If You're asking "now what" perhaps an Investment Plan

I've been away a couple of weeks on hiatus but is seems there is nowhere in the world you can escape the marketplace concern. We have turned into a nation of economy-watchers. It's as if the voyeuristic nature of simply gazing helplessly, frozen in place or prompted by muscle memory, should force us to make investment, retirement and personal finance decisions right now even though we might just regret them at some point in the future. So I offer you a four part series on what we should do in the coming weeks as we anticipate that the previous weeks will give us more of the same.

So we begin with Now What Retirement

Believe it or not, some people, the true Boomers are actually on track for retirement. Right on the cusp of making the decision is quite possibly the wrong time to make most difficult one you will ever make. You may have second guessed your investment strategies over the last several years but had you been closer to what we consider traditional retirement age, those choices became fewer. And harder.

In fact, had these Boomers been preparing as they should have, sitting on their well-diversified portfolios and riding out the downturn in 2008 until the present, they may have actually found inaction more fruitful than shifting gears - gears that should have been set for low in the first place. And now, as the market roils for what looks to be another rise, dip and with any luck, rise again in the coming months, the nearest retirees need to make choices that are just as prudent as they are. For those of you who are not ready but at that age, the sooner you answer the following questions, the closer you too will get to the point.


What to do with your 401(k)? For this person, the choices are relatively narrow with consequences on each decision possibly impacting their income decades down the road. To leave your money in your old employer's 401(k) might be a good idea if your old employer has a good plan. They may have low cost fund options and on the other hand, have higher than needed administrative costs. If your plan had the foresight to include an annuity and you are a woman, this quasi investment (part mutual fund/part insurance plan) will give you a relatively clear look at your future income based on a unisex life expectancy. (Annuities bought outside your 401(k), will cost a woman more because of the expected longer-life span for women as compared to the same age man.)


And if I have to rollover? In most cases, you will be jettisoned form the plan which means you now have to make the choice. If you are a man, the decisions you make should always include "what if I die first" as the ultimate determination of how you take money from your retirement plan. For women, the consideration should be less about what your spouse may or may not do but what you should do should he make the wrong choice. You will need to protect your life first, and doing something that goes against your very nature: putting everyone else second.

Once again, you will consider the annuity. But you probably shouldn't commit your entire nest egg to it. You will need access to cash and keep that money invested at the same time has been the hardest job seniors have had in the low interest rate environment we have right now. A 10-year Treasury, based on inflation at its current levels, is actually considered a loss. So you will need to keep some of your money invested, perhaps across low-cost index funds.


Does Debt have an impact? It will be tempting to use this payout to get your retirement debt in order. This is generally not considered a good option unless that debt is so large that it will saddle you for the rest fo your life. On a fixed income, a debt counselor can construct a good plan and get the process moving along quicker and more efficiently. Keep in mind, you may love the house or condo you live in, but if the debt from trying to own it is too high, a debt counselor will tell you what you can't admit to yourself. If you overpaid for your home and do not expect to live long enough to recover your payment and equity, the counselor should be able to help with this as well.

Without debt, your home may be the single greatest retirement safety net you have. But don't use it until you are actually about to fall. Tapping the equity in advance of when you might have an emergency need is foolhardy in most instances. Wait as long as possible. Involve your children and your attorney (who has your will) and if you have one, a financial planner. You'll need experts.


Should I take Social Security? As to Social Security, take it when you need it. Experts are telling us to wait as long as possible. And it is sage advice. But if it is possible to take it, save it and return it at full retirement without having spent it, you can upgrade your monthly payment to the full payment due at full retirement. But you have to save it. And even if you don't, you now have the emergency medical account you might need is the interim. But if you can do it, don't calculate this income until the last possible minute. Ladder your retirement income so as to get an economic boost every several years with Social Security withdrawal being the last step.

And don't become frustrated with the argument that you could have done more. We all could have. But regret doesn't solve the issue at hand: dealing with what you have is the most important job right now.

So take your eyes of the news. Long-term issues are rarely reported on any channel. They just aren't sexy. If this reality is difficult to imagine, live the sixth months before you retire on half of your current income. Can't seem to do it? Then you need to rethink how much you will need, in part because for most retirees, even if they are beginning retired life with 75% of their current income, inflation, taxes and health care considerations will soon bring it to fifty percent. So calculate from there.

Next up: now what investments


Paul Petillo is the Managing Editor of BlueCollarDollar.com/Target2025.com

The Vote on the Debt Ceiling Doesn't Matter: 5 Thoughts

As we have watched the slow slog towards August 2nd and the expiration of the debt ceiling, there are a few things we should consider in advance of that date and a couple of additional thoughts in the days immediately following. Like most things, the debt ceiling expiration date is mostly arbitrary, much like the turning of a new year or the end of a quarter. In other words, 08.02.11 means little to the average person and in the days following, should not be of much concern. Here's why.

Borrowing: We have been in one of the most favorable borrowing environments since records began being kept. If you qualify for a loan, be it a home mortgage or other big ticket purchase, the date will not change your ability to borrow. It may cost you more but prudent borrowers should have already considered this eventuality prior to beginning their purchase. Interest rates may and probably should go up if an agreement isn't reached. The phrase "lock-it-in" will be considered sage advice as it should be. On the flip side, there is little likelihood the seller of whatever big ticket item you are purchasing may just offer additional financial incentives to offset any increased borrowing cost.

Selling: An increase in interest rates would not benefit those who believe their homes are worth a certain amount. It would stymy the housing market, slow the sale of automobiles and create a situation that most retailers have been dealing with already: more saving than spending. While less spending will not get the economy moving and certainly won't create more jobs, despite the argument in Congress that less spending has the opposite effect. We'll just be stuck in neutral for longer than we had hoped. But not as long as many suggest we will.

Markets, Bonds: If you are a conservative investor with money in bonds, you are much smarter than the media gives you credit. Savvy bond investors ladder their holdings for just such an event and will probably fair well. Yes, the foreign investor might become a little more cautious and the next Treasury auction will be weaker than most hope it will be. But over the long-term, the real reason folks hold bonds, the effect will be offset as time moves on. Yet, if you are in bond mutual funds, you should have little to worry about as long as your holdings aren't too much of your portfolio. If you're older, cash might be a better place in the interim.

Markets, Stocks: More than one person has suggested getting into much safer investments before the 08.02.11 deadline. Cash is okay but if history tells us anything, this might be amongst the worst long-term decisions you could make. Most companies could borrow if they needed to no matter what happens. But why bother. Most of the corporate debt has been refinanced to historically low levels. And most companies in the S&P 500, an index of the largest companies in the country, are flush with cash reserves. That has been the most worrisome part of the recovery: businesses could have hired, they could have afforded to hire but they didn't. Selling stocks even if they dip somewhat should provide an opportunity to buy shares that are worth more for less. If you are buying steadily, this should prove an advantage for those with time.

You: Turn off the television or change the channel. None of what you are hearing, none of the talking heads everyone is trotting out means anything. The politicians involved in the debate are saying little or nothing and in many respects, act like this is the first time such an event has ever happened. Personally, the President should simply invoke his right in the 14th amendment and raise it without Congress. Yes, it will cause an uproar and yes, it would be the right thing to do. But creating tension among the American people is not a solution to solving some of the nation's biggest concerns.

In the three years since the Great Recession began, you should have put all of your plan in place: reduced your personal debt, created a modicum of savings and in the process, increased your contributions to your retirement plans. If you haven't, this will probably send the message again that your wealth is not what Washington thinks it is. You should be much more pliable and hopefully, just a tad smarter - or jaded.

Paul Petillo is the managing editor of BlueCollarDollar.com/Target2025.com

Throwing Your House into Reverse: Not a Mortgage for Everyone

American dream or not, the games you may have once played with financing your home are not available for the vast majority of homeowners. And there is no doubt that this a good thing, a lesson learned that was far too painful but often, those tales are. But there is another game afoot in the world of mortgages, even as the largest lenders pull the plug on the process: the reverse mortgage.

Most of us don't envy those who are toying with this option. We know two things about these folks: one they own quite a bit of their house, referred to as equity and two, these homes are owned by cash-strapped people older than 62.

The reverse mortgage is a rather simple product with relatively simple goals. Because those who are considering this option are often older and in possession of much of the house they live in. This pool of cash is a very tempting option to a fixed income or one where retirement savings no longer is able to keep up with the cost of living. There are a variety of reasons they may need to tap this cash in their homes from medical bills to simply poor money management.

So the concept of tapping some of that equity is quite appealing. A reverse mortgage essentially gives you the money that your house is worth. Ron Lieber recently visited this topic in the New York Times explaining "reverse mortgages begin with a lender that is willing to pay you instead of you paying the bank. How much you get depends on your age, prevailing interest rates and the amount of equity you have in your home. The payout may also depend on whether you choose a lump sum, a line of credit, a regular payment for as long as you live or a regular payment for some fixed number of years."

The problem is getting a lender to do that. Many of the biggest banks have pulled away from offering the product, not because they don't think it is a good idea. But because those they lend the money to tend to fall behind on key elements of the loan agreement: paying taxes and keeping the house in sale-able condition. Aside from a check with the feds, there is no credit check on the applicants.

So banks, seeing the issue of foreclosing on granny because she opted for the lump sum payout and failed to keep current on those obligations have decided the bad PR will come with too steep a price. So enter the second and third tier lenders who will, without a doubt fill the void.

This could create several issues. The first would be fewer loans or on the flip side, loans that revert back to why this type of mortgage got its bad rep in the first place. Fees will be higher in a space with fewer competitors. Elderly will sign more complicated documents that will force them to maintain a fund for emergencies - which on the surface isn't a bad thing but could turn turn out to require higher funding balances than needed, leaving the reverse mortgager with less cash for the effort.

Another issue might be in how your heirs feel about the whole process. Often, parents,who may have mentored their children on the subject of money and financial prudence and who now find their finances in need of some review, may not be willing to or may be too embarrassed to ask for help. If there is no dialogue, the whole process might come as a surprise for kids who thought that house would eventually become part of the estate. And once these second and third tier lenders begin the process of foreclosing, it is often too late for the children to step in to help.

There are some key things to consider here. The first is what options do your parents have? Can they downsize? If not, can you talk to them about the options? Often this conversation needs to happen but it also needs to approached with great care and consideration. But once the barrier has been breached, you can move to include yourself in their financial affairs before it is too late.

This is also some tricky water to navigate. But the effort is worthwhile. If they need the money, and many older Americans will, attempt to get them to allow you to help budget the funds. In the future, HUD will probably set rules about creditworthiness and because many older Americans have little or no recent credit history, this might prove an obstacle at a time when they are already facing one too many. Helping them build some creditworthiness will enable them to be in a better position - with your help - to get the best deal possible.

Once you have gained their trust, you can include your input with their financial planners, with their attorneys and possibly with their medical doctors, all of whom may not be able to tell you what their clients or patients are deciding. You can take control of the vital payments that need to be made and keep things in good financial order.

So this summer, take a moment when visiting your parents or grandparents and have the discussion. And while you are at it, consider a plan to pay off your mortgage as well. (You can find recent articles about this topic here.)

The Weight of Indexing

Even simple is no longer so. And when it comes to index funds, that often suggested answer for everything an investor should do but doesn't, the boringly mundane investment that tracks rather than participates, the it-beats-actively-managed-funds choice of the passively prone, there are now choices. There have been for years in the form of exchange traded funds (ETFs) sold as shares of stock on the open market. But this might be different in ways that deceive rather than simply suggest there are nuances.

Index funds rely on the ability to price securities efficiently. Unfortunately, the markets are not as efficient as they should be with investors often making decisions that make little sense when it comes to determining what a security is worth. And when those bad decisions are made, other investors follow. But that flaw can be overlooked in favor of the low fees (no trading means no costs unless the index changes), low turnover (no trading means the portfolio stays intact) and good diversification (spread out across a wide swath of the market).

Yet if it were only that simple. Those low fees can vary wildly over various index funds and those same index funds may appear to be the same. Buy an S&P 500 index fund you so often hear experts suggest and although they make no effort to hide the average-ness of this investment, in fact, heralding its mundaneness as the very reason you should buy it, that isn't enough.

Traditional index fund are market weighted. This simply means that these funds have holdings that are based on the amount of investor dollars each holds or the company's capitalization. The top 10 companies in an index fund often make up the lion's share of the invested index (20%). So if a market swing like the one that happened in 2008 occur, the whole index stumbles, brought down by the behemoths at the top. That can be problem and it can impact the investor's interpretation of average.

So enter the revamped index fund. The "alternate-index" fund hopes to realign the weighting in these funds to equal, offering the investor an equal share of every stock in the top 500. That means that the largest stock would only get 0.2% of the invested dollar while the stock on the cusp, the one that barely has a presence in the weighted index, would also have 0.2%.

These funds hope to keep the image of low cost and low turnover (considered a tax advantage) in place. By equally weighting the fund, the goal is to outperform the weighted index. There are other entrants to the index world, all hoping to take advantage of what is seen as flaws. That's right, in order to sell the idea that one ndex fund is different than the other, you must point out why.

The alternate index fund arena has spawned other types of funds that offer indexed stocks based on the dividends they pay or even the earnings they post, sometimes even as a combination. The chase to out-perform might seem like a worthwhile idea, but the reality is quite different. When you begin to slice these indexes in different fashions, you expose different opportunities for volatility. And keep in mind, this is the stock market we are talking about.

Unlike their weighted brethren, many of the alternative-index funds rebalance more often due to shifts in stock prices. They also benefit over traditional index funds when the marketplace favors the mid-sized and small-cap companies in the index. if the investor is seeing opportunity in smaller more nimble members of the index, the index does better. Quarterly rebalancing shifts the index back to its 0.2% of each strategy but in doing so, sells winners (losing the tax advantage somewhat and increasing turnover during incredibly volatile times).

Are these worth a look? Possibly if you believe the value will remain in the smaller and mid-sized members of the index. If you are anticipating a large-cap rally, the the traditional index fund will prevail. The question is: do downturns such as the most recent one favor one or the other? In terms of raw numbers, yes. When the markets stumble in tandem, the alternative-index funds tend to do worse, even with a mostly short-term record. But even though the fall is equally as difficult to stomach, it is the recovery that most investors focus on. And during a recovery, the alternative-index fund tends to do better.

Just when you thought the index fund was your friend, it turns out that it has a split personality. Does this mean you should avoid index funds? Not at all. In fact, if you do want to own them, I suggest (which is different than advise) you do so in a Roth IRA rather than in a 401(k) type of account. Their tax efficiency is not worth the trouble in a tax-deferred account as long as capital gains taxes remain low.

Boomers: As you turned 60, Your 401(k) turned 30

It seemed like a good idea. But you have to consider where we were in terms of retirement when the line in the tax code was uncovered. We had pensions and companies didn't much like the idea. These defined benefit plans were designed to keep employees in one job over an entire career and add to that, they were costly and unpredictable. For the employee, the time needed to vest was often long, sometimes as much as ten-years, and the pension once vested, although it was yours, could not be brought with you should you find a better job somewhere else.

The pension also represented the ability to increase your retirement income as your pay increased. This trade-off from human capital in the first years of employment to retirement capital in the later years, made the company liable for the investments and the guarantees that the money would be there. Higher paid workers, often in much higher tax brackets than we have today, were allowed to also save money after those taxes.

When Ted Benna found this line in the tax code (section 401(k) 30 years ago, he realized that this was the answer to what his higher paid clients were looking for: the ability to put money away on a pre-tax basis and if the company so chose to do, it could match those dollars. Business saw this as a way to shed those obligations of managing their pensions and shift the obligation of retirement to the employee.

Sure, the company said, we'll help. We'll hire some experts to set up a plan, we'll load it with a bunch of investments and we'll act as fiduciaries. Heck, they said, we'll even provide the incentive of a match - even though these companies would lace it would all sorts of caveats much like the vesting period of the pension. Yet it would, in their minds, be the answer to a question they had not asked but possibly should have.

Even better, these new plans would be portable. You could take the money you had put aside with you when you left. Once again, this was more a win for the company than the employee, who often left before they got the fully vested match and was forced to roll the money into their own IRA. The fully vested match is often something that happens over time, sometimes as long as ten-years, more commonly over five years.

It can work in a number of ways and this information is part of the Investment Policy Statement that every plan has and few people read. During your first year, you might get the company match - in theory - but if you were to leave, it would not go with you; only the money you had invested would be yours. Perhaps by year two, the company would allow you to take 25% of the company match, and each successive year, a little more. Some companies give the full 100% after five years. So consider the employee who finds a new and better job opportunity and decides to quit a week before the five year waiting period is up. They would lose five years of company matching funds simply because they didn't wait.

This line in the tax code also created a multi-layer business to accommodate this plan, from mutual fund houses to insurance companies to brokers at the investment level to third party administrators and lawyers to help with the legalities. This line in the tax code also created some huge problems for the worker.

Now they needed to find investments in those plans to give them the best retirement. They needed to participate beginning as early as possible and stay involved as long as possible. They needed to get historic returns and be disciplined in an endeavor they had little or no knowledge about prior to this shift. It was a great social experiment in self-help that has failed many people. It also helped a great many people who might not have had much otherwise.

But the plan has problems that have never been suitably addressed, in part because of the belief that people wouldn't allow these provisions. One problem that should have been better adressed was the portability part of the plan. Mr. Benna in a recent interview with the Baltimore Sun bemoaned this ability to "take the money with you". He knew that our natures would get in the way of the right choice. Too many people would cash the plan out, pay the penalties and the taxes and squander the early start that these plans depend on. He thinks that the employee would be better served being forced to leave the money at the old employer.

He also knew that if the 401(k) allowed for a borrowing provision, people would use it. Mr. Benna's redesign of the 401(k) would include auto-enrollment and auto-deductions that would begin at 4% and increase until they reached 10%. He also admits to the problems in target date funds (which we have discussed here in previous essays) but thinks the idea is right. People make emotional choices with their investments and target date funds are designed to take that emotion out of your hands.

Of course you could opt-out but history has shown that few people do. He also suggested that this plan should be, in a perfect world, a supplement to a pension plan. But he was quick to point out that companies still have problems with the predictability of pension costs. Much the same way 401(k) investors have difficulty with investment risks.

In either case and even if you are fortunate enough to have both types of plans, the responsibility of your retirement is still with you. Arriving as close to it debt free is still the best approach to retirement. Investing as much as you can and then more, perhaps twice what you think you can afford, is a better plan. Think of retirement as a storm that is approaching. You wouldn't gather enough supplies to last for a day or two. You would get more than you need. Most folks have not filled their retirement pantries with much more than a loaf of bread and a jar of peanut butter. How prepared are you for a storm that is likely to last for thirty years?

Paul Petillo is the managing editor of Target2025.com/BlueCollarDollar.com

Retirement Planning: Companies are Still Trying

Such is the conundrum of the 401(k). Your retirement planning tool is showing signs of increased balances even as some of the experiments to get people to invest more - via auto-enrollment - is as Aon Hewitt suggests, somewhat sub-optimal.

Auto-enrollment was supposed to get all boats to rise. New workers who knew little about this sort of plan to help them save for retirement were automatically enrolled in their new employer's defined contribution plan. But these new investors did not respond as the industry thought they would. Pamela Hess, director of retirement research at Aon Hewitt suggested in a January 26th press release from the company: "Auto-enrollment is a relatively simple and effective way for companies to help workers plan for retirement—especially younger workers who may not feel the immediate pressure to save for retirement." And yet, once in the plan, these new workers, often referred to as the Gen Y investor, failed to follow through on the effort with interest of their own.


Companies are still trying
It is not as if the companies aren't trying. Designed to simplify the investment decision process, more than half of the companies surveyed attempted to educate these new workers, appealing to this younger investor with the offer of online investment guidance coupled with online investment advice and managed accounts. Compared to 2010, when just 28 percent of employers offered managed accounts, this is a noticeable increase in what is often considered the most basic of fiduciary responsibilities.

Plan sponsors are undaunted by the lackluster use of these plans and continue to offer additional levels of services which include investment modeling and even attempts at profiling how what you have accumulated will be spent down once their employees do retire. Younger employees seem to accept the target date fund, the primary choice for the auto-enrollment effort despite the questions surrounding the viability and transparency of these funds.

Reinstating the matching contribution has helped some of these plans. By the end of 2010, in the wake of the Great Recession, 23% of the companies had stopped or lowered the amount of money the plans contributed. Over half have decided to add these matching contributions back to the plan in 2011 with about 18% of the 23% who stopped toying with the idea of bringing the matching contribution back.

Other incentives to get these workers to contribute more to their 401(k) plans are not so much incentives as elimination of other benefits that future retirees once banked on for their retirement. Fewer companies offer medical benefits to their employees and some have even raised the current cost of health insurance to employees to offset the cost of helping with retirement, a trade-off that seems counterproductive. Others have simply frozen their pension plans pushing workers to seek the alternative self-directed method of ensuring a secure retirement.

Some of these moves have actually forced the employee to invest more and the latest numbers published by Fidelity point to an increase in the average balance in these plans. yet the average balances, now estimated at the 2010 year end were still far below where they actually needed to be. If you had invested steadily over the last decade, your balance, according to Fidelity is around $180,000. If you are within fifteen years of retirement, you are still hundreds of thousands of dollars away from what is often considered the optimal balance.


The 14, 16, 18 Rule
For most investors - I prefer this term to overused "saving for retirement" - the accumulated balance in these plans should equal 14 times your last year's salary. Aon Hewitt points to a need for 16% of the salary of the 31 to 45 year old group as the goal, which includes the total amount of available benefits such as Social Security and any pension plans they might have. Because the youngest workers can count less on these additional sources of income for retirement, they will need 18% of their salary to make retirement comfortable.

If plan participants at Fidelity are any indication, these plans are moving in the right direction. Over a million people involved with the Fidelity offerings have accessed their online tools or simply called for advice. According to Beth McHugh, vice president of market insights at Fidelity, the answer to how much you will need still depends on the worker taking control of the plans. She suggests "At the end of the day saving at appropriate levels, saving continuously and ensuring that you have the appropriate asset allocation are the most critical components to help ensure that you have sufficient savings for retirement."

But contribution levels still remain lower than they should be. The average participant has increased their contribution, but from a paltry 4% to a better 7%. Yet this increase is still far from what the investment and retirement community would like to see workers contribute. Add to that the lack of portfolio diversification once they are in the plan, little effort by the participants to rebalance on a regular basis and for older workers, adequately defining the risks they are taking with those investments all increase the chances that these plans are not doing as well as they could.

Some of the uncertainty of retirement needs may be the problem. Not knowing the impact of taxes (although there has been an increase in the amount of Roth 401(k) options in many plans) and the negative effect of inflation. workers are underestimating what they might need and if they are making educated guesses on that number, taking too many risks too close to retirement to try an offset those issues.


The Selfish Approach
Perhaps the worker should instead frame the plan in a more realistic way. Most advice offered on how these plans should be spent down once you retire involve a suggestion that returns on the plan in a post-employment environment should be all that the retiree tap. This avoidance of using capital - in other words protecting the balance in the plan at all costs, may have created a greater worker angst than is needed.

Focusing on preserving wealth as an heirloom is not how these plans should be calculated. In a era of less, the retirement planning employee should be focusing on what they will need first and not so much on what they might leave to their heirs. While prudent lifestyles are still a great help - both prior to and after they retire - being selfish in your projections is not necessarily a bad thing.

Tell Me a Lie: Retirement Planning and the High Net Worth Boomer

You would like to think that we are all truthful. But that may not be the case. Are Baby Boomers, more specifically those considered high net worth, telling a story about their retirement that isn't quite truthful?

Oscar Wilde probably said it best: "What we have to do, what at any rate it is our duty to do, is to revive the old art of Lying.” Nowhere is this resurgence in the falsehood more prevalent than when we tell a surveyor about our finances. When they look extremely bleak, we tell them they look even worse. When they look okay, we tell them they are really good. It is in our natures to tell lies considering we do it when we smile.

Evidently, a group of wealthy Baby Boomers told a survey group from Bank of America/Merrill Lynch that their retirement not only looked promising but was much better than their parent's retirement was. This is pretty lofty talk from a group that just a couple of years ago was not one bit happy with where their portfolios had gone in the wake of the financial meltdown. Now, $250,000 in investable asets is enough to warrant such retirement superlatives as "freedom" and "relaxation".

What changed? True the markets recovered over the ensuing couple of years. But I doubt that this had anything to do with it. many of these folks, like all age and wealth groups did, panicked at the sudden rebalancing of their portfolios by market forces. Unaccustomed to an all-inclusive debacle, many moved into much more conservative type investments and in the process, created their own mini-bubble in the bond market.

The rest of us moved into target date funds, a sketchy hybrid of funds designed to rebalance our aggressive natures for us. If you are older, the fund you plopped the remaining balance of your 401(k) is close to your age - so you too may have benefited from the updraft of conservatively invested enthusiasm. I wrote about this relationship with the bond market a couple of days ago suggesting that if their isn't a bubble in the bond market, it is because it won't pop when it reaches the end of its run; it'll hiss itself into normalcy.

It may be that this group has a better restructuring plan in place or they are simply lying to themselves - and the surveyors. Consider this: $250,000 in investable assets was consider the borderline between the rest of us schmucks and the high-net worth individual. I'm sure that this number is not even close to the actual investable assets these people had. It is our carrot.

One thing that stands out with the group surveyed is the change in attitude about what retirement is. They mostly believe working in retirement is a way to stay physically and mentally engaged. And for many, it is. For those with less than $250,000 in investable assets, it often isn't the case.

But these high-net worth folks worry about the same things you do: the cost of health care, the cost of children still living at home and that there portfolios, no matter how well managed, might not be enough. So they smile when they say they have it better than their parents and do so while lying about how much better.

And these high-net worth folks are not short on advice, even if they didn't take their own. Get a financial adviser as early as possible, they suggest and of course start early. Good pieces of hindsight advice that they were told as they began their working careers - and didn't follow.

About this advice to use financial advisers earlier. Then there was a survey conducted in 2006, when things were going great: housing values were appreciating, the markets were humming along, and early retirement was well within reach or it was assumed to be. And the results show a complete turnaround in thinking from then to now.

Back then - keep in mind these were the good times - another survey was published: In it, the following: "According to a new MyWay Investment Advisors (MWIA - an independent financial planning and investment advisory firm) survey, 98% of respondents would change the way they work with their advisor with 43% saying they wanted to change the amount they paid for the financial advice and services. This compares to only 13% of advisors who would look to improve how they currently operate, including pricing for clients.. The survey focused on how individuals would like to be treated by their financial advisor or investment professional and how they would like to pay for those services.

"The survey targeted the individuals with annual incomes greater than $75,000 and $150,000 to $600,000 in invested assets, including 401Ks. A duplicate survey was sent to financial planners, investment managers, insurance sales people and other financial industry professionals to compare responses." Why has this advice changed? Pricing and the way pricing is structured has evolved. Yet the higher the net worth, no matter what you pay, you pay more than you should.

So which is the truth? Are they happy now or were they happy then? The most telling piece of info coming from that survey: "When it comes to financial advice, however, financial advisors isn't where most of those surveyed go for information. Only 27% utilize financial advisors while over half (56%) get advice from a friend, publications or on their own.

"Of those that have a financial advisor, only 18% are happy with him or her. a whopping 56% say they are dissatisfied and 23% still have not made a decision."

This means one thing. We can no longer look to those we consider net-worth wealthy for guidance in how to become net-worth wealthy ourselves. Retirement has become a reality and an illusion. It is something we want and fear, something we strive for and are repelled by, something that is both possible and impossible. Yes it is a conundrum.

But it is your puzzle to figure out. And the simplest way to do that is figure out if you are willing to live on less than you have now. You don't need a financial adviser to tell you that you probably haven't invested enough. You know that you are probably wrangling more debt that you would like. You know that your contribution to your 401(k) is les than it should be. And you know that your goals concerning retirement are lofty than they are on paper.

Your balance sheet needs to be revisited and often. You need to double your 401(k) contribution now, no matter what age you are. There are numerous, almost painless ways of doing this including channeling the tax relief on your Social Security payroll tax (2% for the next two years) or simply increasing your contribution by 1% for every month of the upcoming year. You have the pieces to solve this puzzle. It all depends on how much you want to lie. The rich can. So can you.

Paul Petillo is the managing editor of Target2025.com/BlueCollarDollar.com

Retirement Planning Resolutions that should be kept

Even as the news told us with the turn of the calendar that the first Baby Boomer was eligible to retire, all of us wondered if they did. Were their retirement accounts so much better than ours? Did they make promises that they kept? Were they able to dance between the raindrops rather than simply weather the storm? We may never know more than we know about ourselves. But what do we know about ourselves and our retirement plans? Does the answer lie in how we approach our New Years resolutions?

By the time you read this, your New Year's resolutions may already be broken. If not, in the next couple of days they will be seriously tested. This doesn't make you a bad person - in part because you have broken them so often in the past. But there is a pattern in your lapses and if you promised yourself to build a better financial plan, focus more of your income on your retirement accounts, and/or simply spend less, breaking those commitments can have longer range effects that simply gaining a few pounds.

Why do we break the resolutions in the first place? In large part, our resolutions are well intended. But they tend to be an all-or nothing type of promise to not do better so much as to change course. This might relatively easy to do if you are 20 years old. But the older you get, the longer it will take for that ship you call life to readjust its headings.

Which brings us to the second reason we fail to follow through: lack of patience. As much as I hate to bring up the dieting analogy, it does apply to the way you treat your finances. Nothing is instant. You can't will away years of bad habits and as soon as one of those bad habits creeps into your diet, its over. In the world of finance, it might be a purchase done outside of your budget that has the ripple effect of bringing the resolution down.

Statistics have shown that resolutions morph from something that is a need-to-keep promise to one's self to a nice-to-keep promise. This is another reason why, by the end of the first week in January, you have back-burnered the promise to increase your 401(k) contribution, put your credit cards away, talk to your children about money, talk to your husband about the course of your retirement plan. Even if the idea was to build a plan, something anything more than what you have haphazardly pieced together, you have already lost some of the goals you set forth.

Men have no problem breaking resolutions if they make them at all. Women often see it breaking a resolution as a sign of some weakness. Both are wrong. Here are five easy steps to make your financial promises stick in the new year - and if you haven't made any, this will help you make some commitment without the pressure of a change in the calendar.

1. Be patient. No retirement plan was hatched in a day or a week or a year. Most 401(k) plans have internet access available to their plan participants. Log on and find out where you are in terms of contribution. If it is less than 5%, change it to 5%. This is usually the threshold where your pre-tax contribution has no effect on your take-home pay.

2. If you are a couple, do this together. One resolution to keep is that retirement plans are best used if they are combined. Not physically, but on a decision level. One plan might be better, the other might be more generous in the match. One of you might earn more where a 5% contribution is actually a larger dollar amount. One plan might have better investment opportunities. If don't approach this together, you will not get the benefit of two plans as one.

3. Add 1% a month every month thereafter until you reach the 12% mark. This will be not-as-painful but will require you readjust your spending habits.

4. Educate yourself about risk and how much you can embrace. Women have been studied and most of those surveys have drawn similar conclusions: women are more pragmatic when it comes to investments. If men and women looked at what they want and how their plan could help to achieve it, they might find themselves much better situated 15 years down the road than if they chased the next-hot investment cycle.

5. Take a look at your beneficiaries. Your investments and insurances need to be specific. Your will needs to be clear. And if you do this, you will find that this forces you to look deep into the future at a time when one of you - most likely, the woman, will still be around.

Paul Petillo is the managing editor of BlueCollarDollar.com and Target2025.com

Are the Odds Against Us?

Asking that questions seems odd in and of itself.  Of course they are you might answer.  And any Baby Boomer would be correct in this assessment.

But somehow, we seem okay with this. We seek retirement or at least profess we do, often making it seem like some scalable mountain we are in training to ascend. Advice on how to do this, a feat we would rather not attempt, instead taking the paved route with the rest of the tourists, comes from all angles. Invest more, take some risks, approach the effort with no emotion, live frugally, budget, diversify, and the take fewer risks, get healthy, worry, and finally try to outlive your money in retirement by taking no risks.

And lurking in the background, not caring one whit about you in the long-term and perhaps, if it is possible, caring less about your future in the short-term. As I said, when it comes to Wall Street, the odds are against us.

Read more...

Doing it Yourself: A Retirement Plan You Control

Today we are going to tackle the self-directed IRA. We all know what an Individual Retirement Account or IRA is. Briefly, it is the retirement tool for those of us who may not have access to a 401(k) that defers taxes for retirement. The deferring part is not really as complicated as it seems. In a 401(k), you have your contribution taken out before you pay taxes; in an IRA, you pay with after-tax money and then take the deduction when you file, basically subtracting the taxes from your contribution to be paid later.


How is a regular IRA different than a self-directed IRA?
The differences are not as obvious as the title of these products sounds. An IRA is an investment chosen by you and you direct the funds to it for your retirement. It seems like this should be called self-directed but in reality, it is very different from what the IRS views as a self-directed IRA.

In a self-directed IRA, you become the manager of the whole process. Rather than simply sending money to a mutual, fund company, the most common sponsors of IRAs, you direct the underlying investments. In the previous example, the institution is the middleman. In a self-directed IRA, the institution, whomever or whatever one you chose, does what you tell them to do.

While it might seem complicated and finding good help at a reasonable cost is not that easy, the rules are relatively straightforward. Following to the letter is something you have assumed was done for you in the past; not it is up to you.


Find a Trustee for your Self-Directed IRA
A person looking to open a self-directed IRA is in the same position as someone who is opening a Solo 401(k), which we discussed a couple months ago in our retirement planning for small business owners. You need to find a company that will open the self-directed IRA and act as a Trustee, essentially doing whatever you tell them to do. Then you sign broker-to-broker papers and you are done.

Keep in mind, that if you have a Solo 401(k) for self-employed investors, this process was already completed. If you have what is known as Customized Business Pension, you are also ready to take the next step. Sometimes, a self-directed IRA is referred to as checkbook IRA and the rules may require you to open an LLC or limited liability company. Either of these plans removes the custodian and that makes the investment possibilities immediate and up-to-you.

This is relatively easy and worth the effort. But you do have to be careful. Be sure that whatever the self-directed IRA profits from is paid to the trust and not to you directly. This will be the same as a distribution before they are done without penalty. This means that any gains in the IRA will be tax-deferred. So what you are doing is making your money work harder for you now than it might have been in the past.

You can invest it virtually anywhere: a franchise, rental property, annuities, you name it. You are in charge. The only two things you cannot invest in are life insurance and collectibles.


The Rules
There are few rules to follow when choosing your investments. One, you can’t invest in yourself or the spouse of the IRA owner. For that matter, the Internal Revenue Code or IRC prohibits you from investing with any of your lineal descendants and ascendants. This also includes an entity with combined ownership greater than 50% by a disqualified person(s), a 10% owner, officer, director or highly compensated employee of such entity or a fiduciary of the IRA or person providing services to the IRA.

You can’t sell your assets to the IRA either. You can’t use it to loan money to your kids or pay yourself fees for the work you have done. And you can’t use it to buy the home you live in now.


Opportunities for the Post-Recession World
This types of retirement plans opens a whole slew of possibilities for someone who as an IRA or possibly has been rolled over into one because of a job loss. There are some hard fast rules, which you can check last week’s show link to hear about, but done right, this can create outsized gains your plan may not have created otherwise.
First off, I want to caution you. Not so much about following the rules, but understanding right away, that every investment involves risk and investing in real estate can involve quite a lot of it.

The money in this IRA can be used to buy anything from Single family and multi-unit homes, apartment buildings, co-ops, condominiums, commercial property or land, improved or unimproved, leveraged or not.

The goal here is to find income producing property and have it pay your IRA. Whether you buy the property outright or finance it, the IRA owns the asset, not you.


Can You Finance this sort of loan with your IRA?
Because the IRA owns the property and the property’s value is the collateral for the loan, the only thing you have to figure out is how to pay off the loan. If the property is producing income, it pays the IRA which in turn pays the mortgage holder. Sometimes you can use other assets in the IRA or permissible contributions can be made. This is what is known as a non-recourse loan because you cannot extend credit to your own IRA.

The whole transaction needs to flow through the IRA as if it were separate from you, which it sort of is.
The cost is broken down into two categories. Management fees that the custodian charges. Not all firms who manage retirement accounts can so your choices are limited. I’ve included a few links to begin your research but by no means are these companies recommended. This is relatively small, niche market with only about 2% of the almost $4 trillion invested in IRAs under management.

And the cost of property management, taxes, and repairs is another fee the IRA must pay. With any luck, the property will be able to cover these costs with the rental or lease payments.


Some might say “buyer beware”.
Whenever you have such a small marketplace, oversight is not always done the same way it is done among bigger segments of the investment world. I expect that this particular segment of the world will begin to grow rapidly as folks realize that their old job isn’t coming back, their unemployment insurance is about to run out and they haven’t borrowed from their IRA – so far.

Another reason you should be careful is more about what you know. Buying real estate with your retirement money is actually done best by folks who have some prior knowledge about what they are getting into. Perhaps they were involved in the business before. That doesn’t mean it can’t be done, but the more you bring to the game, the better your chances of winning.

You might also look into a franchise with this money. You can also buy debt. Your IRA can become a lender of sorts buying notes on cars, Treasury bills, even lending money to companies looking to raise capital. Always wanted to invest in a hedge fund, with a self-directed IRA, it can invest. Want to invest in precious metals, foreign stock or partnerships and/or joint ventures; your IRA can do this as well.


A couple of simple pieces of adviceObviously there is the risk factor, which makes this not the be-all-to-end-all for all investors. But if you know what you are investing in and the pitfalls of that investment, you can calculate the costs in advance, this can be like heaven-sent. If you are looking at real estate, the potential is there for people who have the money to pursue some amazing bargains. 

Paul Petillo is the Managing Editor of Target2025.com

Missing the Target; Gaining Praise

Target date funds, those investments that pick a date in the far off future and sell you on the notion that your retirement plan is headed in the right direction continue to lose ground.  But that doesn't stop this default investment for the widely used defined contribution plan - your 401(k) - from receiving inflows in record amounts.

After the 2008 investment season and early into 2009, there were only a handful of investors who could claim to have these elusive skills. As far back as Benjamin Graham, the skill that was needed to be a successful investor was widely believed to be a possession of the few.  It wasn't necessarily the wealthy either.  But a subset of the populace who, for some reason, understood the mechanism better than others.

This led more than few folks to look at target date funds as an investment that might hold the elusive key to investment success. Money poured into these types of funds and continues to this day.  This in large part because of the default option that new hires receive.

While all investors face the same problem, those further along in their careers have an unique problem. Too conservative and there won't be enough money.  Too aggressive and there may be losses that are not welcomed.  But target date funds, while they have gained praise as they continue to underperform, are not the answer.

Paul Petillo is the Managing Editor of Target2025.com

The Pressure to Invest: Incentives to Buy Your Clients

What if your company offered you an investment option you couldn't refuse?  Not simply an investment that would do better for you but also for the very businesses your company works with?  Would this be a smart move?  Would you cave to peer pressure and perhaps company pressure as well?

A recent article in the New York Times focused on a start up mutual fund crossed my desk recently. The article, written by Stuart Elliott, dealt with the advertising agency Kirshenbaum Bond Senecal & Partners in New York, part of MDC Partners.

While Mr. Elliott normally deals with the advertising industry, this particular article offered something different. Two employees of the firm believed that if the company had an investment stake in the clients they represent (eighteen of the thirty clients they work with are traded on major exchanges), the focus on their client’s success would improve – with any luck, as their employee’s interest in those businesses via investment would as well.

To that end, MDC launched a new index with those companies as the template for the fund. “The index,: Mr. Elliott writes, “was the brainchild of two Kirshenbaum Bond employees: Aric Cheston, partner and creative director, and Matt Powell, chief technologist. They will each receive a cash bonus of $10,000 from MDC.” The fund, with the ticker symbol KBSPX has yet to show up on any searches as yet.

“Agency executives are opening a brokerage account with another client, the Vanguard Group, into which will be deposited 300 shares of each of the 18 companies."

Mr. Elliott explains further that “The 300 employees of Kirshenbaum Bond will be offered long-term cash and compensation incentives to mirror the performance of the stocks in the index, which they will be able to track each trading day on an intranet on the agency’s Web site.

“MDC is spending an estimated $500,000 to start the index, which includes contributing four restricted shares of MDC stock to the fund for each Kirshenbaum Bond employee, for a total of 1,200 shares.”

Why is this important? Read more about "Skin in the Game: Is investing in your clients worth the Risk?"

Paul Petillo is the Managing Editor of Target2025.com

Your 401K Retirement Plan: Is it What You Know?

Can too much information be a bad thing? As we enter in the next decade, already eight days old, most of us have broken, or fudged just a little, on the New Year's resolutions we promised ourselves. In many cases, these commitments to change your lifestyle, reverse the bad habits, or embrace some new ones are often loftier than life allows. While change is good and change is constant, it is also incredibly difficult.

Now we have two senators attempting to give 401(k) investors a glimpse of their futures. Currently, the Social Security Administration does this in the form of a projection delivered to you just before your birthday. This statement is designed to help you track your employer contributions. But it also gives you some idea how much monthly income you can expect. For numerous people eyeballing retirement, this is the jumping off point. From here, they make calculations on how much they will need to save on their own to make up the difference in what they perceive as a livable, post-work income. The question is: would this be helpful with your 401(k) balance?

In many cases it would. But in an equal number of instances, it could be more trouble than it is worth. The bill introduced to the Senate by Jeff Bingaman, D-N.M., Johnny Isakson, R-Ga., and Herb Kohl, D-Wis. would require plan sponsors to give a snapshot of the future, a look at how much your 401(k) is worth in real dollars, calculated with inflation in mind. (Even Social Security doesn't take their projections that far.)

AARP, the Women's Institute for a Secure Retirement and the Retirement Security Project all support the idea of giving current workers a glimpse of where they stand in the future based on what they are doing today. Those blessing offer a counterpoint to the criticisms that have arisen to the proposed bill.

Consider where the vast majority of us are. After things went south in 2008 and early 2009, three things happened to the 401(k). One, many of us stopped contributing in part because our employers stopped matching those contributions. Two, we moved to the sidelines taking our losses into cash or other types of conservative investments. Or three, we moved what was left in a target date fund.

This investment interruption will come back to haunt us. But it is an indication that we have not come far enough along in this journey to call ourselves smart investors. Had we done nothing: kept our portfolios where they were, kept investing even if the match disappeared, and even increased that contribution if the match went away, we would be back to even if not further along. But we didn't.

And now, the good senators what to tell you how bad things really are. If you look at the average account balance, which is estimated all over the place by whomever you happen to talk to, the average monthly withdrawal rate from your 401(k) when you retire is around $300 a month. The Employee Benefit Research Institute and the Investment Company Institute made their calculations based on year-end 2008 account balances of $45,519. If you use that number, the monthly distribution would be closer to $225. Scary to think that all your 401(k) will do is pay your utility bills.

The critics fear that this sort of information will force folks to invest in riskier investments to try and regain some of those lost portfolio balances. While that might be an okay maneuver for the younger investor (40 years or younger), the older you get, the more worrisome this is. If you fall into either of these groups, the same advice applies:

1. Increase your contribution. Most of us average about 6-7%. Even a couple of increased percentage points can have some long-range differences in that balance at the time of distribution.
2. Get out of your company stock. Investors remain over invested in one company and no one worth their mettle will tell you this is good idea. Even if your company is on a tear. If your 401(k) matches only with company stock, invest only to the match.
3. Have more than one fund. Many folks are either indexed in an S&P500 fund or fully invested in a target date fund (one that picks the year you want to retire and adjusts your portfolio accordingly). Spread your risk. You will need to take some in order for your money to grow and many of us will want to take more than we should. By spreading it around among three of four funds, you can at least be more helpful to your retirement than harmful.

Paul Petillo is the Managing Editor of Target2025.com

Variable Annuities of a Different Sort

Older investors may have a new annuity to examine in 2010. It may be simply a better-for-the-insurer version of the old variable annuity mouse trap. Younger investors also need to take note of this variable annuity product as well.

Annuities come in all sorts of flavors. Single premium annuities are an all-in type that is purchased in a lump sum. Flexible annuities spread the payments over a period of time. Sometimes these are deferred until a later date whereby the investor can withdraw money all at once or in scheduled payments. Investments grow in a tax-deferred environment. Fixed annuities offer the investor the lowest risk (in part because the insurance company invests in bond funds) which insures your principal is never lost. Immediate annuities are also lump sum investments that begin distributions immediately.

But there is a new variable annuity product coming to market that will attempt to lure a wide range of investors into its trap. Everyone should take notice of what this investment/insurance product offers in large part because the sales pitch is designed to play off your fear of losing what you already have gained.. Question is whether you understand what this trap means to your retirement and whether it is worth paying the high cost.

Paul Petillo is the Managing Editor of Target2025.com

Five Investment Questions for 2010

Should you consider past results? By all means.
Is longevity important? Yes, but not necessarily the fund’s length of service.
Does size matter? How do you determine size would be of greater importance.
Who’s your Daddy? The larger the company the greater the likelihood your fund has orphan funds embedded in your portfolio.
How so do you diversify? A little of this, a little of that

Most of us look at the turn of a calendar year with the hope that the investment mistakes we made in the previous year will not be made in the new one. This is noble and in many cases futile. These attempts are usually too difficult to handle, which is why, in many cases you haven't done anything before this point.

But with little effort, you can change how you invest. For the vast majority of us, investing requires far too much time. It requires continued education (which I fully recommend), frequent monitoring (which can involve little more than opening your statement just to make sure your investments are going where you intended) and a clear-cut understanding of where you are on the timeline (beginning to invest or at it for awhile).

Altering bad investment habits is not that difficult. Five Tips for 2010...

Paul Petillo is the Managing Editor of Target2025.com

When the 401k is Not an Option

Some of us may be entering a new job that does not have a 401k or has one that you do not feel is as good as the one you just left. And your employer won't let you keep your money where it was. What to do?

Rolling your 401k into an IRA is another matter. This is for the investor who has some concept of what lies before them. If I were to guess, this type of investor has had an active roll in how their former employer's 401k was allocated. They paid close attention to diversity, perhaps even following conventional wisdom of limiting risk as they aged.

For this retirement investor, the IRA rollover is viable option. It allows closer control of how this money is invested with a variety of considerations weighed with each decision. Not only will this investor spread their allocation over a number of funds, they will do so with an eye on fees and expenses, a consideration of performance of the fund under both good and adverse conditions, and clearheaded understanding of the risks involved.

IRAs cannot be borrowed against and restrict a penalty-free withdrawal of money before 59 1/2 years old. But the choices are the primary attraction. This investor knows, and you should as well, the risks of building a successful IRA portfolio also increase. The biggest concern is investments that crossover.

What 401k plans are supposed to do is provide the investor with a fiduciary responsibility to provide the right tools for their employees. You, as an IRA investor are on your own.

You must monitor the funds you invested in for a change in investment strategy, style drift (when a fund manager invests on the edges of what s/he was hired to do; such as when they invest in large-caps when mid-caps are the focus), and an increase in turnover (a cost for trading repeatedly that the shareholder pays for directly, often done in an attempt to boost returns in the short-term, like at the quarter's end). You bear the burden of this responsibility to your future.

The terms of disbursement are spelled out when you leave the job in the 402(f) notice. This explains your options for handling a 401k disbursement. Even if you want to stay, your old employer really doesn't want the continued burden.

Bottom Line: Once you receive that 402(f), begin to research your options. And even if you think that money will come in handy, never take the cash.

Paul Petillo is the Managing Editor of Target2025.com

Job Separation Investing

Keeping the money in a 401k has its advantages. For older workers, the ability to begin disbursement at age 55 is an attractive plus. Although it is generally ill-advised under almost every circumstance, keeping the money in the 401k retains your ability to borrow from the plan. Some of us will consider keeping this option open. It's an option albeit, not a good one.

Generally, the fees are better in a 401k. Institutions may get a much better deal from the plan sponsor and consideration of this is important in the rollover decision. A much larger plan may come with more options or simply less expensive ones. Fees are an important aspect of total return and a worthwhile item to focus on when making any decision to move.

But you may not have an option if the balance is less than $5,000. This means you are faced with the choice of taking the cash in the account (along with the 20% the account must hold for income taxes and the 10% penalty). The scariest statistic, two-thirds of you take the money and pay those hefty penalties.

The terms of disbursement are spelled out when you leave the job in the 402(f) notice. This explains your options for handling a 401k disbursement. Even if you want to stay, your old employer really doesn't want the continued burden.

Bottom Line: Once you receive that 402(f), begin to research your options. And even if you think that money will come in handy, never take the cash.

Next: rolling to an IRA.

Paul Petillo is the Managing Editor of Target2025.com

Dividends in Mutual Funds

We have been discussing dividends with Paul Petillo, a regular contributor on MomsMakingaMillion Radio for the last several weeks. As we continue or series, we have five questions:
Could you recap briefly for our listeners what we have already discussed?

Our discussion about dividends has offered a brief overview of what they are: profits paid back to the shareholder of record, and how you can buy them directly: through direct stock purchase of through dividend reinvestment plans or DRIPs. By far, the easiest way to take advantage of what these companies offer shareholders is to spread the risk and the time you might take looking for them by using mutual funds.

When we look at mutual funds that pay dividends, what are we looking for exactly?

This group of mutual funds is often referred to as 'equity income'. They are stocks that provide income and fund managers in this space are looking for good stocks selling for less than what they perceive which means they are hunting for value and stocks that pay a dividend. Keep in mind, this was much easier to do just a few short years ago.

Why is that?

There was a tax advantage to these types of funds and in the pre-bailout economy, many companies were increasing their dividends because of it. Since then, many companies, particularly those with a financial component (like GE and GM) or businesses focused on the financial sector (such as Citigroup) have either suspended or reduced their dividend in response to those changes in fortune. Currently, there are about 296 stocks that pay a dividend of some sort. In fact, holding an S&P 500 index fund will net you a dividend yield of about 2.5%. That 2.5% is what equity income funds use as the number to beat.

Are all dividend paying stocks the same?

Not at all. There is a term for it: dividend payout ratio. In the thirties, this ratio was about 90% - that's roughly ninety cents for every dollar made was given to shareholders. Now it is about 30% or less. This is a good rule of thumb for investors. If your stock is paying more than 30% of their profits back to shareholders, this might be a sign of trouble (if you consider that this percentage has gone up while the share price, a vote of investor confidence has gone down). If it is paying less the 30%, the company might be overvalued by the markets or simply in too much trouble to pay enough of the profits to shareholders.

Any last thoughts?

Keep in mind that dividends are backward looking, reflecting profits from the past year. If companies cut their dividends because profits were down, raising or reinstating them might not happen until next year. A lot of companies are going to buy back shares of their own businesses in large part because they are still cheap and because doing so, increases the price of the stock by making less shares available.

Look for companies that have been able to increase dividends over a long period of time (like McDonalds (dividend payout ratio: 52%), Pepsi (dividend payout ratio: 54%), Kimberly-Clark (dividend payout ratio: 55%) or a mutual fund that has beaten the S&P500 average payout of 2.5% (Columbia Dividend Income 2.47%, Nicholas Equity Income, yield 3.12%)

Paul Petillo is the Managing Editor of Target2025.com