “How Planners Charge” and check the box for “fee-only”).

But some of these advisors — especially people who have been in business for only three or four years — might not have the knowledge or experience to analyze your investments in depth. Those with a brokerage-house background are familiar with securities, but others are still learning. They might be qualified to advise on mutual funds but not individual stocks and bonds. They might be taking clients before they’ve finished their CFP.

On average, you’ll find more experienced planners through the National Association of Personal Financial Advisors. Some NAPFA members deal only with people of higher wealth. Others take middle-class clients, too (see what their websites say).

Even planners with good paper qualifications might not serve you well if they don’t understand your life experience. For example, young planners who don’t own homes are not the best guide through mortgage decisions. Someone in his or her mid-30s will think more aggressively about investments than someone in late middle age. If you’re approaching retirement, you want a planner who can feel the same, cold wind of uncertainty that you do.

Fee-only planners typically charge 1 percent on accounts up to $1 million or so, and less on larger amounts. But fees have been going up, says Tom Orecchio of Modera Wealth Management and former president of NAPFA. Some firms charge 1.5 percent or more for the first $500,000.

“Advisors say they’re working harder, for less money, than at any time in their career,” Orecchio says. Accounts under management have declined in value, clients need more handholding, and more new products are coming to market that need evaluating. So they’re charging people more.

Normally, a percentage fee applies only to money that the planner has directly under management. A few planners assess the fee on your total net worth, including your 401(k) and home equity. “That’s for comprehensive financial planning,” says John Sestina of John E. Sestina and Co. “We advise on everything, including whether to refinance a mortgage and how to allocate a 401(k).” He charges $5,000 for accounts up to $1 million (that’s 0.05 percent, at the top) and larger fees for larger accounts. For younger clients, he offers “financial planning lite”– $1,000 for full planning and investment services on accounts of any size, but only two or three meetings a year.

Fee-based advice. Here, you have wolves in sheep’s clothing. It sounds as if they also give fee-only advice. In fact, they sell products and earn commissions. You might pay fees for some products and commissions for others. The size of the fees might depend on what else you buy. “Fee offset” means that the fee is deducted from the commission you pay. Commissions aren’t always visible, so it’s easy to pay more than you realize.

Brokerage house advisory accounts. You pay fees here, too. The broker provides an investment plan, developed and monitored by the firm’s advisory team. You get periodic reports. Small investors, with $25,000 to $50,000, might be charged in the area of 2 percent a year. These accounts don’t include packaged products such as variable annuities or unit trusts. Your broker might sell them to you on the side, earning a commission on the trade.

Skip these expensive advisory accounts if you’re a long-term investor who holds mutual funds and a few stocks. You’re much better off in a regular brokerage account that doesn’t charge fees–or, for that matter, with a fee-only planner.

Regarding conflicts of interest, I’m always careful about the commissioned-sales world because of its fondness for selling high-cost products. But the fee-only world has potential conflicts, too. Planners who charge on an hourly basis might stretch out the time it takes to complete your job. Planners who work on retainer might pay less attention to your account, because they’ve got the money anyway. Planners who charge a percentage of assets have an incentive to hold on to your money — for example, by recommending that you keep your mortgage rather than paying it off.

Always evaluate the advice, in terms of your advisor’s interest as well as your own. Advice isn’t always worth what you pay for it. You might do better by paying less.

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