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November 2006 - Posts

  • Company Pension Plans

    Remember when we discussed early withdrawal penalties for 401k plans and IRA's?

    Well, the same 10% penalty that hits early withdrawals from individual retirement accounts applies if you receive money from a company plan early. Although early is defined in the law as before you reach age 59 1/2, an exception to the penalty means most employees can take penalty-free payouts starting the year they reach age 55. The age 55 exception applies if you get the payout because you leave the job-which, of course, is usually the case. The penalty stretches to age 59 1/2 only for withdrawals while you're still on the job. (Note that the exception applies in the year you reach age 55; you don't have to be 55 when you leave the job and get the money as long as that birthday comes by December 31.)

    Because the point of retirement plans is to help make sure you'll have money to live on in retirement, the 10% penalty is designed to encourage you to roll over early payouts into an IRA. Such a rollover lets you dodge the 10% penalty, but once inside the IRA, the money is still tied up until you're at least 59 1/2.

    As with 401(k) plans, there are other exceptions to the early-withdrawal penalty. At any age, it does not apply if:

    * You are disabled.
    * The distribution is made to your beneficiary after your death.
    * The payments are made in roughly equal installments over your life expectancy or the life expectancy of you and your beneficiary.
    * The money is used to pay medical expenses in excess of 7.5% of your adjusted gross income.

    Retirement Income

    If you receive regular payments from a company pension or annuity, tax may or may not be withheld. The same goes for withdrawals you take from a regular IRA. Believe it or not, it's up to you whether part of the money will be taxable.

    If you want to hang on to a bigger portion of your retirement checks, all you have to do is file a form with the payer. The company that pays your pension or annuity should periodically remind you of your option to block withholding and tell you how to do it.

    Note, though, that withholding on these payments isn't necessarily a bad thing, it stretches the tax bill over the entire year rather than leaving the bill to be paid all at once at tax time. Withholding might make life easier if the alternative is to make quarterly estimated tax payments, which are discussed later. If you allow it, the amount held back from pension and annuity checks is based on information you provide on a Form W-4P, just as withholding on wages is controlled by a Form W-4.

    Pension Payout Trap

    Don't get tripped up by the withholding rule that can sting employees who get lump-sum payments from company retirement plans-the kind of payment you might receive not only when you retire, but also if you quit or are laid off.

    Not so long ago, withholding on such payments was voluntary. The best course for most taxpayers, in fact, was to say "no'' to withholding, take the money and roll it over into an individual retirement account (IRA). Doing so within 60 days meant no tax was due on the payout, so there was no need for withholding.

    Now, however, if you take the money, 20% of it is automatically withheld for the IRS. That's true even though a rollover will still allow you to avoid the tax. In that case, the IRS would have the money you don't owe until you file a tax return for the year and receive a refund. What’s more, you’ll have to make up the 20% from other funds in order to make a complete rollover.

    Congress set the 20% withholding provision to raise money-an estimated $2 billion over five years. But only unsuspecting taxpayers will pay it because there's an easy way around withholding: Simply ask your employer to send the money directly to your rollover IRA. As long as the money doesn't pass through your hands, there is no withholding.

    Posted Nov 29 2006, 04:15 PM by moneycoach with no comments
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  • The Skinny on 401k Plans

    Another tax-saving quadrant investment vehicle is the 401(k) plan, and it's public-sponsored brethren, the 403(b) plan. Let's have a look:

    401(k) plans allow workers to contribute money tax-deferred toward their retirement. Investment options are growing, with stocks and bonds the most popular choices of 401(k) investors.

    Like most investments, the more you know about 401(k)’s the better your retirement will be. For example, there is a limit on how much you can sock away in a 401(k) each year, but the limit is far above the IRA cap. For 2006 the cap rose to $15,000. And, starting back in 2002, workers age 50 and older by the end of the year were allowed to make "catch up" contributions above and beyond the set dollar limitations. Back then, the catch up amount was $1,000, setting a $12,000 contribution ceiling for a worker age 50 and older. The catch up amount rose by $1,000 increments until it hit $5,000 in 2006. So, in 2006, a worker age 50 or older has a $20,000 limit -- almost twice the limit in 2001.

    Clearly, Congress wants to encourage us to save for our retirements. Your personal limit depends on your salary and what percentage the company permits you to put into the retirement plan. Most firms allow contributions of between 2% and 15% of compensation. A big advantage of 401(k) plans is that many employers match a portion of the funds you contribute to your plan.

    403(b) Plans -- Established under a special section of the Internal Revenue Code, a 403(b) plan is a defined-contribution retirement plan available only to employees of private organizations that are tax-exempt under IRC 501(c)(3) and to educational organizations of a state, political subdivision of a state, or an agency or instrumentality of a state.

    Typically, eligible employers include nonprofit and nonpolitical religious, charitable, scientific, educational, and other public interest-oriented organizations such as private schools, colleges, universities, research institutions, and teaching hospitals. The term "qualified" is reserved for plans regulated by IRC sections 401(a) or 403(a).

    The main tax advantage of 403(b) plans is the same benefit derived from 401(k) plans: Amounts contributed (other than employee after-tax contributions) and the "inside" (pre-retirement) buildup of earnings aren't subject to federal income taxes until withdrawn.

    Also like 401(k) plans, 403(b) plan participants can change the rate of contributions to their plans at any time. Also, contributions to 403(b) plans can consist of employee elective deferrals, employer contributions, and after-tax employee contributions.

    Posted Nov 28 2006, 02:46 PM by moneycoach with no comments
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  • Getting to Know IRA's

    In our continuing series on the four investment quadrants, let's tackle the tax issues with some proven investment vehicles that shield your money from the clutches of Uncle Sam.

    First up -- individual retirement accounts (IRA's):

    Individual Retirement Accounts (IRAs)

    Contributing to any kind of IRA is a good idea, even if you can't deduct your contributions. That's because the earnings in the account grow tax-free until you withdraw them. With a traditional IRA, you may be able to deduct your contributions, too:

    * If you are single and participate in an employer-maintained retirement plan, you can deduct the full amount of your traditional IRA contributions if your adjusted gross income (AGI) is less than $33,000. You can deduct a portion of your contributions if your AGI is between $33,000 and $43,000. If your AGI is $43,000 or more, you can't deduct any contributions. If you do not participate in an employer-maintained plan, you can deduct all of your contributions, no matter how high your AGI is.

    * If you are married and filing a joint return, the rules are a bit more complicated. If neither you nor your spouse participates in an employer-maintained retirement plan, your traditional IRA contributions are fully deductible. If you participate in such a plan, your contributions are fully deductible if your AGI is less than $53,000, partly deductible if your AGI is between $53,000 and $63,000, and nondeductible if your AGI is $63,000 or more. If your spouse participates in an employer-maintained plan but you don't, your traditional IRA contributions are fully deductible if your AGI is less than $150,000, partly deductible if your AGI is between $150,000 and $160,000, and nondeductible if your AGI is $160,000 or more.

    When you take money out of a traditional IRA, much—if not all—of it is taxable. As you consider a withdrawal around year-end, weigh the potential advantage of holding off until the New Year arrives. If you can wait to put your hands on the money, you can make Uncle Sam wait an extra year before he gets his share. But if you find yourself in a higher tax bracket in the future-due to higher income or increases in the tax rates-you may want to speed up IRA withdrawals to avoid the stiffer tax bite.

    In the year you reach age 70 1/2, the law demands that you begin withdrawals from your traditional IRA. But the first mandatory distribution—the one for the year you turn 70 1/2—can be put off until as late as the following April 1. Holding off trims your taxable income and your tax bill in the current year. But you must double up in the second year. In addition to the withdrawal made by April 1, another withdrawal has to be made by December 31. If the resulting boost in taxable income shoves you into a higher tax bracket, your income-deferral strategy could backfire. Note that withdrawals from a traditional IRA are taxable unless you made nondeductible contributions in which case a portion of the withdrawal will be nontaxable.

    Roth IRAs

    Another IRA option is the Roth IRA. Contributions to this type of IRA are never deductible, but qualified withdrawals from a Roth IRA are nontaxable.

    With Roth IRA’s, earnings are non-taxable when withdrawn, provided you meet the holding requirements. Another advantage is, unlike traditional IRAs, the IRS does not require you to take a distribution from a Roth IRA when you reach age 70 1/2. Roth IRAs are not without some restrictions, however. As with traditional IRAs, distributions of earnings are taxable and subject to a 10-percent penalty if taken out prematurely. With a Roth, you must leave your money in for five years. If you’re eligible for both a deductible traditional IRA and a Roth IRA, your choice can be a difficult one. You’ll need to balance your need for current deductions with your desire for tax-free retirement income.

    Next up to bat, 401(k) plans.

    Posted Nov 27 2006, 09:16 PM by moneycoach with no comments
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  • Quadrant Three: Saving on Taxes

    The relationship between Wall Street and Congress has always been a tug of war over the amount of money made by investors on Wall Street and the amount of that sum that Uncle Sam deserves in taxes.

    Wall Street would prefer that as little as possible of its investors’ earnings be taxed. Congress doesn’t see it that way, asking investors to dig into their pocketbooks and ante up some of the proceeds from their portfolio gains.

    That's why you may not enjoy your golden years as much if you don’t take advantage of tax-free and tax-deferred investments.

    Thus the importance of our third quadrant – avoiding taxes. I see way too many cases of people making the same mistakes with their retirement plans that cost them plenty in additional tax payments.

    I see people withdrawing too little from their retirement plan. At age 70-1/2, you have to begin making at least minimum withdrawals, based on the life expectancy tables, even if you're still working. Otherwise, you will pay a 50 percent penalty on the minimum amount you failed to withdraw.

    The first withdrawal must be completed by April 1 of the year after you turn 70-1/2. But people forget about the date and wind up paying taxes they could have avoided. Same with withdrawing too much from your retirement plan. I see people with $1 million saved up for retirement. Again, when you reach 70-1/2 and have to start withdrawing funds, your minimum might be over $150,000 a year. If so, or if you have a lump sum withdrawal of over $750,000, you'll pay an extra 15 percent tax on any amount over those ceilings.

    There are also plenty of people not taking advantage of loopholes in the US tax code like tax-deferred investments, and estate planning tools like trusts and annuities.

    Obviously, saving for retirement should be one of your main financial goals. Fortunately, the tax code provides several tax-favored retirement options. A common feature of these options is that the account’s earnings grow tax-free year to year. That’s important over time because it allows the earnings to compound at a higher rate (a great inflation fighting tool, by the way). In the next few blogs, I’ll put together a general description of some of the more common tax-favored plans.

    Posted Nov 25 2006, 10:29 PM by moneycoach with no comments
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  • More on Inflation

    Here are some more examples of how inflation will affect various types of income:

    -- Social Security: Under IRS rules, Social Security benefits are tied to increases in the Consumer Price Index (CPI). If a person's Social Security benefit is $850 a month at the time of retirement, that amount will be adjusted each year with full cost-of-living adjustments (COLAs). In other words, the purchasing power of the benefit remains exactly the same from the very first check to the very last.

    -- Investment Savings: Typically, bank saving accounts and some forms of investment tend to pay a fixed- percentage rate of interest. Keep in mind that if the annual rate of return (the yield) is less than the inflation rate, the purchasing power of these savings and investments will be eroded over time.


    Cost of Inflation 1978 - 2018

    Inflation has averaged more than 5 percent a year over the past two decades, cutting the purchasing power of a dollar by about two-thirds. With a 5 percent rate of inflation, the buying power of your money is cut in half every 14 years. Here are examples of how inflation can affect the average prices of some common items:


    Year 1978 1998 2018

    House $55,500 $162,900 $478,100
    College $2,038 $7,628 $28,551
    Postage $0.15 $0.33 $0.73
    Car $5,814 $19,499 $65,061
    Posted Nov 24 2006, 03:15 PM by moneycoach with no comments
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  • Quadrant II: Keeping Up With Inflation

    You might have heard the line about how inflation means sitting on your nest egg – but not giving you anything to crow about.

    No doubt about it, inflation is an investor's silent enemy. Its steady, subtle erosion of purchasing power is rarely noticed early. Every year, the money you make will buy a little less per dollar than it did a year ago. Over the years, though, as expenses grow and incomes don't, most people can't help but recognize its cumulative damage.

    What is inflation? Simply stated, inflation is an increase in the general cost of goods and services. Inflation can erode your purchasing power and your standard of living during retirement. To maintain your living standards, your income and retirement plan needs to keep pace with the change in costs. This increase should come from a pool of assets that is also growing or from a pool that is large enough to support your needs without being depleted too soon.

    Inflation can cause considerable harm. Over the last decade, for example, the annual increase in the Consumer Price Index (CPI)—a common measure of inflation—has averaged about 2.44%. Even at this low rate, a car purchased for $20,000 today will cost almost $33,000 in 20 years.

    So how does inflation wreak havoc on our savings?

    Let’s look at some numbers to see just how inflation works. A product or a service costing $100 at age 65 will cost $208 at age 80 assuming an inflation rate of 5 percent between the age of 65 and 80.

    Somehow, you’re going to have to grow your savings to have enough money to pay for inflation. That is, to keep your money ahead of inflation.

    What’s the best way to do just that? For starters, estimate the projected inflation rate that you’ll be aiming for. For instance, selecting an inflation rate of 5 percent or more would be a conservative approach ensuring that any projections you make will not fall short of your retirement goals on account of inflation. An inflation rate of 3 or 4 percent is probably a closer estimate of the average yearly inflation rate. With a lower estimated inflation rate, 2 percent or less, you are running a high risk of falling considerably short of what you will need for retirement income.

    Also remember that, whether you are putting together a savings plan by yourself or with professional help, you should choose the inflation factor that fits the level of risk you are ready to assume in a worst-case scenario.

    To clear things up a bit more, take a look at the table below that was developed by the folks at the financial services firm CCH International. Simply take the amount of money at issue and multiply it by an inflation factor from the table. That will give you the amount of cash that you will need in the future to beat back inflation. To have the same buying power as $1,000 today, for example, you will need $1,280 five years from now assuming a 5 percent inflation rate ($1,000 x 1.28).


    Inflation Factors for Selected Annual Inflation Rate Over a Number of Years
    Years 3% Inflation Rate 4% Inflation Rate 5% Inflation Rate

    5 1.16 1.22 1.28
    10 1.34 1.48 1.63
    15 1.56 1.80 2.08
    20 1.81 2.19 2.65
    25 2.09 2.67 3.39
    30 2.43 3.24 4.32
    35 2.81 3.95 5.52
    40 3.26 4.80 7.04

    Source: CCH Incorporated


    The main thing to remember with inflation is that while the amount of money you have saved for retirement may look fine today, trust me, it won’t be enough. If you’ve saved $100,000 for retirement, for example, you’re going to actually need about twice that to pay for the goods and services that you enjoy today.

    Posted Nov 22 2006, 07:33 PM by moneycoach with no comments
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  • What Kind of Investor Are You?

    Investor, know thyself. See if you recognize yourself in any of the main risk control categories:

    Conservative Investor

    * I want my money safe at all times, and I don't want to lose any of it.
    * Any decline in the value of an investment that I own concerns me.
    * I'm uncomfortable with price volatility (i.e., changes in investment share prices).
    * I want to minimize losses and fluctuation in the value of my investments.
    * I like to invest in something safe that offers a fixed rate of return.
    * I'm willing to give up higher rates of return in order to keep most of my principal intact.
    * I prefer investments that provide regular income without much exposure to principal loss.

    Moderate Investor

    * I want my investment return to beat inflation by at least 2 percent.
    * I select investments that have a moderate amount of volatility, yet offer the opportunity for rates of return higher than certificates of deposit or government bonds.
    * Although a decline in the value of my investments concerns me, I can accept temporary market volatility in return for growth opportunities.
    * I would like to increase the value of my investments moderately, with limited exposure to risk, and I am willing to ride out market downturns.
    * I want a balanced investment mix and am willing to put up with some short-term fluctuation in value.

    Aggressive Investor

    * I like substantial appreciation opportunities, even though it puts my capital at high risk.
    * Temporary market fluctuations do not concern me because maximum appreciation is my primary long-term goal.
    * I expect a return greater than stock market indexes from my investments.
    * I am financially able to accept some limited liquidity in my investment portfolio.
    * I take calculated risks in order to ensure a potential for the highest return over time.
    * I have the conviction necessary to hold on to my investment during those years when it could drop in value by 25 percent or more.

    SOURCE: Rutgers University Co-Operative Extension

    Posted Nov 21 2006, 09:44 PM by moneycoach with no comments
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  • Quadrant I: Safety First

    You’ve no doubt heard of Suze Orman, the popular financial guru with her own TV show, her own syndicated column, and a slew of admiring followers.

    Her advice to investors is simple: rid yourself of debt and spread out your investment portfolio among several different asset classes.

    While Orman doesn’t practice what she preaches on diversification – she keeps most of her money in zero-coupon municipal bonds – she does abhor debt – and hates taking financial risks.

    ''Three or four years ago, I knew that with the income from my bonds, I could have $1 million to $1.5 million tax free, and I thought Okay,'' said Ms. Orman in an interview with The New York Times. ''I just wanted to know that when nobody wanted to buy my books, when nobody wanted to listen to me and everyone said bye-bye, that personally it did not matter.''

    Orman wasn’t always so preoccupied with wealth preservation. In the late 1990’s, Orman, like millions of other Americans was hip deep in the US stock market. But once she began accumulating wealth – real wealth – she decided her best bet was to move the majority of her money into bonds and bond funds.

    While that move could cost you, (bonds traditionally don’t provide a hedge against inflation) Ms. Orman provides a valuable lesson in keeping your money safe. In 1994, she even wrote a book about keeping your money safe, titled “''You've Earned It. Don't Lose It.'' It sold a million copies and suddenly, the concept of keeping your money safe had a global platform.

    I’ll go along with Ms. Orman on the philosophy of keeping your wealth intact. After all, my fundamental rule for everybody in retirement is: don’t lose any money. Rule number two: see rule number one. I’m not saying that you should forego conserving the assets you’ve worked so hard to accumulate in your portfolio – nothing of the sort.

    After all, application of principles is the absolute, cardinal, number one rule for everybody I deal with for retirement. However, too much safety might be detrimental to your portfolio. You may be saving your principal but you may not be saving the preservation of your spending power.

    Consider the example of Carol, who is in her mid-seventies. She is in excellent health. She came into the office of a financial planner I know one day (who told me this story) and said that her husband unfortunately passed away a few years ago. Carol became nervous over losing some money in the stock market, so what did she do? She pulled all of her money out and stashed it in extremely safe investments, like government bonds, CDs, cash, and fixed annuities.

    My friend said, “Carol, God bless you, preservation of principal is the number one rule but you are not preserving your spending power. You should know that there’s a few things that are working against you while you keep your money too safe.”

    He told Carol the first thing she should consider in going the “safety” route is inflation, or more officially known by the government as the Consumer Price Index (CPI index). At the time he spoke with Carol, the CPI numbers were telling us that the current rate of inflation was a little over 4%.

    It’s worth noting that there are certain elements of the CPI index that the government does not include, but are elements, like energy, medical expenses, and prescription medication. Hey, you name it.

    Toss those into the mix and you get a more accurate picture of the inflation rate -- about 7.5%. So Carol, who has her money in very safe investments, is actually losing money every year because the rate of return that she earns on those safe investments is very low. Consequently, she was not staying ahead of inflation.

    Carol is hardly alone. She had worked hard all her life to meet her financial goals. But she lacked one key element in her financial plan - - she didn’t plan for unexpected events, some welcome and others not so welcome. These unforeseen occurrences as well as inflation, unanticipated expenses and taxes can erode the value of your assets. And with longer life expectancies and higher costs of long-term care, securing what you've got becomes critical.

    What keeping your money safe really comes down to is managing risk.

    We’ve all heard the tale of the tortoise and the hare – how slow and steady beats fast and careless just about every time.

    No doubt that is true on Wall Street, as well.

    Don’t get me wrong. I’m not advocating not taking any risk. You have to take some chances – preferably, smart, well-researched ones – if your portfolio is going to grow at all.

    The key to managing risk is to be disciplined with your investment style so that risk doesn’t rear up on its hind legs and swallow you whole. As Warren Avis, the founder of Avis Rent-A-Car once said, “As far as I’m concerned, nothing is worth going broke over.”

    As I have found out in my many years as a Wall Street trader and financial writer, risk can mean different things to different people. At the high end, fooling around with risk can lead to economic disaster. That’s what happened a few years ago when investors of Enron and WorldCom, just to name a few scandal-plagued companies in recent years, found out when company officials played fast and loose with billions of dollars of shareholder money. At the smaller end of the spectrum, investors in Enron and WorldCom who parked too much company stock into their portfolios – without diversifying into broader, safer investment venues – paid a whale of a price when those stocks went into freefall.

    Economists – you know, those pompous types who are never around six months after they said the market would rise 500 points when it actually sank like an anchor – define risk as the volatility or variance in return that is created by market volatility. In plain English, what they’re saying is that your stocks will, given time, move up and down. It’s the “up and down” part that really concerns those of us who want to bulletproof our investment portfolios.

    In other words, lousy risk control usually leads to volatility – the up and down thing – and that can wreak havoc on your portfolios’ performance, cause you untold hours of lost sleep, and turn your usual sunny disposition dour, to the point where Jack the Ripper would give you a wide berth if he saw you walking down the street.

    Posted Nov 20 2006, 03:51 PM by moneycoach with no comments
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  • Know Your Investment Quadrants

    Suppose someone challenged you to drive across the country in two days for a chance to win a prize of $1 million? What would your strategy be?

    Allow me to offer you some suggestions. First, you would get a map to chart the safest and most direct route from the East Coast to the West Coast. Second, you’d leave as soon as possible (the best way to arrive early is to leave early). Third, you’d take a reliable vehicle with a track record of performance and dependability.

    That situation is a lot like investing for retirement. It’s a long journey. You should start with a sound map, in the form of a financial plan, to help you chart the safest and most direct route to your goal. Second, the earlier you invest, the earlier you arrive – in most cases. Third, you should take the most reliable and dependable vehicle you can.

    That’s the thrust of the next few blogs – to guide you to a safe and prosperous retirement.

    Are We Our Own Worst Enemy?

    Let’s face it. No matter where you fall on the financial spectrum, investing for retirement is the most important financial move you’ll ever make in your life.

    Unfortunately, it can also be the most complicated.

    Consider the Baby Boomers – 70 million strong. The Boomers are reaching their retirement years -- the first boomer turns 60 on Jan. 1 – but they don’t seem to be fully prepared for retirement.

    Worse yet, they’re growing more anxious about it.

    A 2005 study - The MetLife Survey of American Attitudes Toward Retirement: What’s Changed? - shows Baby Boomers are increasingly anxious about retirement. The new study reports that the number of Boomers ‘worried about retirement’ has doubled, with younger members, ages 41 to 49, more likely to voice concern.

    "Boomers are placing increasing importance on financial independence," said Sandra Timmermann, Ed.D., director of the Institute. "When asked about their primary consideration for satisfaction later in life, they are just as likely to cite finances as health and are very concerned that they will outlive their money, forcing them to scale back their current lifestyle. Lamenting that they do not have the same retirement security that their parents had with defined benefit pension plans, more and more Boomers do not have a comfortable outlook toward retirement.

    "While it is troubling that Boomers are concerned about finances, perhaps more worrisome is that fewer are taking the steps necessary to ensure financial security in retirement," Timmermann added.

    Only two-thirds (66%) of those surveyed believe they are saving at the rate needed to maintain their lifestyle, a decline from 77% in 2001.

    The Boomers are no different than the clients I see walk through my door every day. They are increasingly aware that the stakes are critically high. They also realize that mistakes made in the years leading up to - and in - retirement, can haunt them for years, if not decades.

    That sets up what I call a retirement planning “quadrant” – four cornerstones to successful retirement planning that, unfortunately, Americans have yet to master. In order, they are:

    • Preserving the wealth you have created (the “keep it safe” factor)

    • Keeping ahead of inflation

    • Avoiding onerous taxes

    • Not outliving your money

    These are threats that seem to be converging on Americans at the same time, much like the rare combination of meteorological events that produced a monster nor'easter with 120-mph winds and waves towering 10 stories high in Sebastion Junger’s best-selling book "The Perfect Storm”.

    You remember the book, or maybe you saw the movie with George Clooney in the lead role. It chronicled the fate of a commercial fishing boat, the Andrea Gail, and the heroic battle its captain and five-man crew waged to survive.

    A true story indeed, the tragedy was, they didn’t survive.

    True, nobody is suggesting that you’re going to drown if you don’t master the perfect storm of financial threats that promises to capsize you. But, the ramifications of not getting your financial house in order in your golden years can be far-reaching.

    Next time we'll begin to examine our four cornerstones so we can better understand the true path to financial security.

    Posted Nov 17 2006, 10:48 PM by moneycoach with no comments
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  • More on Personal Portfolios

    Now that we know how personal portfolios work, what advantages do they give us?

    Let's have a look.

    -- No need to play catch up. With a folio, you can assemble a long-term portfolio quickly.

    -- As a long-term stockholder, you could avoid most capital gains taxes. If you did sell, you could match winners and losers and keep taxes to a bare minimum.

    -- As a stockholder, you can vote in corporate proxy fights.

    -- You can benefit from stock splits and spinoffs.

    -- If you’re a socially conscious investor, you can sell stocks you find objectionable, such as alcohol or tobacco companies.

    While personal portfolios may not knock mutual funds off their perch anytime soon, they’re sure making progress. In 2004, the Boston investment analytical firm Cerulli Associates released a study that said the growth in personal portfolios has outpaced the growth in mutual funds for the previous three and a half years by between 2.5 and 6.7 percentage points annually. Consequently, Cerulli believes that fund companies may take a “if you can’t beat’em, join’em, mentality and begin creating their own folio offerings. While that wouldn’t be good news for the online folio start-up firms that have hit the marketplace in the last two or three years – imagine a Fidelity Investments or a Vanguard Group taking on a small folio company – it would be great news for investors, who would have more personal portfolio choices than ever.

    Granted, personal portfolios aren’t for everybody. If you’re a risk averse investor who is uncomfortable calling the shots, personal folios probably aren’t right for you. Chances are a good index mutual fund would allow you to sleep better at night.

    Correspondingly, if you itch to become a professional trader and want to pull the trigger and trade 10, 20, or even 30 times a day, personal portfolios don’t allow you to do that. For those risk-takers, a solid discount brokerage firm may offer a better alternative.

    But for the average investor who is sick and tired of being kicked around by indifferent mutual fund companies, and who want to take more control over their financial fortunes while paying lower fees and enjoying more tax flexibility, it’s hard to argue with personal portfolios.

    Posted Nov 17 2006, 03:35 PM by moneycoach with no comments
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  • Build Your Own Mutual Fund

    Did you know that you can “build” your own mutual fund, thus giving you even mopre control over your financial future?

    With personal portfolios, you can.

    If you fall into that category, then personal portfolios are certainly worth a look.

    Here’s what they are – and how they work:

    Personal portfolios, also known as “folios” in Wall Street circles, enable average Americans to bypass those high mutual fund fees and awful brokerage commissions and build (and own) their own personal mutual fund. That means choosing the stocks that comprise a fund (usually without the direct help of a financial advisor or money manager, though personal portfolio providers provide help), managing the portfolio, and customizing the portfolio periodically to satisfy one’s own objectives.

    How They Work

    With the typical personal portfolio, investors can buy anywhere from 1 to 50 stocks in a given investment category, pre-selected by the folio provider to meet common investment objectives like growth, balance, or capital preservation. Normally, as in the case of Foliofn, the total amount of stocks you can by is limited to about 3,500 listed securities – roughly 95 percent of the amount of stocks listed on the New York Stock Exchange and Nasdaq. While that number includes the most commonly-traded stocks on Wall Street (like IBM, Microsoft, Proctor & Gamble, and some of the newer, hotter technology and biotechnology companies), it can cost extra – around $15.00 per transaction – to buy stocks outside of the 3,500 listed.

    Typically, investors can trade in their personal folios twice daily, giving them ample – but not unlimited – opportunity to change the complexity of their personal portfolios. Folio providers make investors’ portfolios readily available for easy viewing and updating, almost always in the form of “portfolio tracking” pages on their company Web sites.

    Advantages of Personal Portfolios

    With personal portfolios, investors can manage their folios any way they like. If, for example, tax liability is a big concern for a given investor, he or she can create built-in “triggers” in their portfolios (again, with the help of the folio company) that automatically sell a security or two to meet tax planning objectives and avoid a big year-end tax bill. Try doing that with a mutual fund.

    Companies like E*Trade, Quick & Reilly, and Charles Schwab that market personal portfolios say they give investors the diversification advantages of mutual funds, plus more control over fees and taxes, and the added bonus of direct stock ownership.

    Point by point, it’s hard to argue with personal portfolios. In our next blog we'll take a more detailed look at them, and how they differ from mutual funds.

    Posted Nov 15 2006, 09:55 AM by moneycoach with no comments
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  • Hedging with Mutual Funds

    "Hedge fund" is a phrase coined in the 1940’s. Originally limited to private and unregistered investment pools, these funds used fairly sophisticated hedging and arbitrage practices to make significant returns off of the corporate funds market. In the past, hedge funds were the exclusive playing grounds for wealthy and experienced investors. But, as many things in the investment world are prone to experience, hedge funds have widened their activities to include other financial instruments and activities. In today’s terminology, "hedge fund" is a bit misleading because many of these funds use no hedging techniques at all. Now, a “hedge fund” really indicates a private and unregistered investment pool.

    The first hedge fund was set up by Alfred W. Jones in 1949. In 1952, he converted his general partnership fund into a limited partnership investing with several independent portfolio managers and created the first multi-manager hedge fund.

    Like mutual funds, hedge funds take investors’ money and collectively invest it. The biggest difference between hedge and mutual funds is that, unlike mutual funds, hedge funds are not required to register under the federal securities laws. Because hedge funds usually accept only experience and savvy investors and since their securities are not publicly offered, they are able to bypass registration issues. Some hedge funds are also restricted in the number of investors allowed to join.

    Another major difference between hedge and mutual funds is the amount of regulation required for the protection of investors. Mutual funds are subject to fairly tough regulations that require a certain degree of liquidity, demand that mutual fund shares be redeemable at any time, protect against conflicts of interest, assure fairness in the pricing of fund shares, force disclosure and transparency, limit the use of leverage, and more. Hedge funds are free from these kinds of regulation, which allows them to practice leverage and other sophisticated investment techniques unavailable to mutual funds. Just in case you’re alarmed by the lack of regulations governing hedge funds, they are still required to operate under the antifraud provisions of the federal securities laws.

    Hedge funds are risky, and usually favored by investors who know they can afford their investment losses (although, of course, they would prefer not to). Be wary of them.

    Posted Nov 14 2006, 09:54 AM by moneycoach with no comments
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  • Closed End Mututal Funds

    Some mutual funds, like rare diamonds and luxury cars, have a limited inventory. These are called "closed end mutual funds".

    As opposed to being another category of fund, closed-end funds are a broader grouping of mutual funds that include several fund categories that you can buy into. They are unique, however, in several respects.

    While most mutual funds are open-end, meaning they will continue offering shares as long as they have buyers, closed-end mutual funds have a fixed amount of shares that they can sell to investors. A closed-end fund, or CEF, is publicly traded. An initial public offering (IPO), like the offering to introduce a new stock to the public, is where the CEF begins. The shares then trade like stocks on the American or New York Stock Exchange. The NAV is the price of the fund, like open mutual funds, which is based on the holdings in the portfolio.

    Closed-end funds differ from their open-end counterparts in that by selling a specific number of shares they do not keep growing indefinitely as more investors put money into the fund. Like open-end funds, they have a fund manager who buys and sells stocks, but they remain within the structure and limits of the fund dictated by how many shares there are to sell and at what price.

    Another distinct feature of closed-end funds is that, unlike an open-end fund where you buy or sell your shares with the fund directly, with a CEF you buy and sell shares with other investors. If there is a greater demand for the shares, the market price will rise and you will make a profit. This is called a premium. The market price, less the NAV, will give you your premium earned. You can also sell a CEF at a lower price. In this regard, the buying and selling of CEFs is similar to that of the bond market.

    Since closed-end funds require you either to know when there is an initial public offering or to have a seller from which you can buy, they are bought through brokerage houses, meaning there will be a commission. There are brokers who specialize in closed-end mutual funds.

    Here are some categories of closed-end funds.

    -- Diversified stock funds. Essentially growth funds, these funds invest in a variety of industries. In this category you’ll find large- and small-cap funds, blue-chip funds, and so on.
    -- Sector funds. Like open-end funds, they also invest in one specific industry.
    -- International or global funds. As implied by the name, these funds invest in markets worldwide. Many funds pertaining to individual countries are closed-end funds allowing a certain amount of investing in that foreign market.
    -- Dual purpose funds. These funds sell some shares for capital appreciation and others to provide income.

    There are other types of closed-end mutual funds, and, as you can see, the categories are similar to their open-end brothers and sisters, only the shares are limited. You can get some good discounts on closed-end funds. You can also get in on the ground floor of what becomes an open-end fund, as many do move in that direction at some point.

    Posted Nov 13 2006, 03:38 PM by moneycoach with no comments
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  • Small, Large and Mega Funds

    Large-Cap, Mid-Cap, and Small-Cap Funds

    In the world of mutual funds, cap is another word for capital or size of the company. Large-cap are the major corporations; small-cap are the smaller, often growing companies; and mid-cap are somewhere in between. Naturally, the larger, more established companies will present less risk and are, therefore, a safer investment. Small-cap stocks can take off and often have fared better (although not in 1998 and into 1999), but there is a greater risk since these companies are trying to establish themselves. While some small-caps have become huge quickly, others have moved along slowly or vanished into oblivion.

    Small-caps can sometimes be deceiving because a company that starts out small and continues to grow is ultimately no longer a small-cap company. Yet it still may remain in the fund. After all, why throw out your ace pitcher even though he’s no longer a little league player? E-Trade was a small-cap company found in many small-cap funds, but as it grew and brought the funds high returns, fund managers enjoyed reaping the rewards (as did those investing in the fund), so it stayed.

    Investing in different types of cap funds primarily serves to diversify your investments. You don’t want all of the same sized companies because their success does go in cycles. In 1998, large-cap funds sitting with Coca-Cola, General Electric, IBM, and other giant companies performed better than the small-cap mutual funds. In 2002 (and beyond) it was the other way around. One of the possible reasons is the tremendous growth in investing to a much wider sector of the population. No longer are the “yuppies” and Wall Streeters the only ones seeking out stocks and funds. As more and more people get into the stock market and buy into funds from their home PCs, they may be comfortable buying the larger companies with which they are familiar. There’s nothing wrong with this. After all, unless you’ve taken the time to sufficiently study some new, small-but-growing plumbing supply company, you too might lean toward the more familiar Wal-Mart or Disney. Some small-cap companies, such as those in the technical sector, are also very well-known to a very literate computer population, which is why a company like Intel or Dell Computer can also shine. As the newer online investors become more savvy, they too will branch out from safer, more familiar territory and explore the many growing companies.

    Mega Funds

    In a land where we always strive for something bigger, this is a fund that buys into other funds. Like a bigger fish eating smaller fish, it looks at the smaller funds and lets you diversify your diversification. As the number of mutual funds grows by leaps and bounds, you may see more mega funds buying mutual funds much the way mutual funds select from the thousands of stocks at their disposal.

    Posted Nov 10 2006, 01:20 PM by moneycoach with no comments
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  • Socially Responsible Funds

    Socially responsible” depends largely on the fund manager’s definition of social responsibility. Some funds steer clear of products that use animal testing; many do not invest in companies involved with the defense industry, guns, or tobacco; others concern themselves with child labor issues. Some funds use all of the above or other criteria. You then need to match that with what you consider to be socially responsible and find funds that are earning money. They are out there, but they require that you take time to look beyond the marketing and the numbers of a company.

    Several funds are trying to make an effort to seek out the less socially offensive aspects of business and society in general. Dreyfus Third Century Fund and PAX World are two of the most successful, best-known funds in this area. They are looking for protection of the environment and natural resources, occupational health and safety, life supportive goods and services, and companies that do not sell liquor, firearms, or tobacco products.

    The intentions are good and the funds are profitable. Exactly how closely any of these funds stick to their overall criteria is hard to judge, even while making a concerted effort. While a company may clearly not be manufacturing weapons, they may be inadvertently polluting the environment.

    The Domini 400 Social Index

    The Domini 400 Social Index is the result of the efforts of Amy Domini, an author and a money manager for private clients for a Boston firm. Reviewing the investments of her own church in the 1970s, she found the church was investing in companies that made weapons and realized that they, like most of us, did not know all the branches, divisions, and practices of major companies. She set out to enhance the public’s awareness of the practices and policies of large corporations.

    In 1990 Amy Domini started the Domini 400 as a way of screening four hundred stocks with socially redeeming features. Companies in her 400 listing must have a clean record when it comes to the environment, provide fair treatment to women and minorities, and not be involved with alcohol, tobacco, gambling, or manufacturing weapons.

    While this is a very broad description of “socially acceptable,” the Domini 400 has fared slightly above the S&P 500 over three- and five-year periods. The Domini Social Equity Fund, which uses the Domini 400 as a guide, has returned more than 17 percent in recent years.

    Nonetheless, Domini gets both praise and tough criticism for her efforts. For everyone who believes that she’s taking a step in the right direction, making an effort toward enlightening the public as to which companies are practicing which “vices” so to speak, there are others who find either fault with some of her criteria or find additional criteria to eliminate companies on her index. There will always be a level of debate.

    All in all, social awareness is an important issue, and the Domini Index is making a case for it. Perhaps it will spill over into other areas. Perhaps consumers will simply stop supporting companies that have questionable track records in their hiring policies or in their manufacturing of certain products. Just as there has been an anti-fur movement, people could stop buying products such as sneakers from companies with overseas child laborers or could stop using a leading Internet provider where teenagers regularly discuss sex in chat rooms and pornography is rampant. Social responsibility runs deep if you allow it to. Where one draws the line is a personal decision.

    The “socially responsible” funds have met a growing demand by the public for companies to “get their act together.” The trend toward this type of investing is expected to grow in the future with the baby boomers and post–baby boomer generations looking at more than just the bottom line of financial figures and investing with their minds and their consciences.

    Posted Nov 09 2006, 02:34 PM by moneycoach with no comments
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