Category Archives: Education

What is the difference between a 401(k) and a pension plan?

Both plans are designed to provide income for retirement.  There are some very important differences.

A 401(k) is a type of retirement plan known as a “defined contribution plans.”  That means that you know how much you are saving but not how much it is worth when you are ready to retire.  That depends on your ability to invest your savings wisely.  The benefit is that your savings grow tax deferred.  Many employers match your contribution with a contribution of their own, encouraging you to participate.

A pension plan is known as a “defined benefit plan.”  That means that you are guaranteed a certain amount of income by the plan when you retire.  The responsibility of funding the plan and investing the plan assets are your employer’s.

Because your employer is liable for anything that goes wrong with the pension they have promised their employees, many employers have discontinued pension plans and replace them with 401(k) type plans.  This shift the responsibility for your retirement income from the company to you.

If you have a 401(k) for your retirement and are unsure about the best investment options available to you, get the advice of a financial planner who is experienced in this field.

For more information, contact us.

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Consolidating your assets

In 1945, two brothers, Jacob and Samuel, were rescued from the Nazi extermination camp of Buchenwald. The rest of their family had been killed. The brothers joined other refugees that left Europe after World War II. Jacob came to the United States, became an engineer, and worked many years for a major corporation. Samuel immigrated to Australia and became an accountant.

Several years ago, Jacob died. He had never married. Samuel — by now quite elderly —came to the United States to settle Jacob’s affairs. What he found was financial chaos. Jacob had always lived frugally and invested widely. Unfortunately, he kept very poor records. Samuel spent several weeks rummaging through files, boxes, drawers, and even under couch pillows trying to gather together all the certificates, statements, and even uncashed dividend checks that Jacob had left behind. We will never be certain that all of Jacobs’s assets have been located.

Few people leave behind as chaotic a financial tangle as Jacob did, but I find that more than half of the people I advise after a death are not certain that they can identify all of a deceased’s investment assets.

The first lesson from this example is this: DO NOT KEEP STOCK OR BOND CERTIFICATES AT HOME OR IN A SAFE DEPOSIT BOX. KEEP ALL FINANCIAL ASSETS IN BROKERAGE ACCOUNTS.

Modern brokerage accounts now allow access via checkbook, electronic funds transfer (EFT) and charge cards. Have all dividends and interest payments deposited in your account; and, if you need cash, you may write a check. There is no reason for your heirs to search through your papers to find uncashed dividend checks.

As people get older, financial advisors and estate planning attorneys often advise clients to consolidate their assets. This is sound advice and greatly simplifies the job of managing an estate at death.

It is often possible to consolidate assets — even mutual funds that you have bought outside of a brokerage account — with a single financial advisor or team of advisors. This has the advantage of giving your financial advisor a better view of your assets and thus providing more comprehensive plans and advice. It also makes it easier for the surviving spouse or heirs to identify your investment assets.

Investment accounts with brokerage firms, money managers, and mutual funds typically make up the bulk of the assets of most families. It is not unusual for a family to have multiple accounts.

Be sure to make a list of your investment accounts. You may use that investment section of the workbook to do so.

From BEFORE I GO by Arie Korving.  Available at Amazon.

 

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The Biggest Myth About Index Investing

Reader Mailbag: Dividend Investing vs Index Investing

John Bogle has done a great job of “selling” index investing.  He started the Vanguard group with the promise that you could invest in the stock market “on the cheap.”  It’s the thing that made the Vanguard group the second biggest fund family in the country.

Selling things based on price is always popular with the public.  It’s the key to the success of Wal Mart,  Amazon, and a lot of “Big Box” stores.

But Bogle based his sales pitch not just on price, but also the promise that if you bought his funds you would do better than if you bought his competition.  He cites statistics to show that the average mutual fund has under-performed the index, so why not buy the index?

The resulting popularity of index investing has had one big, unfortunate side-effect.  It has created the myth that they are safe.

A government employee planning to retire in the near future asked this question in a forum:

“I plan to rollover my 457 deferred compensation plan into Vanguard index funds upon retirement in a few months. I currently have 50% in Vanguard Small Cap Index Funds and 50% in Vanguard Mid Cap Index Funds and think that these are somewhat aggressive, safe, and low cost.”

The problem with the Vanguard sales pitch is that it’s worked too well.   The financial press has given index investing so much good press that people believe things about them that are not true.

Small and Mid-cap stock index funds are aggressive and low cost, but they are by no means “safe.”  For some reason, there is a widespread misconception that investing in a stock index fund like the Vanguard 500 index fund or its siblings is low risk.  It’s not.

But unless you get a copy of the prospectus and read it carefully, you have to bypass the emphasis on low cost before you get to this warning:

“An investment in the Fund could lose money over short or even long periods. You should expect the Fund’s share price and total return to fluctuate within a wide range.”

The fact is that investing in the stock market is never “safe.”  Not when you buy a stock or when you buy stock via an index fund.  There is no guarantee if any specific return.  In fact, there is no guarantee that you will get your money back.  Over the long term, investors in the stock market have done well if they stayed the course.  But humans have emotions.  They make bad decisions because of misconceptions and buy and sell based on greed and fear.

My concern about the soon-to-be-retired government employee is that he is going to invest all of his retirement nest-egg in high-risk funds while believing that they are “safe.”  He may believe that the past 8 years can be projected into the future.  The stock market has done well since the recovery began in 2009.  We are eventually going to get a “Bear Market” and when that happens the unlucky retiree may find that has retirement account has declined as much as 50% (as the market did in 2008).  At some point he will bail out and not know when to get back in, all because he was unaware of the risk he was taking.

Many professional investors use index funds as part of a well-designed diversified portfolio.  But there should be no misconception that index investing is “safe.”  Don’t be fooled by this myth.

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A good Registered Investment Advisor is a “Life Coach.”

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People who are not familiar with Registered Investment Advisors (RIAs) too often view them as stock brokers.  They are not; they are held to a higher standard and are focused on the client, not the money.  RIAs are trusted advisors who put their clients ahead of themselves.    They are fiduciaries that are skilled in the art making good financial decisions.

Younger professionals who are building careers would do well to find an RIA as their financial guru, a “Life Coach.”  It takes time, experience and a high level of expertise to manage money well.  The young lack that expertise but have the biggest advantage of all: time.  They are in a perfect position to build wealth with the least amount of effort if they can lean on experts who can show them how to navigate the risky ocean of investing.  Just as important, they need a wise guide who can advise them on managing their income.  Too many people, even those with six figure salaries, live paycheck to paycheck.  Knowing what to spend and how to save is the role of the advisor.

This is very important for the independent professional – the doctor or lawyer.  Focused on building a practice, they need someone to advise them on managing their money wisely.

For the business owner, the entrepreneur, it’s even more important.  There is no career track and the challenge of building a business often results in poor money management.  Excessive debt can lead to bankruptcy, a common result in many industries that depend on debt financing.  A good advisor can help the business owner create a personal portfolio that’s independent of his business.  At the same time he can advise the owner the best way of financing his growth.

Once the business is established the owner needs guidance setting up retirement and benefit plans for himself and his employees.  This all part of the RIA’s skill set. And finally, as the business matures and the owner starts thinking of retirement, the advisor provides the guidance to transition the individual and his family to life beyond work.

That’s the point at which the coach gets the pleasure of knowing he’s done a good job as part of a winning team.

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New Years Resolutions for 2017

As another year winds to a close, we wanted to present you with some New Years resolutions designed to improve your financial health in the coming year.

  • Update your estate plan. Has there been a change in your family over the last year?  A marriage, a new baby, a death in the family?  If so, you need to update your estate plan, your insurance policies and your beneficiary designations.
  • Update your internet passwords. Are you using the internet to pay bills, shop, or access your investment accounts?  You will want to update your passwords and make them harder to guess.
  • Review your investments. Have you reviewed your portfolio recently?  Is it still aligned with your needs and goals?  If not, make some changes.
  • Get a personal “Risk Number.” Do you know how much risk you can take?  Most people don’t really know.  Resolve to get your personal “Risk Number“this year.  If you don’t know yours, click here to figure it out.
  • Get your portfolio’s “Risk Number.” Do you know how risky your investments are?  Most people don’t know how much risk they are taking.  Get your portfolio’s “Risk Number” and compare it to yours.  If it’s not the same, you need to consult your financial advisor.
  • Update your financial plan. If you don’t know where you’re going you probably won’t get there.  What’s your financial plan?  If you answered: “I don’t have one” resolve to get one this year.
  • Set your financial goals. Do you know how much you need to save to retire?  Here are some guidelines:

A 30-year-old can open a retirement account and make regular monthly contributions.  By investing properly and aiming for a modest 6% per year rate of return:

  • Saving just $200/month, by age 67 his account will have grown to nearly $350,000.
  • By saving $500 per month the account will be worth over $850,000.
  • Saving $1,000 per month will make our 30-year-old a millionaire by age 59.

 

If you have problems with any of these resolutions, you should definitely consider working with a financial advisor; someone who will be like a health coach for your personal finances.  Resolve to find one this year.

Think of the Advisor as your Sherpa, as it were, whose job it is to guide you amid the extreme altitudes and treacherous passes in investing’s hazardous terrain. That is to say, an Advisor is not someone you hire to beat the market for you, but rather someone who can help you achieve your personal financial objectives as “a facilitator, mentor, and market strategist” for those who, on their own, struggle to achieve their goals.

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Exploding health care costs

Here are some scary projections about the cost of health care for retirees:

 The average lifetime retirement health care premium costs for a 65-year-old healthy couple retiring this year and covered by Medicare Parts B, D, and a supplemental insurance policy will be $266,589. (It is assumed in this report that Medicare subscribers paid Medicare taxes while employed, and therefore will not be responsible for Medicare Part A premiums.)

If we were to include the couple’s total health care (dental, vision, co-pays, and all out-of-pockets), their costs would rise to $394,954. For a 55-year-old couple retiring in 10 years, total lifetime health care costs would be $463,849.

These projections come from Health View Services.

“Obamacare” enrollment has just begun for the coming year and premiums are increasing an average of 22% even as deductibles have increased to $6,000 for the “Bronze” plan before insurance actually pays anything.   The number of companies offering health insurance to individuals is shrinking and some of the larger companies have stopped offering individual policies altogether.

Many people tell us that health care is one of their top concerns in retirement, right up there with running out of money.  Unfortunately the majority has not even begun to put money aside for retirement and those who have underestimate the cost of doctors, hospitals and drugs during their retirement years.

No matter where you are in your life cycle, you should take action now to get to know a knowledgeable financial advisor, preferable a fee-only Registered Investment Advisor (RIA) who specializes in retirement and who can provide guidance on these issues.

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A reader asks: what’s the difference between risk tolerance and risk capacity?

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That’s an interesting question and it depends on who you ask.  The investment industry measures risk in terms of volatility, taking the opportunity for both gains and losses into consideration.

I will answer with a focus on losses rather than gains because, for most people, risk implies the chance that they will lose money rather than make money.

 Risk tolerance is your emotional capacity to withstand losses without panicking.  For example, during the financial crisis of 2008 – 2009 people with a low or modest risk tolerance, who saw their investment portfolios decline by as much as 50% because they were heavily invested in stocks, sold out and did not recoup their losses when the stock market recovered.  Their risk tolerance was not aligned with the risk they were taking in their portfolio.  In many cases they were not aware of the risks they were taking because they had been lulled by the gains they had experienced in the prior years.

People who bought homes in the run-up to the real estate crash of 2008 were unaware of the risk they were taking because they believed that home prices would always go up.  When prices plunged they were left with properties that were worth less than the mortgage they owed.

This exposed them to the issue of risk capacity.

Risk capacity is your ability to absorb losses without affecting your lifestyle.  The wealthy have the capacity to lose thousands, millions, or even billions of dollars.  Jeff Bezos, founder of Amazon, recently lost $6 billion dollars in a few hours when his company’s stock dropped dramatically.  Despite this loss,  he was still worth over $56 billion.    His risk capacity is orders of magnitude greater than most people’s net worth.

The unlucky home buyer who bought a house at an inflated price using creative financing found out that the losses they faced exceeded their net worth.  As a result many people lost their homes and many declared bankruptcy.

There are some new tools available to measure your risk tolerance and determine how well your portfolio is aligned with your risk number.  Click HERE to get your risk number.

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What’s Your Risk Number?

risk

Defining how much risk someone is willing to take can be difficult.  But in the investment world it’s critical.

Fear of risk keeps a lot of people away from investing their money, leaving them at the mercy of the banks and the people at the Federal Reserve.  The Fed has kept interest rates near zero for years, hoping that low rates will cause a rebound in the economy.  The downside of this policy is that traditional savings methods (saving accounts, CDs, buy & hold Treasuries) yield almost no growth.

Investors who are unsure of their risk tolerance and those who completely misjudge it are never quite sure if they are properly invested.  Fearing losses, they may put too much of their funds into “safe” investments, passing up chances to grow their money at more reasonable rates.  Then, fearing that they’ll miss all the upside potential, they get back into more “risky” investments and wind up investing too aggressively.  Then when the markets pull back, they end up pulling the plug, selling at market bottoms, locking in horrible losses, and sitting out the next market recovery until the market “feels safe” again to reinvest near the top and repeating the cycle.

There is a new tool available that help people define their personal “risk number.”

What is your risk number?

Your risk number defines how much risk you are prepared to take by walking you through several market scenarios, asking you to select which scenarios you are more comfortable with.     Let’s say that you have a $100,000 portfolio and in one scenario it could decline to $80,000 in a Bear Market or grow to $130,000 in a Bull Market, in another scenario it could decline to $70,000 or grow to $140,000, and in the third scenario it could decline to $90,000 or grow to $110,000.  Based on your responses, to the various scenarios, the system will generate your risk number.

How can you use that information?

If you are already an investor, you can determine whether you are taking an appropriate level of risk in your portfolio.  If the risk in your portfolio is much greater than your risk number, you can adjust your portfolio to become more conservative.  On the other hand, if you are more risk tolerant and you find that your portfolio is invested too conservatively, you can make adjustments to become less conservative.

Finding your risk number allows you to align your portfolio with your risk tolerance and achieve your personal financial goals.

To find out what your risk number is, click here .

 

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Retirement Lessons from Gene Wilder

Gene Wilder

Gene Wilder

Unlike many movie stars, Gene Wilder did retirement right.

Gene Wilder’s glory years came too late for the Golden Age of Hollywood and too early for the modern era of $50 million superstars, but he did well enough to walk away after a couple of decades.

In an industry where performers in their 80s and 90s outlive their savings and need to keep working into the grave to pay the bills, that’s an achievement.

While the details of his estate have not been made public, there are a number if things we do know.

Gene Wilder died somewhere between filthy rich and flat broke, spending down his cash while remaining comfortable to the end, which came last week from Alzheimer’s complications…

Wilder retired at 58 to do what he enjoyed, writing his memoirs while living in a relatively modest home in Connecticut with his wife.  While he was active in ovarian cancer charities, it’s unclear how much he gave to them other than lending his celebrity to the charities he favored.

After all, the spouse is the only estate planning goal retirees really need to consider. Everything else — from philanthropy to dynastic heirs — comes second.

The lessons here are simple, yet unusual in the entertainment business – whether we’re talking about movies or sports.  Too often highly paid entertainers adopt a lifestyle that absorbs all of their income.  That means that if their careers end after a few years they need to begin a new career.  The alternative is to end up broke.

Wilder put enough aside while he was working to allow him to live in the style he enjoyed for 25 years after retiring and leave his wife in comfort after he passed away.  It’s a lesson for all of us who are not movie stars.  Know what we want, save so that we can afford it, and retire when we’re ready to walk away and leave it all behind.

What’s the Difference Between an IRA and a Roth IRA

A questioner on Investopedia.com asks:

I contribute about 10% to my 401k. I want to know more about Roth IRAs. I have one with my company, but haven’t contributed any percentage yet as I am not sure how much I should contribute. What exactly is a Roth IRA? Additionally, what is the ideal contribution to a 401k for someone making $48K a year?

Here was my reply:

A Roth IRA is a retirement account.  It differs from a regular IRA in two important aspects.  First the negative: you do not get a tax deduction for contributing to a Roth IRA.  But there is a big positive: you do not have to pay taxes on money you take out during retirement.  And, like a regular IRA, your money grows sheltered from taxes.  There’s also another bonus to Roth IRAs: unlike regular IRAs, there are no rules requiring you to take annual required minimum distributions (RMDs) from your Roth IRA, even after you reach age 70 1/2.

In general, the tax benefits of being able to get money out of a Roth IRA outweigh the advantages of the immediate tax deduction you get from making a contribution to a regular IRA.  The younger you are and the lower your tax bracket, the bigger the benefit of a Roth IRA.

There is no “ideal” contribution to a 401k plan unless there is a company match.  You should always take full advantage of a company match because it is  essentially “free money” that the company gives you.

Have a question for us?  Ask away:

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