Monday, November 30, 2009
Friday, November 13, 2009
Why does a cat piss on the carpet? Nobody likes it when the cat does this and the cat knows it but does it anyway. The cat has its reasons and so do I. Investment maintenance.
Most investors drastically under perform the S&P 500. Your goal is to get as close as possible to market returns. How do you get market returns?
1. Do not get scared or greedy, if you do do not act on these emotions.
2 Avoid timing the market. The market is random. Embrace this.
3. Try to pay as little in fees and cut taxes
4. A good investment has high returns and low volatility. Remember this when thinking about investing in something other than a well diversified index fund (either stock or bond market)Below is high hanging fruit, which means we are close to the end! If none of the ideas in the previous post have been new to you, prepare to be "dazzled" while being put to sleep at the same time. High hanging fruit isn't as easy to get as low hanging fruit, and neither are the below ideas.
There is a difference in tax treatment between interest and capital gains. Interest is taxed same as income. Capital gains is taxed at 15%. If you own corporate bonds these are taxed as normal income which for most of us is higher than capital gains rate of 15%. Consider putting interest generating corporate bonds in a tax advantaged account (traditional pre tax IRA might be optimal if you have one laying around as it will be taxed as income anyway)
If you own a index fund (say s&p) in a individual account and it is doing well, don't touch it to defer capital gains as long as possible. This is a free gov loan at 0% interest. Move your money around as little as possible is a good practice anyway, as it usually cost you fees and taxes.
If you have an asset that you think will grow real fast (either stock index fund or see small cap value below) try to put these in a post tax Roth account as it is not taxes.
If you own a fund in and individual account and you are loosing your shirt (say a 15-20% loss on it), time for tax loss harvesting. Sell the looser to take a capital loss on it, and buy something slightly different(be sure to check the rules on this, selling a vanguard s&p fund and buying a fidelity s&p fund is not slightly different) This was a fun pastime of mine in 2008-2009. This is a great way to later generate a tax free loan on the loss (defer taxes). It also helps lower your taxes. If you don't use all your capital loss it rolls over forever and you can write a certain amount off your income each year ($3000 ish) which is usually a better deal than subtracting the capital loss from your capital gains.
Also if you own bonds, consider this. If on one hand you are loaning money out and getting 5% back (corporate bond individual account) and on the other hand getting a loan on your house for 6%, you can see why this is silly There may be good reasons to do this, you like in an earthquake area, cash flow, etc but you are paying a premium. Treat the amount of cash in your house to be % allocation that you have in a bond.
The opposite scenario is worth thinking about. If I could borrow at 1% I would borrow all I could get. but leverage can kill. On leverage Buffet says" a stupid person should never use it and a smart person doesn't need it" or something similar. If you got cash in your house and can borrow on it at a great rate, and can use that money to max out say a Roth, and your rate of return is good(say s&p500 investment) it may make sense to do this. On a personal note I have proved Buffet right in 2008 by borrowing at 0% for 12 months (put kitchen on Lowe's credit card) turning a $15,000 kitchen into a $20,000 kitchen. On average this cute plan should have worked great but it ended up being a jam toast carpet scenario.
Dollar cost averaging. (401ks make this easy) try to invest a continuous stream of money over time. Also Try to avoid reallocating large chunks of money all at once. Instead do it very slowly. This helps avoid market timing mistakes.
Avoid cash drag (money not invested)
Re balance your allocations to where you want them. (once a year or so) Remember what you decided for stock bond allocation? keep it going, adjust for age and other factors that may effect how much risk you are willing to take (Dow Jones number is not a consideration)
Take another look at HSAs. HSAs as you recall are never taxed if you spend the money on health related expense or health insurance. If you are worried about not being able to spend all the money on health costs don't be. If you pull money out of an HSAs in retirement for non health expenses the money is taxed as income (just like an IRA) If you go to the hospital a lot this may not work for you.Take another look at Roths. IRAs (401k pretax) are not as great as most people think. Roths (or 401k post tax) are most likely better.
IF you are well payed now, start saving now to pay tax bill in 2010 when you smartly roll over your IRA into a Roth.
Once in retirement, the plan will be to pull money out in roughly the following order, all the while keeping an eye on your tax bracket and adjust accordingly.
Individual accounts (pay capital gains) when doing this sell small gains first, big gains last to defer taxes and keep The free gov loan going.
IRa's (Will be taxed as normal income) Watch out for mandatory withdrawls in your early 70's
and finally Roths (no taxes!)
The previous entries are pretty solid. Usually hot rods are less reliable than other cars, but if you are willing to take more risk and want to hot rod your portfolio, here are some thoughts. I am getting onto thinner ice here.1 Best way is to move your portfolio to 100% stock allocation (index total market low cost) do this first.
2. There is historic data that shows small cap value index funds returns are higher but more volatile. You get compensated for taking on risk with historic average returns of a Little over 12 %. IF you are willing to accept more volatility, You could buy this index. Roth is a great place to buy this one, due to the tax free growth.
3. Some books mention adding a international total market fund. There is not a lot of long term data on this. May or may not prove to be a good idea. There have been some studies that show it does create a portfolio with less volatility(1%). no more than 30% is a good number to shoot for if you subscribe to this theory this is one hot rod add on that is OK to think about even if you do have bonds. If you think that international companies in general will grow their earnings the same or faster than U.S. companies, than this may be a good option if you end up being right. The flip side of this diversification move is that if you own US stocks, you already have some international exposure.
5. Emerging markets. Quite a bit of volatility or speculation, but this is a hot rod. use sparingly. small caps perform very similarly with less risk so may not be a good idea.
Back to the cat paradox. Why did I write this? Like the pissing cat, I know people don't like talking about this stuff. I too have my reasons. I hate seeing money wasted (mine or others) Life has changed much since the days of our parents. Most had pensions. They didn't have to worry too much about this stuff. Our generation is one of the first with no pension. We gotta handle our own. This seems like a crisis but could prove to be an opportunity. I hope you save/make some money off this advice and have found some interesting and creative ways to spell words. Like 50 cent says "get rich or die tryin" Good luck!
Friday, November 6, 2009
Your goal is to cut taxes. There are many gov programs to reduce/defer tax exposure. There is one that eliminates taxes entirely! This topic is pretty complicated. Make sure you play by the rules (qualify etc) the penalties are steep. Certain people do not qualify for certain plans, there are max limits, withdrawal rules etc to be aware of. It is hard to judge which programs are best, The following is a rough guess for most people. IF you don't want to read any further (this is pretty boring) the take away is that post tax is most likely the best (Roth, Roth 401k) and if you are a real cracker jack and young and taxes go up, 401k pretax contributions could end up being not so hot for you (think tax rate goes way up for everybody) but there is a fix. It is also possibly for some(under $100,000) and soon (year 2010) for all of you to roll over your traditional IRA into a Roth and this is something to look at. You pay the tax bill when you do this, (best to do it with cash) but the pain will probably pay off big time. https://calcsuite.fidelity.com/rothconveval/app/launchPage.htm will spit out a number for you. Terms: I am not going to talk about individual accounts. Pretax is a traditional IRA or 401k, post tax is a Roth 401k or Roth IRA
In order, the way to fill up from best to not best
1. 401k match
2. Roth IRA (post tax $5,000) make sure you dont make too much money for IRAs
3. 401k post tax (if your employer had this I am going to assume your 401k is pretty god (low fee funds available)
For steps 4 and 5 may be a good idea to get em going and then roll em over to a Roth.
4. Traditional IRA (traditional is pretax contribution, do not use if contributed to above Roth.)
5. 401k pretax (young, aggressive, crackerjack savers beware but get going and plan rollover to roth)
there are also other programs which may work well for you such as
6. Health savings account (no taxes period!)
Whenever you quit your job or get laid off, rollover your 401k
This is a rough best guess but is probably accurate. Be pretty curious if somebody else is coming up with a better idea or shuffles em around.
Why is 401k match best? Free money rules. you put in a dollar and so does the company. You wouldn't turn down a raise would you? (if they put it in w company stock sell as soon as possible, while avoiding any fees. You do not want to hold company stock )
Post tax (401k or Roth) rules. for more reasons than i am going to mention. these are defiantly #2. It is easier to pull contributions out than most people realize (no fees or penalties) but you don't want to do this anyway because Roth's are so great. they are also a great thing to hand down to kids when you are dead. Very flexible. I love these.
Why is post tax usually better than pretax when it comes to tax advantaged accounts? Even thought paying less taxes now may be very immediately gratifying, I think it is a better idea to contribute whenever possible post tax rather than pretax for a couple of reasons. You can contribute "more", your tax rate now is probably less than it will be in retirement, the more time you have the more a roth makes sence, and finally you reduce your tax risk.
For super savers-you can effectively contribute "more" post tax as the limits are the same for both. Try to max out your contribution and you will see why post tax is "more" than the same figure amount pretax.Your tax rate in retirement will probably be higher than you are in now. This is one critical piece of the puzzle. You have to guess what tax rate you will be in retirement. If it is higher than the tax bracket you are in now, It makes no sence to defeer your taxes, so Roths can not be beat. It is almost impossible to guess what may happen to your tax bracket. Taxes are pretty low right now. deficit is high. I think the highest rate now is about 32%. rates have been as high as 87% in the past. I personally suspect that taxes in general are going to go up. I am also giving you credit for planning your retirement well (you have read this far). If you are likely to have a pension or other income in retirement, this is even more true. For these reasons I think it is a good assumption that your tax rate will stay the same or be going to go up in retirement. If you are 5 years from retirement and have just started your retirement savings, you are in a very different boat and post tax is not for you.
If you are young you probably aren't getting taxed real heavy right now anyway, why deffer taxes that are already low?
later, when you are at your max tax bracket(say in your 50s or when you are getting a massive one time pay spike say win lotto) and are confident you will be in a lower tax bracket in retirement it may make sense to then go pretax.
The longer your money sits the more obvious the Roth advantage becomes.
Pretax (traditional) disadvantage. You are required to withdraw a certain amount at around age 71. this forced withdrawal could be big enough to bump you into a high tax bracket and wipe out some of the 401k advantage ( tax rate in retirement that is higher than the tax rate you could have payed when you were young) What is worse is since you deffered taxes, now you gotta pay taxes on the forced withdrawal, which could force you to pull more money out of your 401k.
Finally future increases taxes are a big risk to your retirement. paying taxes now eliminate that risk. pay tax now (Roth) and you know what you got. What are taxes gonna be in the future? who knows? Go to this link and see what i mean (how does a 87% tax rate sound? It happened.) http://www.truthandpolitics.org/top-rates.php it has max tax rates over the last century
Pre tax is risky. If you end up in a significantly higher tax bracket in retirement than you were when you deferred your taxes, you could live to regret the day you deferred your taxes. This can happen if you are good (start young max contributions and have a high rate of return, a crackerjack, or a little cracker jack and a fat pension) The stars would have to line up a little for this to happen (say capital gains stays at 15% future tax rate goes way up). I am not saying that if your only choice is a trad 401k that you shouldn't do it(remember rollover trick to weasel out of this), but that Roths are way better.
want the cold numbers? Here is a calculator that should give you an idea. http://www.ifa.com/401k/calculator/RothConvertCalc.asp
The neat thing about running these is you can make up your own assumptions and come to your own conclusions. If you monkey around with your tax rate in retirement you can make the numbers dance and do what you want with em.
Why are 401ks slightly worse than IRAS? the bad deal is that 401k plans are typically have a limited investment choices that have higher expense ratios. This more true for some 401ks than others. I hear school teachers have terrible 401ks choices. You can fix this sometimes and is not a good excuse to not contribute to one. the work around or fix?
When you change jobs, rollover your 401k. This is a great deal (Get more low cost mutual funds to choose)Make sure they do not cut you a check
Some places have brokerage link accounts.
Letter campaign to your employer tell em you want better options.
Health savings accounts. This is new. If you have a "high deductible health insurance" you may qualify. If you don't use it at the end of the year you still get to keep it. money is never taxed. I say again never. you can invest it. You can use the money immediately on most health related expenses (Dr visit medicine and more importantly down the road health insurance) You can use it for your spouse or child. the bad, the money can only be used for health related things and you got to keep records and the investment options are sometimes not great(low choices high fees) It takes a year to build up enough money to invest. This can be a great deal for people who plan to pay for their own insurance once retired.
529's i don't know much about. other than pay for higher ed, can change name of kid. something to look into at some point. IF somebody would like to comment feel free.
By the way all these retirement accounts have the added advantage of litigation protection. (think OJ going golfing even though he has got a huge settlement against him) which may be a reason in and of itself to do em.
Are you still awake? congradulations! you are the only one who made it through this blog entry.
Thursday, November 5, 2009
Tuesday, November 3, 2009
Yes/No. What you described is called an active mutual fund. Here is the problem. your smart mutual fund manager needs to get paid. And they get paid well to produce nothing. expense fees for actively managed mutual funds are commonly over 1 percent compared to an index fund with an easy to find expense ratio of .3%. So in order to profit from these smart managers they have to beat indexes buy .7% to break even. They don't. Everybody has a "smart" money manager and they all play against each other, looking for the best deal in the market, and getting rid of the worst deals. A easy way to picture this is a game of tug o war with a bunch of strong (smart) men on one side and a bunch of strong men on the other. on average No real work gets done. On average the average mutual fund should produce average market returns minus their inflated costs. Pay less get more.
Another way to do the same thing just more so is hire a broker to manage your money. He/she takes 1% or so off the top and typically selects a bunch of"hot" actively(read high expense ratio) managed mutual funds. The financial sector is by far and away the biggest sector of our economy(think gas + health care), guess who feeds em? Pay less get more.
For those who are more impressed by numbers, it is far bleaker for active funds.
for the past 25 years a s&p 500 index fund 12.3% return
for the past 25 years actively manage funds returned 10.0%
subtract taxes and inflation for the same period (active mutual funds with higher turnover generate more taxes) and you get
s&p index fund real returns 8.2%
active fund real return 4.9%
Pay less get more.
Anyway enough explaining. If you want a return on your investment that is better than 95% of investors, and want to avoid fees, think about the following or something similar.
First come up with what percentage stocks and bonds you want. IF you are aggressive and can sleep through anything and are young 100% stocks may be OK (some good books I have read have said nobody should be 100% stocks, but historically 100% stocks have never been beat over long term)
other popular theories are take your age and buy that % of bonds
This is a hard personal choice and one that once made should be stuck with no matter how scared or greedy you feel as speculation kills. (only adjust for say age or amount of risk you can take not how the stock market is doing) www.ifa.com is a great website and has a good risk evaluator to find out what kind of person you are and can give you an idea of how to allocate, although in a more complex way. Remember that every 1% lost is a massive hit to your retirement, that it is a long time till you actually pull the money out, and historically you should allocate as much stock as you are comfortable.
Know thy self. If the market drops 50%-65% and you are in stocks at 100% can you sleep or would you sell? how about 70%? IF you would freak out and sell do not go 100% stocks. better to figure this out now and stick with your plan. It should never drop 100%, as that would mean the top 5000 businesses in the country simultaneously went broke, and we would have bigger problems (think a huge comet takes out earth everybody dead so doesn't matter) . What is good for me isnt good for you. bonds have historically been trumped by stocks as far as performance. you do get compensated for taking risk and due to the majic of compound interest, It makes a huge difference in retirement.
how do i know what indexes to buy?
buy a total market representing either the Dow Jones (wilshir 5000) index with the lowest fees you can find.
or buy S&P 500 index with the lowest fees you can find
here are two I found
vanguard VTSMX expense ratio .18%
expense ratio .10%(min investment $10,000 though)
the lowest cost fund I have found is a fidelity fund similar to above at .07% but you need $100,000 min good luck!
If you want bonds buy look at a total bond indexhere are two i found
expense ratio .22
expense ratio .38%
There are also blended funds that may work well for you. (fidelity 4in 1, etc)
as long as you are indexed (the broader the less risk) and lowest cost possible you are good.
by buying total market the only risk you have is "market risk" which is plenty for most people. The more specific you get the more risk you take on, the less diversified you are. more on that later.
now just buy and hold (watch out for 90 day short term trading fees) and you have done you best to avoid FEES.
The above is a good plan. It may not be a perfect plan but a good plan is good, simple and you will beat the pants off most people over the long haul (95% of people for similar stock bond allocation apple to apple comparison).
If youy are looking at ETF's be careful, the expense ratio excludes certain costs(not an apple to apple comparison with mutual funds). the bid ask spread is one example and sometimes there is a market premium aka the amout you pay is more that the etf is worth (book value/per share type deal. you gotta pay $10 to buy it. These all end up being a hidden 2 time loaded fee (one to buy and later to sell) Most of my reading recomends against etfs to avoid fees/keep it simple. also it is hard to get 100% of your cash into an etf which creates cash drag.(cash sitting and doing nothing) I have screwed this up myself.
Monday, November 2, 2009
Part 1. Foundation.
What determines how much stocks go up or down?(feel free to skip this q)
Answer: According to John Bogle (founder vanguard) The annual total return on stocks =earnings growth minus Dividends plus"speculative return"
the annual growth rate of earnings+ dividends from 1900 to 2005 is 9.5% the total market return for the same period is 9.6%
Earnings growth is the real driver on stock market returns over a long period of time. as long as on average earnings are grown, the stock market over the long haul will go up.
Speculation is driven by marketplaces "educated" guesses on what will happen to the earnings growth rate in the future but it is also driven by fear and greed
Why is Compounding interest Magic?
% are slippery little devils. unless you put a calculator to it, normal people are often surprised/amazed at the results compounding interest has. take $10,000. 30 years at 9 percent interest= 132,676 is a very different number than 30 years at 8% ($100,626) so just a 1% diff is $32,050 diff after 30 years. spoiler alert-this is the main reason it is so important to save, allocate investments correctly, and control cost, and do all of this now. failures and successes now are magnified later (think exponentially) small victories now will be huge successes 30 years from now.
How much do I get to keep from my investments?
Your (inflation adjusted) annual return=your investment returns minus expenses (financial sector fees+taxes) minus inflation. Basically there are three things that eat your return.
The financial sector through fees and expenses and commissions (spoiler alert go for low fees, stay away from brokers)
The government thru taxes and inflation (spoiler alert Roths and 401ks)
2 of these you can control (you can't control inflation)
What makes a good investment? The Ideal investment is one that has High annual returns and low volatility or risk. You have got to decide how much risk you can accept(can i sleep at night knowing that my money could go down by?) and balance it out with what rate of return you need/want. this may vary for some people. So a good investment for one person is not necessarily a good investment for everyone. It is very important to sleep well.
Is investing in stock risky? Yes. The average stock can go up or down "wildly" If you picked 1 stock from a big (top 100) company 1920 and held onto it to today the chances are extremely high that that stock would be worth nothing. I am taking about a single stock.
the return: 9.6% historic average 1900-2005
Are bonds risky? Yes. Companies, and governments can and do default on bonds. bonds are less risky than stocks because if a company goes broke, bond holders get dibs on the bones. Also bonds are loans with contractual rate of returns. again single bond.
the returns long term gov bonds 5.4% historic average
Are Cd's risky? Yes. Cd's will not beat inflation (at least by much). If your CD is going up 2% and inflation is going up 2% you are really not investing your money, you are saving it. To save for a 30 year retirement think about saving 50% of your take home income 30 years before retirement. I don't know too many people who can save this well. This is risk in a sneaky way. If an investment can not possibly get you to where you are going, it may be the riskiest of all. Think of riding a turtle is safer than riding in a car. but if you are going to go to new york, the turtle will never get you there. so Id say if your goal is to make it to new york, a turtle is infinitely more risky than a car. average 3.7%
rate of return
How can I make stocks less risky? Diversification. It is the only free lunch out there in investing. by buying the whole stock market you get average market returns with way less volatility/risk than any individual stock. Bonds same story.
Average returns seems so average. I am above average. Shouldn't I gun for above average returns by picking things i think are above average?
No. you might get lucky for a year, ma by 2, but over say 30 years plan on being average. trying to beat average returns for 30 years is like flipping a coin 30 times and trying to beat 50% heads. what is worse is the whole time you are doing this your volatility goes way up. basically way more risk for same average return. If you get average market returns you are getting returns that are higher than 95% of all investors. This is counter intuitive but is due to investors getting greedy and fearful (market timing) and getting fleeces by the financial sector (fees and expenses, etc)
How do I max out my diversification?
By buying the whole stock market or if you are buying bonds by buying the whole bond market.
Should i just listen to a friend on how to invest for my retirement. no.
This is gonna take a while, you may wanna read some books on it "The smartest retirement book you'll ever read by Danial Solin is good (he has got a couple of the smartest books all are similar) "the little book of common sense investing" by John Bogle is good.
Next up, how to buy the whole market, how to allocate funds, how to save money by lowering fees and finnaly how to fix taxes Im gonna try to go for low hanging fruit (the things that will help the most ) first.