fivecentnickel.com » Saving & Investing http://www.fivecentnickel.com personal finance tips, tricks, and commentary Fri, 10 Feb 2012 23:28:09 +0000 http://wordpress.org/?v=2.9.2 en hourly 1 Stocks are Not Bonds, CDs, or Savings Accounts http://www.fivecentnickel.com/2012/02/10/stocks-are-not-bonds-cds-or-savings-accounts/ http://www.fivecentnickel.com/2012/02/10/stocks-are-not-bonds-cds-or-savings-accounts/#comments Fri, 10 Feb 2012 17:38:53 +0000 Nickel http://www.fivecentnickel.com/?p=25872 With interest rates continuing to hover at historically low levels, investors looking for income are understandably frustrated. Perhaps it should come as no surprise, then, that more people are recommending dividend stocks as an alternative to bonds, CDs, or even savings accounts. See here for an example.

As such articles sometimes (but not always) point out, stocks are not bonds, and they’re sure as heck not CDs or savings accounts. Stocks have an entirely different risk profile and, no matter how high their yield, they’re not a reasonable replacement for fixed income investments or cash equivalents.

Think about it… If you’ve been holding cash, there’s probably a good reason for it. And that reason is almost certainly not compatible with putting your money in the stock market.

Yes, high yield stocks can be good income producers, but they can also be very volatile. Don’t believe me? Check this out…

From it’s peak in the summer of 2007 to it’s low point in the spring of 2009, the S&P Dividend ETF (SDY) plummeted from $65.89 to $27.53 — a loss of 58.2% in less than two years. As of today, it’s back up to a bit over $55, which is still more than 15% below it’s peak.

Sure, it currently yields a little over 3.1%, and yes, some dividend stocks yield more or perform better than average (though others yield less and/or perform worse). Regardless… Yikes! Does that sound like a reasonable alternative for holding your cash?

Here’s my advice… If you need (or want) to hold a cash equivalent in your portfolio, then hold your nose and do so. There is no such thing as a free lunch. If you chase higher yields, you increase your risk.

Yes, inflation is a concern, and I’m not suggesting that you shun the stock market in favor of the alternatives. But don’t go putting money that you might need in the near term in the stock market simply because your savings account is paying a pittance.

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]]> http://www.fivecentnickel.com/2012/02/10/stocks-are-not-bonds-cds-or-savings-accounts/feed/ 5 Own Your Investments, Rent Your Fun http://www.fivecentnickel.com/2012/02/08/own-your-investments-rent-your-fun/ http://www.fivecentnickel.com/2012/02/08/own-your-investments-rent-your-fun/#comments Wed, 08 Feb 2012 16:24:32 +0000 Nickel http://www.fivecentnickel.com/?p=25832 I’m not sure where I first heard it, but whenever I get the urge to “invest” in a lake place, or do something similarly extravagant, I always fall back on this saying:

“Own your investments and rent your fun.”

I’ve mused in the past about buying a vacation home, but the harsh reality is that such endeavors are rarely as wonderful as you’d expect.

Yes, it would be great to have a weekend getaway, but second homes can easily become a money pit. You need to furnish them. You need to heat and cool them. You need to pay property taxes on them. You “need” to buy a boat to tie to the dock. Etc., etc., etc.

Sure, you can offset a portion of the costs by renting your place out, but let’s be honest… The most attractive rental periods are when you’d most like to use it yourself. Plus, there are tons of headaches associated with being a landlord, even if it’s just part-time.

You also need to cut the grass, trim the shrubs, and otherwise maintain your weekend getaway. These things take time and/or money. And for what? So you can be saddled with an illiquid “investment” that will throw your portfolio out of whack, and will also likely underperform the alternatives?

Instead, I suggest that you do what we do. Rent your fun. Instead of “investing” in a lake house, spring for a week’s rental every once in awhile. Instead of “investing” in a condo at the beach, rent one over Spring Break. You get the idea.

Yes, these things sound expensive – and they can be – but if you consider the alternative, they don’t look so bad. You get the fun without the maintenance headaches, the extra mortgage payment, the extra insurance policy, the extra property tax bill, the extra… Everything.

Don’t get me wrong, I’m not writing this to encourage people to take vacations they can’t afford. Rather, I’m writing this to encourage people to consider their alternatives, and to avoid justifying an huge impulse buy that they’ll like regret as a “investment” in their future.

Instead, you need to develop a clear investment plan. Look at how much time you have until retirement (or whatever other goals you have), consider your ability and need to take risk, and so forth. Then put your plan into action.

If you want to invest in real estate, fine. But realize that it’s a business, and that buying a place at the lake on the expectation that it will appreciate like crazy isn’t the same thing. Not even close.

Own your investments and rent your fun.

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]]> http://www.fivecentnickel.com/2012/02/08/own-your-investments-rent-your-fun/feed/ 8 Is Your Investment Allocation Right? http://www.fivecentnickel.com/2012/02/03/is-your-investment-allocation-right/ http://www.fivecentnickel.com/2012/02/03/is-your-investment-allocation-right/#comments Fri, 03 Feb 2012 11:00:39 +0000 Nickel http://www.fivecentnickel.com/?p=25552 Is Your Investment Allocation Right?

Here’s an interesting thought experiment from Carl Richards over on the NY Times “Bucks” blog…

Imagine that your investment portfolio somehow got liquidated overnight, such that when you wake up your holding are 100% in cash. If you were give the opportunity to buy back into the market at no cost, would you re-create the same portfolio that you’re currently holding?

If so, great. But if not, then why aren’t you already making changes? Perhaps your portfolio is too risky, or maybe it’s not risky enough. If that’s the case, then you should be taking steps to correct your allocation.

Sure, there are costs associated with re-configuring your portfolio. But there are ways of minimizing these costs. And there are also potentially huge costs association with hold the wrong mix of investments.

I would argue that a big reason that people don’t make changes is inertia, and Richards agrees. It takes time and effort to evaluate your goals and determine whether or not your portfolio fits your needs. It’s far easier to ignore your portfolio than it is to re-evaluate it.

But just because it’s easier to maintain the status quo doesn’t mean that’s the right decision. Do yourself a favor and take some time to reconsider your options. Sure, you may find that you’ve already dialed in the perfect solution. Then again, maybe not.

Source: NY Times Bucks via MyMoneyBlog

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]]> http://www.fivecentnickel.com/2012/02/03/is-your-investment-allocation-right/feed/ 4 Will the IRS Disallow Backdoor Roth Contributions? http://www.fivecentnickel.com/2012/02/01/will-the-irs-disallow-backdoor-roth-contributions/ http://www.fivecentnickel.com/2012/02/01/will-the-irs-disallow-backdoor-roth-contributions/#comments Wed, 01 Feb 2012 11:00:25 +0000 Nickel http://www.fivecentnickel.com/?p=25482 Will the IRS Disallow Backdoor Roth Contributions?

I’ve talked quite a bit about making “backdoor” Roth contributions if you’re over the income limits for contributing to a Roth IRA. In short, you can make a non-deductible contribution to a traditional and then immediately convert it into their Roth.

This strategy has become so popular that mainstream publications such as Forbes have started talking about it. But is it legal? That was the topic of a recent discussion over on the Bogleheads forum.

This discussion was prompted by an article by Michael Kitces, who is a financial planner extraordinaire and the Director of Research for the Pinnacle Advisory Group.

According to Kitces, while the individual steps of the backdoor Roth maneuver don’t run afoul of IRS regulations, these contributions could be disallowed under the step transaction doctrine.

The step transaction doctrine is a legal principle that essentially allows the IRS to look at the overall effect of a multi-step transaction and treat it as a single, integrated event.

In other words, rather than looking at the legality or tax treatment of individual steps, the IRS is free to look at the overall result of the transaction — i.e., that an individual over the contribution limits was able to make a Roth IRA contribution — and tax (or penalize) it accordingly.

So… The question is whether or not the IRS would balk at backdoor Roth contributions. I’m not particularly concerned about it, in part because the removal of income limits for converting funds to a Roth IRA appears to have been specifically intended to allow high income individuals to do just that, but…

It seems at least theoretically possible that the IRS could view this as an over-contribution, which comes with a recurring penalty of 6%/year (albeit with a 3 year statute of limitations), and these transactions could be messy to unwind.

At the same time, it’s worth noting that IRA expert Ed Slott weighed in on this issue last spring, arguing that the step transaction doctrine is a non-issue for backdoor Roth contributions.

My pal TFB has also tackled the subject. The short version is that he’s recharacterizing his recent conversions, and will re-convert at a later date to reduce the odds of his conversions being viewed through the lens of the step transaction doctrine.

What about you? If you’ve been making backdoor Roth contributions, are you concerned about running afoul of the IRS?

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]]> http://www.fivecentnickel.com/2012/02/01/will-the-irs-disallow-backdoor-roth-contributions/feed/ 9 Thoughts on Kodak, Bankruptcy, and Investing http://www.fivecentnickel.com/2012/01/20/thoughts-on-kodak-bankruptcy-and-investing/ http://www.fivecentnickel.com/2012/01/20/thoughts-on-kodak-bankruptcy-and-investing/#comments Fri, 20 Jan 2012 11:00:28 +0000 Nickel http://www.fivecentnickel.com/?p=25052 Thoughts on Kodak, Bankruptcy, and Investing

Over the past couple of weeks, there have been rumors swirling about Eastman Kodak’s financial (in)solvency. And then it happened. They filed for Chapter 11 bankruptcy protection yesterday. Not surprisingly, their stock dropped 35%. But really, that’s just the tip of the iceberg.

Kodak actually traded at an all-time high of just under $93/share in February 1997. And now? It closed last night at $0.36/share. That’s a stunning decline of 99.99% over the past 14 years. Yikes!

As of right now, they owe a total of $6.75B (yes, billion) to more than 100k creditors. At the same time, they have around $5.1B in assets. Thus, even if they liquidated everything, they’d still be in a $1.75B hole. Not good. Not good at all.

And guess what? Back when we first started getting interested in our finances, we almost invested in Kodak. This was back in the mid-90s, and their stock (like many others) had been on a tear. They were also seemingly well-positioned to take advantage of the transition to digital photography. What could go wrong?

Well… They wound up struggling to make the digital transition and their business suffered.

This was before we had discovered the wonders of broad-based index funds — and before we had enough money for the then-steep investment minimums in most mutual funds. Thus, we were busy filtering through blue chip companies in search of dividend reinvestment plans (DRIPs) that would allow us to directly invest our hard-earned dollars.

We were enamored with such household names as 3M (MMM), Campbell’s Soup (CPB), Coca-Cola (K), Intel (INTC), Merck (MRK), Procter and Gamble (PG), and yes, Eastman Kodak (EK). Over the years, some of these have performed reasonably well and others haven’t. But none have imploded like Kodak.

Truth be told, our DRIP investing phase didn’t last very long. We soon discovered the wonders of indexing, and built up enough cash to get over the minimum investment barrier. We ultimately liquidated our individual stock positions and haven’t looked back since.

If nothing else, our near miss with Kodak should be taken as a cautionary tale about diversification. At the time, we were only holding five or six companies — in part due to a lack of capital — so taking a major hit on any one company would have really hurt.

Of course, it’s not like they lost that 99.99% overnight, but still… I certainly sleep better at night knowing that we own literally thousands of companies. Yes, we still have market risk, but there’s little in the way of company-specific risk.

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]]> http://www.fivecentnickel.com/2012/01/20/thoughts-on-kodak-bankruptcy-and-investing/feed/ 7 Make the Most of Your Pay Raise http://www.fivecentnickel.com/2012/01/19/make-the-most-of-your-pay-raise/ http://www.fivecentnickel.com/2012/01/19/make-the-most-of-your-pay-raise/#comments Thu, 19 Jan 2012 22:58:29 +0000 Hank Coleman http://www.fivecentnickel.com/?p=25042 Reducing the Cost of Medical Care

Despite high unemployment and lingering financial turmoil from the recent recession, American workers continue to earn pay raises each year. According to the Bureau of Labor Statistics, the typical worker earned an average pay raise of 1.9% last year, and they are on tap to earn a similar raise in 2012.

These annual pay raises will help wages keep up with inflation. While a 2% to 3% raise may not seem like a lot of money at first glance, it can equal $1,000 or more per year for a family earning $50,000. But the real question remains, what should you do with your new pay raise after you earn it?

If you do not take an active role in putting the money to good use, then you are more inclined to simply find it disappearing into your monthly budget before you can even realize the money is gone. Below are five ways to help you put your new pay raise to good use.

Pay off high interest debt

Using a new pay praise to pay off high interest debt is typically a wise move. Having credit cards that charge you 18% or more in annual interest can quickly start to add up. Paying off credit cards with a high interest rate with a pay raise is like earning the same amount from an investment.

If you were paying 18% each year in interest on a credit card and paid off that card with your new pay raise, it is just like having earned 18% annual rate of return on your money. While the stock market zigzags like a roller coaster, paying off your high interest debt can be as sure a return as possible.

Build up your emergency fund

One thing that I personally struggle with is having a fully funded emergency fund in place. Most financial experts recommend that you have three to six months of living expenses set aside in an emergency fund. What many people do not often realize is that six months of expenses is actually quite a large amount of money in many cases. It can quickly equal $10k-$20k for some families. Living on your previous income and saving your new pay raise is a great way to help boost your emergency fund if have not quite reached your goal of six months of living expenses.

Boost your retirement savings

Using your pay raise to build up your retirement savings can be a great plan. You have until April 15th of each year to finish contributing to an IRA. If you receive a year-end bonus or a pay raise at the beginning of the year, you can put that money to good use by finishing up maximizing your retirement account contributions.

A pay raise is also a great way to build up to maximizing your 401(k) retirement plan contributions. In 2012, you can contribute up to $17,000 to your 401(k). That is a lot of money, especially if you are just starting out in your career. But, you can incrementally increase your 401(k) contributions each year until you reach your maximum contribution level. If your small increase is timed with your new pay raise you won’t even notice the difference.

Double check your insurance coverages

Do you have enough insurance coverage? Far too many people find themselves underinsured in many aspects of their lives. Do you have umbrella insurance to protect yourself from being sued? Do you have flood insurance on your house? According to FEMA, over 30% of all home damage from flooding occurred on homes that are not in a federally designated flood zone. Purchasing flood insurance if you live outside of a flood plain is very inexpensive. Spending money now on the proper insurance coverages can help you save on insurance in the long run.

Splurge on yourself a little

I am not talking about spending your entire pay raise by purchasing things for yourself. But, you did earn the money, and you should enjoy it. Many financial experts recommend taking a small portion, such as 10%, of your raise or any year-end bonus you earn and spending it on something for yourself. Doing so will help you stick to your other plans for the rest of the money. This is similar to having a cheat day on a diet. If you are too strict with yourself and how you spend your money, you will be more inclined to fall off the wagon and be resentful to your new financial goals.

Are you one of the lucky ones that will receive a pay raise this year? What will you do with your new pay raise? Will you just absorb it into your monthly budget, or will you use it to increase your financial wellbeing? Living on your previous year’s income and using your new pay raise to accomplish your financial goals is a great use of the new money. What do you like to do with a pay raise?

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]]> http://www.fivecentnickel.com/2012/01/19/make-the-most-of-your-pay-raise/feed/ 6 401(k), 403(b), and 457(b) Contribution Limits for 2012 http://www.fivecentnickel.com/2012/01/18/401k-403b-and-457b-contribution-limits-for-2012/ http://www.fivecentnickel.com/2012/01/18/401k-403b-and-457b-contribution-limits-for-2012/#comments Wed, 18 Jan 2012 18:00:36 +0000 Nickel http://www.fivecentnickel.com/?p=24972 Contribution Limits for 2012

Do you have a workplace retirement plan such as a 401(k), 403(b), or 457(b)? If so, then you might be interested in knowing that the contribution limits for these account types has increased for 2012.

This means that individuals under age 50 can contribute up to $17,000 to their 401(k) account this year, up from last year’s limit of $16,500. And if you’re over age 50, you can contribute an extra $5,500 toward your retirement this year.

Beyond the above, the aggregate limit (employer + employee contributions), which is specified by Section 415(c)(1)(a) of the Internal Revenue Code, has increased to $50k/year. This is the so-called 415(c) limit and, while it doesn’t affect many of you, it does have an impact on some people (especially if you’re self-employed and have a high incomes).

Note that 403(b) and 457(b) plans, as well as the Thrift Savings plan, are subject to the same contribution limits, so those of you in the non-profit, educational, and public sectors will likewise be able to save a bit more this year.

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]]> http://www.fivecentnickel.com/2012/01/18/401k-403b-and-457b-contribution-limits-for-2012/feed/ 0 Contribute to Your Roth IRA, Even if it Stretches Your Budget http://www.fivecentnickel.com/2012/01/18/contribute-to-your-roth-ira-even-if-it-stretches-your-budget/ http://www.fivecentnickel.com/2012/01/18/contribute-to-your-roth-ira-even-if-it-stretches-your-budget/#comments Wed, 18 Jan 2012 13:41:40 +0000 Nickel http://www.fivecentnickel.com/?p=24962 Contribute to Your Roth IRA

Your 2011 taxes are due in just under three months. That also means that you have just under three months left to make any 2011 IRA contributions that you might have been putting off.

But what if you’re neglected to contribute to an IRA because you’re not sure you can afford it? Maybe the only cash you have on hand is earmarked for emergencies, and you’re not willing to risk the 10% early withdrawal penalty that comes with a traditional IRA.

Well, I’d like to encourage you to think twice about that stance and consider making a Roth IRA contribution. As I noted the other day, Roth IRA contributions can be withdrawn at any time and for any reason without penalty. And if you don’t believe little old me about this, you can check it out for yourself in IRS Publication 590.

While I’m not crazy about this flexibility to the extent that it encourages (or at least allows) people to raid their retirement to buy shiny things, one huge benefit is that it gives you the flexibility to make a contribution even if you’re not sure you can afford it.

This flexibility is very valuable because you’re only allowed to contribute a limited amount to IRAs each year. In other words, if you fall behind on contributions now, you won’t be able to make up for it later when you can (hopefully) better afford it.

If you make the contribution now and fate smiles upon you, you’ll be able to re-build your emergency savings “on the outside” while having more money stashed away inside your Roth IRA. And if things go awry, you’re free to yank that money out (up to the amount that you’ve contributed) and use it to take care of whatever emergency you’re dealing with.

Some issues to be aware of:

  1. This rule applies to Roth IRAs only, so don’t try this trick with a traditional IRA.
  2. The usual contribution limits still apply, so don’t try to sock more money away than is allowed.
  3. Roth IRA conversions are subject to a five year waiting period before they can be withdrawn without facing a penalty.
  4. Make sure a Roth is right for you. If you expect to pay the same or higher taxes in the future, then a Roth might make sense for your situation. But if you expect your tax burden to fall in the future, a traditional IRA might be better — but remember, only Roth IRAs qualify for the penalty-free withdrawal of contributions.
  5. Given that this is money that you may need to withdraw at any time, be sure not to put it at risk once inside the Roth. Instead, plug it into a money market fund or something similar until you’ve re-built your emergency savings.

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]]> http://www.fivecentnickel.com/2012/01/18/contribute-to-your-roth-ira-even-if-it-stretches-your-budget/feed/ 9 Far-Out Investment Strategies http://www.fivecentnickel.com/2012/01/17/far-out-investment-strategies/ http://www.fivecentnickel.com/2012/01/17/far-out-investment-strategies/#comments Tue, 17 Jan 2012 19:10:58 +0000 Jeffrey Steele http://www.fivecentnickel.com/?p=24922 Far-Out Investment Strategies

There’s no time like the recently-passed 10-year anniversary of the Enron wipeout to revisit some solid pieces of investment wisdom. And one of those nuggets is of such all-encompassing sagacity that it can be easily summarized in a single word.

Diversify.

If you’ll remember the Enron affair, so insightfully captured in “The Smartest Guys in the Room,” as the fraudulent energy giant teetered on disaster’s brink mere days before crashing and exploding in a spectacular fireball, CEO Ken Lay and his minions exhorted employees who had placed their life savings in Enron stock to avoid selling their shares.

I’m sure you know the rest of story… When Enron immolated, those workers had nothing left to show for years and years of faithful toil and investment. As we marked the decade anniversary, some former Enron workers who once enjoyed nice nest-eggs still struggled from the catastrophe that befell them in 2001.

I don’t claim to be an investment guru. But I have spent a lot of time chatting with financial oracles and savants, and have no reluctance passing along their guidance to investment novices. What I hear from the experts is that too many people invest too close to home for their own good. While they ought to be casting a wide net, their investments are about as far-flung as the confines of a toddler’s playpen.

In other words, diversification isn’t just about investing in diverse asset classes. It’s also about investing in a geographically diverse assortment of equities.

Doubly dangerous

The tendency of many to invest close to home begins with backing their own employers with their hard-earned dollars. They figure it’s a vote of confidence in their own futures to buy shares in the firms employing them. Nothing is further from the truth, as the “little people” at Enron discovered.

When their company died, not only were their jobs wiped out, but most or all of their portfolios were as well. Had they invested no more than four percent in any one stock, a figure often suggested, at least 96 percent of their stock investments would have been saved from the conflagration.

If it’s wise to ensure your portfolio is well diversified outside your own firm, it’s almost as brilliant to avoid investing heavily in companies in your home city, state, or region. Years ago, I spoke on that topic with Larry Swedroe, the St. Louis-based author of “Investment Mistakes Even Smart Investors Make and How to Avoid Them.”

“People make the mistake of confusing the familiar with the safe,” he told me. “Take a guess what people in Georgia own a disproportionate percentage of stock in. Coca-Cola. Guess what people in Rochester, N.Y. have traditionally owned more of. Not only is stock in Coca-Cola not a safer investment for people in Georgia, it may be a riskier investment. Because if something major happens to the company, what will happen to home values and job opportunities in Georgia?”

Imagine a regional economic shock impacts your neck of the woods. Your home turf is locked in a slump, affecting your job security and likely your home’s value. But it’s not just those items impacted, it’s also your portfolio, because you invested disproportionately in area firms. You need ready cash, but to get it, you may have to sell stocks in regional companies at the worst time, when their prices is low.

Adopting a world view

Taking this approach to the next logical level, does it also make sense to avoid having all your stock holdings in U.S. companies? You bet it does, and for many of the same reasons. Virtually any Yank is going to be tempted to feel the all-American firms he or she grew up with will be the ones that pose the least risk. But that’s just again confusing the familiar with the safe. “People in the United States think U.S. stocks are the safest,” Swedroe remarked to me. “And guess what people in France think?”

Gaining international diversification is like buying insurance that covers potential problems here in the United States, he noted. “Some years you collect, and some years you don’t,” he said.

“But you don’t complain in years you don’t collect on your insurance, because you didn’t die or your house didn’t burn down. Owning international stocks is like that. In years when they do poorly, that’s the price of insurance.

“But you get a smoother ride over the whole period.”

If you’re invested only in American companies, you’re ignoring a world of opportunity. More than half of all investment opportunities lie outside the borders of this country. And many of those in emerging economies have more upside than opportunities here. Some experts suggest even firms in other developed countries have more room to run than U.S. companies. That means you may be getting in on long-term growth potential by investing internationally.

All about correlation

What it all boils down to is you want low correlation in the stocks you own. When stocks are not correlated, they’re diverse. Stock holdings in many countries around the world? Lower correlation. Stock holdings only in the U.S.? Higher correlation. Stock holdings just in your city or region? Still higher correlation. And stock held only in the company in which you’re employed? If it could accurately be called correlation at all, that would be correlation on steroids.

If someone at the publicly-traded company that employs you suggests you place most of your investing bets on your own employer, keep this in mind. They’re likely not the smartest guys in the room. But they may be the most sinister.

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]]> http://www.fivecentnickel.com/2012/01/17/far-out-investment-strategies/feed/ 2 Roth IRA Withdrawal Rules: How to Get Your Money Out Early http://www.fivecentnickel.com/2012/01/16/roth-ira-withdrawal-rules-how-to-get-your-money-out-early/ http://www.fivecentnickel.com/2012/01/16/roth-ira-withdrawal-rules-how-to-get-your-money-out-early/#comments Mon, 16 Jan 2012 15:48:19 +0000 Nickel http://www.fivecentnickel.com/?p=24912 Roth IRA Withdrawal Rules

As a followup to Friday’s post on contributing to a traditional IRA and converting to a Roth IRA (i.e., funding a “back door” Roth) I wanted to spend a little time talking about Roth IRA withdrawal rules.

This post was actually inspired by a comment from a reader named John who is interested in using IRA funds to buy his family’s farm in about five years:

If I convert traditional, previously-deducted IRA funds to Roth IRA funds and then pay taxes on it, can I then withdraw the taxed contributions at a later time in order to purchase the investment property? I would not be withdrawing earnings, only the initial contribution.

The short answer is yes – with some restrictions.

Unlike the situation I talked about in my previous post, where you’re making a non-deductible contribution and then converting it, John is correct that he’ll have to pay taxes when he converts his deductible contributions (and any subsequent earnings). The reason for this is simple: you’ve never paid taxes on this money, so you have to do so before you can stick it in Roth IRA (since you pay taxes up front with a Roth).

The real question is whether or not John can pull this money out without consequences at some point in the future — but presumably before he reaches retirement age. Of course, if he waits until age 59.5, then all bets are off. He’s free to withdraw whatever he wants, whenever he wants.

But before that time… Can he make a penalty-free withdrawal to buy the family farm?

For starters, we need to talk about the order of distribution. As with others types of IRAs, the IRS views all of your Roth IRAs (assuming that you have more than one) as a single pot of money. And when you withdraw, you are assumed to first be accessing your original contributions. After that money is depleted, you are assumed to be accessing dollars that you converted. And after that, you are assumed to be accessing earnings.

For original contributions: This would be money that he contributed straight into his Roth IRA, subject to annual contribution limits. As it turns out, you can withdraw your Roth IRA contributions at any time without paying any taxes (you’ve already paid taxes on this money) or penalties.

For conversions: Conversions (money converted from a traditional IRA into a Roth IRA are treated similar to contributions, with an important difference. If you withdraw money that you converted into your Roth less than five years after the conversion, you have to pay a 10% penalty. This stops people from simply converting their traditional IRAs into a Roth to gain immediate access to the money. But once the five year rule has been met, you can withdraw your conversions at any time without paying any taxes (you’ve already paid taxes on this money) or penalties.

For any subsequent earnings: Finally, what about any investment earnings/gains that have occurred inside of you Roth? Let’s say you contributed a total of $10k over the years, and it’s now worth $12k. The last $2k that you withdraw would be the earnings. For starters, any earnings that are withdrawn less than five years after you opened your Roth IRA are subject to income taxes. Moreover, if you are under 59.5, the withdrawal will be taxable unless you meet certain exceptions, and you it will also be subject to a 10% penalty. Once you reach age 59.5 and your account has satisfied the five-year rule, you can withdraw your earnings free and clear.

So what about these exceptions that I mentioned above? There are several things that will make a distribution “qualified,” and thus not subject to taxes or penalties. One is reaching age 59.5 (and having satisfied the five year rule in the case of earnings). The others include: distributions made to a beneficiary after your death, disability, or using the funds to pay certain costs associated with being a first-time homebuyer.

So…. The short answer is that yes, John can convert from a traditional IRA to a Roth IRA, pay any taxes that are due (just be careful about getting bumped into a higher tax bracket!) and then withdraw the conversions in five (or more) years without paying any additional taxes or penalties.

Note that I’m not saying that this is necessarily a good idea — that depends on the details of John’s circumstances, and that’s a decision that he’ll have to make for himself after considering a number of factors. Rather, I’ve just focused on what’s possible, and when the penalties will (or won’t) kick in.

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]]> http://www.fivecentnickel.com/2012/01/16/roth-ira-withdrawal-rules-how-to-get-your-money-out-early/feed/ 1 Contribute and Convert: Funding Our Roth IRAs Through the Backdoor http://www.fivecentnickel.com/2012/01/13/contribute-and-convert-funding-our-roth-iras-through-the-backdoor/ http://www.fivecentnickel.com/2012/01/13/contribute-and-convert-funding-our-roth-iras-through-the-backdoor/#comments Fri, 13 Jan 2012 16:00:19 +0000 Nickel http://www.fivecentnickel.com/?p=24772 Contribute and Convert: Funding Our Roth IRAs Through the Backdoor

As a followup to my post earlier this week on Roth IRA income limits, I wanted to highlight how we typically make our Roth IRA contributions. For background, we’re in a relatively high (and variable) income tax bracket. Because of this, we flirt with the Roth income limits on an annual basis, and it’s hard to know for certain whether we’ll be above or below the line until late in the year.

While we could wait until the end of the year, or even early the following year, to determine whether or not we can contribute, I’d rather get it knocked out right away. Thus, we make what others have termed “backdoor” Roth IRA contributions.

For background, the income limits for converting from a traditional IRA to a Roth IRA went away back in 2010. Beyond this, there are no income limits for contributing to a traditional IRA. Yes, there are income limits for determining whether or not you can deduct your traditional IRA contributions, but you’re free to contribute no matter how much you make.

The workaround, then, is to contribute to a traditional IRA (this will be non-deductible if you make enough to be ineligible for a Roth) and then convert it to to a Roth IRA. And that’s exactly what we do every January. For those of you that invest with Vanguard, I’ve outlined the steps below to show you exactly how it’s done…

For starters, you’ll need to make your traditional IRA contribution. There are a variety of ways to do this, with the easiest be funding your IRA from a linked bank account. For now, I’ll assume that you’ve already done this.

Once your traditional IRA fund are in place, simply log in and select “Exchange (Sell funds to buy funds)” option from the “Transact on this account” pulldown menu.

When asked what you want to sell, choose the traditional IRA holding(s) that you wish to convert out of. When asked what you want to buy, choose the Roth IRA holding(s) that you wish to convert into.

Once you click to review, you’ll be warned that “A conversion is a taxable event. Generally, you’ll owe taxes on the amount you convert from your traditional, SEP, or rollover IRA into a Roth IRA.”

Assuming that you made a non-deductible contribution, that you don’t have any untaxed gains in the account you’re converting, and that you don’t have any other non-Roth IRA IRA accounts in your name, however, there will be no tax liability*. It will be as if you had contributed directly to the Roth IRA in the first place, except you’ll have circumvented the income limits.

Given the above, I selected the “Do Not Withhold” option when asked about tax withholding and then submitted the order.

That’s it. We’ve now fully funded our Roth IRAs for 2012 and don’t have to think about whether or not we’ll finish above/below the income limits.

*Note: If you have previously made tax-deductible contributions to a non-Roth IRA, even if they’re in a different account, making a conversion like this will generate a tax liability. The reason for this is that the IRS views all of your IRAs as one big pot of money, and they don’t let you pick and choose which dollars you convert.

The good news is that money in “qualified” plans, such as 401(k) or 403(b) plans, is not included in the tax calculation, so you could conceivably move all of your pre-tax money into a Solo 401(k) to effectively hide it before doing the “contribute and convert” thing.

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]]> http://www.fivecentnickel.com/2012/01/13/contribute-and-convert-funding-our-roth-iras-through-the-backdoor/feed/ 7 Roth IRA Income Limits for 2012 http://www.fivecentnickel.com/2012/01/11/roth-ira-income-limits-for-2012/ http://www.fivecentnickel.com/2012/01/11/roth-ira-income-limits-for-2012/#comments Wed, 11 Jan 2012 16:06:50 +0000 Nickel http://www.fivecentnickel.com/?p=24712 Roth IRA Income Limits for 2012

I recently wrote about Roth IRA contribution limits for 2012, which are unchanged from 2011. Today I want to talk about the current income limits for contributing to a Roth IRA. Here goes:

Married Filing Jointly: Contributions phase out from $173k-$183k
Single or Head of Household: Contributions phase out from $110k-$125k
Married Filing Separately, Living Apart: Contributions phase from $110k-$125k
Married Filing Separately, Other: Contributions phase out from $0-$10k

(Note that these numbers all refer to modified adjusted gross income, or MAGI)

The good news is that even if you exceed the income limits, there is a workaround for funding your Roth IRA. Indeed, as of 2010, the income limits for converting from a traditional IRA to a Roth went away, so if you earn too much, you can make a non-deductible traditional IRA contribution and then convert it to your Roth.

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]]> http://www.fivecentnickel.com/2012/01/11/roth-ira-income-limits-for-2012/feed/ 0 Savings Bond Purchase Limit Increased to $10k in 2012 http://www.fivecentnickel.com/2012/01/04/savings-bond-purchase-limit-increased-in-2012/ http://www.fivecentnickel.com/2012/01/04/savings-bond-purchase-limit-increased-in-2012/#comments Wed, 04 Jan 2012 16:44:07 +0000 Nickel http://www.fivecentnickel.com/?p=24412 Savings Bond Purchase Limit Increased to $10k in 2012

If you’re a fan of savings bonds, then I have some good news for you… The Treasury has increased the TreasuryDirect purchase limit from $5k per bond type (I or EE) per year to $10k. This change offsets the loss of over-the-counter sales of paper savings bonds, effective January 1, 2012.

From the press release that I just received:

The annual purchase limit for online United States Savings Bonds is $10,000 per series, effective January 4, 2012, the Department of the Treasury announced today. The new limit applies to Series EE and Series I savings bonds purchased through TreasuryDirect at www.treasurydirect.gov. Under the new rules, an individual can buy a maximum of $10,000 worth of electronic savings bonds of each series in a single calendar year, or a total of $20,000.

Since 2008, investors could buy a maximum of $5,000 in each series and in each form (paper or electronic). So a single owner could buy $20,000 in one year. As of January 1, 2012, paper bonds are no longer being sold through financial institutions. With today’s announcement, the total amount an individual can purchase in online savings bonds in one calendar year is $20,000. An investor still can purchase up to $5,000 annually in Series I paper savings bonds using his/her tax refund and IRS Form 8888.

So, in effect, they’ve increased the Series I Savings Bond limit from $10k ($5k electronic + $5k paper) to $15k ($10k electronic + %$5k paper) so long as you’re willing to jump through the hoop of buying paper bonds with your tax return.

From my perspective, this is very welcome news. While the fixed rate is still a disappointing 0%, these bonds provide a degree of inflation protection, and also have tax advantages, especially if you redeem them to cover educational expenses.

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]]> http://www.fivecentnickel.com/2012/01/04/savings-bond-purchase-limit-increased-in-2012/feed/ 0 S&P Dividend Aristocrats for 2012 http://www.fivecentnickel.com/2012/01/04/sp-dividend-aristocrats-for-2012/ http://www.fivecentnickel.com/2012/01/04/sp-dividend-aristocrats-for-2012/#comments Wed, 04 Jan 2012 14:43:08 +0000 Nickel http://www.fivecentnickel.com/?p=24402 Reducing the Cost of Medical Care

A few years back, I published a list of “Dividend Aristocrats” — companies in the S&P 500 that have increased their dividend payouts for at least 25 consecutive years. These are large, blue chip companies that have historically provided (slightly) better performance and (slightly) lower volatility than the S&P 500 as a whole.

The list declined from 52 companies in 2009 to 42 in 2010 as many companies cut their dividend payouts. It then held steady in 2011, with three companies being dropped and three added. For 2012, one company (CenturyLink; CTL) has been removed from the index while ten companies have being added.

These ten include:

  • AT&T (T)
  • Colgate-Palmolive (CL)
  • Franklin Resources (BEN)
  • Genuine Parts (GPC)
  • HCP (HCP)
  • Illinois Tool Works (ITW)
  • Medtronic (MDT)
  • Nucor (NUE)
  • Sysco (SYY)
  • T. Rowe Price Group (TROW)

The full list of 51 companies follows:

  • 3M Co (MMM)
  • AFLAC Inc (AFL)
  • Abbott Laboratories (ABT)
  • Air Products & Chemicals Inc (APD)
  • Archer-Daniels-Midland Co (ADM)
  • AT&T (T)
  • Automatic Data Processing (ADP)
  • Bard, C.R. Inc (BCR)
  • Becton, Dickinson & Co (BDX)
  • Bemis Co Inc (BMS)
  • Brown-Forman Corp B (BF/B)
  • Chubb Corp (CB)
  • Cincinnati Financial Corp (CINF)
  • Cintas Corp (CTAS)
  • Clorox Co (CLX)
  • Coca-Cola Co (KO)
  • Colgate-Palmolive (CL)
  • Consolidated Edison Inc (ED)
  • Dover Corp (DOV)
  • Ecolab Inc (ECL)
  • Emerson Electric Co (EMR)
  • Exxon Mobil Corp (XOM)
  • Family Dollar Stores Inc (FDO)
  • Franklin Resources (BEN)
  • Genuine Parts (GPC)
  • Grainger, W.W. Inc (GWW)
  • HCP (HCP)
  • Hormel Foods Corp (HRL)
  • Illinois Tool Works (ITW)
  • Johnson & Johnson (JNJ)
  • Kimberly-Clark (KMB)
  • Leggett & Platt (LEG)
  • Lowe’s Cos Inc (LOW)
  • McCormick & Co (MKC)
  • McDonald’s Corp (MCD)
  • McGraw-Hill Cos Inc (MHP)
  • Medtronic (MDT)
  • Nucor (NUE)
  • PPG Industries Inc (PPG)
  • PepsiCo Inc (PEP)
  • Pitney Bowes Inc (PBI)
  • Procter & Gamble (PG)
  • Sherwin-Williams Co (SHW)
  • Sigma-Aldrich Corp (SIAL)
  • Stanley Black & Decker (SWK)
  • Sysco (SYY)
  • T. Rowe Price Group (TROW)
  • Target Corp (TGT)
  • VF Corp (VFC)
  • Wal-Mart Stores (WMT)
  • Walgreen Co (WAG)

Unfortunately, if you’re interested in a mutual fund or ETF that tracks this group, you’re out of luck. The closest thing that I’ve been able to find has been the SPDR S&P Dividend ETF (SDY), which seeks to track the S&P High Yield Dividend Aristocrats. This is a list of the 60 highest yielding members of the S&P Composite 1500 index that have increased their dividends for at least 25 straight years.

Thus, SDY tracks the performance of companies drawn from a broader swath of the market (the S&P 1500 vs. S&P 500) and selects for those Aristocrats with the highest yield rather than including them all. As of this writing, the SDY has a dividend yield of 3.20% compared to 2.02% for SPY, which tracks the entire S&P 500.

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]]> http://www.fivecentnickel.com/2012/01/04/sp-dividend-aristocrats-for-2012/feed/ 2 2012 Stock Market Predictions http://www.fivecentnickel.com/2012/01/02/2012-stock-market-predictions/ http://www.fivecentnickel.com/2012/01/02/2012-stock-market-predictions/#comments Mon, 02 Jan 2012 18:15:42 +0000 Nickel http://www.fivecentnickel.com/?p=24362 In case you haven’t heard, the S&P 500 closed the year at 1257.60 this past Friday. That’s just a hair down from the 2010 closing price of 1257.64 — essentially even in the grand scheme of things.

Despite the flat performance overall, the past year was anything but uneventful. Don’t believe me? Check out the graph below.

S&P 500 2011 Performance

After some nice gains during the first half of the year, Congress managed to cook up a crisis which resulted in a US credit downgrade and dramatic losses stock market losses. From that point forward, the market gradually regained its footing, though it was far from a smooth recovery.

Of course, the above numbers ignore dividend reinvestment. After account for dividends, the market (as measured by the S&P 500) returned something close to 2% for the year. Not great, especially given the volatility, but better than nothing.

Through it all, I managed to do a good bit of tax loss harvesting on the equity side, and we also benefited nicely from our bond holdings (Total Bond Market [VBMFX] and TIPS [VIPSX]), which account for roughly 40% of our total portfolio.

With that as a backdrop, I though it would be fun to run a poll asking for 2012 stock market predictions…

How much will the S&P 500 change from the beginning to the end of 2012?
View Results

If you’d like to make a guess as to the specific closing price at the end of 2012, please do so in the comments section (but please also select a poll choice). You won’t win anything but bragging rights if you get ir right, but hey…

Bragging is kinda fun. ;-)

Note: E-mail and RSS subscribers may need to click through for the poll to work.

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]]> http://www.fivecentnickel.com/2012/01/02/2012-stock-market-predictions/feed/ 1 What are the 2012 Traditional and Roth IRA Contribution Limits? http://www.fivecentnickel.com/2011/12/30/what-are-the-2012-traditional-and-roth-ira-contribution-limits/ http://www.fivecentnickel.com/2011/12/30/what-are-the-2012-traditional-and-roth-ira-contribution-limits/#comments Fri, 30 Dec 2011 15:48:25 +0000 Nickel http://www.fivecentnickel.com/?p=24352 With just a few days left before the New Year, I thought I’d put together a quick post on IRA contribution limits for 2012. As a reminder, contribution limits have been indexed to inflation since 2008, and can increase in $500 increments (as necessary). As you can see from the table below, however, nothing has changed in recent years.

Year Under Age 50 Age 50+
2002-2004 $3,000/year $3,500/year
2005 $4,000/year $4,500/year
2006-2007 $4,000/year $5,000/year
2008 $5,000/year $6,000/year
2009 $5,000/year $6,000/year
2010 $5,000/year $6,000/year
2011 $5,000/year $6,000/year
2012 $5,000/year $6,000/year

A few notes…

First, note that this limit is a combined limit for traditional and Roth contributions. Thus, while you can contribute to both in the same year, the total contribution cannot exceed the $5,000 (or $6,000) limit.

Second, your traditional IRA contributions may be tax deductible, depending on whether or not you’re covered by a retirement plan at work, and how much money you make. Details can be found here and here.

Finally, remember that you can make contributions for 2011 all the way up to April 17th, 2012 (the due date for filing 2011 tax returns). Thus, if you still haven’t gotten around to it making your 2011 contributions, you still have time.

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]]> http://www.fivecentnickel.com/2011/12/30/what-are-the-2012-traditional-and-roth-ira-contribution-limits/feed/ 14 How to Invest a Windfall http://www.fivecentnickel.com/2011/12/14/how-to-invest-a-windfall/ http://www.fivecentnickel.com/2011/12/14/how-to-invest-a-windfall/#comments Wed, 14 Dec 2011 11:00:26 +0000 Nickel http://www.fivecentnickel.com/?p=23822 How to Invest a Windfall

The other day, I ran across an interesting article by Rick Ferri about how to go about investing a lump sum of cash. Should you dump it all in the market at once, or should you dollar cost average? Based on historical data, your highest expected return comes from investing it all at once.

Of course, with higher expected returns comes more risk — and they’re just that, expected. While dollar cost averaging might reduce your expected returns, it also prevents you from investing it all at just the wrong moment. As such, many people would be more comfortable deploying their cash a little at a time.

For his part, Ferri suggests that you ask yourself four questions.

How big is your windfall?

For starters, if your windfall is relatively small relative to your existing portfolio, Ferri suggests that you invest it all at once in your target allocation and be done with it. Ferri’s rule of thumb is 20%. If it exceeds that 20% of your current investments, then go to the next question.

Was this money from a pension plan payout?

If the money comes from a lump sum retirement payout, then the cash was presumably invested in the stock or bond market prior to the distribution, and it should go straight back in at your target allocation.

Was the money from the sale of a business or property?

If yes, then the money was previously exposed to market risk, and Ferri suggests investing half the money today and then dollar cost averaging the the balance over the next two years. In his view, this spreads out the “entry-point risk.”

Was the money inherited or won?

Finally, if the money comes from a source where you had no previous ownership — such as an inheritance or lottery winnings — Ferri suggests investing 40% now and then dollar cost averaging the remaining 60% over the next three years.

Beyond the above, he also suggests the possibility of revisiting your target allocation depending on how big the windfall is. If it’s less than 20% of your current savings, then you probably shouldn’t bother changing your allocation. But if it’s more than that, you might want to revise your overall investment strategy.

The thinking here is that with a much larger nest egg, you probably don’t need to take as much risk to meet your goals. In other words, your risk capacity has been reduced, and you might want to shift to a more conservative portfolio.

While the specific rules he lays out strike me as a bit odd — e.g., why DCA half over two years in one case vs. 60% over three years in the other case? — he also makes some points that are worth considering.

For starters, if it’s not a huge amount relative to your current nest egg, don’t sweat it. Just dump it in the market and move on. At the same time, if it is a significant amount, then consider the source, and also consider its implications for your investment strategy going forward.

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]]> http://www.fivecentnickel.com/2011/12/14/how-to-invest-a-windfall/feed/ 5 Insider Trading: Don’t Do It – Unless You’re in Congress http://www.fivecentnickel.com/2011/11/14/insider-trading-dont-do-it-unless-youre-in-congress/ http://www.fivecentnickel.com/2011/11/14/insider-trading-dont-do-it-unless-youre-in-congress/#comments Mon, 14 Nov 2011 17:17:53 +0000 Nickel http://www.fivecentnickel.com/?p=22972 Insider Trading: Don't Do It - Unless You're in Congress

Back in 2003, Martha Stewart was indicted on multiple charges including securities fraud and obstruction of justice. These charges stemmed from an investigation into an investment move back in 2001, when she allegedly dumped her shares of ImClone based on insider information that she had received from her broker. As it turns out, this sort of “insider trading” has been illegal since 1934.

But did you know that these rules, spelled out in the Securities Exchange Act of 1934, don’t apply to members of Congress? Despite the fact that they come into contact with non-public, potentially market-moving information on a daily basis, our Senators and Representatives are apparently free to profit from this knowledge.

This was the topic of an investigative report on 60 Minutes last night, and it was maddening to say the least.

According to Peter Schweizer, a fellow at the Hoover Institution:

“The fact is, if you sit on a healthcare committee and you know that Medicare, for example, is– is considering not reimbursing for a certain drug that’s market moving information. And if you can trade stock on– off of that information and do so legally, that’s a great profit making opportunity. And that sort of behavior goes on.”

In fact, this is very similar to what Martha Stewart was accused of doing. She apparently caught wind that one of ImClone’s experimental drugs wouldn’t be getting FDA approval before that information was made public, and she acted on it.

Why are members of Congress allowed to do this, when you or I would be subject to huge fines and time in prison?

“It’s really the way the rules have been defined. And the people who make the rules are the political class in Washington. And they’ve conveniently written them in such a way that they don’t apply to themselves. [...] We know that during the healthcare debate people were trading healthcare stocks. We know that during the financial crisis of 2008 they were getting out of the market before the rest of America really knew what was going on.”

For example, following a top secret briefing about the impending financial collapse in 2008, Congressman Spencer Bachus (R-AL) bought options that would rise as the market collapsed. And collapse it did.

And during the healthcare debate of 2009, then-House Minority Leader John Boehner (R-OH) allegedly loaded up on health insurance stocks just before the “public option” was removed from the Federal healthcare reform legislation.

And these deals aren’t limited to one party or the other… In 2008, former Speaker of the House Nancy Pelosi (D-CA) was granted access to the Visa IPO back in 2008 while the House was considering credit card legislation that would hurt the credit card industry. Her initial $220k investment went up $100k in two days.

While the credit card legislation would ultimately make it into law, that didn’t happen until much later, and the successful legislation was initiated in the Senate.

What do you think? While everyday citizens — as well as members of the Executive and Judicial branches — are barred from this sort of behavior, Congress gets of Scot free. As far as I’m concerned, this stinks.

Interestingly, going back at least to 2004, there has been interest in closing this loophole, but the issue hasn’t gained any traction. And why would it? The inmates are running the asylum, and they have no interest in regulating themselves.

Source: CBS News

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]]> http://www.fivecentnickel.com/2011/11/14/insider-trading-dont-do-it-unless-youre-in-congress/feed/ 12 Lending Club Update – October 2011 http://www.fivecentnickel.com/2011/11/10/lending-club-update-october-2011/ http://www.fivecentnickel.com/2011/11/10/lending-club-update-october-2011/#comments Thu, 10 Nov 2011 17:00:01 +0000 Nickel http://www.fivecentnickel.com/?p=22912 Lending Club Update

It’s been awhile since I updated my Lending Club performance, so I thought I’d take a moment today and let you guys know what’s going on. As I’ve mentioned in the past, I haven’t been adding notes to my portfolio this year. Instead, I’ve been pulling the cash out to our savings account as payments come in.

In terms of performance, our net annualized return (NAR) currently stands at 7.86%, which is a bit lower than the 8.30% that we were enjoying as of last May (when I last shared the numbers). According to Moneydance, our “real-world” performance has been a bit lower, right at 7.60% — this difference is mostly due to idle cash.

This dip in performance is to be expected. Since we haven’t been adding any new notes, the average age of our portfolio is increasing (our oldest notes are around 2.5 years old), and we’ve suffered some additional defaults. As of my last update, our portfolio looked like this:

  • 336 loans were current
  • 88 loans had been paid off
  • 2 loans were 16-30 days late
  • 13 loans were 30-120 days late
  • 13 loans had defaulted and/or been charged off

And as of now, it looks like this:

  • 294 loans are current
  • 120 loans have been paid off
  • 1 loan is currently 16-30 days late
  • 16 loans are currently 30-120 days late
  • 19 loans have defaulted and/or been charged off

So we’ve suffered six additional defaults in the past five months. The good news is that the later in its life that a note defaults, the less we lose. Thus, even though the defaults continue, they affect us less and less (on average) as our portfolio ages.

As for why we’re not adding any more notes… I’ve been too busy to put much time into note selection, and I’ve also decided that peer lending just doesn’t have the right risk-reward balance for our needs. In other words, we’re taking on a good bit of risk (as evidenced by the numerous defaults) with a relatively limited upside.

What about you? If you’re Lending Club investor, how have your investments performed? How many notes do you own? And how long have you been doing it?

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]]> http://www.fivecentnickel.com/2011/11/10/lending-club-update-october-2011/feed/ 18 Three Urgent Home Repair Jobs, and Three You Can Skip (or at Least Delay) http://www.fivecentnickel.com/2011/11/10/three-urgent-home-repair-jobs-and-three-you-can-skip-or-at-least-delay/ http://www.fivecentnickel.com/2011/11/10/three-urgent-home-repair-jobs-and-three-you-can-skip-or-at-least-delay/#comments Thu, 10 Nov 2011 14:03:43 +0000 Ed Avis http://www.fivecentnickel.com/?p=22902 Three Urgent Home Repair Jobs, and Three You Can Skip

When you think of the basics of a civilized family existence, a decent home is foundational. Doesn’t grace at your table frequently end with thanks for “the roof over our heads”? But not all home repair jobs are equally vital. The roof? Yes, you need a good roof. But, if you’re facing financial difficulties, a lot of other jobs can be dodged until thing improve.

Here are three home repair jobs that require immediate action, and three you can skip — for now.

Jobs that require action now

A leaky roof. You’ll notice a common theme in this short list of must-do house repair jobs — they all involve ways your house can be seriously damaged by water. A leaky roof tops the list.

You may think the ugly circle of mildew on your bedroom ceiling is harmless, but it is a clear sign that water is getting in somehow. Other signs of a leaky roof are sagging ceilings, a wet or moldy smell, and, obviously, water droplets anywhere on the ceiling, wall, or floor.

If you see any of these signs, call a roofer immediately! Water can wreck wood, plaster, drywall, and just about any other building material that it comes into contact with, so a leaking roof can do serious, expensive damage. However, you shouldn’t rush to accept the first bid you receive, no matter how panicked you are.

Roof replacement is not a complicated construction job, so a lower bidder will probably do about the same quality job as a higher bidder. Get multiple bids, ask for references, and then sign an agreement with the lowest bidder — as long as their references check out.

Leaking water heater. Again, water can be a killer. If your water heater springs a leak, you can be in for serious trouble (not to mention a lot of cold showers). Like the roof, replacing a water heater is not a complicated job. It does require a plumber (unless you’re quite handy), but it’s an everyday job for a residential plumber. Get three bids, and go online to see what a typical water heater would cost if you bought it yourself.

Obviously the professional installation will bump up the price a couple of hundred dollars, but if Home Depot is offering your type of water heater at $400 and the plumber wants $1,200 to put one in, you’re getting ripped off. Plumbers who make weekend calls sometimes charge more than they should, figuring you don’t want a cold shower on Sunday morning. Don’t do it — you can live until Monday without a shower.

If the water heater is leaking on Saturday night and it’s more than a pile of towels can absorb, you should be able to find the valve to turn off the water going into the heater. Then on Monday morning make some more calls and you’ll surely find a plumber offering a fair price.

Broken sump pump. Okay, for this one you might pay the emergency plumber weekend fee, especially if water is filling your basement. But if you’re reasonably handy and it’s not an emergency situation, you might try this one yourself. It’s going to be easier than either of the two jobs above.

Exact details are beyond the scope of this column, but here are two basic tips: (1) unplug the pump before you touch anything; and (2) when you go to the hardware store, try to buy precisely the same pump that just broke (as counterintuitive as this may sound, you’ll know you are getting the right pump). Whether you do this yourself or hire a plumber, get it taken care of before more damage is done!

Three Jobs You Can Put Off

Damaged siding. Yes, water can seep in through damaged siding, but not nearly as much as comes in through a leaky roof. There’s a reason you see houses with 30-year-old siding — rarely is there an urgent need to replace it. Most people replace their siding for one of two reasons: (1) it’s ugly and they want to update the house; or (2) they want to insulate their home, and adding new siding is a nice complement to that job.

Obviously, you’ll need to use your head with this one, but there is typically no need to panic over what might turn out to be cosmetic damage. You should also keep in mind that total replacement is not the only solution — if your siding is just damaged here and there, fix those pieces and you’ll be good to go.

Painting/patching/cracks. A fresh paint job is a great way to make your interior look great, but if money is tight, try simply cleaning the walls instead. Depending on the paint, you can usually wash your walls with mild detergent in warm water. Then fix nail holes with a bit of spackle and a dab of touch-up paint. A few hours work and your walls will look much better.

Of course, if you’re dealing with damaged or cracked paint (or caulk) on the exterior, you’ll need to assess the situation. Often times a quick touchup job can save major headaches down the line.

Broken dishwasher/washing machine/dryer. Yes, living with broken major appliances can be inconvenient, but you can certainly get by without all three of these. In fact, your great grandparents probably lived without any of them! Get your hands in that sink and go to work! Your wallet will thank you.

Build a cash cushion

These are, of course, just the tip of the iceberg when it comes to home repairs. The point here is that certain things need to be dealt with immediately, whereas others can be dealt with as time (and money) allows. In general terms, if there is a risk of water damage or fire, you’ll need to act quickly. But if not, you may be put things off for the time being.

But… It’s important to keep in mind that you’re really just delaying the inevitable. If you find yourself having to put off repairs for financial reasons, that’s a pretty clear sign that you need to do a better job of building a cash cushion. Dust off your monthly budget and multiply it by three (or six, or whatever multiple you’re comfortable with) and set that as your target.

From there, it’s simply a matter of tightening your belt and setting aside whatever you can afford in a dedicated savings account at your favorite bank. It may take awhile to get there, but once you build savings into your budget, it’s just a matter of time before these sorts of crises will be a thing of the past.

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]]> http://www.fivecentnickel.com/2011/11/10/three-urgent-home-repair-jobs-and-three-you-can-skip-or-at-least-delay/feed/ 4 Net Worth as a Function of Age http://www.fivecentnickel.com/2011/11/09/net-worth-as-a-function-of-age/ http://www.fivecentnickel.com/2011/11/09/net-worth-as-a-function-of-age/#comments Wed, 09 Nov 2011 14:20:20 +0000 Nickel http://www.fivecentnickel.com/?p=22892 Net Worth as a Function of Age

By now you’ve likely heard about the growing wealth gap, where the rich are getting richer and the poor are getting poorer while the middle class disappears. But did you know that the age structure of wealth is changing, as well?

Not surprisingly, older Americans have a higher median net worth than younger Americans. But over the past 25 years, the difference has grown dramatically. In 1984, households headed by an adult 35 or younger had a median net worth of $11,521 while those headed by someone 65 or older had a median net worth of $120,457.

Fast forward to 2009… The median net worth of households headed by someone under age 35 dropped to $3,662 while the median net worth of those headed by someone over 65 years of age has grown to $170,494. Thus, the gap has grown from 10.5x in 1984 to 46.5x in 2009 — the largest age-based wealth gap on record.

For those in the younger age group, this represents a 68% decline in wealth while the older age group has enjoyed a 42% increase. Yikes. That’s a huge change for those at the bottom end of the age distribution. So why the change?

A big part of the difference may be that there has been a gradual increase in college attendance over the years, which means that more and more young people have been going to college, and thus taking on more debt and delaying their entry into the work force. While it’s been argued that college is a good investment, it takes time to overcome those initial costs.

Another major player has likely been the housing market. While older homeowners typically got into the housing market long ago, before the massive boom (and eventual bust) in home prices, many younger homeowners bought into a red hot housing market that was poised for collapse.

Whatever the cause, it’s clear that the next generation might not have it better than the one before it.

Source: CNN/Money

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]]> http://www.fivecentnickel.com/2011/11/09/net-worth-as-a-function-of-age/feed/ 9 TreasuryDirect Changes Security Features – Easier Account Access? http://www.fivecentnickel.com/2011/11/07/treasurydirect-changes-security-features-easier-account-access/ http://www.fivecentnickel.com/2011/11/07/treasurydirect-changes-security-features-easier-account-access/#comments Mon, 07 Nov 2011 16:07:31 +0000 Nickel http://www.fivecentnickel.com/?p=22722 TreasuryDirect Changes Security Features

Guess what? It just got easier to access your TreasuryDirect account. If you’re not familiar with TreasuryDirect, it’s a website run by the US Treasury which allows individual investors to make direct purchases of Treasury securities. And it used to be a huge pain in the butt to login.

Not only did you need your account number and password (which was entered on a virtual keyboard), but there were multiple security questions, plus you needed a physical access card. This card was roughly equivalent to an old-school secret decoder ring in that they’d give you row/column coordinates and you had to look up values on your card and enter them in the appropriate fields.

Using the card itself wasn’t terribly hard, but you had to keep track of it and have it handy whenever you wanted to login. I ended up taking a picture of mine and storing the image inside a encrypted password keeper because, without it, I couldn’t get into our account.

And if you lost your card? Too bad for you… You’d have to call the Treasury, verify your identity, and then wait for a replacement card to be snail-mailed to you before you could get back in.

I was thus intrigued when I got an e-mail last month saying the following:

Dear TreasuryDirect Account Holder:

We’re committed to providing a secure environment for your investments and personal information.

In a few weeks, we’ll be replacing the access card with personalized images, one time passcodes, and computer registration as new layers of security to your TreasuryDirect account. Continue to use your access card until you’re notified within your TreasuryDirect account.

Thank you for using TreasuryDirect.

Woohoo! No more physical access cards! And no more lists of security questions. In their place would be a much more standard login process involving personalized images, computer registration, and one-time passcodes. The changes apparently went live this past Friday (Nov 4th) and I was able to test them out over the weekend.

In short, the login process is now a whole lot easier. I started by entering my account number, after which I was greeted with the following message:

We are unable to recognize your computer. (You may not have registered your computer or some settings may have changed.)

To provide an additional form of authentication, we have sent you an e-mail containing a one time passcode. The passcode will be valid for 2 hours from the time it was sent. If you do not receive your e-mail within 30 minutes, please contact us at 304-480-7711. Please enter your passcode, indicate whether you want to register your computer, and click Submit.

The one-time code showed up a few minutes later. I clicked the “Remember This Computer” box, entered my code, and clicked submit. I was then asked to enter my password using a the mouse to click buttons on a virtual keyboard. Interestingly, I noticed that the password is not case-sensitive — kind of odd for a website that seems so focused on security.

After that, I was asked to choose a personalized image and enter a caption, which will be presented me in the future so I’ll know that I’m on the real TreasuryDirect site as opposed a scammer’s site designed to steal my credentials. This is pretty much standard fare for financial institutions nowadays, and I’m glad to see the Treasury taking a step into the 21st century.

But guess what? While logging out and logging back in to test the process for this article, I somehow managed to lock myself out of my account!

For security reasons, your account has been locked and cannot be accessed. Please contact us at (304) 480-7711.

As I write this, I’m sitting on hold waiting to get my account unlocked. Even with the new security features, some things never change…

Update: I was on hold so long that it forced me over to a voicemail system where I had to leave account and contact details so they could call me back. I’m still waiting for that call.

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]]> http://www.fivecentnickel.com/2011/11/07/treasurydirect-changes-security-features-easier-account-access/feed/ 25 Series I Savings Bond Rates – November 2011 http://www.fivecentnickel.com/2011/10/26/series-i-savings-bond-rates-november-2011/ http://www.fivecentnickel.com/2011/10/26/series-i-savings-bond-rates-november-2011/#comments Wed, 26 Oct 2011 16:03:18 +0000 Nickel http://www.fivecentnickel.com/?p=22432 Series I Savings Bond Rates - November 2011

This is just a quick note to say that September inflation numbers are out, so we can now calculate the new Series I Savings Bond rates that will go into effect in November. I’ve talked in the past about how to predict Savings Bond interest rates. The short answer is this:

The I Bond rate is made up of two pieces: the fixed rate and the variable rate. The variable rate is pegged to inflation, and that’s the piece that you can easily calculate if you know how much the CPI-U has changed over the past six months. Simply divide the old CPI-U into the new one and you’ll get an estimate of the semi-annual inflation rate. From there, you just double it to estimate the annual change and add the fixed rate.

Back in April, the CPI-U stood at 223.467 and by September, it had increased to 226.889. This work out to a 1.53% increase (i..e, 226.889 / 223.467 = 1.0153). If we double this, we get 3.06% for the variable portion of the I Bond rate.

In other words, all I Bonds will receive a rate of 3.06% + the applicable fixed rate for the next six month period. For new issues, I would fully expect the fixed rate to stay at 0%, but we’ll have to wait until November 1st to find out for sure.

If you buy now, you’ll get the current rate (4.6% + 0%) for the next months, after which you will receive 3.06% for six months, and then whatever the applicable rates are after that. If you wait until November 1st, you’ll like receive 3.06% + 0%, and then whatever the rate is six months in the future.

In other words, if it were me, I’d probably buy now instead of waiting. In fact, we did just that last May, when we bought our annual limit at the 4.6% rate. What about you? Do you invest in I Bonds? If so, have you already taken the plunge for this year? Or have you been waiting in hopes of a better (non-zero) fixed rate?

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]]> http://www.fivecentnickel.com/2011/10/26/series-i-savings-bond-rates-november-2011/feed/ 11 Why You Should Join an Investment Club http://www.fivecentnickel.com/2011/10/06/why-you-should-join-an-investment-club/ http://www.fivecentnickel.com/2011/10/06/why-you-should-join-an-investment-club/#comments Thu, 06 Oct 2011 13:26:30 +0000 Jeffrey Steele http://www.fivecentnickel.com/?p=21692 Why You Should Join an Investment Club

For nearly 25 years, the ups and downs of the Dow Jones, Nasdaq, and S&P 500 have buffeted my financial outlook, making me queasier at times than a rider on Cedar Point’s Maverick roller coaster. I’ve felt I owned the world during market highs, and like a 1929 ledge diver as markets plunged.

I survived the crash of October ‘87, the bursting of the tech bubble in early 2000 and the Great Recession of 2008-10. And through it all, I went right on routinely injecting fresh cash into my stock portfolios via dollar-cost averaging.

I thought I’d become inured to the fear that grips ordinary investors, spurring them to bail from the market at inopportune times. But the wild upheavals in the market in recent weeks have threatened to have even me pouring on the Maalox. I can only guess at the trepidation gripping would-be investors who know they should begin investing in equities, but can’t quite stomach the thought of their hard-earned dollars turning to dust.

I have a suggestion that may make it easier for them to get started, and that is to launch an investment club, or arrange to join an existing investment club.

Though I’ve never been a member myself, it’s not for lack of wishing I could be. Participating in an investment club has always seemed like it would be a fun and beneficial activity. Having produced a number of articles for different publications on how to start and run an investment club, I’ve talked to myriad people who spoke of their investment club participation as one of the wisest — and most enjoyable — things they’ve ever done.

Investment clubs defined

So what is an investment club? It’s a group of individuals who get together every week or every month to pool their money and jointly invest in different stocks they have researched. In a number of instances, investment clubs have been sustained for years, and have earned their long-term members not-inconsiderable sums.

But if you think the main benefit of investment club membership is making money, think again. From what I’ve heard from veteran participants, profits go far beyond cash. Here’s a look at some of the ways clubs make their members richer in dollars, and in other ways.

Learning the markets. Investment club members don’t just guess what stocks to pick. In most clubs, members are assigned to research different stocks, and must come back to their next meeting with a thumbs up or down on putting their club’s money in those stocks. Undertaking this activity repeatedly, and learning from other members, they build skills in how to analyze equities — and become informed investors. In the end, the club becomes a mechanism to, first, educate the uninitiated, and then to get them investing.

Studies have shown that within a year of joining an investment club, many beginners are not only investing through their clubs but on their own as well.

Thinking globally. Members gain a broader understanding of the world. They begin to take greater interest in domestic and international events, political upheaval and demographic and consumer trends, because all can impact their choice of when and where to invest.

Savings/retirement focus. Most Americans don’t put enough money into savings accounts, and don’t do enough retirement planning. The days when they’ll need savings or retirement funds creep up, and by then it’s too late to accumulate a nestegg.

By getting members focused earlier on savings and retirement issues, investment clubs help members develop very positive wealth-accumulation mindsets. They are expected to attend meetings, meaning they must put aside cash for the pool on a regular basis. Their membership helps them master the discipline of saving a lot — a little at a time.

Profitable field trips. In a number of investment clubs, members go beyond reading and surfing the net for information about companies. They go out on jaunts as a club and visit local brokerages, to meet their officials and get their investing insights.

Forging friendships. Just as does a ski club, an amateur theater group, or your local beer league softball team, an investment club gets you out of the house, meeting other people and building lasting friendships. Investment clubs stage holiday parties and summer picnics, and typically the socializing is paid for from profits generated by the club’s own wise investment moves. Many clubs also throw celebrations when the value of their portfolios has climbed to certain pre-determined dollar levels. When this happens, they forgo the monthly meeting and party down, to remind themselves of why they invest.

The takeaway

While it’s possible to join an existing club, that’s not as easy as gathering some friends and starting your own. The Madison Heights, Mich.-based National Association of Investors Corporation (NAIC), a non-profit organization focused on investor education, offers tips to get you started at its website, www.betterinvesting.org. If you’re timid about sticking your toe in the stock market, remember… There’s courage — and strength — in numbers. And joining an investment club may be just the move you need to gain those critical traits.

Note from Nickel: If you’re a cost-concious, buy-and-hold investor that doesn’t have a taste for individual stocks, then I would suggest getting active in an online discussion group such as the Bogleheads Forum. They even have local groups so you can meet up with other like-minded folks.

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]]> http://www.fivecentnickel.com/2011/10/06/why-you-should-join-an-investment-club/feed/ 5 Investing in Gold: Are you a Gold Bug? http://www.fivecentnickel.com/2011/10/04/investing-in-gold-are-you-a-gold-bug/ http://www.fivecentnickel.com/2011/10/04/investing-in-gold-are-you-a-gold-bug/#comments Tue, 04 Oct 2011 16:48:27 +0000 Hank Coleman http://www.fivecentnickel.com/?p=21562 Investing in Gold: Are you a Gold Bug? hspace=

Lately, you cannot turn on a television or surf the internet without being bombarded by advertisements proclaiming the benefits of buying gold and having it in your investment portfolio. Gold bugs, a name that people use to describe the lovers of the glittering metal, would want investors to believe that the financial sky is falling and buying either gold coins, gold bullion, or shares in gold ETFs are the only solutions to our economic woes.

While I know that it will not be a popular stance, I’m here to tell you that if you have not bought gold already, you have most likely missed the boat in its short-term rise. Gold has skyrocketed over the past couple of years thanks to a rocky economy. Now is not the time to chase great returns. Can gold and other precious metals be a great small slice of your overall investment portfolio? Absolutely. But now may not be the time to load up on one specific asset class that has had a huge run.

I hate buying anything at its 52-week high

I am a value investor and a contrarian at heart. I absolutely hate buying any investment at its 52-week high, no matter how great it is supposed to be. It goes against every fiber of my investor being. Every time I see a television commercial predicting the dollar’s demise and gold’s continued skyrocket, I have trouble thinking of anything other than the age old guaranteed formula for making a profit with your investments. You have to buy low and sell high.

Now is not the time to buy gold with it not only at its 52-week high price but at its all-time high. Entering the market now could possibly set you up for a downfall from these astronomical prices.

Note: Shortly after Hank submitted this piece, the price of gold tumbled more than 10%, though the price is still very high in historical terms. For example, check out the current price of GLD (link), a gold ETF. Click out to the “all time” view to see how the prices has risen over the past few years.

I can’t stand the volatility associated with gold

I am an investor. I’m not a trader. There is a big difference in the two. I am only interested in purchasing investments for the long-term. I have the luxury of not needing any of the proceeds from my investments to pay for my financial goals such as retirement, my children’s college education, or buying a house.

Every time I hear the price of gold, my stomach gets queasy. Since the US government has allowed citizens to again start owning gold in 1974, the price of gold has only appreciated a little over 6% from 1974 until the end of 2009 with many years of declines. It wasn’t until the past few years that we have seen the price of gold completely skyrocket. At the end of August, one ounce of goal is worth a little over $1,827. The price of gold started the year at $1,421, and that move equals a 28.5% rate of return just year-to-date heading into the final quarter of the year.

I personally cannot stomach something that behaves this erratically. I know that my risk appetite for investments doesn’t match up to the swings that can be common with the price of gold. Because of those price swings, I limit the amount of gold that I hold in my own investment portfolio.

Note: As of today, the price of gold stands at $1620 — a 12% drop from the end of August, but still 14% higher than at the start of the year.

Gold prices trade on emotion

Most gold bugs praise gold for its ability to be a hedge against inflation. While that argument is fundamentally true, it still lacks practical applications if it had to be enacted. If a horrible catastrophe struck, we would not be exclusively trading gold coins and gold bullion for goods and services. In my opinion, the argument that we will all use gold as an exclusive form of currency when inflation soars is flawed.

In the past, we haven’t resorted to gold as an everyday currency as a result of turmoil. During the 1970s and 1980s, when gas prices soared and inflation spiked over 10% annually, American citizens were not in stores using gold coins to purchase items. Many experts actually think that Americans would revert to a barter type economy if there was a complete collapse of the dollar instead of relying on gold.

Because so few American households actually hold physical gold instead of simply shares in an ETF or on paper, it would make it nearly impossible for gold to be used as an everyday currency should disaster strike.

Do I know where the price of gold is heading? Of course not. But I’m always cautious about anything that is sold on late night television infomercials, and that is especially true for investment products. Maybe the price of gold is going higher. Maybe we are poised for a crash as the economy recovers. No one knows for sure.

Just be aware that, if you want to make gold or other precious metals a small portion of your investment nest egg, there are better ways of investing in them than through radio and TV barkers.

What about you? Have you been bit by the gold bug? How much (as a percentage) of your total investment portfolio is made up of gold or other precious metals?

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]]> http://www.fivecentnickel.com/2011/10/04/investing-in-gold-are-you-a-gold-bug/feed/ 6 Do You Have a Plan? http://www.fivecentnickel.com/2011/09/30/do-you-have-a-plan/ http://www.fivecentnickel.com/2011/09/30/do-you-have-a-plan/#comments Fri, 30 Sep 2011 14:55:49 +0000 Nickel http://www.fivecentnickel.com/?p=21522 Do You Have a Plan?

While on Twitter the other day, I ran across someone who was lamenting that she had bought a few stocks “awhile ago,” and that some were doing well, some very poorly… “Wondering when to get out.”

My first thought was: Hmmm. What was your plan for this money? And why do want/need to get out? Simply because some are up and some are down and it’s making you uneasy? In that case, you might want to re-think your risk tolerance. Or is it because you actually need the money?

What this all boils down to is whether or not you have a plan for your money – and whether or not you’re comfortable with that plan. The stock market is not a place to put money on a whim, and you certainly shouldn’t be putting money there if there’s a decent chance you’ll need it in the next 5-10 years.

Why? Because it might go down. A lot. And you might wind up being forced to sell at the bottom. Fortunately, it’s relatively easy to avoid this fate.

For starters, you need to have a healthy emergency fund, which will provide a cash cushion in the event of unforeseen financial difficulties. If not, you could be forced to liquidate your investments at the worst possible time.

Next, you’ll need a clear idea of your goals. If you’re saving for something like a house downpayment or a car, and you foresee needing the money in the next few years, then you should stick to guaranteed investments like CDs or even a savings account. Sure, the interest rate won’t be very high, but your money won’t shrink, either.

If, on the other hand, you’re saving for the long-term (e.g., college for your young kids, retirement, etc.) then you might consider investing in stocks and bonds. In this case, it’s important to think hard and do some research before acting.

  • How much in stocks vs. bonds?
  • Do you want international exposure?
  • Individual equities or mutual funds?
  • Actively managed or index funds?

And so forth. I can’t tell you what’s best for you, but I can tell you what we do…

We’re currently holding a 60/40 split between stocks and bonds. This roughly reflects the old “age in bonds” rule, and puts us at a comfortable (to us) spot on the risk/return continuum.

Within the stock category, it’s 2/3 domestic and 1/3 international. Within the bond category, it’s 2/3 total (domestic) bond market and 1/3 TIPS. For all of these holdings, we’re primarily using index mutual funds, which provide broad diversification and rock-bottom costs.

The bulk of our holding include:

  • Vanguard Total Stock Market Index Fund (link)
  • Vanguard Total International Stock Index Fund (link)
  • Vanguard Total Bond Market Index Fund (link)
  • Vanguard Inflation Protected Securities (link)

From here, we never have to ask questions like “When should I get out?” We simply make new contributions in proportion to these targets and rebalance when things get out of whack. As we approach our goals, we’ll gradually adjust our stock holdings down and bump our bonds up.

What about you? Do you have a plan?

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]]> http://www.fivecentnickel.com/2011/09/30/do-you-have-a-plan/feed/ 3 Vanguard Adds Same-Day Trading for Bank Transfers http://www.fivecentnickel.com/2011/09/26/vanguard-adds-same-day-trading-for-bank-transfers/ http://www.fivecentnickel.com/2011/09/26/vanguard-adds-same-day-trading-for-bank-transfers/#comments Mon, 26 Sep 2011 15:37:44 +0000 Nickel http://www.fivecentnickel.com/?p=21402 Vanguard Adds Same-Day Trading for Bank Transfers

It’s no secret that I love Vanguard. In fact, with the exception of two employer-related retirement accounts that are held at Fidelity, we do all of our investing at Vanguard. I was thus pleased to see that they’ve added the ability to make same-day mutual fund trades when transferring money in from a linked bank account.

Same-day trades with electronic bank transfers
Now you can get today’s trade date if you use our electronic bank transfer service to buy a Vanguard mutual fund. Just submit your request on business days before the close of regular trading on the New York Stock Exchange (generally 4 p.m., Eastern time) and you’ll receive that day’s closing price.

They’ve apparently been rolling this out gradually for awhile but, as of last week, it’s available to everyone. While the vast majority of our investing happens through automatic (pre-scheduled) transfers, it’s certainly nice to have a bit of added flexibility.

The old rule was that, if you bought (with outside funds from a linked bank account) by 10PM Eastern on a particular day*, you’d get the next day’s trade date (and closing price). Thus, if you wanted to put new money into the market on a particularly bad day, your cash already had to be at Vanguard, presumably sitting in a money market fund.

The problem with this is that money market mutual funds are currently paying a pittance — just 0.03% for the Vanguard Prime Money Market as of this writing. While bank interest rates aren’t exactly high, you can do way better than 0.03% with an online savings account.

In essence, Vanguard is now trusting that your funds transfer request will clear without any problems. Given that trades don’t technically settle for three days, they’ll still have your money (or not) before the settlement deadline. This change brings them in line with many other brokers who have been offering this level of service all along.

*Note: As always, exchanges between funds occur on the day you place the order, as long as you place it before the market closes.

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]]> http://www.fivecentnickel.com/2011/09/26/vanguard-adds-same-day-trading-for-bank-transfers/feed/ 1 Think Twice Before Buying a Timeshare http://www.fivecentnickel.com/2011/09/20/think-twice-before-buying-a-timeshare/ http://www.fivecentnickel.com/2011/09/20/think-twice-before-buying-a-timeshare/#comments Tue, 20 Sep 2011 13:00:11 +0000 Hank Coleman http://www.fivecentnickel.com/?p=21132 Think Twice Before Buying a Timeshare

If the American Dream is to own your own home, then owning a timeshare or a vacation home may not be far down the list. Many people dream of having enough money to spend a couple of weeks every summer at the beach or in the mountains.

Owning a timeshare allows you to dip your toes into the vacation home market even if it’s just for one or two weeks during the year, even if you can’t afford the luxury of a second home. Many people are looking for ways to save money on travel, but a timeshare may not be the best way use of your hard earned income to accomplish your vacation dreams.

The savings may not be as great as a hotel

Don’t be fooled into thinking that purchasing a timeshare is an easy way to purchase a piece of your dream vacation home at a fraction of the sticker price. Timeshares are still very pricey even if you’re buying the equivalent of just one or two weeks at a time. In fact, many timeshare programs are run by hotel chains with locations around the country, but owning a timeshare may cost you as much or more than renting a comparable hotel room.

Like chips in a casino, points often hide the true cost of what you’re spending, as it’s hard to equate them with actual dollar values. At one popular timeshare company in the US, you could use your yearly timeshare points to purchase a two week vacation in Hawaii in a one bedroom place for approximately 300,000 points during the peak season.

To put the above in perspective, I have a friend who receives 89k points/year, and he paid $10k to receive those points. If you financed your timeshare using a ten year loan like he did, you would have purchased those 89,000 points for about $1,000 per year plus a ton of interest. That two week hotel stay in Hawaii ultimately could cost you approximately $3,370 — again, ignoring the interest payments — once you convert your points into a dollar value. Could you have found a nice hotel for two weeks in Hawaii for less?

Timeshares add to your debt

Given how expensive they can be, it should come as no surprise that timeshares can put you into debt very fast. Remember my friend from above? That loan that he took out cost him a whopping $230/month! By the time he finishes paying off his loan for the timeshare, he will have paid $27,600 (!) for a $10,000 timeshare purchase. So, technically, a Hawaiian vacation like the one mentioned in the earlier example really costs over $6,000 if you take into account the interest that he’s paying.

The fees keep coming

Even after you pay off your loan and own your timeshare free and clear, you’ll still have to pay monthly maintenance fees. These fees are very similar to HOA fees, or dues that you have to pay for the upkeep of the property. The maintenance fees for many popular timeshares can be upwards of $45 per month. So that “free” vacation that you’ve finally paid off will continue to cost you hundreds of dollars per year. And like HOA fees, timeshare maintenance fees can increase over time.

Timeshares are hard to resell

Another major downside of timeshares is that there is practically no secondary market for reselling your purchase. Thus, if you have buyer’s remorse or you just need to recover your money, you’ll have a hard time recouping anywhere near what you spent. In many cases, timeshare owners wind up selling their timeshares back to the property management companies at a tiny fraction of the original price.

While saving money on vacations is an admirable, don’t get swept away by the dream of owning your own vacation home. When you purchase a timeshare, you may be buying a small piece of that dream, but purchasing a timeshare is not for everyone, and it’s not a particularly good investment.

If you’ve owned a timeshare, I’d love to hear about your experiences. What’s the best part of timeshare ownership? And the worst? Any lessons that you’d like to share with the rest of us?

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]]> http://www.fivecentnickel.com/2011/09/20/think-twice-before-buying-a-timeshare/feed/ 14 Is the Home Mortgage Interest Tax Deduction a Good Deal? http://www.fivecentnickel.com/2011/09/14/is-the-home-mortgage-interest-tax-deduction-a-good-deal/ http://www.fivecentnickel.com/2011/09/14/is-the-home-mortgage-interest-tax-deduction-a-good-deal/#comments Wed, 14 Sep 2011 17:51:35 +0000 Nickel http://www.fivecentnickel.com/?p=21062 Is the Home Mortgage Interest Tax Deduction a Good Deal?

Interest payments on home mortgages have long been tax deductible in the United States. In fact, prior to the Tax Reform Act of 1986, interest on all personal loans was tax deductible. The deductibility of loan interest dates back to the introduction of the income tax system in 1913 when, according to an article in the NY Times, it was difficult to distinguish between personal interest and business interest in a nation full of small proprietors.

Regardless of Congress’ initial intentions, the home mortgage interest deduction eventually became a stepping stone to home ownership. The reason for this is that it effectively decreases the cost of borrowing to buy a home. There are, however, some limitations that reduce the value of this deduction.

For starters, you must elect to itemize your deductions, and the mortgage interest (and other deductions) only reduce your tax bill to the extent that your itemized deductions exceed the standard deduction. Another limitation, but one which does not impact the majority of Americans, is that interest is only deductible on the first $1M of mortgage debt. A similar limit of $100k applies to home equity loans regardless of their purpose.

Another important thing to keep in mind is that an income tax deduction is very different from an income tax credit. Whereas the former reduces the amount of your income tax that is subject to taxes, the latter directly reduces your tax bill.

Take, for example, an individual in the 25% federal income tax bracket. For every $1000 in mortgage interest that they pay in excess of the standard deduction, their tax bill will be reduced by $250 (plus whatever state income tax benefits they might enjoy). In contrast, a $1000 tax credit would reduce their total tax bill by $1000.

While the home mortgage interest tax deduction is undoubtedly beneficial to those with mortgages, many people use it as an excuse to keep their mortgage when perhaps they shouldn’t. We could debate all day long whether or not you should pay off your mortgage early – with the alternative being to keep your mortgage in favor of putting extra money into your investments. In my opinion, the mortgage interest deduction should be just a small part of this decision.

Let’s consider a simple example…

The standard deduction for 2011 is $11,600 for married couples filing jointly. Let’s assume that a married couple buys a $300k house on January 1st with 20% down, resulting in a $240k fixed rate mortgage at 5%. Over the course of the first year, they will pay a total of $11,919.58 in mortgage interest. Let’s further assume that they donate $3k to charity and pay $3k in property taxes.

Taken together, these mortgage interest and charitable contributions add up to $17,919.58 in deductible expenses. Sounds great, right? Assuming that they’re in the 25% tax bracket, this works out to a tax savings of $4,479.90 — or does it?

The reality is that they would’ve been able to take the standard deduction regardless, so we really need to subtract that out to find out the marginal gain from itemizing. The standard deduction would have reduced their tax bill by $2,900 ($11,600 x 0.25) so they’re really only gaining $1,579.90 in additional tax savings.

That’s $1,579.90 tax savings in return for paying an extra $11,919.58 in interest — a 13% tax savings. While this 13% savings is far better than nothing, it’s nowhere near as good as one might expect based on their tax bracket. And if they hadn’t made that charitable contribution, the benefit would have been less.

As with anything, you’ll need to run the numbers and decide what’s best for you. Just be aware that when someone warns you not to pay off your mortgage because you’ll be giving up that huge tax deduction, the numbers aren’t nearly as good as you might think.

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]]> http://www.fivecentnickel.com/2011/09/14/is-the-home-mortgage-interest-tax-deduction-a-good-deal/feed/ 12 Being Retired? That’s So Tired http://www.fivecentnickel.com/2011/09/13/being-retired-thats-so-tired/ http://www.fivecentnickel.com/2011/09/13/being-retired-thats-so-tired/#comments Tue, 13 Sep 2011 10:00:24 +0000 Jeffrey Steele http://www.fivecentnickel.com/?p=20982 Being Retired? That's So Tired

The American paradigm for decades was that you worked for an employer your entire life. Then at 65, you were feted at a retirement party, handed a gold watch by your boss, and sent off on a serene path into your Golden Years.

After 40 or 50 years savoring all the good things about work life — the satisfaction of challenges surmounted, the colleagues who turned into friends, the reassurances of a steady paycheck and a comforting routine — you were suddenly expected to love a new life of sleeping in, idling away long afternoons, playing a little golf, and trying to keep out of your spouse’s way.

Where once you’d enjoyed a built-in social network provided by your co-workers, the folks with whom you rode the bus or train to work, the waitresses at your workday lunch spot, your world now grew exponentially smaller — a first but significant shrinkage on the path to dwindling to the size of your deathbed.

No wonder there was another American cliche associated with the above. It involved the guy who, after retiring in fairly good health, suddenly dropped to the pavement, dead of a heart attack a few short years or months after retiring.

More recently, I’ve heard of a new standard replacing the old one. It’s being forged by retirees who, after learning that a life of golf games, grandkids, and gazing at TV didn’t match their retirement dreams, decided they needed to go back to work. Not necessarily for money, but for their mental health.

I’ve heard these stories over and over: The former watch repairman who returned to tinkering with timepieces three days a week, the barber who took over a chair in the very shop he’d sold years before, the retired construction tradesman who assumed the reins of the home delivery service at his sons’ eatery.

About seven years ago, I interviewed Dr. John Gorham, who started work at the Washington State University College of Veterinary Medicine in Pullman, WA right after World War II. When Gorham logged his very first workday, Harry S. Truman was in the White House, TV was in its infancy, and the Chicago Cubs’ last World Series appearance had come a few months earlier.

An awful lot had changed by the time of that interview nearly 60 years later. But one thing hadn’t changed. In 2004, Gorham, then 81, still came to work each day as a professor of veterinary pathology, just as he had since 1946.

“It’s because I like to go to work every day,” he told me. “The people here are all 30 or 40 years younger than I am, and I get a kick out of being around the group. They’re after new research, and it’s just fun going to work.”

Paradigm shift

Turns out, Gorham was out ahead of the pack on this issue. Many folks today are realizing that spending the last years or decades of their life without ambition, challenges, or paychecks isn’t a particularly bright idea.

A few weeks ago, I spoke with Sara Rix, senior strategic policy advisor with the AARP Public Policy Institute in Washington, D.C. The topic: the merits of working longer. Today’s labor force is adding a lot of older people, especially those between 65 and 69, as folks delay retirement, or retire the retirement idea entirely, Rix told me. The rate of employment beyond the traditional retirement age has ballooned from 18.4% in 1985 to 31.5% last year. Among women, it’s actually doubled, from 13.5% in 1985 to 27% in 2010, Rix says, adding, “They like the social environment work provides.”

AARP’s Jean C. Setzfand puts it a different way. “Few people anymore see retirement as a time when they’ll put their feet up and do nothing,” she wrote recently. “Increasingly, people expect to work past 65 or 67, even if their job is something completely different from the one they’ve done their whole lives.”

And the fact is, it’s a brilliant money move to work a little longer, AARP points out. “Remaining at work longer is an option for many of us,” Rix says, noting the benefits of delaying retirement by even a few years means that many more years of savings, and that fewer number of years of financial outflow.

There’s also the issue of Social Security payments, which can be taken starting at 62, 65, or 70. If you hold out taking Social Security payments until age 70 because you can, your benefits are about 80 percent higher than at 62.

And that’s yet one more reason to consider working a little longer.

To give you an idea of the most advantageous age for you to take social security, and to learn the penalties for starting the flow of social security checks earlier rather than later, visit AARP’s new Social Security Benefit Calculator.

“Even a year of extra work makes a difference,” Rix says. “People ought to look into the advantages of working longer. And it doesn’t have to be 10 years longer. It can be one, two, or three years longer.”

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]]> http://www.fivecentnickel.com/2011/09/13/being-retired-thats-so-tired/feed/ 3 Tax Loss Harvesting, 31 Days Later http://www.fivecentnickel.com/2011/09/12/tax-loss-harvesting-31-days-later/ http://www.fivecentnickel.com/2011/09/12/tax-loss-harvesting-31-days-later/#comments Mon, 12 Sep 2011 13:39:18 +0000 Nickel http://www.fivecentnickel.com/?p=21002 Tax Loss Harvesting, 31 Days Later

Just over a month ago, we were dealing with wild stock market swings in the wake of the debt ceiling debacle, and market indices had fallen to levels where many of us were carrying paper losses. I thus suggested that it might be a good time to harvest some losses for tax purposes.

Harvesting our losses

I’m not sure about you, but I followed through and harvested a significant chunk of losses. The beauty of this is that you can carry unused losses forward indefinitely, and you can also use your losses to write off $3k/year in ordinary income, which is taxed at a higher rate than long-term capital gains.

Assuming a federal rate of 25% and assuming a state income tax rate of 6%, that $3k/year tax break works out to an annual savings of $930. And that will continue until we’ve used up our losses. Not bad for a few minutes work.

Anyway… When I made these moves, I ended up shifting money from the Vanguard Total Stock Market Index (VTSAX) into the Vanguard Large Cap Index (VLCAX). Thus, we were never out of the market, meaning that we’d be fully invested in the event of a quick rebound. While these two funds track each other rather closely, they follow different indices, so we’re also safe when it comes to avoiding a wash sale.

To make things easier on the back end (more below) and to avoid trouble with Vanguard’s frequent trading policy, I then converted our mutual fund shares into the equivalent ETF (i.e., I converted VLCAX into VV).

Returning to the issue of wash sales… To avoid triggering a wash sale, we weren’t able to move back into the Total Stock Market Index for 31 days (not counting the original trade date). Given that our original sale was made on August 10th, and that there are 31 days in August, we had to sit in VV until at least September 10th.

Note: To determine your wash sale window, simply pull out a calendar and count forward (or backward) 31 days starting with the day after (or before) your transaction date.

Making the roundtrip

While I’m comfortable with holding VV for the long term, my preference would be to get back into VTI (the ETF equivalent of the Vanguard Total Market Index Fund) if we could do so without incurring any gains. And guess what? Given the recent performance of the stock market, we’re not too far from being able to make that happen. Depending on how things go today, it might have even happened by the time you read this.

Assuming that I can make this roundtrip work, I will have banked a bunch of losses and our portfolio will look exactly as it did before the process started (albeit with some ETFs in place of regular mutual fund shares). While I’m not particularly interested in generating losses (who is?), we might as well make a bit of lemonade when the market hands us lemons.

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]]> http://www.fivecentnickel.com/2011/09/12/tax-loss-harvesting-31-days-later/feed/ 8 The Paradox of Thrift http://www.fivecentnickel.com/2011/09/08/the-paradox-of-thrift/ http://www.fivecentnickel.com/2011/09/08/the-paradox-of-thrift/#comments Thu, 08 Sep 2011 10:00:26 +0000 Hank Coleman http://www.fivecentnickel.com/?p=20872 The Paradox of Thrift

When you save your money instead of spending it, you are actually hurting the economy in a small way. It may seem counterintuitive that your savings are adding to our economy’s decline, but they are. Most of us have come to embrace globalism and our intertwining financial lives, but we often fail to realize that saving our money actually has far-reaching, unintended consequences.

Most consider increasing the amount of money you save to be a positive financial attribute, but it can actually work against the greater good when it happens across the board. Economists call this the Paradox of Thrift.

Spend, save, or invest

When you earn money, there are three basic things that you can do with it. You can either spend it, save it, or invest it. With the American economy treading water, the nation’s savings rate has been steadily creeping up. Historically, Americans have not saved or invested much of their paychecks. In fact, the savings rate in America has typically hovered around 1% of a person’s take home pay.

But with today’s economy struggling and unemployment high, the nation’s savings rate has recently risen to 5-6%. With people saving more money from each of their paychecks, less is being spent on consumer goods. While an increased savings rate is typically seen as a positive financial trait, it can create unintended problems.

What is the Paradox Of Thrift?

In the early 20th century, the famous economist John Maynard Keynes wrote about what he called the Paradox of Thrift which ultimately states that saving more money instead of spending it can exacerbate a troubled economy like the one we currently find ourselves in. Consumer spending drives 70% of the American economy. If more people are saving and investing their money instead of spending it at our nation’s malls and other retailers, the entire economy suffers.

This can turn into a vicious, self-perpetuating cycle. More savings results in less spending. Less spending on consumer goods reduces the revenues that American companies earn. When companies’ earnings decrease, they typically lay off workers. When workers lose their jobs, they tend to tighten their belts and try to save more money — though they might actually have less to save (or spend) at this point.

In other words… Saving money and being thrifty results in less spending, fewer jobs, a declining economy, and an aggregate decrease in savings. Quite the paradox.

What should you do with your money?

Given the above, what should you be doing with your own money in the current economy? In my view, even with interest rates at all-time lows, you should continue saving and investing for your future and your financial goals. Honestly, even a 6% savings rate isn’t good enough. Many financial planners encourage people to save 10% or more for retirement alone — and that doesn’t include other financial goals such as buying a new home or helping your children pay for college.

Why you shouldn’t care about the Paradox Of Thrift

Your money — and what you choose to do with it — is just a small part of the economy. In the grand scheme of things, it really doesn’t matter what any one person does with their money. It only matters what we all do as a collective group. Should large-scale, macroeconomic factors such as this dictate what we do as individuals? Should second and third order effects bother us if we are looking out for our own wellbeing? Not in my book.

So… Do you feel bad about hurting the economy when you stash some money in your savings account or buy a CD? Bad enough to go out and start spending? More generally, do you believe in the Paradox of Thrift — that saving more of your money contributes to an overall economic decline?

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]]> http://www.fivecentnickel.com/2011/09/08/the-paradox-of-thrift/feed/ 16 The High Cost of Raising Kids http://www.fivecentnickel.com/2011/09/07/the-high-cost-of-raising-kids/ http://www.fivecentnickel.com/2011/09/07/the-high-cost-of-raising-kids/#comments Wed, 07 Sep 2011 14:56:00 +0000 Nickel http://www.fivecentnickel.com/?p=20862 While perusing GetRichSlowly yesterday*, I discovered an amusing comic strip related to the high cost of raising kids.

(click to enlarge)

This is funny (to me at least) in large part because it’s true. As a father of four, I can say with certainty that kids are expensive. Yes, there are lots of things that you can do to cut costs — and we do many of them. But there’s no avoiding the fact that it costs more to support more people. And that extra money spent takes away from what you could otherwise be adding to an investment portfolio.

Of course, this isn’t to say that kids aren’t worth the cost. That’s obviously a very personal decision. In our case, we’ve certainly had no regrets. But that doesn’t change the fact that there are a number of financial tradeoffs involved.

It’s been suggested that the cost of raising a child from birth to age 17 is well over $200k. I’ve never sat down and tabulated the cost, but here are just a few things that come to mind.

  • Lost earnings (stay-at-home-parent) and/or childcare
  • Baby stuff, toys, etc.
  • Higher grocery bills for feeding more mouths
  • More clothing for more bodies
  • Larger house to accommodate more people
  • More home furnishings to fill that house
  • More expensive house from living in a better school district
  • Higher property taxes from living in a better school district
  • Private school tuition if you live in a bad school district
  • Larger car (depending on how many kids you have)
  • Gas money for all the extra errands, practices, etc.
  • Piano lessons, taekwando, sports registrations, etc.
  • Increased health insurance costs (premiums, copays, etc.)
  • Increased life insurance costs (a bigger policy to support more people)
  • Increased car insurance costs if/when you have a teenage driver
  • Increased travel costs (e.g., airfare x family size)
  • College education (if you choose to help them out)

And the list goes on…

Of course, you have to trade some of these things out against the costs you might incur in the absence of a family obligation. For example, due to the higher cost of traveling, you might opt for a relatively cheap summer camping trip or a trip to the beach rather than the trip to Europe that the couple next door just took.

And there are, of course, economies of scale… While some of these expenses increase linearly, others do not. The second (and third and fourth) kids don’t double (or triple or quadruple) your costs.

But the larger point still stands. Kids are costly, and you have to be comfortable with that (or at least aware of it) when deciding to start a family.

*Note: I actually discovered this article when reading JD’s article about the XKCD comic strip on compounding interest vs. earning more money. While some of JD’s numbers are suspect, he (and the comic strip) make an excellent point. While smart investing is great, you can’t ignore the power of increasing your earnings.

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]]> http://www.fivecentnickel.com/2011/09/07/the-high-cost-of-raising-kids/feed/ 8 Money Market or CDs? http://www.fivecentnickel.com/2011/09/06/money-market-or-cds/ http://www.fivecentnickel.com/2011/09/06/money-market-or-cds/#comments Tue, 06 Sep 2011 14:51:18 +0000 Lisa White http://www.fivecentnickel.com/?p=20852 Money Market or CDs?

With record gas prices, rising food costs, and stagnant (or declining) salaries, it’s difficult to save money these days. If you’re like me, when I come across extra money to sock away, I want it to be accessible, secure and earning the highest interest rate possible.

I’ve found that both money markets and certificates of deposits are great options to consider for the investment-weary, although interest rates have been frustratingly low for the past several years. There are, however, important differences that will determine which is right for you.

Here is a short primer on both, including the pros and cons.

Certificates of deposit (CDs)

Certificates of deposit, or CDs, tie up your money for a specified length of time, ranging from a few short months to several years. During this time, your money typically earns a fixed interest rate that largely depends on the length of the CD term. The longer the money is locked away, the higher the rate you will receive.

If you withdraw your money before the CD maturity date, there is a penalty in terms of the number of days of interest — typically 60 days on the low end up to 6 months on the high end. In general terms, you want to avoid early withdrawal because that penalty will eat into your earnings. And if the penalty exceeds the amount of interest earned as of the date of withdrawal, the difference may be deducted from your principal.

The upside is that you can determine your earnings with CDs beforehand, so you’ll know exactly what you’re getting. Also, this is a very safe investment choice. Your money is insured up to the current FDIC insurance limits. However, those who opt for longer maturity time frames will also lose access to this money for a long time period, and will face interest rate risk.

One of the most important factors in purchasing your CD should be interest rate. This amount varies depending on the current interest rate, how much money is being invested, the maturity length of the CD and the bank you are using. Another important factor are the penalty terms. If the penalty is low enough and the rate (vs. your alternatives) is high enough, you might even consider using a long-term CD as a short-term investment vehicle.

When CD shopping be sure to pay close attention to the terminology — especially distinctions like annual percentage yield (APY) vs. annual percentage rate (APR). The number that you’re ultimately interested in is the APY, which tells you the rate at which your earnings will grow each year. APR doesn’t include the effects of compounding, so you’ll have to be sure the other terms are equivalent if comparing based on APR.

As an example, if you invest $5,000 in a CD that’s paying 5% APY, then you will earn $250 in your first year. And then the next year, you will earn 5% on the new balance of $5,250 — and so on.

In addition to banks, credit unions and full-service brokerage firms sell federally-insured CDs. Since brokers shop the entire country for high yields, brokered CDs may be a good option, though you’ll need to be careful to be sure you don’t exceed FDIC limits (if you buy through a broker, the CD still counts against your FDIC limit at the issuing bank), and there may also be limitations on your ability to withdraw your funds early.

There are also other flavors of CDs, like equity-indexed CDs, which base their returns in part on the performance of the stock market. Minimum investments are often higher for indexed CDs, and you are typically required to hold them to maturity, with no option for early withdrawal. In addition, your upside potential is typically capped in return for the relative security that a CD can offer. This means that, even if the stock market takes off, you will only enjoy a limited gain.

Money markets

There are two main types of money markets. Money market deposit accounts (MMDAs) are a cross between a checking and a savings account. Although earning more than interest-bearing checking accounts, you are restricted in the number of withdrawals each month. Offered by banks, the deposit is insured by the FDIC, so both the principal and interest are 100% guaranteed.

In contrast, money market mutual funds (MMMFs), are typically offered by mutual fund families and are not FDIC insured. These funds offer market-based interest rates and the average maturity of securities is 90 days or less. These funds typically seek to maintain a stable value of $1/share, with dividends being paid out monthly. There are, however, no guarantees and the lack of FDIC protection means that MMMFs are riskier than MMDAs and other bank accounts.

Although money market accounts are more accessible than CDs, banks are required to limit you to six withdrawals per month, and they may also require a steep minimum balance or they will charge you a monthly service fee. The interest rates associated with these accounts is also often determined by the amount of money deposited. The more money put in, the higher the rate of return.

Making the Decision

When choosing between a CD and money market account, it’s best to first determine your needs. Will this money be saved for short-term or long-term expenses? If you’re looking to use it for a vacation, car repairs, or a home expense within the next six months or less, a money market would be your best bet.

For rainy-day or more long-term savings, such as to cover expenses during a job loss or for a new house, a CD may be a better choice — especially if create a ladder of CDs with varying maturities such that you’ll have one coming due every 6-12 months.

Because CDs and money market funds are both safe short-term investment options, both are worth considering for money you don’t want to tie up or risk in the stock or bond markets. Just be sure to do your homework to see which banks offer the best rates and terms before committing to an account.

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]]> http://www.fivecentnickel.com/2011/09/06/money-market-or-cds/feed/ 3 An Extreme Early Mortgage Payoff Story http://www.fivecentnickel.com/2011/09/02/an-extreme-early-mortgage-payoff-story/ http://www.fivecentnickel.com/2011/09/02/an-extreme-early-mortgage-payoff-story/#comments Fri, 02 Sep 2011 14:51:50 +0000 Nickel http://www.fivecentnickel.com/?p=20572 An Extreme Early Mortgage Payoff Story

Earlier this week, a long-time commenter named Carlos (aka CharlieBoy) mentioned that he paid off his mortgage early. Having done the same thing myself, I was intrigued, so I sent him a note asking for details.

Within a few hours, Carlos sent a lengthy reply with tons of details. Today, I’ll be summarizing his story.

“My wife and I purchased our house in the fall of 2008 for $300,000. I believe the interest rate was 6%. We used the equity from our old house to pay off three small auto loans and to make a 35% down payment on our new house. The big down payment made it easy for us to refinance it two times since 2008 because we were never under water.

We didn’t want to buy a huge house with a huge mortgage. We decided not to let the bank or agent tell us how much house we could afford. WE did the math, WE knew our budget; therefore, WE decided how much we were comfortable paying each month. We found a house that works well for us within our budget.

Sure, it doesn’t have the desirable three-car garage that we wish we had, but a bigger garage comes with even a bigger mortgage, so we decided we could live with a smaller garage but with the smaller mortgage. [...] Back in 2008 the bank would have let us borrow two times the amount that we borrowed. Ouch!”

That’s quite impressive… They paid paid off a $195k (= $300k – 35% down payment) mortgage in about three years. But how? Well, a big part of it was the decision to downsize so they could pay off those three auto loans and put up a big, fat 35% down payment. But there’s more…

“Just a few weeks after we bought the house in 2008, we refinanced our mortgage into a 5%, 15-year loan. To make up for the larger monthly payment of a 15-year mortgage, we had to make some budget cuts. It wasn’t too hard because we no longer had car payments. We don’t go to regular restaurants, and we rarely go to movie theaters.

Last December, we refinanced it again at 3.75%. That was our Christmas gift to ourselves. That lowered our monthly payment once again, but the thought of spending the next 15 years slaving away for a mortgage company continued to bother me every day, we started saving even more to pay it down faster.

By living below our means, we started sending every extra penny we saved to pay down our mortgage principal after we saved a little for emergencies.”

Okay, they refinanced to more agreeable terms, scraped up additional money for extra mortgage payments, etc. But still, how so fast?

“The extra payments towards the principal were making a huge difference, but then something else happened. In April, I changed jobs, which meant I had to decide what I wanted to do with my 401(k). I kept going back and fourth between cashing it out to pay off my mortgage or just rolling it over to an IRA.

I know very well that cashing out your 401(k) to invest in a 3.75% mortgage is not considered wise when you look at the stock market’s historic returns of 7% to 8%. I don’t even recommend it to anybody.”

Yikes. Cashing out a retirement account early results in a hefty tax bill plus 10% early distribution penalty. Ouch. So why did he do it?

Well, he went on to argue that, due to our country’s massive deficits and the political mess that has developed over the past few years, the investment outlook in this country just isn’t that good, and he’s not expecting anywhere near historic returns for the foreseeable future. Given an expectation of low returns, he could justify taking the hit to get out from under his mortgage.

This is a pretty extreme view, and Carlos is well aware of that. After all, he explicitly states that he doesn’t necessarily recommend this course of action to others. But it was the right decision for him.

Looking forward:

“By not having a mortgage, I can now focus more aggressively on my retirement. Who knows, I might save enough money to invest in a small business. Not having a mortgage will create more opportunities for me. Getting rid of my biggest financial responsibility makes sense in every way to me.”

Having paid off a mortgage myself, I can say with certainty that it does free up a lot of cash and provide a lot of flexibility. That being said, trading your 401(k) for a mortgage-free life isn’t a decision to be made lightly. Given that contributions to retirement accounts are capped on an annual basis, Carlos will have to work extra hard to rebuild his retirement nest egg.

Sure, he’ll be able to pour money into a tax-efficient (but taxable) portfolio to complement the money he’s able to stash in retirement accounts, but he’s lost a bunch of tax-advantaged space (not to mention the 10% penalty) that he can’t easily re-gain.

So… What do you think? Is Carlos crazy for cashing out his 401(k)? Or crazy like a fox? As much as I disagree with the decision to liquidate his 401(k), I have a feeling that Carlos is going to be just fine in the long run.

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]]> http://www.fivecentnickel.com/2011/09/02/an-extreme-early-mortgage-payoff-story/feed/ 54 Lump Sum Investing vs. Dollar Cost Averaging http://www.fivecentnickel.com/2011/08/31/lump-sum-investing-vs-dollar-cost-averaging/ http://www.fivecentnickel.com/2011/08/31/lump-sum-investing-vs-dollar-cost-averaging/#comments Wed, 31 Aug 2011 16:41:50 +0000 Nickel http://www.fivecentnickel.com/?p=20552 Lump Sum Investing vs. Dollar Cost Averaging

I ran across an interesting discussion on the Bogleheads Investment Forum. It centered on the issue of lump sum investing vs. dollar cost averaging.

With lump sum investing, you take whatever you have on hand to invest and you put it in the market all at once in your desired asset allocation. With DCA, you invest it in chunks over a period of time. As the market rises, you get fewer shares. As it falls, you get more.

In general terms, DCA is a risk avoidance strategy. Viewed in a vacuum, this might be good. On average, however, it also reduces your expected returns. The reason for this is that, historically, the market has trended upward.

By holding money in cash, you’re missing out on a portion of this expected return. Of course, the market is anything but a smooth ride, so by holding a portion of you money on the sidelines you avoid the risk of buying in before a major downturn.

Okay, let’s just stop and think for a moment… Let’s say you have a target allocation of 60% stocks and 40% bonds on you inherit a million dollars in cash.

Assuming that your target allocation remains the same and that you ultimately want all of it invested, would you immediately buy $600k in stocks and $400k in bonds? Or would you sit on the cash and deploy it a little at a time — say $50k per month for the next 20 months?

I’d bet that a fair number of you would opt for the latter. Put the money in the market a little at a time to avoid a calamity. But is that really the wise thing to do?

A commenter named Don offered up this hypothetical scenario:

Let’s say you inherit a large portfolio, and by the grace of the gods, on the day you inherit it, it happens to match your preferred asset allocation perfectly.

Would you:

1) immediately liquidate to cash and start dollar cost averaging back to your asset allocation.
2) sleep well knowing that you have a well diversified portfolio appropriate to your risk tolerance and goals.

I would wager that almost everyone would choose 2.

I would tend to agree with Don’s assessment — that most people would choose option #2 and leave well enough alone.

But why?

Ignoring possible tax implications (which is fair because of the stepped-up basis associated with an inheritance), option #1 is the equivalent of receiving a cash windfall and dollar cost averaging — which I suspect many people would do. In contrast, option #2 is the equivalent to receiving a cash windfall and immediately dumping it in the market.

Perhaps I’m wrong about what “most people” would do, but I have to admit that I’d be inclined to DCA a large cash windfall, whereas I’d leave well enough alone if I inherited a portfolio that matched my desired allocation. Does this make sense? Not really, but that’s what my gut would tell me to do. Which leads back to the above question… Why?

I guess it’s because a loss following a conscious decision to make a lump sum investment would sting more than an equivalent loss that resulted from inaction (i.e., allowing an inherited portfolio to take a nosedive). Yes, I realize that I’m ultimately making the decision in both cases, but in one case I’m taking action, and in the other case I’m not.

Irrational? Absolutely. Which is why it’s important to take a step back and analyze situations like this. As a wise man once said, money is more about the mind than the math.

As an aside, if you are deathly afraid of the loss that you might incur when making a lump sum investment, you might want to reconsider your risk tolerance. Perhaps this is a sign that your investments are too aggressive and that you should shift toward a more conservative allocation.

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]]> http://www.fivecentnickel.com/2011/08/31/lump-sum-investing-vs-dollar-cost-averaging/feed/ 23 Investing a Windfall (and Making Up for a Late Start) http://www.fivecentnickel.com/2011/08/29/investing-a-windfall-and-making-up-for-a-late-start/ http://www.fivecentnickel.com/2011/08/29/investing-a-windfall-and-making-up-for-a-late-start/#comments Mon, 29 Aug 2011 10:00:49 +0000 Nickel http://www.fivecentnickel.com/?p=20522 A reader that I’ll call Diane recently wrote in with a question about investing a windfall. She says:

I am getting some extra money — about $10k — and I have no idea what to do with it.

I am 57 years old and have no debt. I have about $9k in my company’s 401(k), and that is my only savings right now. I also purchased a house about three months ago.

The problem is that I have no knowledge on how to invest, but I do have a couple of people in my life with some understanding of investing.

Do you have any suggestions, or could you give me some resources that could help me make this decision?

This is an excellent question, and there are actually several issues here.

For starters, I’m not sure if that “no debt” statement means that she has no debt period, or that she has no consumer debt, but perhaps has a mortgage associated with the recent home purchase. The lack of high interest consumer debt is great. If there is a mortgage, I’m hoping that it’s at least at a low rate. Given the recent interest rate landscape, that should be the case.

Regardless, the thing that really stuck out to me was that she’s approaching 60 and has very little in the way of retirement (or other) savings. While it’s certainly nice to have an extra $10k to invest (and talk about this further in a minute), that money won’t make much of a difference if she doesn’t find a way to free up some extra cash flow and make saving/investing a priority.

The reason I say this is that, even if she can earn 8% returns on that money, it will only grow to $18.5k by the time she turns 65. And honestly, 8% returns aren’t particularly likely unless she takes on a good bit of risk between now and then. Obviously, this isn’t the sort of money that will free Diane up to retire in comfort, but it’s a start.

Spending and saving

So my first suggestion — even though she didn’t really ask about this — would be to take a very careful look at her spending patterns and figure out what she can do to free up extra cash that can be directed into an investment portfolio each and every month. Cut the cable, downsize the cell phone plan, reduce utility costs, quit dining out, etc.

Of course, spending is only one part of the equation, so Diane should also look closely at her income and try to figure out ways of earning extra money. Given that she’s been able to stay out of debt based on what she’s already earning, this extra money could be used to supercharge her savings – an absolute necessity given that she’s starting so late.

Now… Returning to that $10k windfall… If it were me, the first thing I would do would be to establish an emergency fund. Depending on Diane’s circumstances, this could be as little as $1k (at least to start), though it might need to be considerably more.

Learning and planning

At the same time, I would recommend that she start learning about investing. Yes, she said that there are some people in her life with “some understanding of investing,” but it’s hard to know exactly what this means. What I can say for certain is that nobody cares about your own financial well being as much as you do. Thus, you need to put yourself in a position to make informed decisions.

For this, I would start by reading my two go-to books about investing: The Bogleheads’ Guide to Investing and The Four Pillars of Investing. Hopefully these books will be available from the library. If not, I consider buying both of them to be money well spent.

From there, the goal should be to develop (and implement!) a plan. What are her goals? What’s her timeframe? How risk tolerant is she? Etc. By answering these questions honestly, it should be possible for Diane to develop an appropriate asset allocation — both for the $10k windfall and for the ongoing investment of her newfound savings.

If she’s still uncomfortable with her finances after doing a bit of self-education, it might be worth spending a few hundred dollars to talk to buy some time with a reputable fee-only financial planner who can help her get her ducks in a row – though I would only recommend doing this after reading the books. Once again, this will likely be money well spent.

Putting the plan into action

As for where to stash this money, the 401(k) may be a great option — or maybe not. It depends on her investment choices (and the associated fees) as well as whether or not her employer offers a matching contribution. While she can’t just contribute the $10k directly to her 401(k), she can crank up her contributions to a ridiculous level for the rest of the year and use the $10k to make up the shortfall, effectively transferring the money from her savings account into the 401(k)*. Money is fungible.

Or, for maximal flexibility (but without the employer match), she could open a traditional or Roth IRA at a low-cost provider like Vanguard. The current contribution limit is the smaller of your taxable compensation for 2011 or $5k for people under 50. This max rises to a max of $6k if you, like Diane, are over 50 years of age. She could opt for a single fund, like one of the Target Retirement options, or a simple mix of broad market index stock and bond funds.

While much of what I’ve written above might sound like Greek to the uninitiated, it’s really not that complex, and the two books that I’ve linked above should explain everything in sufficient detail to at least get started.

As always, if you have any suggestions of your own, please don’t hesitate to leave a comment.

*Note: Depending on how the employer match is structured — for example, if it’s capped each month — a more gradual approach might be advisable. The devil is in the details.

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]]> http://www.fivecentnickel.com/2011/08/29/investing-a-windfall-and-making-up-for-a-late-start/feed/ 10 Financial Advisors, Asset Management Fees, and You http://www.fivecentnickel.com/2011/08/17/financial-advisors-asset-management-fees-and-you/ http://www.fivecentnickel.com/2011/08/17/financial-advisors-asset-management-fees-and-you/#comments Wed, 17 Aug 2011 10:00:59 +0000 Nickel http://www.fivecentnickel.com/?p=20132 Financial Advisors, Asset Management Fees, and You

You’ve heard time and again that expenses matter when it comes to investing. In fact, when it comes to mutual funds, Morningstar has gone so far as to argue that “investors should make expense ratios a primary test in fund selection… In every single time period and data point tested, low-cost funds beat high-cost funds.”

This begs the question…

If expenses are so important, then why are so many people so quick to fork over a ton of money to an investment advisor? The “assets under management” model, where an advisor collects a percentage of the funds that they’re managing, has become increasingly popular. Typically, this fee is around 1%.

The high cost of 1%

While that might not sound like a lot, 1% can have a huge impact on your investment returns. Consider, for example, a hypothetical investment portfolio with an initial value of $250k. In this case, the investor doesn’t have a huge tolerance for risk, so he dials in a nice 60/40 split between stocks and bonds.

If we assume that, over the next 30 years, this portfolio averages 6% annual returns, our investor friend would be sitting on over $1.4M. If, on the other hand, they had turned over their portfolio to an advisor charging 1%, and if that advisor (in accordance with the investor’s risk tolerance) had assembled a similar 60/40 portfolio, it would be worth less than $1.1M after 30 years.

This is a difference of more than $350k – all because of that pesky 1% annual fee.

Of course, you could argue that the advisor would do a better job of managing that money, thereby offsetting the higher cost. And while I do agree that good financial advisors can add value, it’s rarely enough to come close to offsetting a 1% fee.

Sure, there might be a rare advisor who can significantly outmaneuver the market, but what are the odds that you just happened to connect with one of them?

Effects on retirement income

Still not convinced? Let’s fast forward to retirement… If we assume that a particular investment allocation is sufficient to provide you with a (say) 4% safe withdrawal rate, then an additional 1% advisory fee means that your advisor is getting a quarter of your retirement income.

Read that again. For every four dollars of spendable income that your portfolio generates, your advisor will get one of them. That’s huge. So do yourself a favor and get educated. Read some books about investing. Take a course (or two) at a local community college. Then read some more books about investing.

From there, it’s just a matter of putting your newfound knowledge to work.

An alternative approach

If you’re still not comfortable with an entirely DIY approach, keep in mind that there are financial advisors out there who will assemble a plan for an hourly rate. From there, you just need to implement it. Open an account with a trustworthy outfit like Vanguard or Fidelity, spread your existing funds into your target allocation, set up auto-investments for ongoing contributions, and rebalance as necessary.

Yes, it really is that simple. And if you ever feel like you need a checkup, you can pay for another hour or two of your advisor’s time on an as-needed basis.

If you’re still overwhelmed, you can always invest in a target-date mutual fund like the Vanguard Target Retirement series. While I’ve criticized these sorts of funds in the past, they’re generally a solid option for new investors who are just getting their feet wet – and you don’t have to fork over an extra 1%.

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]]> http://www.fivecentnickel.com/2011/08/17/financial-advisors-asset-management-fees-and-you/feed/ 13 Navigating a Turbulent Market http://www.fivecentnickel.com/2011/08/15/navigating-a-turbulent-market/ http://www.fivecentnickel.com/2011/08/15/navigating-a-turbulent-market/#comments Mon, 15 Aug 2011 10:00:27 +0000 Nickel http://www.fivecentnickel.com/?p=20082 Navigating a Turbulent Market

Whew! What a week. Unless you’ve been living in a cave, you’ve likely heard about last week’s roller coaster ride on Wall Street. It all started the previous Friday night when Standard & Poor’s downgraded US government debt.

Once Monday rolled around, the stock market tanked. Then it recovered. Then it tanked again. And after that? It recovered again.

Amazingly, despite the volatility, the markets (depending on which index you were watching) closed down around 1.5% for the week. Not too bad, all things considered. But it could have been much worse if you lost your nerve and sold in a panic.

Riding the roller coaster

Let’s start by looking at some concrete numbers. These are the closing values of the Vanguard Total Stock Market Index fund (VTSMX):

  • Friday, Aug 5th – $29.99/share (pre-downgrade)
  • Monday, Aug 8th – $27.88/share (down 7.03%)
  • Tuesday, Aug 9th – $29.29/share (up 5.06%)
  • Wednesday, Aug 10th – $28.05/share (down 4.23%)
  • Thursday, Aug 11th – $29.38/share (up 4.74%)
  • Friday, Aug 12th – $29.53/share (up 0.51%)

Now let’s consider the case of a hypothetical investor with $10k invested in VTSMX at the close of business on August 5th. That works out to a bit over 333 shares.

Ready? Here we go…

As the market crashed on Monday, our investor friend panicked and sold his holdings. On Tuesday, as the market rallied in the late afternoon, he regretted his move and bought back in. But on Wednesday, the bottom dropped out and he sold. Then on Thursday, things were looking up, so he bought back in. By the time Friday rolled around, he was exhausted – and the market didn’t move much – so he sat tight.

Given that the market was down just 1.5% over the course of the week, would you care to take a guess how our investor friend fared? Believe it or not, he lost 10.52%!

Lessons learned

While this is clearly an oversimplified, worst-case scenario with a number of flaws – not the least of which is that Vanguard’s short term trading policy would prevent you from buying and selling one of their funds like this – it helps to underscore an investing truism. If you make emotional decisions you can get wiped out.

Of course, we could just as well tell the story of an investor with cash in hand and remarkable timing. By buying on the dips and selling after the rallies, this story would be quite different. But honestly, which do you think is more common? For “everyman” investors to show uncanny timing and make a killing? Or for them to panic and get killed?

The point here is that you need to have a plan and stick to it. Trying to time the market is, for the most part, a loser’s game. For starters, you need to have a well-defined (and proper) asset allocation in mind. If you were unnerved by last week’s volatility, you might not be as risk tolerant as you thought.

Beyond having the proper allocation, you’ll need to periodically rebalance your portfolio to maintain this allocation, and you should also consider harvesting your losses for tax savings. And sure, if you have cash on hand, don’t be afraid buy a bit extra when the market is down.

But whatever you do, don’t lose your nerve and sell in a panic. If you do, you’ll wind up turning you paper losses into very real, and potentially devastating losses.

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]]> http://www.fivecentnickel.com/2011/08/15/navigating-a-turbulent-market/feed/ 3 Syncing Your Savings http://www.fivecentnickel.com/2011/08/11/syncing-your-savings/ http://www.fivecentnickel.com/2011/08/11/syncing-your-savings/#comments Thu, 11 Aug 2011 10:00:59 +0000 Lisa White http://www.fivecentnickel.com/?p=20062 Syncing Your Savings

In this economy, it seems harder than ever to make your money work for you.

Is a money market account the way to go, or is a long-term CD worthwhile? Should I open a basic savings account instead of an IRA?

We work hard for our money. It shouldn’t be a lot of work to figure out how to make it grow.

Paying off debt and establishing a savings plan takes discipline, but no one would disagree that it’s a worthwhile effort. With so many people unstable in their jobs or unemployed, food and gas at record high prices, and homeowners losing equity, building a financial cushion has become a necessity.

For those who are unemployed or forced to live paycheck-to-paycheck, building a savings may not be top of mind right now. But if you have even a little discretionary income, or hope to in the future, it’s important to know your options.

Figure out your goals

Before choosing where to dump your money, it’s best it figure out what you are allocating it for. Do you need an account to save for living expenses in the case of a job loss, or will the money be used for next year’s big anniversary trip? Or perhaps you’re saving for something even further down the road.

The length of time you will be saving helps determine where your extra money should go.

Also think about how liquid this account needs to be. Will you be “borrowing” here and there, or is this cash “out of sight, out of mind” until absolutely necessary? Are there other penalty-free accounts you can draw from in case of an emergency?

In most cases, it’s probably best to consider multiple accounts, since there likely will be more than one goal you are looking to achieve. Don’t be afraid to spread your money too thin. A dollar here and a dollar there still adds up to $2, even if the interest made is not quite as high.

Look at your alternatives

After earmarking your savings amounts, figuring out the liquidity needed, and deciding how many accounts are required, it’s time to get educated on what your options are.

Considering you are not a Wall Street heavyweight, your best bet is to look at what your local banks have to offer in the way of savings accounts CDs, (certificates of deposit), money market accounts, and IRAs (individual retirement accounts).

Here is a brief lowdown on what each type has to offer in terms of savings.

  • Saving accounts – If you are not put off by lower interest rates and need total liquidity to withdraw your money at any time, savings accounts are for you. It’s a good idea to have at least one account like this for emergency money, if for nothing else.
  • CDs – With CDs, you will get higher interest rates in exchange for less liquidity. If you’re looking to build your money, it’s best to reinvest the interest, rather than spend it. CDs with longer maturities or time periods will pay a higher interest rate, but you will pay a penalty for an early withdrawal. Be sure to shop around for the highest interest rates.
  • Money market accounts – A money market is a type of deposit account, like checking and savings, that typically offers higher interest rates. This is because account holders will have less access due to limited transactions permitted each month. This is a good choice for those who tend to withdraw money more often than they should.
  • IRA – The two most often used IRAs are traditional and Roth IRAs. With both, you are limited in the amount you can contribute. With traditional IRAs, these contributions are deductible, so you end up paying less taxes. Asset growth in this account is also tax deferred. With a Roth IRA, you fund it with after-tax dollars and future withdrawals are tax free. This means contributions will be taxed once and earnings will never be taxed. By law, you cannot withdraw money from an IRA until you are 59.5 years old. Early withdrawals are typically subject to a 10% penalty and taxation equal at your current rate.

Note that rates, requirements, and investment options vary, both by account type and by financial institution. Thus, it may literally pay to do your homework when searching for the best savings option.

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]]> http://www.fivecentnickel.com/2011/08/11/syncing-your-savings/feed/ 3 Are You Credit Rich? http://www.fivecentnickel.com/2011/08/10/are-you-credit-rich/ http://www.fivecentnickel.com/2011/08/10/are-you-credit-rich/#comments Wed, 10 Aug 2011 12:38:12 +0000 Nickel http://www.fivecentnickel.com/?p=20032 Are You Credit Rich?

The other day, while chatting with an acquaintance, the topic of the economy came up. We talked a bit about the recent market turbulence, the debt ceiling debacle, the S&P credit downgrade, etc. He lamented that his 401(k) was taking a beating, and that this was coming on the heels of everything they dealt with in recent years.

He didn’t offer details, and I didn’t feel comfortable asking, but they apparently lost their house, at least one car, their boat, etc. He then said something interesting:

“It’s not like we were rich. We were just credit rich. I was young and stupid and made a lot of bad decisions because I thought we could afford that stuff. Turns out I was wrong.”

And in that one simple phrase – credit rich – he summed up what’s at the heart of our economic problems. In terms of both personal finance and government spending, we’ve been relying far too much on borrowed money. You’ve heard over and over that you should spend less than you earn, but many don’t. Even now, after the hard lessons that we’ve learned over the past few years.

It’s very easy to look around yourself and see people living in huge houses, driving fancy cars, and playing with all sorts of cool toys, and to think that you “deserve” the same. But the fact is that you deserve better. You work hard for your money. Don’t use it as a weak foundation for a massive house of (credit) cards.

This isn’t to say that you shouldn’t take out a mortgage to buy a house. We did. And we’ve since paid it off. Credit, when used responsibly, can be a powerful thing. But when it’s used recklessly, it can be even more powerful – in the opposite direction.

Sure, even without over-extending ourselves, our family could afford a larger house, a fancier car, or a nice boat. But we choose not to spend our money on such things, as we’d rather have a paid off mortgage and a growing investment portfolio.

Don’t get me wrong… We still live in a nice neighborhood, we travel, and we have decent cars. But we also try to live by the mantra that good enough is good enough. First and foremost, we take care of our savings and investment goals. Once those things are taken care of, we more or less let the chips fall where they may – but we never finance our purchases, or otherwise spend more than we earn. Ever.

Yes, this is a lot easier than it used to be, as our household income has risen over the years, and we have more leeway than we used to. But even when you’re just starting out, it is possible. Live cheap. Scrimp and save. Build up a small cash cushion to cover any short-term challenges, and don’t ever lose sight of the big picture.

You’ll thank yourself in the long run.

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]]> http://www.fivecentnickel.com/2011/08/10/are-you-credit-rich/feed/ 7 Time for Tax Loss Harvesting? http://www.fivecentnickel.com/2011/08/09/time-for-tax-loss-harvesting/ http://www.fivecentnickel.com/2011/08/09/time-for-tax-loss-harvesting/#comments Tue, 09 Aug 2011 15:15:30 +0000 Nickel http://www.fivecentnickel.com/?p=20022 Time for Tax Loss Harvesting?

Over the past week, we’ve witnessed a painful stock market meltdown. It started in late July, intensified through the debt ceiling debate, and culminated with a 7% decline yesterday in the wake of the US credit downgrade. But with every challenge comes opportunity…

Harvesting your losses

As long as you have a sufficiently long time horizon, market turmoil like this is nothing more than a bump in the road. Instead of panicking, my wife and I are sticking to the plan and trying to make the best of a bad situation. For us, this means that we’re doing a bit of tax loss harvesting.

The term “tax loss harvesting” refers to selling shares to book your losses, replacing them with a similar, but not identical, investment vehicle (so you don’t trigger a wash sale or miss out on a near-term recovery) and writing off the losses at tax time.

As it turns out, investment losses (i.e., “capital losses”) can be used to offset investment gains (i.e., “capital gains”). And if you don’t have any (or enough) gains to offset, you can use your losses to offset ordinary income. While you’re limited to offsetting $3k/year of ordinary income, you can carry your losses forward until they’re used up.

In the 25% tax bracket, every $3000 in ordinary income that you offset equals a $750 tax savings – not bad for a bit of paperwork, right? And if you book enough losses, you can do this for several years to come.

Avoiding a wash sale

As I noted above, the main thing that you need to look out for is triggering a wash sale. The wash sale rule requires investors to wait at least 31 days after selling a security for a loss before repurchasing the same security, or a “substantially identical” investment. If you buy back in within 30 days, the IRS will treat it as if you never sold in the first place, and you’ll lose the ability to claim a loss.

You should also keep in mind that the IRS will also treat it as a wash sale if you make your purchase within the 30 days before the sale of your downtrodden shares, so you can’t simply buy shares ahead of the sale to avoid triggering a wash sale.

Once the 30 day window has elapsed, you’re welcome to exchange back into the original investment. Just be aware that, if the market has recovered in the mean time, you might wind up booking gains when you switch back, wiping our part (or all) of your tax savings. Of course, if things continue to head south, you could wind up booking even more losses when switching back.

As far as “substantially identical” goes, the IRS hasn’t provided a clear definition. When it comes to stocks, this isn’t a huge deal. In general terms, you should be safe selling one company and buying another, even if it’s in the same industry. But for mutual funds and ETFs, things are a bit murkier.

The general consensus is that you can’t, for example, sell an index mutual fund and buy the equivalent ETF. Likewise, you can’t sell a fund from one company and buy another company’s fund that tracks the same index (e.g., Vanguard 500 Index vs. Fidelity Spartan 500 Index). But you can swap out investments that track different indices, even if they’re from the same mutual fund family (e.g., Vanguard 500 Index vs. Vanguard Total Stock Market).

Of course, I’m not a tax professional. I’m just sharing what I believe to be true based on my own research. If you’re nervous about this sort of thing, you’d be well advised to do your own research, or to check with an investment or tax pro.

Choosing loss harvesting “partners”

In general terms, when you trade one investment for another while tax loss harvesting, you’ll want them to fill the same niche. To be sure that’s the case, I recommend going to Google Finance and punching in the ticker symbol of your current investment.

Once the chart comes up, add the symbol of the replacement investment using the “Compare:” box. Now click out to a longer timeframe – say 5 or 10 years. Do the prices of the two investments track each other fairly well? If so, great. You’ve found a good match. If not, keep looking.

So, dear readers, have you taken advantage of the recent turmoil by harvesting some investment losses?

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]]> http://www.fivecentnickel.com/2011/08/09/time-for-tax-loss-harvesting/feed/ 7 Get a $100 Bonus From TradeKing http://www.fivecentnickel.com/2011/08/02/get-a-100-bonus-from-tradeking/ http://www.fivecentnickel.com/2011/08/02/get-a-100-bonus-from-tradeking/#comments Tue, 02 Aug 2011 18:33:30 +0000 Nickel http://www.fivecentnickel.com/?p=19832 Get a $100 Bonus From TradeKing

If you’re in the market for a new brokerage account, TradeKing is offering a $100 bonus for opening a new account, funding it with at least $2500, and making three trades. This offer is good throughout the month of August.

It’s also worth noting that this deal qualifies for TradeKing’s offer of refunding $150 in transfer fees if you’d like to move your investments over from another broker. To get your refund, simply open an account, fill out the account transfer form, and then submit the transfer reimbursement form.

In case you’re not familiar with TradeKing, they’re widely considered to be one of the best online brokers, having been repeatedly named #1 in customer service by Smart Money, and having also been ranked the #1 brokerage for long-term investors by Barron’s. In terms of price structure, they offer $4.95 flat-rate stock (and ETF) trades with no account minimums and no inactivity fees.

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]]> http://www.fivecentnickel.com/2011/08/02/get-a-100-bonus-from-tradeking/feed/ 0 Where to Find Better Interest Rates for Your Savings http://www.fivecentnickel.com/2011/08/01/where-to-find-better-interest-rates-for-your-savings/ http://www.fivecentnickel.com/2011/08/01/where-to-find-better-interest-rates-for-your-savings/#comments Mon, 01 Aug 2011 10:00:04 +0000 Nickel http://www.fivecentnickel.com/?p=19792 Where to Find Better Interest Rates for Your Savings

Are you tired of earning a pittance on your hard earned savings? Not too long ago you could earn 3%, 4%, 5% or more by sticking your cash in a high yield savings account. But today? Not even close. Interest rates now top out in the low 1% range, and it seems like there’s no light at the end of the tunnel.

So what’s a savvy saver to do? Well, you could just accept the low rates as an unavoidable consequence of the current economic landscape, or… You could get creative and get at least a bit more bang for your buck. Here are three ways to get a better rate for your savings.

High yield (rewards) checking accounts

While savings accounts were once home to the highest interest rates, checking accounts are now getting in on the action. Be forewarned that you may have to jump through some hoops – like setting up direct deposit and making a minimum number of debit card transactions per month – but if you’re up to the challenge, you can score a great rate.

For example, MoneyRates.com currently lists reward checking accounts with rates as high as 5.01% APY. Note that many of these offers are regional, so you may have to shop around a bit, but there are some killer deals out there for the taking.

Long-term CDs with low penalties

I’ve mentioned this one in the past, but if you can find a bank with a low penalty for early withdrawal, you can use long-term CDs to get a higher interest with minimal downside risk. For example, Ally Bank has a 60 day interest penalty if you break their CDs early.

Given that Ally’s five year CD rates are paying roughly double what you can get from an online savings account, the break-even point is roughly four months. Beyond that point, you’ll come out ahead relative to having your money in a savings account, even if you have to access the money before the CD matures. And if rates rise dramatically, you can simply break your CD and re-invest.

If you go this route, here’s a tip: Split your money into multiple CDs. That way you can access just a portion of it without paying a penalty for early withdrawal of the full amount.

Series I savings bonds

Another solid option is to use Series I savings bonds, which are inflation-indexed bonds offered by the U.S. government. Rates on I bonds are updated semi-annually in May and November. As of right now, newly-issued I bonds are paying 4.6%, though that number will fluctuate over time depending on the inflation rate.

The downside here is that I bonds cannot be redeemed during the first 12 months, so they’re not a great vehicle for your emergency fund – or at least not for your entire emergency fund. But once that 12 months is up, you can redeem them. Between 1-5 years after they’re issued, there’s a 90 day interest penalty, and after five years you can redeem them penalty free.

Beyond offering a decent interest rate (at least relative to a savings account), interest that you earn from I bonds isn’t taxed until redemption (i.e., it’s tax deferred) and it’s also exempt from state income taxes – as well as federal taxes if you use the proceed to for eligible education expenses.

But don’t get greedy…

And now… A word to the wise. In general terms, if you’re holding cash, you probably want if to be both safe and reasonably liquid. You should thus avoid locking it up or taking unnecessary risks with it. In this vein, I would recommend shying away from things like peer lending.

While outfits like Lending Club tout 8-10% annual returns, and you sometimes see them mentioned in discussions related to improving your interest rates, the reality is that they are neither risk-free nor liquid. While investments like this may have their place in your portfolio, they’re far from being a cash equivalent.

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]]> http://www.fivecentnickel.com/2011/08/01/where-to-find-better-interest-rates-for-your-savings/feed/ 4 Wealth Building Techniques That I Learned From the Garbage Man http://www.fivecentnickel.com/2011/07/28/wealth-building-techniques-that-i-learned-from-the-garbage-man/ http://www.fivecentnickel.com/2011/07/28/wealth-building-techniques-that-i-learned-from-the-garbage-man/#comments Thu, 28 Jul 2011 10:00:05 +0000 Neal Frankle http://www.fivecentnickel.com/?p=19652 Wealth Building Techniques That I Learned From the Garbage Man

When I began my career as a financial advisor, I worked in a bank. On my third day on the job, I met one of the wealthiest men I would ever meet. Phil was worth over $10 million dollars – and this was back in 1986.

As if that weren’t enough, Phil never inherited a dime from anyone. And to make his accomplishments even more astounding, he was a garbage man. Even though he was worth millions when I met him, he had no intention of leaving his job.

I was amazed by what Phil had accomplished so I asked how he did it. He was kind and agreed to share his story. We sat together for over an hour.

Here’s what I learned:

1. Real estate

Phil told me that he amassed his wealth by purchasing a piece of real estate every year. He thought of it as his own small business. He bought a single family home every year and rented it out to nice, stable families. He didn’t try to make a killing. He believed in growing his wealth slowly. It was a smart investment strategy.

You might think it would be tough to buy a piece of real estate every year on a garbageman’s salary, and you’re right. Phil grew his wealth during a period of steady real estate appreciation. He refinanced his properties often. He took out equity and purchased another home each year. Of course, because Phil’s income was limited, he couldn’t afford to get into a negative cash flow situation, and he never did. Also, keep in mind, Phil had a large family of 6 and his wife didn’t work outside the home.

While I believe that this could be a fantastic time to follow in Phil’s footsteps, it would probably be a mistake to count on quick appreciation right now. That being the case, it will take more time to build your wealth using real estate.

What would Phil Do Today?

I’m no longer in contact with Phil, but my guess is he’s still buying real estate now. But he wouldn’t pull out equity and take the risk of running a negative cash flow. He’d take it slowly. My thinking is that if it’s good enough for Phil, it’s probably a good idea for you and me.

The lesson is to take advantage of opportunity, but be willing to adapt to current circumstances. I meet lots of people who want to build wealth quickly. They want to make up for lost time or past mistakes. That’s a huge mistake because the risks pile up when you take that approach.

If you want to buy real estate right now, it might be a great move. But don’t get in over your head, and don’t get into a negative cash flow situation. If you do, and then find that you lose your job, you could end up on the very wrong end of the stick.

2. Methodology

Phil told me that he always invested before doing anything else. His number one priority was investing. If he didn’t have the money to go on vacation, he and his family stayed home. If he didn’t have the money to buy a new car, he stuck with his old jalopy. But he never failed to invest every year.

You’ve probably heard the expression “pay yourself first.” It’s really smart advice. In fact, if you do this, I can see how you might not even need to track your spending. But above all else, make investing your priority.

If Phil were just starting today, he might not be able to buy a rental home every year. But he’d put something aside no matter what and build on it. You may not be able to put down a huge stash of cash each year right now. But start with some amount and make sure that you put that money aside no matter what.

3. Use time

As I said above, Phil wasn’t in any rush. And he understood that he had no real reason to rush. He liked working. He thought of real estate as his retirement plan.

The lesson here is to make sure you’re not taking on too much unnecessary risk. If your time frame is 20 years (for example) make investments consistent with that period of time. Don’t worry about short-term valuations because they just don’t matter.

4. Family man

Family was really important to Phil. He stayed married to the same woman for 35 years. Much has been written about the financial devastation of divorce, and Phil seemed to intuitively understand that.

But he also involved his family in his financial plan. Even in the 80s, he made sure his family understood and supported the need to invest. They were all aligned. Phil’s children knew better than to expect their father to support a lavish lifestyle. They also understood they would have to carry their own weight.

I’ve seen more than my share of couples who worked hard, did everything right, and still ended up broke in their retirement. The reason? The gave or lent money to their kids without understanding the economic fallout for themselves. They gave up that cash out of love, but they sacrificed their own futures. I realize that it’s tough to say no to people you love when they need want your financial support but, before writing those checks, make sure you weigh the pros and cons for everyone involved.

The bottom line to Phil’s story is that he didn’t have or need a “silver bullet,” and neither do you. You’ll read many financial success stories like Phil’s. Why? Because the principals work.

You may not need $10 million but, if you’re like me, you do need to make a plan and execute it if you want a secure future. The steps Phil took are steps that anyone can take. We may not end up with the same result, and the times are different to be sure. But still, Phil’s example is a good one.

Over the years, I’ve seen people succeed in all kinds of economic conditions and situations. In fact, the situations rarely had anything to do with the success these people enjoyed. I really believe that success is available to all of us but we’re going to have to get out of our comfort zone in order to make it happen.

We have make investing a priority.

We have to say “no” to people we love sometimes.

And we have to invest in the future and stick with our strategy during uncomfortable periods.

What are you willing to do to secure your future? What are you willing to change?

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]]> http://www.fivecentnickel.com/2011/07/28/wealth-building-techniques-that-i-learned-from-the-garbage-man/feed/ 8 Why You Should Invest Like a Girl http://www.fivecentnickel.com/2011/07/22/invest-like-a-girl/ http://www.fivecentnickel.com/2011/07/22/invest-like-a-girl/#comments Fri, 22 Jul 2011 14:07:02 +0000 Nickel http://www.fivecentnickel.com/?p=19552 Why You Should Invest Like a Girl

I recently ran across some interesting data on the differences between men and women when it comes to investing for retirement. What follows is based on “How America Saves 2011,” which is Vanguard’s annual report on retirement plans.

And yes, I realize that it’s dangerous to generalize, but there are some interesting nuggets of wisdom in here…

Participation rates

According to the report women who earn between $30k-$100k/year are more likely to participate in their workplace retirement plan than men in the same income range. The differences aren’t always huge, but they’re definitely noticeable. For example, in the $50k-$75k range, 78% of women joined their retirement plan vs. just 68% of men. Moving outside of that range (below $30k or over $100k) the situation reverses, and men are slightly more likely than women to participate.

Savings rates

Women who have joined their employer’s retirement plan also tend to save more than men. For example, returning to that $50k-$75k range, women put an average of 7.4% of their income into their retirement plan vs. 6.8% for men. Looking more broadly across the data, women out-contributed men by a 6.9% to 6.7% difference, and they have done so in seven of the past ten years.

While the difference here isn’t huge, it adds up over time. For example, consider someone at the top end of that $50k-$75k pay range. The extra 0.6% they’re saving amounts to “just” $450/year. But if we hold that contribution rate constant over time and assume an annual salary increase of 3.5% on that base $75k salary along with an 8% investment return, we’re talking about nearly $80k more in savings over 30 years.

Diversification

On average, women tend to have a more diversified investment portfolio than men. In 2010, women held and average of 10% of their portfolio in bonds funds vs. 9% for men, and women had an average of 25% of their account balance in balance (stock + bond) funds vs. 22% for men. This isn’t necessarily a good or bad thing, as it really just means that men are slightly more aggressive in their investing, and it ignores factors such as age.

Nonetheless, this difference appears to have served women well during the recent market downturn, as the average woman’s retirement account grew more than the average man’s retirement account from 2005-2010. Of course, this also includes contributions, so the higher savings rates mentioned above contribute to this difference.

Changing course

Based on an analysis of IRA accounts, men were 10% more likely to abandon stock between January 2007 and October 2009. Of course, we all know what happened at the tail end of that time period – the S&P 500 skyrocketed 56% from March to September 2009. While a lot people jumped back in during this run up, many of them sold near the bottom and then missed at least part of the recovery.

Putting it all together

When you read through the above, it sounds like women are (on average) doing very well when it comes to retirement investing… And yet the median account balance for women in employer-sponsored plans was just over $21k vs. more than $33k for men. In terms of averages, the difference was even greater – $96k vs. $59k.

What gives? According to the report, though women have better investing habits, they tend to have (again, on average) shorter job tenures and lower incomes. In other words, they have much more to overcome when it comes to preparing for retirement.

As for why women are better investors, Vanguard suggests that women might be more likely than men to seek advice – and to follow the instructions that they are given. At the same time, economists have suggested that men then to overestimate their investing abilities which can result in bad decisions and poor results.

Source: The Vanguard Group

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]]> http://www.fivecentnickel.com/2011/07/22/invest-like-a-girl/feed/ 3 Will Municipal Bonds Lose Their Tax Advantage? http://www.fivecentnickel.com/2011/07/21/will-municipal-bonds-lose-their-tax-advantage/ http://www.fivecentnickel.com/2011/07/21/will-municipal-bonds-lose-their-tax-advantage/#comments Thu, 21 Jul 2011 17:00:33 +0000 Nickel http://www.fivecentnickel.com/?p=19382 Will Municipal Bonds Lose Their Tax Advantage?

Municipal bonds, which are issued by states and local communities, are a popular choice for those who are looking for a fixed income investment in a taxable account. The reason for this is that the income generated by muni bonds is tax exempt, which boosts their effective yield as compared to taxable bonds.

Beyond being a boon to investors, this tax break is a great help to the communities that issue the bonds, as they can pay a lower interest rate and still be competitive with higher rate bonds that don’t share this tax advantage. But this all comes at a price… According to the Joint Committee on Taxation, the federal government will lose out on over $200B in tax revenue due to the muni bond tax exemption between 2010-2014.

Given the above, it’s perhaps not surprising that lawmakers are talking about reforming the tax treatment of municipal bonds. Of course, according to Jason Zweig, this has been talked about over 100 times since 1918, and it’s never happened. But with all the recent interest in reducing the deficit, it seems that more people are talking about it than in the past.

Aside from taking away a well-loved tax shelter from investors, the taxation of municipal bonds would essentially equate to the federal government taking money away from local communities, as those communities would have to start paying higher interest rates to make their bonds attractive enough to draw investors.

Given the rough shape that many states are currently in, it’s hard to imagine Congress acting to make things worse, but you never know. One possibility is that, if the tax exemption was taken away, the feds would provide subsidies to local communities to help offset the added cost, but at a rate lower than the tax exemption.

Who knows… As I noted above, this has been debated multiple times in the past and has never gone anywhere but, given the current economic climate, it’s probably worth keeping an eye on these discussions.

Source: CNN/Money

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]]> http://www.fivecentnickel.com/2011/07/21/will-municipal-bonds-lose-their-tax-advantage/feed/ 8 Why I Like Savings Bonds http://www.fivecentnickel.com/2011/07/20/why-i-like-savings-bonds/ http://www.fivecentnickel.com/2011/07/20/why-i-like-savings-bonds/#comments Wed, 20 Jul 2011 14:22:47 +0000 Nickel http://www.fivecentnickel.com/?p=19352 Why I Like Savings Bonds

Several people have asked why I like Series I savings bonds, so I thought I’d address that with a dedicated post…

For context, the Treasury has recently announced that they’re (mostly) getting rid of paper savings bonds, which effectively cuts the annual purchase limit in half (from $5k paper + $5k electronic to just $5k electronic). While you can work around this limitation by buying savings bonds with your tax refund, that’s a bit of a hassle.

Inflation protection

For starters, I bonds offer a degree of inflation protection, as their rate (updated every May and November) is partially pegged to the CPI. The rate is actually made up of two components – a variable rate calculated from changes in the CPI and a fixed rate that represents a premium over inflation.

Recently, the fixed rate has been pegged at 0%, which means that you have to depend on that variable rate to generate your return. In other words, your “real” (inflation adjusted) return is 0% before taxes. Not great, but at least you’re not lagging behind inflation, as you would if you stuck your money in a savings account.

Tax treatment

Another nice feature of savings bonds (both I and EE bonds) is that the interest is exempt from both state and local taxes, and federal taxes aren’t due until the bonds are redeemed. Thus, savings bonds give you an IRA-like tax deferral in addition to existing IRA contribution limits.

And guess what? If you use your bond proceeds to pay for college, the interest income will ultimately be tax free (subject to restrictions; details). Thus, they can be a nice complement to things like a 529 plan.

Effectively higher rates

A common criticism of I bonds is that, due to the low (currently zero) fixed rate, you’re guaranteed to lose to inflation after taxes, even with the state and local tax exemption. As I’ve noted above, this isn’t entirely true, as you can use the proceeds to pay for college and get a federal tax exemption.

To crystallize the above points, let’s take a look at the tax equivalent yield of current I bonds. As of May 2011, the variable rate stands at 4.6%. Compared to available savings and CD rates, this is quite high. Sure, it might drop in the future, but only if inflation likewise declines.

So what about the tax equivalent yield? The tax equivalent yield of an investment is the rate that you would have to earn in a fully taxable investment to equal the return that you’re getting in a tax-advantaged investment. You calculate it by dividing the rate of the latter by one minus the tax rate, as follows:

Tax Equivalent Yield = Tax-Free Yield / (1 – (% Tax Bracket / 100))

Assuming that you live in a state with a 6% income tax rate, which is a fairly middle-of-the-road value, your tax equivalent yield on a current I bond would be roughly 4.9% – not too shabby. But wait! What if you’re planning on using it to pay for college, and you’re in the 25% tax bracket? In that case, (25% federal + 6% state) your tax equivalent yield would increase to nearly 6.7%!

Yes, your rates will bob up and down every six months, but it’s hard to argue with those sorts of numbers given the current interest rate landscape. Of course, if you live in a state with no income tax, the numbers will change, but that federal exemption is still a big deal.

Reasonable redemption policies

Finally, we have to consider getting your money back out… Sure, you’ll get better-than-bank interest rates, but what good is that if you can’t access your money? There’s good news and bad news here. For starters, you can’t redeem your savings bonds during the first 12 months. Period.

Once 12 months has passed, however, you can redeem for a 90 day interest penalty. And this penalty could be very low if you do it during a period of low inflation (when rates are at their lowest). After five years, the penalty goes away entirely.

So there you have it… We like Series I savings bonds for the combination of inflation protection and tax advantages – and the accompanying boost in terms of tax equivalent yield. They’re not sexy, and they’re not exciting, but they are a valuable part of our portfolio.

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]]> http://www.fivecentnickel.com/2011/07/20/why-i-like-savings-bonds/feed/ 6 Buying Paper Savings Bonds in a Paperless Era http://www.fivecentnickel.com/2011/07/18/buying-paper-savings-bonds-in-a-paperless-era/ http://www.fivecentnickel.com/2011/07/18/buying-paper-savings-bonds-in-a-paperless-era/#comments Mon, 18 Jul 2011 13:33:48 +0000 Nickel http://www.fivecentnickel.com/?p=19332 Buying Paper Savings Bonds in a Paperless Era

Last week I mentioned that paper savings bonds (both Series I and EE bonds) are going away at the end of 2011. To be honest, the lack of paper doesn’t really bother me – I’m fine with using TreasuryDirect – my concern is that this effectively cuts the purchase limit in half.

There has been a lot of discussion about this elsewhere on the web but…

In recent years, you’ve been allowed to buy $5k worth of each type of savings bonds (per Social Security) through both the paper and electronic channels. In other words, you were able to buy $10k of each type of savings bond. With the loss of paper, the Treasury has confirmed that you will now be limited to $5k of each type.

For a variety of reasons that I won’t go into here, I’m not interested in EE bonds, but I am interested in I bonds. In fact, my wife and I have bought our $10k limit in each of the past couple of years. Sadly, that’s no longer possible. Or is it?

As it turns out, there’s a loophole in the new, paperless policy… Paper savings bonds will still be available if you’re due a tax refund. The IRS has a long list of FAQs, but the upshot is that you just have to file Form 8888 along with your return. On it, you instruct the IRS to issue all or part of your return in paper savings bonds in $50 increments up to the $5k limit.

Moreover, there are lines available for two additional purchases. For married filing jointly, the initial purchase will be in your name with your spouse as the co-owner (the purchase doesn’t apply to the co-owner’s limit) and then you can flip it around and buy in your spouse’s name on the following line.

That’s all well and good, but who wants the headache of estimating your taxes early and making sure that you overpay your taxes by $5k or $10k per year? And who wants to give the government an interest free loan from whenever the overpayment is made until you ultimately file your taxes? Not me.

Fortunately, there is a simple workaround. Instead of overpaying throughout the year, simply wait until you figure up your 2011 taxes during the winter/spring of 2012. From there, simply file an extension and submit an additional payment that creates a $5k or $10k overpayment, whichever you prefer.

Example: If you figure your taxes and find that you are due a return of $795, file an extension using Form 4868 and include an extra payment of $9205, thereby creating a $10k overpayment. You can either send a check or use EFTPS to make this payment.

Now just wait a week or so to be sure the payment has cleared (check with your bank to be sure), and then file your tax return (be sure to adjust the numbers for the extra payment that you’ve made) and file your return along with Form 8888 requesting your savings bonds. That’s it, very easy.

Note that, because the extension allows you to file as late as October 15th, this approach also allows you to wait until after the May 1st rate update to file and request your bonds if you so desire. If not, just be sure to get this all done before the rates change.

Update: Upon closer inspection of the instructions, it appears that you can buy savings bonds in multiple names, but that the total cannot exceed $5k (or your refund amount, whichever is smaller).

Source: The Finance Buff

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]]> http://www.fivecentnickel.com/2011/07/18/buying-paper-savings-bonds-in-a-paperless-era/feed/ 3 Paper Savings Bonds Going Away? http://www.fivecentnickel.com/2011/07/14/paper-savings-bonds-going-away/ http://www.fivecentnickel.com/2011/07/14/paper-savings-bonds-going-away/#comments Thu, 14 Jul 2011 17:00:54 +0000 Nickel http://www.fivecentnickel.com/?p=19292 Paper Savings Bonds Going Away?

Last night while noodling around on the web, I ran across a press release from the Treasury stating that they will stop over-the-counter sales of paper U.S. Savings Bonds at the end of the year. In other words, you’ll no longer be able to stroll into your bank and load up on Series I or EE Savings Bonds.

The stated goal here is to save money – up to $70M over the first five years – by getting people to buy savings bonds online via TreasuryDirect. I’m all for saving money, but…

As things currently stand, you can buy up to $5k worth of Series I Savings Bonds in paper form, and another $5k online – i.e., there’s a $10k combined limit. Now that you can’t paper bonds at the bank, what will happen to the limit? Will it be effectively cut in half? Or will the Treasury bump up the online limit?

It’s also unclear if they’re just dropping OTC sales in banks, or if they’re also cutting off mail-in sales. While it would make sense for them to move away from paper entirely, the press release clearly states that paper bonds will still be available for purchase using your tax refund, so who knows?

My suspicion is that they’ll leave the online purchase limit where it stands (at $5k) because you’ll still be able to buy paper bonds, albeit in a limited and inconvenient way – by overpaying your taxes and then using the refund to buy paper bonds. Who knows… We’ll just have to wait and see.

Oh, and for what it’s worth, if you currently hold paper bonds, you’ll be able to continue redeeming them at your local bank. And if you lose your bonds, you can still have them re-issued in paper form.

Update: Based on discussions on the Bogleheads forum (which include a couple of e-mail responses from the Treasury), it sounds like the mail-in program will also be discontinued, and that the online limit will stay the same – $5k for I Bonds, $5k for EE bonds. Bummer.

Source: TreasuryDirect.gov

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