How to Invest in a Taxable Account

January 04, 2024

Investing in your retirement account can be quite different from investing in a taxable account. Here are some options to consider when investing in a taxable account:

Use it for short term goals. One of the advantages of a taxable account is that you don’t need to worry about any tax penalties on withdrawals. For that reason, it probably makes the most sense to use a taxable account for goals other than retirement and education like an emergency fund, a vacation, or a down payment on a car or home. In that case, you don’t want to take risk so cash is king. To maximize the interest you earn, you can search for high-yielding rewards checking accounts, online savings accounts, and CDs on sites like Deposit Accounts and Bankrate.

Keep it simple for retirement. Just like in a 401(k) or IRA, you can simplify your retirement investing as much as possible with a target date fund that’s fully diversified and automatically becomes more conservative as you get closer to the target retirement date. There are a couple of differences in a taxable account though. The bad news is that you’ll be paying taxes on it each year so you want a fund that doesn’t trade as often. The good news is that you’re not limited to the options in an employer’s plan so you can choose target date funds with low turnover (how often the fund trades and hence generates taxes) like ones composed of passive index funds.

Invest more conservatively for early retirement. If you plan to retire early, a taxable account can be used for income until you’re no longer subject to penalties in your other retirement accounts or to generate less taxable income so you can qualify for bigger subsidies if you plan to purchase health insurance through the Affordable Care Act before qualifying for Medicare at age 65. In either case, you’ll want to invest more conservatively than with your other investments since this money will be used first and possibly depleted over a relatively short period of time. Consider a conservative balanced fund or make your own conservative mix using US savings bonds (which are tax-deferred and don’t fluctuate in value like other bonds do) or tax-free municipal bonds instead of taxable bonds if you’re in a high tax bracket.

Make your overall retirement portfolio more tax-efficient. You can also use a taxable account to complement your other retirement accounts by holding those investments that are most tax-efficient, meaning they lose the least percentage of earnings to taxes. Your best bets here are stocks and stock funds since the gains are taxed at a capital gains rate that’s lower than your ordinary income tax rate as long as you hold them for more than a year. In addition, the volatility of stocks can also be your friend since you can use losses to offset other taxes (as long as you don’t repurchase the same or an identical investment 30 days before or after you sell it). When you pass away, there’s also no tax on the stocks’ gain over your lifetime when your heirs sell them.

In particular, consider individual stocks (which give you the most control over taxes) and stock funds with low turnover like index funds and tax-managed funds. Foreign stocks and funds in taxable accounts are also eligible for a foreign tax credit for any taxes paid to foreign governments. That’s not available when they’re in tax-sheltered accounts so you may want to prioritize them in taxable accounts over US stocks.

For retirement, you’ll probably want to max out any tax-advantaged accounts you’re eligible for first. But if you’re fortunate enough to still have extra savings, there are ways to make the best use of a taxable account. Like all financial decisions, it all depends on your individual situation and goals.

Should You Contribute To Pre-Tax Or Roth 401k?

May 01, 2023

For all the efforts that companies undertake to make participating in their retirement plan benefits easy, there’s no simple way to help employees decide whether the money they contribute from their own paychecks should be traditional (also called pre-tax) or Roth (also sometimes called after-tax Roth). The answer can be very nuanced depending on your situation, and for the most part, we won’t know whether we chose correctly until it’s too late. We’ll only really know if we got the answer right when it comes time to withdraw and we actually know our taxable income, current tax brackets, and lifestyle needs.

Since my crystal ball seems to be broken, I’ve attempted to distill the various factors in a way that makes more sense. Keep in mind that many of the factors listed in the chart below are just different ways of saying the same thing, but the intention is to present it in the way that makes the most sense to you.

The biggest factor affecting this decision: taxes

If we all could just know what tax rates will be when we retire and start withdrawing from our retirement savings, along with what our own income will be at that point, this would be a simple choice – if you knew your tax rate would be lower when withdrawing from your retirement account, you’d choose pre-tax and avoid paying taxes on the money today so that you could pay at a lower rate in the future.

On the flip side, if you knew that tax rates would be higher when you’re withdrawing and you’d be paying more in taxes, choose Roth to pay today’s lower rates, then enjoy your savings without tax consequences in the future.

Predicting the future of tax rates

I’m personally making Roth contributions right now in my 401(k) because I believe that we are currently experiencing the lowest tax rates I’ll see in my lifetime. And while I very well may have a lower income in retirement, the tax brackets themselves may be different, so even if I have a lower income, I think I might have a higher tax rate in the future. (keep in mind that I could be wrong about this – reason tells me that tax rates will have to go up in the future, but Congress has surprised us before!)

I like that I can change this strategy at any time. For example, when my husband sold some stock he’d been given as a child for a big capital gain, I switched to pre-tax for the rest of that year in an effort to lower our overall taxable income.

Income limits and the ability to withdraw without taxes

I also like the idea of having investments available to me in retirement that I can liquidate and withdraw without concern for the tax consequences, and my husband and I have too high of a combined income to contribute to Roth IRAs, so I like that the Roth 401(k) doesn’t have an income limit.

Now, there is a way around those income limits using a “back-door” Roth IRA, but that doesn’t work for me because I also have a rather large rollover traditional IRA.

Another consideration: access to the contributions for early retirement

You can’t withdraw Roth 401(k) contributions before 59 1/2 without penalty. However, you can withdraw contributions to a Roth IRA early. If you’re lucky enough to retire before then, you can always roll your Roth 401(k) into a Roth IRA. Then, tap those contributions if necessary, without concern for taxes or early withdrawal penalties. That’s another reason you want to at least have some retirement savings as Roth, regardless of tax rates.

Factors to consider:

Factor:Traditional (pre-tax)Roth (after-tax)
You think your taxes are higher today than they’ll be when you withdrawMakes more senseMakes less sense
You think your taxes are lower today than they’ll be when you withdrawMakes less senseMakes more sense
You want to avoid required distributions after age 72Makes less senseMakes more sense, as long as you roll to a Roth IRA
You think your income tax bracket will be lower when you withdrawMakes more senseMakes less sense
You think your income tax bracket will be higher when you withdrawMakes less senseMakes more sense
You need more tax deductions todayMakes more senseMakes less sense
You have a long time until withdrawal and plan to invest aggressivelyMakes less senseMakes more sense
You’d like access to your contributions before the traditional retirement ageDoesn’t make senseMakes sense

Splitting the difference

If you’re unsure or thinking about it makes your head hurt, you could always split your contributions between the two. In other words, if you’re putting 10% away, you could do 5% pre-tax and 5% Roth. The total $22,500 (plus $7,500 catch-up for over 50) applies as a total to both. However, there’s no rule that you have to put your money into just one bucket or the other at a time.

One more thing to know

No matter your contribution type, any matching dollars or employer contributions will always be pre-tax, per IRS rules. So even if you put all your own contributions into Roth, you’ll still have pre-tax money if you receive any from your job. Now, you may be able to convert those contributions to Roth, depending on plan rules. But if you do that, you’ll have to pay taxes on the amount converted, so plan carefully.

How To Save For Retirement Beyond The 401(k)

May 01, 2023

Preparing for retirement is an essential part of financial planning. Employer-sponsored retirement plans, such as 401(k) plans, are a common tool for saving. While contributing to a 401(k) can be a great way to save for retirement, it’s important to consider other options as well.

First things first

Are you fortunate enough to work for a company that offers to match employer-sponsored retirement plan contributions? If so, you should put the required minimum into the account to get that free money. Doing less is basically like turning down a raise!

Once you’re doing that, there are reasons that you may want to save additional funds outside the 401(k). Of course, if you don’t have a match or a 401(k) available, you may also need another way to save. Besides not having a 401(k) option, the most common reason to invest outside a 401(k) is investment selection. So, here are some other common options:

IRA

 For the self-employed, there are actually many different tax-advantaged retirement accounts you can contribute to. If you work for a company that doesn’t offer a retirement plan, you can still contribute to an IRA. If this is the case, you can contribute up to $7,000 (or $8,000 if 50+) to an IRA. Additionally, you can deduct traditional IRA contributions no matter your income. However, income limitations exist on deducting contributions when you already have a 401(k) or 403(b) available.

A popular choice these days is the Roth IRA. This is partially because of the tax benefits. However, there is also more flexibility in accessing Roth IRA money early versus traditional or even Roth 401(k)s. For example, you can withdraw your Roth IRA contributions without taxes or penalties. Another benefit is your ability to withdraw up to $10k in growth for a first-time home purchase. You don’t have that option with a 401(k), at least not without tax consequences.

HSA

If you have access to a high-deductible health insurance plan, you can contribute to a health savings account (HSA). Contributions are limited to $4,150 per person or $8,300 per family (plus an extra $1,000 if age 55+). The contributions are tax-deductible, and the money can be used tax-free for qualified health care expenses. If you use the money for non-medical expenses, it’s subject to taxes plus a 20% penalty. However, the penalty goes away once you reach age 65, turning it into a tax-deferred retirement account that’s still tax-free for health care expenses (including most Medicare and qualified long-term care insurance premiums). You may also consider avoiding using the HSA even for medical expenses and investing it to grow for retirement.

US Government Savings Bonds

Each person can purchase up to $10k per year in Series EE US Government Savings Bonds. For Series I Savings Bonds, that limit is $10k (plus another $5k from tax refunds). The federal government guarantees these tax-deferred bonds, which don’t fluctuate in value. As such, they can be good conservative options for retirement savings. However, you can’t cash them in the first 12 months, and you lose the last 3 months of interest if you cash them in the first 5 years. Interest rates may remain low, but the I Bonds are based on inflation, which is slowly creeping up.

Regular account

If you’ve maxed out your other options, you can always invest for retirement in a regular taxable account. You can minimize taxes by investing according to your tax bracket. For example, invest in tax-free municipal bonds if you’re in a high tax bracket. Holding individual securities for at least a year will keep capital gains taxes low. You can also choose low-turnover funds like index funds and ETFs. Another strategy is to use losses to offset other taxes, including up to $3k per year from regular income taxes. The excess carries forward indefinitely. Just be aware that if you repurchase an identical investment within 30 days, you won’t be able to take the loss off your taxes.

Regardless of how you choose to save for retirement, the most important thing is that you save enough. Run a retirement calculator to see how much you need to save. Then, increase contributions through payroll or direct deposit. If you can’t save enough now, try gradually increasing your savings rate each year. Like it or not, your ability to retire depends on you.

The 401(k) Self-Directed Brokerage Window

May 01, 2023

Are you a hands-on investor seeking investments beyond your 401(k) plan’s core list of investment choices? If so, you may have a self-directed brokerage account (SDBA) option in your retirement plan.

Who typically uses a self-directed brokerage account in a 401(k) plan?

SDBAs are intended for experienced investors who are comfortable making their own investment decisions. This option is generally popular among savers with larger retirement plan balances or who work with an outside financial advisor. For example, Schwab recently reported that the average account balance of those using this option is just over $273,000. Compare this to Fidelity’s reported average balance of all 401(k) participants, which is just under $104,000.

What does a self-directed brokerage account offer?

The main benefit is that SDBAs give you more flexibility regarding the investment options available. Wider access can be a refreshing alternative if you are generally unhappy with the currently available investment options.

For example, let’s say your 401(k) plan doesn’t include target-date or asset allocation funds. With the SDBA, you can add those funds to your retirement portfolio. This can be appealing if you’re trying to access asset classes not represented in your core portfolio. Examples include emerging market stocks, international small cap, and value or growth-oriented funds. SDBAs can even help you diversify with alternative asset classes such as real estate and commodities.

Beware of the paralysis of too many choices

But as behavioral finance studies on the paradox of choice have shown us, too many options can hinder participation. This is true for 401(k) plans as well. Choosing the right investments for your goals, risk tolerance, and time horizon also requires discipline. Most investors lack a written game plan or investment policy statement. As a result, many individual investors are prone to the “behavior gap” and underperform the actual funds they own due to mistakes related to emotional decision-making and market timing. 

Self-directed brokerage accounts are designed for advanced investors who know how to research and manage their investments. Bankrate warns investors that the additional choices commonly associated with self-directed accounts do not lead to better outcomes for most investors. In order to follow a disciplined investment plan, focus on things within your control, such as asset allocation, contribution rates, minimizing costs, and asset location (i.e., pre-tax vs. Roth 401(k)).

Pay attention to the fees

It’s important to note that while SDBAs offer greater investment flexibility, they may also come with higher fees. These fees can include transaction fees, account maintenance fees, and trading commissions. So, carefully consider the costs and benefits of an SDBA and your investment objectives and risk tolerance before opening one.

Minimizing your overall investment costs is one thing you have some control over as an investor. So, it’s equally important to understand all fees and expenses as it is to know your core 401(k) plan expenses.

Some 401(k) plans charge an annual maintenance fee for using the mutual fund or brokerage window. It is also necessary to identify if there are any commissions and transaction costs associated with trades made through SDBA accounts. You can check your plan’s fee disclosure to better understand the actual costs related to your 401(k) plan.

Check mutual fund expenses

In some cases, you may also see increased mutual fund expenses when you go outside your core investment options. This is because most funds available in the SDBA are retail share classes. Retail share classes tend to be much more expensive than the institutional funds many large retirement plans provide access to. On the other hand, if your 401(k) plan has expensive mutual funds, the self-directed brokerage account is a potential remedy.

How does its performance compare?

Finally, it is important to note that there is a reason self-directed brokerage accounts are underutilized. The average investor is often better served by simplifying their investments as much as possible. That is why it is important to establish benchmarks to track your performance.

Self-directed brokerage accounts give you an opportunity to try to outperform or diversify your plan’s core options. But if you choose to take the self-direct route and find that your investment performance consistently lags behind the core investment portfolio, you may need to take a simpler approach to your retirement savings plan.

Is It The Right Time To Convert To Roth?

January 21, 2021

Are you wondering if you should convert your retirement account to a Roth by the end of the year? After all, there’s no income limit on IRA conversions. Many employers are now allowing employees to convert their company retirement plan balances to Roth while they’re still working there. At first glance, it may sound appealing. Earnings in a Roth can grow tax-free, and who doesn’t like tax-free? However, here are some reasons why now might not be the time for a Roth conversion:

3 reasons you might not convert to Roth this year

1) You have to withdraw money from the retirement account to pay the taxes. If you have to pay the taxes from money you withdraw from the account, it usually doesn’t make financial sense as that money will no longer be growing for your retirement. This is even more of a tax concern if the withdrawal is subject to a 10% early withdrawal penalty.

2) You’ll pay a lower tax rate in retirement. This can be a tricky one because the tendency is to compare your current tax bracket with what you expect it to be in retirement. There are a couple of things to keep in mind though. One is that the conversion itself can push you into a higher tax bracket. The second is that when you eventually withdraw the money from your non-Roth retirement account, it won’t all be taxed at that rate.

You can calculate your marginal tax bracket and effective average tax rate here for current and projected retirement income. (Don’t factor in inflation for your future retirement income since the tax brackets are adjusted for inflation too.) The tax you pay on the conversion is your current marginal tax bracket. However, the tax you avoid on the Roth IRA withdrawals is your future effective average tax rate.

3) You have a child applying for financial aid. A Roth conversion would increase your reported income on financial aid forms and potentially reduce your child’s financial aid eligibility. You can estimate your expected family contribution to college bills based on your taxable income here.

Of course, there are also situations where a Roth conversion makes sense:

6 reasons to consider converting to Roth this year

1) Your investments are down in value. This could be an opportunity to pay taxes while they’re low and then a long-term investment time horizon allows them to grow tax-free. When the markets give you a temporary investment lemon, a Roth conversion lets you turn it into tax lemonade.

2) You think the tax rate could be higher upon withdrawal. You may not have worked at least part of the year (in school, taking time off to care for a child, or just in between jobs), have larger than usual deductions, or have other reasons to be in a lower tax bracket this year. In that case, this could be a good time to pay the tax on a Roth conversion.

You may also rather pay taxes on the money now since you expect the money to be taxed at a higher rate in the future. Perhaps you’re getting a large pension or have other income that will fill in the lower tax brackets in retirement. Maybe you’re worried about tax rates going higher by the time you retire. You may also intend to pass the account on to heirs that could be in a higher tax bracket.

3) You have money to pay the taxes outside of the retirement account.  By using the money to pay the tax on the conversion, it’s like you’re making a “contribution” to the account. Let’s say you have $24k sitting in a savings account and you’re going to convert a $100k pre-tax IRA to a Roth IRA. At a 24% tax rate, the $100k pre-tax IRA is equivalent to a $76k Roth IRA. By converting and using money outside of the account to pay the taxes, the $100k pre-tax IRA balance becomes a $100k Roth IRA balance, which is equivalent to a $24k “contribution” to the Roth IRA.

Had you simply invested the $24k in a taxable account, you’d have to pay taxes on the earnings. By transferring the value into the Roth IRA, the earnings grow tax free. This calculator helps you crunch your own numbers.

4) You want to use the money for a non-qualified expense in 5 years or more. After you convert and wait 5 years, you can withdraw the amount you converted at any time and for any reason, without tax or penalty. Just be aware that if you withdraw any post-conversion earnings before age 59½, you may have to pay income taxes plus a 10% penalty tax.

5) You might retire before age 65. 65 is the earliest you’re eligible for Medicare so if you retire before that, you might need to purchase health insurance through the Affordable Care Act. The subsidies in that program are based on your taxable income, so tax-free withdrawals from a Roth account wouldn’t count against you.

6) You want to avoid required minimum distributions (RMDs). Unlike traditional IRAs, 401ks, and other retirement accounts that require distributions starting at age 72 (or 70½, depending on your age), Roth IRAs are not subject to RMDs so more of your money grows tax free for longer. If this is your motivation, remember that you can always wait to convert until you retire, when you might pay a lower tax rate. Also keep in mind, Roth conversions are not a one-time-only event. You can do multiple conversions and spread the tax impact over different tax years if you are concerned about pushing your income into a higher tax bracket in any particular year.

There are good reasons to convert and not to convert to a Roth. Don’t just do what sounds good or blindly follow what other people are doing. Ask yourself if it’s a good time for you based on your situation or consult an unbiased financial planner for guidance. If now is not the right time, you can always convert when the timing is right.

How To Contribute To A Roth IRA If You Make Too Much

January 21, 2021

There are multiple reasons to contribute to a Roth IRA, but if you make too much money, the Roth may not seem to be an option. However, there are a few things to keep in mind before completely writing off the Roth IRA.

The limit is based on MAGI, not total income

One is that the income limits are based on MAGI (modified adjusted gross income). That means if you contribute enough to a pre-tax 401(k) or similar qualified retirement plan, you may be able to bring your MAGI below the income limits. (Here is a little more on MAGI.)

Income limits apply to contributions, but not to conversions

The bigger point here for people whose MAGI far exceeds the income limits is the fact that there is no income limit to converting a traditional IRA into a Roth IRA. This is the key that allows people who make too much money to put money directly into a Roth IRA to still participate.

How it works

You can simply contribute to a traditional IRA and then convert your traditional IRA into a Roth IRA. Anyone can contribute, regardless of income levels, but many people don’t because it’s not tax-deductible if you earn too much to contribute to an IRA and are covered by a retirement plan at work.

This is called a “backdoor” Roth IRA contribution. Since it’s really a conversion rather than a contribution, you may have to wait 5 years before you can withdraw the amount you converted penalty-free before age 59 1/2. You’ll have to file IRS Form 8606 to document the non-deducted contribution to the traditional IRA, which will offset the 1099-R form you’ll receive for the conversion.

If you already have a traditional IRA, beware the pro-rata rule

There is a potentially huge caveat to this strategy though. If you have other funds in a traditional (pre-tax) IRA already that you aren’t converting, you have to pay taxes on the same percentage of the conversion amount as you have in total IRA dollars that are pre-tax. That means you could end up owing taxes on the conversion even if all the money you convert was nondeductible and thus after-tax.

Here’s what I mean

For example, let’s say that you have an existing IRA with $95k of pre-tax money and you contribute $5k to a new IRA after-tax. Since 95% of your total IRA money is pre-tax (because it was already there before and presumably contributed pre-tax), 95% of any money you convert to a Roth IRA is taxable even if you convert the new IRA with all after-tax money.

In other words, the IRS looks at all of your IRAs as if they were one account and taxes your conversions on a pro-rata basis. In this case, you would owe taxes on 95% of the $5k you convert — basically you’d have $4,750 of taxable income. So you can still do it, and $250 would be converted without causing a tax effect. It’s just not a tax-free transaction.

One way to avoid the pro-rata rule

The good news is that there may be a way to avoid this. If your current job’s retirement plan will allow you to roll your existing IRA money into your existing employer’s retirement plan, then you’d be eliminating the need to pro-rate by no longer having an existing pre-tax IRA. If you move your IRA into your 401(k), then complete the “backdoor” transaction, the only IRA money you would have in this example would be the $5k after-tax IRA, so you won’t pay any taxes on the conversion since 0% of your total IRA money is pre-tax.

Still not a bad deal

Even if you can’t avoid the tax on the conversion, it’s not necessarily a bad deal. After all, you or your heirs will have to pay taxes on your IRA money someday. By converting some (or all) of it into a Roth, at least future earnings can grow tax-free. It’s probably not worth it if you have to withdraw money from the IRA to pay taxes on the conversion.

So there you have it. You can contribute to a Roth IRA one way or another as long as you have some type of earned income. Otherwise, you won’t be able to contribute to a traditional IRA either.

Should You Invest in an Equity-Indexed Annuity?

April 17, 2017

Should you consider investing in an annuity linked to stock market returns but with less risk than the stock market? I recently had a coaching session with an employee who had invested a lump sum distribution from a retirement account into an equity-indexed annuity. Did she make the right decision, she wondered, and should she add more to the annuity or diversify into something else?

Remind Me What an Annuity Is, Please!

An annuity is a contract between you and an insurance company in which the insurance company agrees to make periodic payments to you, starting immediately or at some future time, in return for payment from you, either in a lump sum now or over flexible installments over time. With a “fixed annuity,” the insurance company agrees to a fixed return and a fixed payment. With a “variable annuity,” the rate of return and the payment vary depending on the investment choices within the contract.

So What is an Equity-Indexed Annuity?

An equity indexed annuity is the lovechild of a fixed and a variable annuity. With an equity-indexed annuity (EIA), the insurance company will pay an interest rate linked to a stock market index if the market index is up, with a guaranteed minimum rate if the market is down. In the case of the employee I spoke with, she would earn an annual rate of return linked to the performance of the S&P 500 during the accumulation phase of the annuity, capped at 6%. If the S&P 500 index went down, her return would be 0% for that year.

Who is a Good Candidate for an Equity-Indexed Annuity?

The primary financial planning purpose of an annuity is to turn a sum of money into a stream of income you cannot outlive. An equity-indexed annuity makes the most sense for an investor who is a) looking to create a future fixed income in retirement and b) who is not comfortable with direct stock market risk but would like to participate partially in potential stock market returns. In the case of this employee, she was willing to accept a cap on returns of 6% in return for no loss of her investment if the market declined.

She was also within 10 years of retirement and much more concerned about maintaining the value of her savings than she was in generating out-sized returns. It’s important to have both fixed and flexible sources of income in retirement so ideally an investor would refrain from putting all their retirement savings into an annuity. I encouraged this employee to keep some of her retirement funds in her 401(k) and IRA so she would have a source of income to meet flexible expenses in retirement such as a big vacation, dental work or an unexpected home repair.

Who is Not a Good Candidate for an Equity-Indexed Annuity?

A more aggressive investor would not be comfortable capping returns at 6% – especially in a year when the S&P 500 index went up 20%. Plus annuities generally have high fees which can eat into investment performance. EIAs typically have high surrender charges during the first 8-10 years of the contract so once purchased, you’ve got a strong incentive to stay put.

The moderately aggressive to aggressive investor could consider accumulating savings in a diversified portfolio of low fee index funds. That investor could potentially build a larger nest egg and then purchase an immediate annuity at retirement with some of those savings if interested in turning them into a stream of income. Because of the higher fees, younger investors are also generally not good candidates for equity indexed annuities. Finally, an investor who doesn’t ever plan to turn their savings into retirement income is not a good candidate for an annuity.

Was it a Fit for Her?

Was an equity-indexed annuity a good fit for this employee? After weighing the pros and cons, her conclusion was “yes.” She was willing to trade upside potential in order to eliminate the risk of losing money.

She was planning to annuitize within ten years – turning her annuity into a stream of payments in retirement. Moreover, she had chosen a reputable insurance company with an A+ rating from A.M.Best. Although she was excited about the annuity return/risk profile, she decided it would be best to continue to keep some of her retirement money in her employer plan so she’d have some flexible sources of income to meet unexpected retirement expenses.

Do Your Homework

Annuities are very complex investments. Before signing on the dotted line, make sure you’ve read and understand all the provisions in the contract. If you are considering an equity-indexed annuity, start with this fact sheet from FINRA. Check out the financial strength of the issuing insurance company and make sure it has a high rating for its financial position. If possible, get an unbiased second opinion from a financial planner in your workplace financial wellness program or a fee-only CFP® professional.

 

Do you have a question you’d like answered on the blog? Please email me at [email protected]. You can follow me on the blog by signing up here and on Twitter @cynthiameyer_FF.

 

Why You Should Love Investing

April 13, 2017

When a lot of people think of financial planning, they think of investing…with dread. It sounds complicated, time consuming, and risky. But for me, investing is actually my favorite part of financial planning. Let me tell you why…

In most areas of life, we generally get what we put in, whether that’s in terms of the price we pay or the amount of time and hard work we expend. In other words, you get what you pay for. However, investing is the one area of life where you get rewarded for being both cheap and lazy.

Let’s start with the first step, which is diversification. As you’ve probably heard, you don’t want to put all your eggs in one basket, but you still have to decide how many of your “eggs” or money to put in each “basket” or asset class: stocks, bonds, cash, and real assets. What makes this confusing is that there’s a ton of conflicting views on this so investment expert Meb Faber decided to compare 9 of the top recommended asset allocation strategies by various other investment experts and see how they performed since the 1970s. What he found is that the difference between the best and the worst performing strategy was only 1.6% and if you removed the worst performing portfolio (which is an outlier since it only has 25% in stocks), the difference was only 1%. When he compared the models of the major financial institutions, he found that the difference was only about half a percent.

However, just because they ended up in similar places doesn’t mean that they performed similarly from year to year. Each of the models had many years in which they outperformed and many in which they under-performed. If you chose a model based on which was the top performing over the previous decade, you would actually have done much worse. Whether you use a one-stop shop asset allocation fund, a robo-advisor, one of the model portfolios listed in one of Faber’s blog posts above, or a financial advisor’s recommendation, which portfolio you pick is less important than that you pick one (to make sure you’re reasonably diversified) and stick with it through thick and thin. (Everyone, even Warren Buffett, has periods of under-performance.)

There’s one other way you can sabotage your returns: costs. It’s been estimated that the average mutual fund costs .9% a year in expenses and 1.44% a year in transaction costs. (This doesn’t even include any loads or commissions you may pay to purchase the fund.) That 2.34% would be enough to turn the best performing strategy into the worst.

It’s not like you’re getting anything for those costs either. In fact, a recent Morningstar study called low fund fees “the most proven predictor of future fund returns.” Warren Buffett has said the same thing. So as you choose which funds to use in your portfolio, look for ones with low fees (called the expense ratio) and low turnover (which leads to lower transaction costs). If index funds are available, they tend to have the lowest costs and hence tend to outperform more expensive actively managed funds over long periods of time.

The moral of the story is that investment success boils down to three simple rules:

  1. Be diversified. Pick a reasonably diversified portfolio. Don’t be a greedy pig (bet on individual stocks) or a fearful chicken (keep all your money in bonds and cash). After all, both pigs and chickens get slaughtered.
  2. Be cheap. Use low cost funds to implement your asset allocation strategy. In this case, you get what you don’t pay for.
  3. Be lazy. Once you have your portfolio, stick with it. Don’t try to time the market or otherwise, mess with it other than to rebalance it periodically back to the original allocation or to switch to lower cost funds as they become available.

Think about it. Where else are you most rewarded for being both cheap and lazy? Now do you love investing? If so, the first step is to save so you have something to invest, but that’s another story…

 

Don’t Make These Common Investing Mistakes With Your 401(k)

March 17, 2016

In our CEO’s new book, What Your Financial Advisor Isn’t Telling You: 10 Essential Truths You Need to Know About Your Money, Liz Davidson writes about how the best place to invest your money is often where you made that money: your workplace. While most people generally understand the value of contributing to their retirement plan, there’s a lot of confusion about how they should choose investments. Here are the biggest mistakes I see people making: Continue reading “Don’t Make These Common Investing Mistakes With Your 401(k)”

Don’t Make Jeb Bush’s Mistakes…With Your Investments

March 03, 2016

A couple of weeks ago, former Republican presidential front-runner Jeb Bush tearfully exited the race. The self-described policy wonk’s economic proposals may not have won him the election, but they might actually help him with his investment portfolio. Here were some of his policies during the campaign and how they might apply to his finances: Continue reading “Don’t Make Jeb Bush’s Mistakes…With Your Investments”

Multi-level Marketing or Pyramid Scheme?

January 25, 2016

I’ve been hearing more and more from friends that they are considering a side gig selling a product or service. We all know stories of people who have made substantial extra income from things like nutritional cleansing, personal care products, cosmetics, financial products and vitamins. Many of these are established companies and household names. Consumers like their products and the feeling that comes with supporting their friends and neighbors. Continue reading “Multi-level Marketing or Pyramid Scheme?”

Can You Put Your Investment Plan On A Note Card?

August 10, 2015

Does investing seem complicated? Despite the presence of overly complicated financial strategies and the often vexing financial jargon used by financial professionals, investing does not have to be so complex.Investing is simply a balancing act where the challenge is to find the ideal balance between risk and reward. Continue reading “Can You Put Your Investment Plan On A Note Card?”

Some Of The Riskiest Investments May Surprise You

July 30, 2015

One of the biggest fears people have when it comes to investing is a year like 2008, when the US stock market fell almost 40%. But as long as you didn’t bail out of stocks, you would have recovered your losses in about 5 years and then gone on to make more money. The same is true of every other market downturn since the Great Depression. If you’re worried about the real risk of permanent loss, some of the riskiest investments actually seem much safer. Here are ones that may surprise you: Continue reading “Some Of The Riskiest Investments May Surprise You”

What Makes A Good Mutual Fund?

June 25, 2015

That’s a common question I get in our investing workshops. Most people instinctively look at performance. After all, that’s how we typically measure ability and try to predict future performance in most areas but investing is different. Continue reading “What Makes A Good Mutual Fund?”

There’s No Such Thing As A “Safe” Investment

June 23, 2015

There is so much information regarding the best investment mix for your financial goals. I challenge you to watch one episode of Squawk Box and see how long it takes for your head to spin with all of the conflicting information. On top of everything, everyone has a different idea about risk. I was talking with my colleague, Kelley, and asked her to share her perspective on how people should look at risk. Below is her guidance. Continue reading “There’s No Such Thing As A “Safe” Investment”

A 6% Guaranteed Return?

June 18, 2015

Would you like a guaranteed 6% return on your investments? Is that even possible? I recently got a helpline call from a woman who thought it was. Her advisor had suggested that she roll her 401k into an annuity that paid “a guaranteed 6% return regardless of what the stock market does.” She thought the only downside is that she had to leave the money in the annuity for 10 years and that there was a 1% fee so the guaranteed return would be 5% after fees. Continue reading “A 6% Guaranteed Return?”

The “Hidden” Sales Charge

June 17, 2015

I received a call recently from an investor that was a little confused about differences in mutual fund share classes. It seems this individual opened an IRA with a financial advisor a few years ago and purchased an “A” share mutual fund. Then, just a few days ago, they received a letter from the custodian informing them that “B” shares would no longer be available for purchase. The investor had never heard of a “B” share and wasn’t quite sure what this meant, so they decided to call the Financial Helpline. Continue reading “The “Hidden” Sales Charge”

How to Invest While Getting a Tan

June 10, 2015

June signifies summer, a time when millions of Americans flock to frolic in the sand and soak up some sun. If only investing were as easy as a day at the beach…or is it? It can be if you follow these simple guidelines: Continue reading “How to Invest While Getting a Tan”