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 After five years, the money can be withdrawn tax-free.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 - 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 and Risky Portfolios

They must be pretty smart down in Corpus Christi. I’ve never been there. Judging by the personal finance column that appears in the Caller-Times, H. Swint Friday a professor of finance at Texas A&M University-Corpus Christi with a doctorate in finance and a master's in economics and is a certified financial planner thinks they are. From what I gather, the folks who live there, even the beginners down in Texas take risks.



Corpus Christi Harbor

Mr. Friday, whose column titled Personal Finance 101 suggests some restructuring for your portfolio based on research offered by Harry Markowitz, a mathematical economist. Professor Markowitz, also no slouch in the credit department is also mentioned as the founder of the Modern Portfolio Theory and was involved in optimal portfolio performance research.

We all know what optimal portfolio performance is. Right? No? Without a lot of the mathematical twists and turns, it is the perfect balance of risk. Providing of course you know what kind of risk tolerance you have, which many of us don’t, you can create what Mr. Friday and Markowitz call an M portfolio.

This, at least according to Mr. Friday, is beginner’s stuff. All you have to do is understand that “Higher standard deviation portfolios are more volatile” which I'm sure all of you know.

In all fairness, before he dangles the hope of the perfect portfolio in front of those readers, he does offer some disclaimers. You should be well aware of composition, a nice word that offers up a blend of not only tolerance and wealth but also the intent. The desire for returns, as Mr. Friday writes is not even on the list when investors in Corpus Christi consider building this type of investment.

You would hope that your financial adviser has the sense to pick up on all of these nuances, subtract liabilities and then, calculate what you are worth as an earner. The higher the net pay, the greater the score your financial adviser might give you for your ability to live up to your potential human capital.

“Human capital” is what pensions are all about. Companies were able to exploit your human capital when you were younger and as you aged, offered payment for years of loyalty with a pension for your after-work years. In retirement planning outside of a pension, this carries extra importance. It is why it so critical to get going as early as possible in your working career on building a retirement account to allow compounding to do most of the heavy lifting.

When Mr. Friday discusses human capital, he is looking at the potential for losing everything against the how long your income recovery time is.

Mr. Markowitz’s portfolio research suggests that his M portfolio, after buying risk free T-bills as a hedge against the risk, what the investor should “own to some degree is a mix of all the assets in the world at their respective values in the world portfolio of assets. That is, each asset including oil, timber, gold, silver, beef, art, real estate and so on is included in this portfolio and they are included at their current representative value in the world portfolio. So, for example, if the total value of the world's portfolio is $100 and the total value of the world's oil is $1 then oil would have a 1 percent representation in the M portfolio.”

All you beginners out there get that? Did it offer any of you experts out there something that you might find plausible?



Mr. Friday’s lesson in how to build a portfolio has merit but not for anyone who considers themselves at more than the halfway point of their working career. Such a portfolio would probably do spectacularly considering the rising prices of commodities of late. With demand looking to increase for the world’s limited supply of what looks like a long list of raw materials, even a few that might qualify as hedges against inflation, the average investor would be better off avoiding such risk the way the M portfolio outlines.

But if it seemed like something you just have to try, consider doing it as part of a mutual fund/ETF. One, operated by the noteworthy Jim Rogers comes to mind. According to RCG Alternative Investments site, “The Rogers International Commodity Index (RICI) represents the value of a compendium (or "basket") of commodities employed in the global economy, ranging from agricultural products (such as wheat, corn and cotton) and energy products (including crude oil, gasoline and natural gas) to metals and minerals (including gold, silver, aluminum and lead). As of July 31, 1998, there were thirty-five different contracts represented in the Index.”

This would mean your portfolio, if constructed as suggested, would be based on only two investments: The commodity index (The RICI TRAKRS Index is a total return index designed by Merrill Lynch, Pierce, Fenner & Smith Incorporated and is traded as a Dow Jones Index) and T-bills. I would be wary of that kind of limited diversification no matter how much you made, how risky you felt, or what you estimated your human capital to be worth.

Adding some additional investments and bringing each of those investments down from 50% each to only 10% would give you just enough risk for any portfolio. Both investments are hedges against inflation and although that might seem like a logical place to put your money today, allocating too much of it in both would not give you the long-range options that a balanced risk portfolio would.