Some Retirement Account Suggestions

A recent Boston Globe article offered this: "When millions of U.S. investors open their second-quarter retirement account statements soon they might be disappointed with their dividends, analysts say.

"Most investors will find their stock and bond funds in 401(k) and individual retirement accounts sank between April and June amid skyrocketing fuel prices and a slowing economy." The temptation many fear is that these individuals will begin tapping those plans, seeing the balances as better used for day-to-day living expenses rather than day-to-day expenses in the future.

You should avoid touching that 401(k), now posing more as a 201(k) after recent market turmoil for two reasons: One, if you are well away from retirement (say fifty or below) you are looking at a long time for the markets (and your savings tied to those markets) to recover.

The second reason has more to do with why. If it is for debt relief, then scale back your contribution and use the extra cash towards debt (contribute only what matches). If it is for market relief, reduce the fees in your plan and index your savings. Normally, I suggest index funds be held outside your defined contribution plans for the better tax treatment but with the markets sending mixed signals and more aggressive funds failing to offer fee relief, perhaps the switch would make the losses less painful.

These times do make pensions (defined benefit plans), those antiquated savings stabilizers (like Social Security) look awfully good. I just hope next time some politician suggests privatization, that we remember these trying times.

Where You Live; What you are Worth - Retirement Planning and Credit

Do you live in a state where housing has taken a big hit? Do you live in, near or around a place where credit has all but dried up and foreclosures have appeared like so much acne before prom night?
Have you felt immune to the downside fallout of those events because you pay your bills (and more importantly, your mortgage) on time, have little or no debt and money in the bank?

The credit crisis is about to make itself known to millions of Americans who otherwise would have felt as though all of that bad financial news was not their concern. Even folks who have pristine credit, the very ones who use at it is supposed to be used and were proud of the lending power (credit limit) these credit issuers gave them. You were a good risk.

Lately though, credit card companies are estimating, or should I say, re-estimating that risk and its worth to their bottom line. Bad loan decisions and the overall tightening credit market has forced many lenders to rethink their generosity and with that, how much money you can borrow. What was previously a five figure credit limit on home equity lines and credit cards has been reduced often by as much as 90%.

What can you do?
In most instances, nothing. If the financial institution you do business with decides that there is overwhelming risk in your ability to pay off balances, even if you have done so faithfully in the past, the credit limit can and in many cases, without warning, be reduced. Primarily, this seems to be targeted towards small business owners who rely on those credit limits for business and travel decisions. But it is finding its way into the average person’s financial lives as well.

If there is so much as a hint of financial stress in your credit score, even if you don’t live in a state with a high degree of foreclosures, you will eventually come under scrutiny. Best thing to do is maintain your credit score. Do this by paying your bills on time and by communicating with your lender. In many instances, they would like to assess their risk and remedy the situation to not only their best interest, but yours as well.

They may lower or waive any fees on the account or renegotiate the terms of the current loan. Do this by threatening to shop around. There are some better risk-situated financial institutions willing to lure business away from competitors.

The last thing you can do is reconsider the project you might be starting around the house. Determining the value of a remodel has gotten more difficult with the best changes coming from structural improvements rather than upgrades to living spaces. Exterior maintenance and things like electrical, insulation, and plumbing will be more worthwhile fix-it projects than a new kitchen or bathroom.

Small businesses might reconsider the need for certain business trips in terms of return on that investment of time. In some cases, the credit companies may be unwittingly making a business decision for you.

Retirement Planning: The Annuity as a New Idea?

When the new ideas seem complicated, they are not workable for the average investor/employee. Pensions were simple. You worked and when that long career was over, you were rewarded. The advent of the 401(k), a Wall Street invention unlike any other profit generating idea ever created, was offered to the most captive group of investors, add a little fear of the future and you have the perfect income producing vehicle.

And then, say it could be better. Say it needs to be improved. Say it is not really our fault – we are smart enough just not as logical as previously thought. There are far too many of us not using these tools and far too many potentially profitable fees left uncollected.

Which gives folks like Professor Merton, the John and Natty McArthur University Professor at Harvard Business School and a winner of the 1997 Nobel Memorial Prize in Economic Sciences an opportunity.

Its just too bad Prof. Merton mentioned annuities. He actually had my attention until that point. Perhaps I should begin with the thinking about retirement allocation that he so deftly describes as" "But that knowledge won't qualify you to decide how much mid-cap European stock you should have in your portfolio, any more than it would enable you to perform surgery on yourself." True enough, but removing a splinter is simple surgery; transplanting a heart on the other hand is not.

If knowledge and time truly are the only obstacles - although I believe that the ever complicated financial products that are available are designed to make us feel less than qualified to remove even a simple splinter, then Wall Street should demystify the process.

If annuities were truly the solution, then businesses could once again create a pension with guarantees. Why they don't is quite easy to answer: They do like the cost structure.

Retirement, as we have come to dream about, is a time in life when we can rely on an income that we worked hard for and the time to enjoy it. Granted, this has been redefined with every passing day - each uptick in inflation, each economic downturn and each political misstep with taxes and spending, keep that dream from fully developing.

But I should emphasize that the single biggest drag on any retirement savings is the cost of getting there. We can play "minimum/maximum needed income" games all day but the simplest solution would be to give the employee a financial review on the same day businesses take the time to give them appraisals. Having the employee opt for channeling their next pay raise or bonus into a long-term plan might be all the incentive they need to continue to work harder all while giving the employee a sense that the company is more than just a "gatekeeper" and closer to the good old days of pensions, when the company seemed to actually care about loyalty and rewarded it with a defined benefit.

Now I fully realize that we will never be able to go back to those days, but annuities - an investment/insurance hybrid of dubious nature and questionable need is not the answer.

Taxes and Retirement Planning

As the late George Carlin once said, “the poor are only there to keep the middle class going to work each day.” And so it goes, we are off to work each day, hoping beyond hope to scrap by without having your life’s work stripped away by health insurance costs, lack of creditworthiness and kids and/or parents who are becoming increasingly dependent on your incomes.

And the one hidden menace, lurking in the background is taxes. Sure, I focus a great deal on the influences of the economy at large, the subtle impact of inflation and the political landscape of money, but taxes, the thing that no one likes to admit keeps the public engine running in communities across the country, are about to increase. But will you notice?


On the Local Level
Revenue for state and local governments ebb and flow with the state of the economy. When property values jumped dramatically, taxes tied to the assessed value of those home filled the coffers and made new project planning easier. But as those values decrease, those revenues will still be needed to keep the communities running even if its residents feel as though those taxes would be better kept on their own side of the balance sheet.

Some states are making swaps, using one revenue source to pay for another that may not be doing as well. A good example of these kinds of swaps is cigarette and alcohol taxes increasing as property taxes are frozen (usually at 1-3% of assessed value), capped or cut.

Expect sales taxes, if your state has them, to increase over the next several years. This does help tourist rich cities to capitalize on outside sources of revenue but for the most part, it slows the economic growth by taking spending money from the consumer.

Look for an increase in amnesty programs, events designed to get delinquent taxpayers back into the system using the lure of payment without penalties of late fees.

On the Federal Level

This is the big unknown question. Senator Barrack Obama has made I clear he believe that the families with household incomes exceeding $250,000 should be paying what he refers to as “their fair share”. Investors expect that this group, the ones most likely to support the capital gains tax of 15%, to pay more for the sale of stocks if he is elected. (The prevailing belief is that even if Obama is elected and increases this tax on the wealthiest of families, it would be capped at 28%.)

Senator John McCain on the other hand, is offering much of the same program that has been successful, but only if you ask the right people. Mr. Obama’s plan would force many folks who have not diversified, specifically those with illiquid assets, to do so before the new president takes office.

If Obama gets his way, states and local municipalities would see a huge influx in revenue from tax-exempt municipal bonds. This can be tricky territory though. Some munis trigger the alternative minimum tax (AMT) because they pay interest.

The Effect on your Retirement Plan

Unless you are among the highest wage earners, your approach to retirement planning should be focused not so much on how much is in the nest egg but how much income, less taxes and inflation, will allow you to be comfortable. That number is generally different for each of us and unfortunately is based on a perfect situation (usually calculated without considering taxes and inflation).

Most of us can expect to take home – after retirement – a paycheck that is 30% lighter than we estimate (3% for inflation – modest and hopeful guess, 15 – 20% income taxes on earnings from deferred income sources like pensions and retirement accounts, and 10% on property and local taxes).

That means you will need to save an additional 30% above what you are currently putting away for your future or, lower your expectations on how much you will need.

We can count on one thing: Your elected officials feel your pain but can do little about it. Taxes will not go down no matter whom takes the helm in Washington or at the local level. The best you can do is plan for the worst.

Retirement Planning and Fidelity's Long-Term Care Insurance Estimates

Recently, Fidelity, the mutual fund giant began surveying insurance providers asking how much long-term care insurance you might need to calculate into a retirement strategy, often referred to as a plan. In truth though, it is only a strategy that if followed over the course of a great many years, develops into what looks to be a well thought-out plan. Plans seem so inflexible. (I travel deeply into this jungle in the tenth chapter of the book Retirement Planning for the Utterly Confused.)

Mark Meiners, director of the Center for Health Policy, Research and Ethics in the College of Nursing and Health Science at George Mason University says “Unfortunately, many Americans falsely believe that their long-term care costs will be covered by Medicaid, but this is true only after they’ve spent themselves into impoverishment.”
As I write in the book, “I can tell you two things for sure. Social Security and Medicare will not pay for your long-term care.

“Most insurance companies use a fairly straightforward criterion when making the decision to pay the insured for their claim. The insurer will require a certified and licensed health provider do a determination of “chronically ill”.
“What is chronically ill you ask? Generally this refers to someone who is incapable of performing at least two daily activities of living such as feeding themselves, bathing and toiletry activities or someone who requires substantial supervision. This is often referred to as an ADL or Activity of Daily Living.
“Sounds simple enough but insurance companies rarely have fixed guidelines when it comes to triggering the policy. Policies can be written to cover a variety of care situations and you must determine this at the time of policy execution. Problem is how do you know what you will need. Will your policy need to cover a nursing home stay, of which a portion of the total is reimbursed over a preset time period?”

That said, I think everyone considering this kind of a policy read the book, I will take what Fidelity has suggested and see if it passes muster.

Fidelity recommends that folks considering a long-term care policy narrow the search to six categories, each with its own characteristics.

1) A policy premium that fits comfortably within a family’s financial means.

At first glance this sounds like a relatively easy target but the main problem with retirement and the saving for it, those premiums can eat up a good deal of potential retirement cash. Finding the right balance between saving and tossing the cash to an insurance policy, that is cheaper the earlier you buy it, can be so difficult to determine that most folks who may need it will pass on the chance.

Fidelity writes that, “Investors should carefully forecast their ability to pay the premiums year after year.” I think is both bold and wrongheaded by a mutual fund company to refer to insurance as investment. Insurance is not a liquid asset.

Bottom line: Figure about $200 a month if you are fifty years old, in good health and have prioritized all of your other insurance products based on risk. A 65-year-old might pay as much as $350.


2) Backing by a carrier with a strong track record of paying claims.

I have argued this topic over the past months with numerous people in the field. Fidelity offers this piece of advice: “The ability to receive policy benefits depends on the integrity of the company and its history of financial strength.” This is huge unknown since so few are actually in the position to pay out on claims. Once the baby Boomers retire en masse, it will be difficult to switch policies if your insurer turns out to be financially unable to handle a sudden increase in claimants. Like all insurance products, the gamble is on both ends, with the insurer and the policyholder.

3) Comprehensive coverage that covers in-home as well as facilities-based care.

Fidelity found that families want “flexibility in terms of the services they opt for when facing a long term care challenge.” Remember, this kind of flexibility will cost you extra. Few folks calculate in the inflation factor and/or whether the facility will keep you. Most folks would rather stay at home.

4) A benefit period of at least 2, but no more than 4 years, for each person.

Most people split the difference.

The numbers Fidelity analyzed are not so bad in terms of how they were gathered. But consider this. Most disability policies run for five years. The data they collected “on over 6 million long-term care insurance policies sold between 1984 and 2004, found that 75 percent of all individuals would not have exhausted benefits lasting 2 years. A 4-year benefit period would have been adequate 90 percent of the time.”

Sometimes, companies will separate the policy into nursing home or in-home care coverage but the lifetime benefit is easily calculated by multiplying the benefit times the policy coverage period.

Like many policies that have a wide swath of unknown territory to deal with, such as LTC policies, there is generally a waiting period before the policy kicks in. Because Medicare covers the first one hundred days, many LTC policies do not begin before 90 days. You can request a shorter waiting period but the monthly premium is often prohibitively higher.

5) Five percent guaranteed annual benefit increase except for buyers older than age 75.

Fidelity seems to have little faith in the Federal Reserve’s ability to use monetary policy to keep inflation in check. The 5% mark is well about what the nation’s top bankers deem suitable. Inflation protection usually comes via a rider on the policy. Three percent is usually the norm with the costs of this add-on rising with each percentage point in protection.


6) For joint policies, a “shared coverage” provision that enables each insured person to tap the other’s benefits if necessary.

This may be one extra cost too many.

Now consider the following. You put $180 away in a portfolio with a modest long-term return of 9% and save it for 20 years, taxed at 10% and with inflation calculated at 3%, you would have amassed $56,447. The policy paying $300 would cover only $129,600 in total lifetime cost, which, if you suspect you will be in relatively good health, will leave paying for a policy that may have been just as well been paid for in cash.

If you need cold hard facts... You will need $100,000 in savings at retirement for both you and your spouse to cover health care and insurance. From that point, you should calculate your retirement savings.

I would pass on the LTC if you were planning on leaving nothing to your heirs (but you still need to save much than you are now unless you want to spend those golden years with your kids). But if your heirs are concerned about you spending down their inheritance, ask them to chip in on an LTC policy and then it might be worth the costs.

H is for Honesty - Retirement Planning

We all want honesty, except when it comes to our finances. We desperately want to be told what we want to hear about our retirement plans rather than what we need to hear. And the honesty we look for - or better yet, the lies we would like to be told are as follows:

1. We will have enough money to retire.
I would love to believe that you or any one has this calculated correctly. It seems that each day the free market has the opportunity to do what it does best, the number we have assumed is best case scenario, needs to be recalculated.

2. We will be able to get debt free.
Debt free is a nice goal but debt management is a more honest approach to what your future holds. We use credit at the pumps, in restaurants or any time - and this is just good advice - we lose sight of our credit cards during a purchase. So each month, we need to manage that debt.

3. We will be able to estimate the cost of insurance.
Most of can't do that now. Do you assume that it will be easier on a fixed income? think again. Fidelity suggests that a nest egg of just over a million dollars might be enough to cover your future health insurance costs.

4. Our kids and in some case, our parents will not have an effect on our retirement plans.
If you believe this to be true, you never had kids and/or your parents have since been deceased. otherwise, these two groups will cost you more than you think. A recent New York Times article suggested that inheritances that may have been expected by many near-to-retirement adults can no longer be assumed. For those of us with parents who have no inheritance to spend down, you may be the only salvation for their financial well-being. And your kids...

5. Your investments are not as honest as you once assumed they were.
Look at oil. Look at the stock market. Look at bonds. Look at your tax bill. Need I say more?

Being financially honest with yourself is step one in considering how far you need to go to get to some semblance of retirement.

A is for Asset Allocation

B is for Balance

C is for Continuity

D is for Diversity

E is for (Tracking) Errors

F is for Free-Float

G is for Gross Income

Retirement Planning and the Advice of Professional Money and Investment Planners

In a recent column in the San Diego Union Tribune, a financial planner was enlisted to offer a reader a financial make-over. The goal was to retire at 55, after a divorce, after a recent home purchase, and after racking up a five figure debt with credit cards.

The planner suggested:

"Use emergency savings to pay off debt.

"Decrease monthly retirement contributions from $500 to $300; use the extra $200 to rebuild emergency fund.

"To retire at 55, work part time for 10 years (with a minimum salary of $20,000) and consider selling home and buying a smaller property outright to eliminate a mortgage during retirement.

"Establish a budget to manage current spending habits.

"Revise W-4 form with employer to account for mortgage and property tax deductions; doing so will increase income by $400.

"Take on more risk and diversify asset allocations to maximize returns for the next few years before retirement.

"Look into the purchase of a $1 million umbrella policy as well as disability insurance.

"Have a coordinated will and trust drawn up along with applicable medical directives and powers of attorney."

And because the article allowed for comments, I added the following: "Sounds like her planner needs to suggest the harsh realities. Let's start with her inability to come up with or budget for those property taxes. With a current liability (mortgage payment, which seems to me was adjusted at some point) and a $5,000 a year property tax bill (something that is guaranteed never to decline), Ms. Ventura will not even come close to enough to live on with her pension. If she were to retire right now, with the assets she has, she would have about $300 a week for all of her other incidentals.

"Her planner," I wrote, "wants her to decrease her retirement contribution by 30%, add more insurance, not really retire (work part-time for earning least $20,000 a year - doing what?) and rearrange her asset allocation to get 10.68% a year return (even without the use of index funds, no short term or intermediate bond investment coupled with large-cap and international exposure could hope to get those kinds of returns which so far over the last ten-years hasn't and projecting even optimistically out over the next ten years will).

"And after all of that, he wants her to sell her home.

Why not just keep working until she is 65, put away the credit cards (while continuing to pay them down - which if she took her current personal savings to do would allow her to redirect that $450 to rebuilding that account - which would still have, according to the numbers listed above, well over $13,000 in checking and savings) and budget in another $300 towards the mortgage payments bringing the overall life of the loan down to around fifteen years. This will leave her living tight - like the rest of us - but will also increase the chance that she will have her home when she retires (meaning when she stops working) and might be able to pay for the taxes on the property.

I see no mention of health insurance in Mr. Phelps plan short of a disability policy or an employer sponsored long-term care arrangement. That 403(b) and 457 plan will begin to cover that but if a recent estimate by Fidelity suggests, her savings for insurance in a post-work life will fall short by $850,000.

True, Ms. Ventura is doing better than most but she is going to need to rethink those post-divorce goals. And this is true for many of us.

When we calculate how much we will need, we tend to gloss over numerous factors in an attempt to tailor our dreams to fit. Her financial make-over would have cost her $1,200 and she would not really be any closer to the truth about her future than had she just faced the facts.

One: Divorce changes the whole retirement picture. Ms. Ventura is no exception, she will have to recover much more financially than had she remained married.

Two: The cost of retirement is rising every day, just like everything else. Plan on a 15% increase in those costs, year-over-year. Can she handle that and still retire at 55? Not likely.

Three: There are no guarantees. That employer sponsored pension may falter. Those investments may weaken. That house may be worth less as the taxes on it rise.

The best base calculation she can make: Can she live on half of what she is making now? Because that, for an increasing number of us, is the reality of retirement.

Retirement Planning: Better than Mutual Funds?

Fellow blogger Old School Value cited all of the reasons mutual funds are not for him in a recent post. But many of those same missteps, I suggested could also be attributed to any investment.

The alternative I suppose would be buying individual stocks. How would these six mistakes stack up in such an environment?

OSV suggested the following list of reasons why he doesn't like mutual funds.
1. I looked at the percentage gains and chose funds based on the previous years returns.
How many people buy stocks for the exact same reason. Herd mentality is human nature and mutual funds tend to moderate herd sentiment much better than individual traders do.
2. I chased after rising funds.
It takes quite a bit of investor acumen to resist selling into a rising market and buy one at the bottom. At least the fund will temper the fall provided you didn't invest too specifically.
3. I somehow always seemed to look at "growth" funds.
Who doesn't? Value suggests something that would be too staid and conservative although they do provide a nice income pop via dividends in man instances from companies long past their growth prime. Growth is sexier.
4. I switched between funds like a race driver switching lanes.
If you do this too often it is because you have fallen prey to the re-balance myth. It is okay to review each quarter and research each year, but if you bought a fund based on its long-term history, the tenure of its manager and less-than-sector-average fees it charges, you can avoid switching with each change of the season.
5. I figured a 2% expense ratio didn't affect my investment returns.
Index... If all else fails, index...
6. I had no idea what I or what the mutual funds were doing and I didn't do anything about it.
As do most stock investors. Market shocks come when investors didn't see this or that piece of news coming and were caught unaware. And it can happen to the best mutual fund managers as well but I'd be willing to bet that they will be able to spread those losses much better than the individual will.

For all that is wrong with mutual funds, they are still better than most of us give them credit for.

Retirement Planning: Mutual Funds vs. Annuities

Most of you who have been following my writing and reading my books over the years know exactly how I feel about annuities. I believe that they are an insurance product not an investment, and unless you have absolutely no other choice, should be avoided.

But those calls for restraint sometimes fall on deaf ears. There is, as some point out, too many attractive features despite the downside costs.

Some retirees are faced with a payout in one lump sum as they exit the work place. And because you no longer have a steady and reliable stream of income, immediate annuities provide some measure of how much you have to spend each month.

The downside risks in annuities are something to consider and if you don’t, the attraction these instruments have can be problematic. If you decide to sell the annuity, the escape fees can be sizable although they diminish over time. The costs of managing the underlying investment, which is usually a relatively conservative mutual fund, often comes with higher than industry average fees for similar funds. And should you die early, the money is gone.

There are additional downside risks, even as the annuity industry attempts to convince you that, over time and providing you live a longer-than-average length of time, you could conceivably receive up to 40% more than you would have had you invested in mutual funds without the insurance factor.

One of those downside risks is inflation. Once your income is fixed, it will never increase as time drifts past. Each year it will buy less as the dollars you receive are worth less. To offset these problems, you can of course, add riders to your policy extending the payments to a spouse in the event of your death or even protecting against that inflation factor but these cost money – which is subtracted from – you guessed it – your monthly payout.

Now the mutual fund industry has stepped up its efforts at attracting these soon-to-be retirees with a payout fund, offering regular income checks and the ability to leave the remaining balance to whomever you wish as part of your estate.

But these products come with warning from the very industry that is promoting them. They worry, that the markets could not provide the guaranteed income that the investor might expect and because of that, many fund families are suggesting that you buy an annuity any way. Another major concern that fund offering these payout investments warn about is a change in investment strategies.

Normally, a payout fund will offer a stream of income over a set period of time – 20-30 years. And while your assets may appreciate, they will drop due to regular withdrawals. The money is inheritable should you meet an early demise.

Probably the best suggestion would be to keep your money where you want it in a Roth IRA. You may face the same market-decline possibilities, but the fees (if you choose an index fund) will be considerably lower and that makes all the difference over the long-term.

Retirement Planning and the Financial Professional

What do you do when, according to a recent post by Harriet Brackey of the Sun-Sentinel Tribune, professional advisers gather and one “thinks he can pick outstanding companies and beat the market” while another, “uses many studies to show that no one beats the market for long and so he favors index investments” and another offers an, “in the middle, putting the bulk of his clients’ money into an index-like investment, yet playing around the edges with active stock or bond picking, hoping to goose up the overall return of the portfolio”?

Why does this confusion seem shocking yet at the same time, not so much?

It seems that this group of professionals does not have a unified game plan for their clients for three good reasons.

There is money to made in confusion. If you can keep the theories shifting, the folks who pay for these services believe that they are doing better than their peers - and that brings me to my second point.

We spend far too much time creating benchmarks based on another person's idea of successful investing and retirement planning. Financial planners know this and try to "tailor" your investments accordingly, making them seem so personal.

The guy who suggests his client index should do exactly that. Perhaps a growth index (mid-cap or small-cap) a value index (large-cap) and emerging market and an international index would suit just about every investor's needs. Which makes the financial planner obsolete. Not only will that client save money in fees for the financial planner, they will also be paying less for the funds.

Retirement Planning at 60-years-old

Now is the time to ask the serious questions.

Are you considering what your after-work sources of income will be? Can you live on them now? Take your Social Security payments, any pensions you might receive, and any other source of income from savings or retirement plans, add them together and create a household budget around them. Does this support your idea of retirement?

Can you afford taxes, insurance and upkeep on your home? Is it too big? Will it need major repairs to last until you are eighty, or ninety? Do you still have a mortgage? Have you created equity? Do you have debt?

It is the classic observation that George Foreman made: “The question isn't at what age I want to retire, it's at what income.”

There is an excellent chance that you will still be working when you celebrate your sixtieth birthday. The ability to remain viable and contribute something to the workplace should be worn as a badge of honor. Unless you are working for the wrong reasons.

If you are working because you failed to save enough for the retirement you envisioned, then now is the time to lower those expectations just a little bit. Many of us harbor outsized visions of what we want retirement to be. By age sixty, we will either be disappointed or overjoyed.

Perhaps you have been blessed when better than average health. If so, working beyond what many consider normal retirement age is creating wealth that will make your post-work years more comfortable.

But far too many adults are entering this time of life with less-than-perfect health and worse, the inability to pay for health insurance to cover it – if they have insurance at all.

Debt, and not just mortgage debt, has become a problem among this age group, weighing on their mental well-being and forcing many to work because they have to rather than because they want to.

It is possible that you have more than you think. If you have lived in the same house and built up a good deal of equity – the difference between what you owe and what the house is worth, this might be a solution to your problem. You could downsize, selling the property, satisfying your debts and even creating a small, but much needed nest egg to help with your retirement years.

If you do, you should consider places where the amenities meet your needs. Do you want to be close to your family? For many people thinking about retirement, this is a serious consideration. They want to be near their families, help with their grandchildren and even be closer to their own children.

If you intend to move, ask yourself if there a viable and mixed population present? Recent studies have proven that communities that cater exclusively to seniors do not fulfill many of the social needs of people entering retirement. They like the neighborhoods they live in to have a good mix of people already living there. Businesses often look for the same types of neighborhoods and in doing so, increase the livability of the area.

If you are considering working until you are seventy, you can delay taking your Social Security withdrawals until later. Any retirement savings in 401(k) plans or IRAs will need to begin distributing funds by age 70 ½. Until then, you can continue to make contributions.

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Retirement Planning at 50

If you are fifty right now, you are among the last wave of Baby Boomers scheduled to overwhelm the retirement system, bankrupt Social Security, and tax the health care system of our country as never before.

Unless of course you have subscribed to what author Louisa May Alcott suggests this age should be. She wrote, "Have regular hours for work and play; make each day both useful and pleasant, and prove that you understand the worth of time by employing it well. Then youth will be delightful, old age will bring few regrets, and life will become a beautiful success."

Is it that easy? In most instances, the answer is yes. At age fifty, something you could not possibly have imagined at 20, even thirty-years old, you should have a fairly good idea of what your retirement will look like.

Finding ways to improve what might be an unclear vista are a little harder at this age but far from impossible. You know more financial stuff than you would care to admit, made more mistakes than you would like to acknowledge, and probably regret decisions you have made along the way. No matter. They can all be fixed.

The solutions unfortunately, will be a little more severe because of it but they will not imprison you in a life without some joy.

The plan is threefold. You need to determine how long it will take to get completely debt free. There are lots of websites and blogs out there professing a debt-free existence � which if you are working is just a silly notion. Retirement is no place for a mortgage payment. It is no place for credit card bills. Do the math and find a solution. If you need to see a credit counselor, do not hesitate. Pick a not-for-profit one and stay on the budgetary diet they give you.

Then ask yourself, how is your health? Can you work until you are seventy? If the answer is yes, then begin to save as much money as you can in your employer's tax-deferred account. Remember, seventy is only four to five years beyond our current notion of retirement age. If you have chosen an occupation that allows you to continue working, consider it. If you have a job that will not accommodate you into your seventies, begin to develop some alternatives now.

It is not too late to begin saving in your 401(k) at work. You must structure it differently and contribute a good deal more (the maximum will help you catch-up and the government has allowed for additional catch-up contributions when you reach fifty), but it will prove to be better than not having one.

• What is a 401(k)?
  
• How much should I contribute?
  
• What is an index fund?
  

And lastly, begin looking at your after-work sources of income. These are generally fixed sources of cash. Take your Social Security payments, any pensions you might receive, and any other source of income, add them together and create a household budget around them. Can you live on this amount of money? Can you afford taxes, insurance and upkeep on your home? Is it too big? Will it need major repairs to last until you are eighty, or ninety?

These are hard questions. But you are not without options.

Additional Reading

• Investment News
  
• Retirement Planning Help

Retirement Planning and Financial Professionals

What do you do when, according to a recent post by Harriet Brackey of the Sun-Sentinel, professional advisers gather and one “thinks he can pick outstanding companies and beat the market” while another, “uses many studies to show that no one beats the market for long and so he favors index investments” and another offers an, “in the middle, putting the bulk of his clients’ money into an index-like investment, yet playing around the edges with active stock or bond picking, hoping to goose up the overall return of the portfolio.”

Why does it seem shocking yet at the same time, not so much?

It seems that this group of professionals does not have a unified game plan for their clients for three good reasons.

There is money to made in confusion. If you can keep the theories shifting, the folks who pay for these services believe that they are doing better than their peers - and that brings me to my second point.

We spend far too much time creating benchmarks based on another person's idea of successful investing and retirement planning. Financial planners know this and try to "tailor" your investments accordingly, making them seem so personal.

The guy who suggests his client index should do exactly that. Perhaps a growth index (mid-cap or small-cap) a value index (large-cap) and emerging market and an international index would suit just about every investor's needs. Which makes the financial planner obsolete. Not only will that client save money in fees for the financial planner, they will also be paying less for the funds.

Additional reading:

BlueCollarDollar.com
Investment News

Retirement Planning At 40

By age forty, you should be at least half way through your working career. If you started saving at twenty, you may be two-thirds of the way and may even be focusing on the possibility of an early retirement. But for the sake of discussion, we�ll assume you haven�t even begun to save, that you probably have more than your fair share of debt, are living a life surrounded by family � both kids and parents.

And on top of all of that, you probably suffer from � big word alert! � cognitive dissonance.

Life as a Game show

Television game shows are real life tests of our human nature. In the case of Let's Make a Deal, Monty Hall presented challenges to contestants that tested their risk taking ability. What most of us didn't realize, even as we played along from the comfort of our homes was the behavioral economics problem that was being conducted in real time and with real prizes.

John Tierney, science writer at the New York Times explained what cognitive dissonance is, calling it the Monty Hall game.

Mr. Tierney described a test that was done at M.I.T. by Professor Dan Arley based on the show (which still can be caught on the Game Show Network). Given the choice of three doors, two of which had a goat behind it and one which had a car, the folks playing the game on TV could not determine their odds of winning once Mr. Hall, as he always did, revealed what was behind one of the doors.

Professor Arley, using his students in the experiment, found that they could not determine their chances either. With three doors and three choices, Monty knew we were unable to determine our odds. That made the game difficult to play with any success.

Once Monty opened a door with a goat behind it, he would then give the contestant the opportunity to switch between the two remaining doors.

The students believed that once one door was opened, their odds of having choosing the right door, the one with the car behind it improved. In fact, the opposite was true.

Making the Right Choices

By age forty, you have let this sort of cognitive dissonance get in the way of picking the right door for your own retirement planning. It is human nature and defies rationality and its okay.

If you were given three choices: pay the bills, begin saving for retirement, or rework our everyday finances so we could save more today, we all tend to take calculate our odds incorrectly and fail to make the right choice.

So how do we fix it? How do we make the right choice when we are faced with the day-to-day struggles of just keeping the checkbook balanced, the mortgage paid and the kids fed? It is simpler than you might think.

Here are four simple moves, that if you made them right now will not only get you on the right course, it will help you pick the right door every time.

First: March yourself in to your personnel office, human resource coordinator, or whomever is handling your company's 401(k) plan and sign up.

A 401(k) plan is a tax deferred, defined contribution plan that takes money from your paycheck before taxes are taken out. You determine how much is taken out each pay period, either as a percentage or as a fixed dollar amount. The money is often matched by an employer contribution � up to a certain amount � and is directed to a retirement plan that most commonly uses mutual funds to invest for your future.

Agree to put 5-10% away � I�ll tell you where at the link below � and never, ever, under any circumstances, touch it until you retire.

• What is a 401(k)?
  
• How much can I contribute?
  
• What is the a defined contribution plan?
  
• What is an index fund?
  

Second: If your kids are old enough, tell them where you sit financially. If they are too young to understand, make the commitment between you and your spouse/partner to stop the leaks in your budget. Every penny counts now, as it never has before. Saying it out loud helps.

Third: Consolidate your debt. This could be difficult. If you have damaged your credit score in any way � missed or were late on a payment for example � you may have difficulty getting a good interest rate on a loan that will tie all of your credit problems into one manageable account. Instead, enlist the services of a not-for-profit consumer credit counselor. They can help you get on a plan, talk to your creditors, and get you on the right track.

Fourth: Think about every choice you make, from this point on, in terms of how it will affect your retirement. Each financial decision will have a long-term effect on your retirement plan.

Are you fixing up the house so that you can retire there or do you plan to sell it someday for a smaller property or warmer climates?

Is your health good? (This is by far, one of the most overlooked pieces of your retirement plan. Making it to those later years in good health � well exercised, no smoking, etc., will save you untold dollars in medical costs).

Am I sacrificing my retirement for my children�s college? (With the importance of higher education on potential earning power growing each year, it is hard to turn selfish and say, "sorry, kids, my retirement is more important that the loans you might have to take for school" but if you are at square one, the hard questions need to be asked. And worse, they need to be answered.

All is not lost nor is it doom and gloom. But each passing day with too much debt, outsized pressures on your income and no retirement savings to speak of means your expectations for retirement will need to be lowered.

One last thought. This is an excellent time to begin to develop a second career. Something that you like doing that possibly could provide you a little income after you retire. Statistics are beginning to surface that Baby Boomers are not fully satisfied in retirement unless they have some sort of structure or focus. Developing this now and when you are in your early fifties, acts like a financial safety net as well. It is far more rewarding to work at something you love because you want to, not because you have to.

Additional reading

• Investment News
  
• Retiring with a Plan
  

Retirement Planning: At 30

Retirement planning at age 30 puts you in a unique position. You would have done better had you started saving years ago. And yet, you are still at an age where you can capture many of the same opportunities that you may have missed.

At age thirty, life begins to seem like a game of rock-paper-scissors. You are familiar with the game. Competitors face off against each other, pump their arms and reveal a fist (rock), an outstretched hand (paper) or two fingers (scissors). Best of three wins the contest.

The game is so simple; it has been used to decide court cases and even disputes over works of art. They played it recently on the television show Survivor to determine who would go to Exile Island. Some scientists even suggest that game may govern the equilibrium of the universe.

In your thirties, the wrong move could leave you facing financial set back, one that could take years to unravel. If you are just beginning your retirement journey, you will find yourself in one of three financial positions. You will either have no debt with no savings, no savings and debt, or a family, house, car, and everything that goes along with life at this stage in the game. (Ironically, even those that have started to save, possibly through their work, still fall more or less into one of the three categories.

While the situation is far from dire, you do need to get things together quickly.

If you have no debt and no savings, there are some simple solutions to your retirement plan. Begin to build an emergency account - $25 a week to a money market account with limited check writing abilities is often enough to get started.

A money market account generally pays a higher interest rate than regular passbook savings and checking. Access to the account is often limited to a few checks a year. This limited access but immediate availability make these accounts ideal for creating an emergency savings account

Next, if you haven't done so already, look into beginning to save for retirement with a tax deferred retirement account.

Using your employer's retirement plan, the most common being a 401(k) account (public employees often use a 403(b) account in the same way), you can begin building an account for your future. If your employer offers a match, lucky you.

A match acts like an incentive to save. Offered by your employer, your contribution, up to a certain limit, is matched dollar for dollar.

You need to contribute at least that much to the account. This is free money that is put into your account with your contributions, and when invested and allowed to grow over time, will give you a sizable jump on where you need to be.

• What is a 401(k)?
  
• How much should I contribute?
  
• What is an index fund?

Even if your employer doesn't match your contribution, you should put away 5-10% of your pre-tax income. This money is withdrawn before the taxes are taken out and in some instances, this can actually lower your overall tax by licking you into a lower bracket. The upside to this: it may have very little effect on what you take home.

If you have no savings and debt, a much more common scenario, you can also be saved and surprisingly, without too much pain. It is obvious that you are living somewhat beyond your means. You have financed your lifestyle with money you didn't have.

The simplest way for you to get back on track is to build a spending framework. That's right: a budget.

Budgets act like road maps. They simply give you an overview of where you are now ­ assets (income) minus liabilities (what you owe and to whom) equals how much you have left to spend or save in a given period of time, usually over the course of a month.

Budgets can be like diets and New Year's resolutions. You start out with the best intentions but the changes you have promised yourself to make are often too drastic to achieve. But unlike diets and New Year's resolutions, they are incredibly important for two reasons.

It allows you to see where you are financially. Your money is not working for you if you are servicing debt. Debt comes with a cost and each time you pay interest on debt, you are paying for the use of that money. This exacts a toll on your savings.

Budgets also give you some idea of what it takes to get through the month ­ real dollars. At this stage of life, it is no sin to live paycheck-to-paycheck. We have all done it. Many of us still do.

Paying off your credit cards is easier than you might think. I have developed a simple way called the sliding scale. Here's how it works.

If you have three cards ­ this about average ­ list the minimum payments of each on a sheet of paper. For the sake of example, let's assume that these minimums are $25, $35, and $50. Your plan of attack using the sliding scale is simple. Pay double the amount due on the lowest minimum until that card's balance is paid off.

The payment schedule on the sliding scale would change from $25, $35 and $50 to $50 ($25 x 2), $35 and $50 for a total of $135

This increases your monthly credit card payments ­ something you should make on time and without fail every month ­ from $110 to $135.

Once that card is paid off, put it away for extreme emergencies and roll the $50 payment over to the next minimum. You are still paying the same amount but with one card paid off and the other card getting an $85 payment instead of $35 ($50 from the first plus $35 from the second), you are well on your way to satisfying that card's outstanding balance.

When that card is paid-off, put it away as well. Now, you are paying $135 to the card with the $50 minimum payment. Without taking too much from your budget (just $25 more a month), you have begun to tackle your credit card debt in a meaningful way.

At thirty, however, you might also have a car you have financed, college bills and possibly even a mortgage. A budget will give you the opportunity to see how much money goes where.

If you fall into the last category: family, a house, a car (possibly two) and no savings, it is time to change that. Now it becomes vitally important to begin to use your employer's retirement plan (see the thirty-year old with no savings and no debt), work on living within your means (see the thirty-year old with no savings and debt), and enjoy yourself.

The attitude you bring to life is more important at this stage than ever. You can see the future and have made tentative plans on how you will get there. You need to look forward to forty, and fifty, and even sixty as something worth achieving. Making the right retirement moves now will allow you to move forward with no regrets.

Retirement Planning at 20-years-old

Retirement saving is best done early and consistently. Retirement planning, the roadmap to how you will spend your after-work life is not as easy ­ especially when you are in your twenties.

Alyce P. Cornyn-Selby once wrote, "Procrastination is, hands down, our favorite form of self-sabotage." And who can deny that this is the single biggest hurdle we will need to jump in retirement planning.

As twenty-year olds, fresh out of school, whether it be high school, trade school, or college, we see the world in terms of the here and now. We are young and that youthful exuberance gives us the false sense that time is endless. We are undeterred, full of hope and rich in the belief that time is on our side. And in a way, it is.

We have our first job and with it, our first taste of financial independence. We divvy up our paychecks in terms of what it will buy: x-amount of dollars for rent, transportation, clothes and entertainment and not always in that order. Few twenty-year-olds are able to see the value of saving at this age. There are simply too many opportunities to seize and fun things to experience.

And your retirement plan should not take away from that time in your life. It should compliment it. But there are three things you must confront first before you begin the party that twenty is.

First, you need a financial mentor. This can be your parents, an uncle, aunt, grandparent or even a co-worker. This person will need to be older and wiser than you and someone you can trust.

This person will be nothing more than a sounding board for your financial decisions. They will, if they do the job correctly, play a sort of devil's advocate. Many of the big financial decisions we will make at this age will involve the use of credit. A financial mentor will allow you to ask yourself, while asking them, "do I need this now or can I wait until a time when I can afford it?" They will offer you a look at the mistakes they have made and what they would have done differently. Their experience becomes your lesson plan.

The second element of a retirement plan requires a clear understanding of how compounding works. When I am explaining compounding to beginning investors, I often tell use the story of the "Sultan'.

President Jackson once gave a gift to the Sultan of Muscat (now called Oman) after the ratification of a treaty between the two nations.

The gift was a silver coin with the minted date of 1804 (although the coin was actually struck in 1834) that was "sneaked" out of the country via secret emissary. Remarkably, the coin remained in its original condition for almost 150 years before it was purchased by the family of the late Walter Childs of Brattleboro, Vt. in 1945 for $5000.

The coin was then placed in a vault for the next 54 years. Until, of course, it was auctioned off for 4.14 million dollars!

Despite the "wow" factor of that fortune, many of you would be just as surprised to know, had that $5,000 been invested in a simple index fund that follows the S&P 500 (the 500 largest companies trading publicly in the US), you would have made $400,000 more than Mr. Child's family did when they took the coin to auction.

The key to compounding is beginning small, doing it consistently, and starting early. If your first job offers a 401(k) plan, a tax-deferred investment plan, sign up for at least a 5% deduction. In all likelihood, that small of an amount of pre-tax income will not affect your take-home pay.

• What is a 401(k)?
  

• What is an IRA?
  
  
• What is an index fund?

The last thing you will need to do is avoid using credit for purchases under $500. That's right. Put the cards away until you absolutely need it.

At this level of borrowing, the purchase in more likely to be financed with a fixed rate, more apt to come after serious consideration, and it will probably be more of a necessity than a whim. A purchase of that size is much easier to add to your budget ­ the available money you have to spend on your life¹s necessities.

The best thing you do at twenty is develop a retirement philosophy that let¹s you live within your means ­ cash for everything that costs less than $500 to avoid unnecessary and unsustainable debt. When you do this while investing a small portion of your paycheck each week ­ just a 5% deduction from your payroll, you will be on the right road to retirement. If your employer doesn¹t offer a tax-deferred plan, have $25 a week automatically deposited into a savings account that you can set-up for automatic deductions to an IRA.

We will return to our retirement glossary next week.

G is for Gross Income - Retirement Planning

We continue our look at some of the important factors of a good retirement plan. This alphabetical look at what you need to know continues with a look at gross income.

In Retirement Planning, G is for Gross Income

There are very few downsides to owning a Roth IRA. Of course there is the tax advantage. After five years, the money can be withdrawn tax-free. Unlike a traditional IRA, all of the withdrawals are taxed at your regular income. (The reason for this difference is based on whether the money was taxed prior to deposit – traditional IRA deposits were a deduction from taxes whereas a Roth IRA is funded with after tax contributions.)

A traditional IRA requires you to take withdraws by age 70 ½ (actually the date is April 1st in the year following your 70 ½ birthday). A Roth does not have any such requirements, allowing you to keep the money invested until you need it – if ever. And that “if ever” allows you to pass the Roth IRA on to your heirs who, although they would be required to take distributions, would find the added income from the inherited Roth IRA would be tax-free.

While there is no guarantee that your Roth IRA will grow without set-backs – what you pick for your investments determines the portfolio’s possibilities, the ability to save more is restricted not only by age but by gross income.

Age and Income

Your contributions before you reach fifty-years-old are limited in both the Roth IRA and the traditional IRA to $5,000. But after fifty, the annual contribution jumps to $6,000 with adjustments being made thereafter based on inflation.

But gross income also plays a role in how much you can contribute. More specifically, modified gross income. If you are single, that income cannot exceed $101,000 and if you are married, filing jointly, the income limit is set at $159,000. Modified gross income is calculated using IRS publication 590 (turn to page 61) and does not include any Roth conversions you may have made in the current tax year.

What if you make too much? It is a nice problem to have but to avoid not investing at all, the IRS allows you to make non-deductible IRA contributions. Conversions have income limits as well ($100,000 a year for individual or joint filers – sorry, married filers filing separately re not allowed to convert). But hold onto the non-deductible IRA until 2010 and convert without penalty.

There are still taxes to be paid on the conversion however but they can be spread over the following years (2011 and 2012).

A is for Asset Allocation

B is for Balance

C is for Continuity

D is for Diversity

E is for (Tracking) Errors

F is for Free-Float

Retirement Planning - F is for Free-Float

F is for Free-Float

One of the best reasons to use an index fund in your retirement plan that is modeled on the benchmark S&P 500, besides the low cost is the methodology employed by the index to get the best possible measure of how your investment is doing. While all of the stocks in the S&P 500 are considered large-caps, the way they are capitalized is not necessarily uniform.

The simplest way to determine market capitalization is to multiply the price of the shares times the number of shares. This unfortunately makes the mistake of including shares of stock that are held inside the company and are not available for trade part of the company’s total worth.

A company is only as good as the price of its shares. The more shares that are available to the marketplace, the better this yardstick becomes as a measure. Closely held shares that are literally “off-the-market” blur the overall picture.

By using a method called free-float, the indexes can accurately determine what the true market value of a company is. The S&P 500 uses this method in its index.

Free-float drops those restricted shares, ownership holdings and other blocks of stock not available for the public and considers only the shares that could be traded.

These broad indexes have had a reputation for long-term out-performance. Out-performance is a nice way of saying they did better than funds that are similar and for some very obvious reasons. The high cost of running an actively managed fund means that the actively managed fund must overcome those costs in performance percentages before they can begin to post competitive returns.



A is for Asset Allocation

B is for Balance

C is for Continuity

D is for Diversity

E is for (Tracking) Errors

Retirement Planning - E is for Errors - Tracking Errors

E is for (Tracking) Errors

Indexes play an important role in retirement planning. Numerous people use them for their ease of use and convenience (many are located in your company sponsored 401(k) plans) and most importantly, their low cost.

The index funds that do the best job do so because they excel at penny pinching. And that takes more than just a smattering of skill. They must maintain the underlying portfolio, making moves seemingly in an instant each time the index re-balances (doing so before the rest of the traders increase the price of the stock that was added and deflating the stock that is being sold out of the index).

Any difference between the index’s benchmark and the underlying portfolio is considered a tracking error. These tracking errors are particularly pronounced during an unsettled market. Index fund managers may have enormous amounts of cash sitting idly on the sidelines as the markets adjust to news.

They would like to invest it but they, much like the rest of us, are gripped in fear that where they put their money will be the wrong place. Unsure of beefing up one position in favor of another, the money languishes, largely un-invested, while the benchmark moves ahead in most instances, completely unfazed by these decisions.

Measuring These Errors

Just when you thought all you had to do was buy and index and forget about it, along comes this paradox. But how do determine how much of an error is acceptable? The simple answer is chose a fund that is closest to the benchmark. But in the real world, that fund may not be accessible to you (perhaps it is too costly to buy into to or your retirement plan at work doesn’t offer such a beast). In that case, use this measure.

If over the course of a year – not a quarter or a half a year – your index fund’s return is more that five basis points lower than the return posted by the benchmark, you should consider moving your money.

A is for Asset Allocation

B is for Balance

C is for Continuity

D is for Diversity

Retirement Planning - D is for Diversity

D is for Diversity

Diversity creates more problems for retirement investors than we have space here to count. More than one study has revealed that fear of making the wrong choice stops us from making any choice at all. It is no different when you need to make a choice about which mutual fund to put in your 401(k). The problem is, which fund is the right fund?

Many mutual funds often have default investments for new enrollees. This is a way to get you participating without too much effort. But your employer doesn’t always hire the best fund families to run the plan and the choices might be limited. No problem.

The single greatest way to gain immediate diversification is with an index fund that tracks the S&P 500 index of the largest companies. This Goldilocks index – never too hot, never too cold, but just right – is the perfect investment to use as you begin your retirement journey. Once you learn more about how to make your plan work, you will need to diversify to include an index that tracks the rest of the market.

A is for Asset Allocation

B is for Balance

C is for Continuity

Retirement Planning - C is for Continuity

Retirement Planning: C is for Continuity

One of the keys to getting from point A (your working days) to point B (your retirement days) is continuity. A retirement plan thrives on the steady flow of cash to work its long-term magic. It can never stop.

These days though, a walk down a grocery aisle or a visit to the gas pumps is almost we need to remind us that our dollar is not going as far as it once was. So you might find yourself looking for ways to free up a little extra spending money for the month. You might even find yourself eyeing the 401(k) contribution you make weekly and are seeing that money better spent in the here and now. It is a human reaction to survival.

If you must lower your contribution, limit yourself to the level of your employer’s matching funds or 5%, whichever is higher. This amount will not have an impact on what your take home pay would have been had you stopped participating completely. Keep that money funding your future. One note of caution, try to save more if things improve. You need to pay yourself first and the key is continuity.

Previously:
A is for Asset Allocation
B is for Balance

Retirement Planning - B is for Balance

As we continue our alphabetical look at the wide variety of investment terms that are thrown about - in such a way as to generally assume you know what is being spoken or written - we will look at balance.

B is for Balance

There has been entirely too much emphasis placed on the need for balance. I firmly believe that in order for each part of your plan to work, it needs to have time to develop. Few people are willing to ride market unrest out, constantly tweaking their portfolio of mutual funds to get the same return, quarter over quarter, year over year.

Not only is this difficult for professional money managers, it is nearly impossible for the average investor to do.

There are far more important things to “waste” our time doing. If you follow some basic rules, you will be fine.

Ask The Right Questions

Among the first things you should ask yourself is “why did I buy this fund?” If it was because you found the long-term returns to be in line with your goals, then let the fund manager work out any kinks the market might throw his/her way. Check the fund each quarter but focus on the yearly prospectus. You should also keep those dollars invested. A down market is a buying opportunity for investors who use dollar cost averaging.

What is DCA?

Dollar cost averaging or DCA is one of the single most important ways to build a retirement portfolio. The method invests money each month directed to your defined contribution plan in equal amounts. This allows you to buy more shares of your mutual fund when the price is low and less when the price is high. It employs one of the basic market principles better than most investors would and does it with no effort.

There are several reasons that this works. Suppose the mutual fund you purchased was selling shares for $5. For each $5 you invested, you received a share in the fund. The market, doing what it does best changes based on an innumerable amount of factors. In some instances, this makes the share appreciate, increasing the price and in others, the price goes down.

When the price increases to $7, your designated investment dollars does not see that as a buying opportunity. Your five dollars instead buys only a portion of a share, in this case, only about three quarter of a share. In this instance, it keeps you from buying shares that might be overpriced.

But if the market goes down and the share price decreases to $2.50, your five-dollar investment has bought a share and a half. Investors have a difficult time controlling the desire to buy more when the markets are on the way up and selling when they are declining in value. DCA solves this.

In your Retirement Plan

The idea behind it is simple and is employed with great success in your company-sponsored plan. In those plans, money is automatically taken from your paycheck. If you are using a traditional 401(k), it is done before taxes are taken from your paycheck. If you are participating in a Roth 401(k) it is taken from after-tax dollars.

In both plans, a steady stream of cash is invested for your future. IRA users have some different challenges facing their use of DCA to its best advantage. Often, IRA investors opt for sending their mutual funds a check each month. This allows them to act based on current headlines.

If this sounds like something you are doing, set-up your contribution to be done automatically and write that amount in your budget. This will give you the opportunity to take advantage of all of the magic the DCA offers.

Previously: A is for Asset Allocation

Retirement Planning - A is for Asset Allocation

Today, we begin a look at the alphabet soup that has become investing and more importantly, retirement planning. For most people, the concept of saving is already understood, the downside effects of having debt has been completely drilled in - from every angle imaginable, and the importance of a retirement plan or planning strategy is absolutely necessary to prevent financial disaster when we hit or sixties or seventies.

A is for Asset Allocation

When there is market turmoil, one of the first things you should examine is how well you have allocated the assets in your retirement portfolio. This is no easy task.

If your 401(k) was properly allocated a year ago, before the economy slowed down, with mutual funds that were focused on growing your money and with your risk tolerance in mind, you will be fine. Fundamentally, not that much has changed.

Smart investors know they need to give their portfolios twelve months to fully utilize the plan. History has shown that with time, many of the imbalances that have a stranglehold on the markets will loosen their grip and things will return to normal.

Hold tight, time will come to the rescue.

What is asset allocation?

How those assets are positioned in your retirement portfolio however is a different matter.

In a retirement plan, asset allocation takes on a different meaning. In your portfolio, you should have basket of mutual funds that focus on different parts of the market. This method of investing protects you from swings in the market that is often specific to one group of investments. The markets rarely fail altogether.

The most recent example of this happened in early 2008 when the stocks of banks and other financial institutions began to falter. The most famous was the failure of technology stocks in 2000. Had you not allocated your assets properly, you would have felt a greater loss than the market as a whole did. Asset allocation protects you from this.

The Right Mix

In order for asset allocation to work, you need to determine two things: your age and your risk tolerance. Age is not so much a reference to how old you are but how far off in the distant or near future your retirement is.

Your risk tolerance is a reference to how much of your investments you are willing to put to the test.

If you are in your twenties, it is generally assumed that you should be the most tolerant of risk, investing in growth mutual funds and able to overcome any short-term problems.

Allocation assets becomes much more important once you reach forty, beginning to temper your risk and protect some of your assets. By age sixty, you should be investing a conservative mix of stocks and bonds.

How to get the Right Allocation

Perhaps the simplest way: invest in target funds that save for a future retirement date. These types of funds gradually change your assets over the years, essentially re-allocating for you.

Retirement Planning and Your Personal Finance Skills, Part Three

Personal Financial Literacy Quiz:

(Answers and explanations by me are at the bottom of the page)

21. Matt has a good job on the production line of a factory in his home town. During the past year or two, the state in which Matt lives has been raising taxes on its businesses to the point where they are much higher than in neighboring states. What effect is this likely to have on Matt's job?

a.) Higher business taxes will cause more businesses to move into Matt's state, raising wages.

b.) Higher business taxes can't have any effect on Matt's job.

c.) Matt's company may consider moving to a lower-tax state, threatening Matt's job.

d.) He is likely to get a large raise to offset the effect of higher taxes.

22. If you have caused an accident, which type of automobile insurance would cover damage to your own car?

a.) Comprehensive.

b.) Liability.

c.) Term.

d.) Collision.

23. Scott and Eric are young men. Each has a good credit history. They work at the same company and make approximately the same salary. Scott has borrowed $6,000 to take a foreign vacation. Eric has borrowed $6,000 to buy a car. Who is likely to pay the lowest finance charge?

a.) Eric will pay less because the car is collateral for the loan.

b.) They will both pay the same because the rate is set by law.

c.) Scott will pay less because people who travel overseas are better risks.

d.) They will both pay the same because they have almost identical financial backgrounds.

24. If you went to college and earned a four-year degree, how much more money could you expect to earn than if you only had a high school diploma?

a.) About 10 times as much.

b.) No more; I would make about the same either way.


c.) A little more; about 20% more.

d.) A lot more; about 70% more.

25. Many savings programs are protected by the Federal government against loss. Which of the following is not?

a.) A U.S. Savings Bond.

b.) A certificate of deposit at the bank.

c.) A bond issued by one of the 50 States.

d.) A U. S. Treasury Bond.

26. If each of the following persons had the same amount of take home pay, who would need the greatest amount of life insurance?

a.) An elderly retired man, with a wife who is also retired.

b.) A young married man without children.

c.) A young single woman with two young children.

d.) A young single woman without children.

27. Which of the following instruments is NOT typically associated with spending?

a.) Debit card.

b.) Certificate of deposit.

c.) Cash.

d.) Credit card.

28. Which of the following credit card users is likely to pay the GREATEST dollar amount in finance charges per year, if they all charge the same amount per year on their cards?

a.) Jessica, who pays at least the minimum amount each month and more, when she has the money.

b.) Vera, who generally pays off her credit card in full but, occasionally, will pay the minimum when she is short of cash

c.) Megan, who always pays off her credit card bill in full shortly after she receives it

d.) Erin, who only pays the minimum amount each month.

29. Which of the following statements is true?

a.) Banks and other lenders share the credit history of their borrowers with each other and are likely to know of any loan payments that you have missed.

b.) People have so many loans it is very unlikely that one bank will know your history with another bank

c.) Your bad loan payment record with one bank will not be considered if you apply to another bank for a loan.

d.) If you missed a payment more than 2 years ago, it cannot be considered in a loan decision.

30. Dan must borrow $12,000 to complete his college education. Which of the following would NOT be likely to reduce the finance charge rate?

a.) If he went to a state college rather than a private college.

b.) If his parents cosigned the loan.

c.) If his parents took out an additional mortgage on their house for the loan.

d.) If the loan was insured by the Federal Government.

31. If you had a savings account at a bank, which of the following would be correct concerning the interest that you would earn on this account?

a.) Earnings from savings account interest may not be taxed.

b.) Income tax may be charged on the interest if your income is high enough.


c.) Sales tax may be charged on the interest that you earn.

d.) You cannot earn interest until you pass your 18th birthday.

ANSWERS: 21) c; 22) d; 23)a; 24)d; 25)c 26) c; 27) b; 28) d; 29) a; 30) a; 31) b

Part One

Part Two

Retirement Planning and Your Personal Finance Skills, Part Two

Beginning a retirement plan is right at any age. The younger you start, the better off you are. But it is often the small financial mistakes we make every day that inflict the most damage, often years down the road. If you are close to retirement, offer this to your children. If you are years away, these questions should hold even more importance.

In her incredibly interesting fiction "Special Topics in Calamity Physics", Marisha Pessl suggested the following observation about imminent futures: "A person's life is nothing more that a series of tip-offs of what's to come. If we had the brains to notice these clues, we might be able to change our future." The quote was credited to Dr. Fellini Loggia, but I'm not sure he exists - it is fiction.

The Fed's Personal Financial Literacy Quiz:

(Answers with explanations - from me- at bottom of page, part three comes later this week.)

11. Sara and Joshua just had a baby. They received money as baby gifts and want to put it away for the baby's education. Which of the following tends to have the highest growth over periods of time as long as 18 years?

a.) A checking account.
b.) Stocks.
c.) A U.S. Govt. savings bond.
d.) A savings account.

12. Barbara has just applied for a credit card. She is an 18-year-old high school graduate with few valuable possessions and no credit history. If Barbara is granted a credit card, which of the following is the most likely way that the credit card company will reduce ITS risk?

a.) It will make Barbara's parents pledge their home to repay Karen's credit card debt.
b.) It will require Barbara to have both parents co-sign for the card.
c.) It will charge Barbara twice the finance charge rate it charges older cardholders.
d.) It will start Barbara out with a small line of credit to see how she handles the account.

13. Chelsea worked her way through college earning $15,000 per year. After graduation, her first job pays $30,000. The total dollar amount Chelsea will have to pay in Federal Income taxes in her new job will:

a.) Double, at least, from when she was in college.
b.) Go up a little from when she was in college.
c.) Stay the same as when she was in college.
d.) Be lower than when she was in college.

14. Which of the following best describes the primary sources of income for most people age 20-35?

a.) Dividends and interest.
b.) Salaries, wages, tips.
c.) Profits from business.
d.) Rents.

15. If you are behind on your debt payments and go to a responsible credit counseling service such as the Consumer Credit Counseling Services, what help can they give you?

a.) They can cancel and cut up all of your credit cards without your permission.
b.) They can get the federal government to apply your income taxes to pay off your debts.
c.) They can work with those who loaned you money to set up a payment schedule that you can meet.
d.) They can force those who loaned you money to forgive all your debts.

16. Rob and Mary are the same age. At age 25 Mary began saving $2,000 a year while Rob saved nothing. At age 50, Rob realized that he needed money for retirement and started saving $4,000 per year while Mary kept saving her $2,000. Now they are both 75 years old. Who has the most money in his or her retirement account?

a.) They would each have the same amount because they put away exactly the same
b.) Rob, because he saved more each year
c.) Mary, because she has put away more money
d.) Mary, because her money has grown for a longer time at compound interest.

17. Many young people receive health insurance benefits through their parents. Which of the following statements is true about health insurance coverage?

a.) You are covered by your parents' insurance until you marry, regardless of your age.
b.) If your parents become unemployed, your insurance coverage may stop, regardless of your age.
c.) Young people don't need health insurance because they are so healthy.
d.) You continue to be covered by your parents' insurance as long as you live at home, regardless of your age.

18. Don and Bill work together in the finance department of the same company and earn the same pay. Bill spends his free time taking work-related classes to improve his computer skills; while Don spends his free time socializing with friends and working out at a fitness center. After five years, what is likely to be true?

a.) Don will make more because he is more social.
b.) Don will make more because Bill is likely to be laid off.
c.) Bill will make more money because he is more valuable to his company.
d.) Don and Bill will continue to make the same money.

19. If your credit card is stolen and the thief runs up a total debt of $1,000, but you notify the issuer of the card as soon as you discover it is missing, what is the maximum amount that you can be forced to pay according to Federal law?

a.) $500
b.) $1000
c.) Nothing.
d.) $50

20. Which of the following statements is NOT correct about most ATM (Automated Teller Machine.) cards?

a.) You can generally get cash 24 hours-a-day.
b.) You can generally obtain information concerning your bank balance at an ATM machine.
c.) You can get cash anywhere in the world with no fee.
d.) You must have a bank account to have an ATM Card.

ANSWERS: 11) b; 12) d; 13) a; 14) b; 15) c; 16) d; 17) b; 18) c; 19) d; 20) c

Part One of the Fed's Personal Finance Quiz can be found here as well.