Media such as TV, radio, magazines, and newspaper makes money by reporting bad news. We have dedicated news TV channels such as CNN, CNBC, MSNBC, and Fox News that makes more money when more people watch them and reporting bad news makes good money. Economic data such as unemployment data and housing starts are very disturbing. I think that we can correlate any speech on the economy from President Obama, Treasury Secretary Geitner, or Federal Reserve Chairman Bernanke with a drop in the stock market. Perhaps they should change topics to the Weather or Sports.
We actually had some good data that was not given much notice:
* January retail sales were unexpectedly positive
* January index of leading economic indicators was unexpectedly positive
* January home refinancing rate was higher than expected
* January home affordability index has improved making it possible for many people to become first time home owners.
Why would we have any positive news? Money is going into the economy from such things as people who are refinancing their mortgage saving money, Social Security recipients got a 5.8% pay increase, and lower gas prices.Recent actions by the government are very positive. The actions by the Federal Reserve to increase consumer credit is critical for large dollar purchases. All politics aside, the stimulus package is positive on almost all fronts and while the government officials on the federal level were giving it bad reviews almost all state and local government officials were thankful to have funds to meet commitments. We do need money for things like schools and unemployment benefits.
One major issue remains, underwater or negative equity mortgages on homes. Historically, homes appreciated at a 4-5% annual rate. So when home prices were run up at a much higher rate, in parts of the country, and then people were given a 2nd loan up to 125% of the home value it created a very speculative bubble. The average home price in these areas of the country has further to decline to get back to levels expected by projecting historic values. This is the very difficult issue to be solved by the Treasury Department and TARP. A method that was used in the 1980's, during the Savings and Loan debacle, the government took over some banks for a short time. I recently heard Bill Seidman, FDIC Chairman during this period, discuss this on CNBC. In essence, they were nationalized for a short time like is being debated now. The government did the difficult work of removing, repackaging, & repricing the toxic assets within bank. When a bank is taken over by the government, the investors lose money. The depositors are taken care of according to the FDIC rules. What this means is that investing in bank stocks, especially Bank of America and Citigroup, should be avoided until TARP actions are known.
Smile, enjoy your family and the important things of life. A steady diet of bad news, especially during meals, is bad for your health.
Sunday, February 22, 2009
Monday, February 16, 2009
IRA Terms
It is important to know the lingo when involved with an Individual Retirement Account, IRA.
Here's the plain-English guide to some of the terms you'll likely encounter as you set up and manage your account.
1. Adjusted gross income, or AGI -- Used to calculate federal income tax, your AGI includes all the income you received over the course of the year, such as wages, interest, dividends and capital gains, minus things such as business expenses, contributions to a qualified IRA, moving expenses, alimony and capital losses, interest penalty on early withdrawal of bank CD certificates and payments made to retirement plans such as SEP and SIMPLE IRAs.
2. Contribution -- IRA contributions are limited to $5,000 for the 2008 tax year if you're younger than 50. If you're 50 or older, you can contribute as much as $6,000 for the 2008 tax year. The limits are the same for 2009. Contributions are classified as either tax deductible or nondeductible.
3. Deductible or nondeductible -- Contributions to a traditional IRA are tax-deductible if you are not covered by your employer's retirement plan. Even if you do participate in a company pension or 401(k) plan, you still may be able to deduct contributions to a traditional IRA depending on your income and filing status. Contributions to a Roth IRA are not deductible.
4. Education IRA -- Renamed Coverdell education savings account, in honor of the late Sen. Paul Coverdell, this is not strictly an IRA, since it doesn't finance retirement. Instead, you can make annual contributions, of up to $2,000 per child, to an account that's exclusively for helping to pay education costs. The money you put aside in a Coverdell account doesn't count against the annual retirement IRA contribution limits for you or your child. You can't deduct the Coverdell contributions from your income taxes, but earnings are tax-deferred and qualified withdrawals are tax-free.
5. Individual retirement account, or IRA -- IRAs are retirement accounts with tax advantages. You may contribute up to $5,000 in 2008. Or, if you're 50 or older, you can put aside up to $6,000 for that tax year. But your contributions can't exceed your earned income. The investment grows tax-free until you begin making withdrawals, usually after age 59½. Take money out before then and you will usually get hit with a 10-percent penalty unless you meet certain specified requirements.
6. Modified adjusted gross income, or MAGI -- For the purpose of determining your contribution limit, some people use their MAGI. Some modifiers include foreign-earned income, housing costs of U.S. citizens or residents living abroad and income from sources within Puerto Rico, Guam or American Samoa.
7. Required minimum distribution -- Generally, if you have a traditional IRA, you must begin taking money out of the account by April 1 of the year after you turn 70½. The amount is a minimum distribution determined by your age and life expectancy. The IRS has established simplified tables that a traditional IRA owner can use to determine the required distribution. If required payments are not made on time, the IRS will collect an excise tax. Roth IRAs aren't subject to minimum distribution requirements until after the Roth owner dies.
8. Rollover -- This is the term used when transferring assets from one tax-deferred retirement plan to another.
9. Roth IRA -- The most notable thing about a Roth is withdrawals are tax-free if the account has been open for at least five years and you're at least 59½ when you start to withdraw money. Contributions to a Roth are not tax-deductible. You can withdraw your contributions anytime you want, no penalty or taxes. You can also withdraw earnings for a qualifying event if the account is at least 5 years old. Qualifying events include: death or disability of the account holder and a first-home purchase.
10. Tax and penalty-free withdrawals -- You can take money out of your IRA tax-free and penalty-free as long as you repay the full amount within 60 days, but may only do it once in a 12-month period. The withdrawal proviso was intended to make IRAs portable.
Here's the plain-English guide to some of the terms you'll likely encounter as you set up and manage your account.
1. Adjusted gross income, or AGI -- Used to calculate federal income tax, your AGI includes all the income you received over the course of the year, such as wages, interest, dividends and capital gains, minus things such as business expenses, contributions to a qualified IRA, moving expenses, alimony and capital losses, interest penalty on early withdrawal of bank CD certificates and payments made to retirement plans such as SEP and SIMPLE IRAs.
2. Contribution -- IRA contributions are limited to $5,000 for the 2008 tax year if you're younger than 50. If you're 50 or older, you can contribute as much as $6,000 for the 2008 tax year. The limits are the same for 2009. Contributions are classified as either tax deductible or nondeductible.
3. Deductible or nondeductible -- Contributions to a traditional IRA are tax-deductible if you are not covered by your employer's retirement plan. Even if you do participate in a company pension or 401(k) plan, you still may be able to deduct contributions to a traditional IRA depending on your income and filing status. Contributions to a Roth IRA are not deductible.
4. Education IRA -- Renamed Coverdell education savings account, in honor of the late Sen. Paul Coverdell, this is not strictly an IRA, since it doesn't finance retirement. Instead, you can make annual contributions, of up to $2,000 per child, to an account that's exclusively for helping to pay education costs. The money you put aside in a Coverdell account doesn't count against the annual retirement IRA contribution limits for you or your child. You can't deduct the Coverdell contributions from your income taxes, but earnings are tax-deferred and qualified withdrawals are tax-free.
5. Individual retirement account, or IRA -- IRAs are retirement accounts with tax advantages. You may contribute up to $5,000 in 2008. Or, if you're 50 or older, you can put aside up to $6,000 for that tax year. But your contributions can't exceed your earned income. The investment grows tax-free until you begin making withdrawals, usually after age 59½. Take money out before then and you will usually get hit with a 10-percent penalty unless you meet certain specified requirements.
6. Modified adjusted gross income, or MAGI -- For the purpose of determining your contribution limit, some people use their MAGI. Some modifiers include foreign-earned income, housing costs of U.S. citizens or residents living abroad and income from sources within Puerto Rico, Guam or American Samoa.
7. Required minimum distribution -- Generally, if you have a traditional IRA, you must begin taking money out of the account by April 1 of the year after you turn 70½. The amount is a minimum distribution determined by your age and life expectancy. The IRS has established simplified tables that a traditional IRA owner can use to determine the required distribution. If required payments are not made on time, the IRS will collect an excise tax. Roth IRAs aren't subject to minimum distribution requirements until after the Roth owner dies.
8. Rollover -- This is the term used when transferring assets from one tax-deferred retirement plan to another.
9. Roth IRA -- The most notable thing about a Roth is withdrawals are tax-free if the account has been open for at least five years and you're at least 59½ when you start to withdraw money. Contributions to a Roth are not tax-deductible. You can withdraw your contributions anytime you want, no penalty or taxes. You can also withdraw earnings for a qualifying event if the account is at least 5 years old. Qualifying events include: death or disability of the account holder and a first-home purchase.
10. Tax and penalty-free withdrawals -- You can take money out of your IRA tax-free and penalty-free as long as you repay the full amount within 60 days, but may only do it once in a 12-month period. The withdrawal proviso was intended to make IRAs portable.
Retirement, 20- and 30-Somethings
The question is what should someone who is in their 20's and 30's do to prepare for retirement? Here is a common sense approach.
Start Early
When debt from student loans and credit cards is hanging over your head, it’s understandable that saving for retirement often gets put on the back burner. But failing to do so will hurt you significantly come retirement. According to human-resources consulting company Hewitt Associates, close to one-third of 30- to 39-year-olds don’t even have a 401(k) yet. At this age, says T. Rowe's Ritter, people should be stashing at least 10% to 15% of their annual salary in a retirement plan to maintain their current lifestyle when it comes time to stop working.
Get All of Your Employer’s Match
Most employers match 50 cents for every dollar you invest up to 6% of your pay, according to Hewitt Associates. Fail to invest enough to get your employer's full company match and you'll miss out on free money. Even if your employer stops its matching program it's still important to save as much as you can. When the recession ends, it’s possible that these companies will start offering a match again.
Don’t Try to Time the Market
One of the biggest mistakes investors in their 20s and 30s could make is to pull all their money out of the market, and then try to time when the market will rebound so they can put it back in. Historically, some of the biggest gains in the stock market have occurred in the months following significant losses. If your money isn’t in the market when that occurs, you could miss out on recouping your losses -- and possibly earning some sizable gains. Keep in mind that the 10% you’re putting into your 401(k) today is buying more shares than it would have bought a year ago since shares are so cheap. Plus, those contributions will have a longer time to grow and multiply.
Pick the Proper Risk Level
One of the most basic rules of investing is: The longer your time horizon, the more risk you can take. For those in their 20s and 30s, that means investing a majority, or all, of your portfolio in equities. Ideally, the mix should include about 60% in large-cap stocks, 20% in medium- and small-caps and 20% in international companies. If you don't feel comfortable picking your own holdings, try a target-date fund. These mutual funds are specific to the date you plan to retire and become more conservative as the investor nears retirement.
Put Extra Cash in a Roth
Already put enough of your salary in your 401(k) to meet your employer's match? Then consider stashing some money in a Roth 401(k) or Roth IRA. While you won't get an upfront tax deduction, the account does grow tax free. Plus, any withdrawals taken during retirement aren't subject to income tax, provided you're at least 59 1/2 and you've held the account for five years or more.
Start Early
When debt from student loans and credit cards is hanging over your head, it’s understandable that saving for retirement often gets put on the back burner. But failing to do so will hurt you significantly come retirement. According to human-resources consulting company Hewitt Associates, close to one-third of 30- to 39-year-olds don’t even have a 401(k) yet. At this age, says T. Rowe's Ritter, people should be stashing at least 10% to 15% of their annual salary in a retirement plan to maintain their current lifestyle when it comes time to stop working.
Get All of Your Employer’s Match
Most employers match 50 cents for every dollar you invest up to 6% of your pay, according to Hewitt Associates. Fail to invest enough to get your employer's full company match and you'll miss out on free money. Even if your employer stops its matching program it's still important to save as much as you can. When the recession ends, it’s possible that these companies will start offering a match again.
Don’t Try to Time the Market
One of the biggest mistakes investors in their 20s and 30s could make is to pull all their money out of the market, and then try to time when the market will rebound so they can put it back in. Historically, some of the biggest gains in the stock market have occurred in the months following significant losses. If your money isn’t in the market when that occurs, you could miss out on recouping your losses -- and possibly earning some sizable gains. Keep in mind that the 10% you’re putting into your 401(k) today is buying more shares than it would have bought a year ago since shares are so cheap. Plus, those contributions will have a longer time to grow and multiply.
Pick the Proper Risk Level
One of the most basic rules of investing is: The longer your time horizon, the more risk you can take. For those in their 20s and 30s, that means investing a majority, or all, of your portfolio in equities. Ideally, the mix should include about 60% in large-cap stocks, 20% in medium- and small-caps and 20% in international companies. If you don't feel comfortable picking your own holdings, try a target-date fund. These mutual funds are specific to the date you plan to retire and become more conservative as the investor nears retirement.
Put Extra Cash in a Roth
Already put enough of your salary in your 401(k) to meet your employer's match? Then consider stashing some money in a Roth 401(k) or Roth IRA. While you won't get an upfront tax deduction, the account does grow tax free. Plus, any withdrawals taken during retirement aren't subject to income tax, provided you're at least 59 1/2 and you've held the account for five years or more.
Saturday, February 14, 2009
Stimulus Bill - Change Happened
The President will sign the Stimulus Bill on Monday 2/16/2009. Many Personal Finance rules will change on Monday and it is important that you know the new rules. Many aspects of this bill are very good and understanding its impact is very important.
Personal Finance Tax Changes
* $400 payroll tax credit for workers earning up to $75,000; married couples filing jointly get $800 for income up to $150,000
* Increase in earned income tax credit for working families with more than three children
* Increased eligibility for refundable child tax credit, with all income over $3000 qualifying
* Tax credit of up to $2500 for tuition and college expenses
* Computers and computer technology will qualify for inclusion in tax-advantaged savings plans * A tax credit for first-time homebuyers increases from $7500 to $8000, and will not have to be repaid
* Taxpayers earning less than $125,000 can deduct sales and excise taxes paid on new cars
* $2400 of unemployment benefits will not be subject to federal income tax
* Middle-income taxpayers get an exemption from the alternative minimum tax of $46,700 for an individual and $70,950 for a married couple $69,759
Bottom Line: More money will be coming your way this year. Incentives are in place for cars, first time homebuyers, and education. The bill is pro family. The impact of these changes can be more precisely computed once the specifics are known.
Energy Tax Credits
* 30% cap on tax credit for energy efficiency purchases by homeowners, up to $1500 per residence
* Credit for purchase of residential solar, geothermal, wind and fuel cells
Bottom Line: Before purchasing any major appliance for your home, you need to determine if the appliance qualifies for the energy efficiency tax credit. You can get a tax credit for alternative energy options.
Additional Income
* One-time payment of $250 for retirees, disabled people, SSI recipients, railroad retirees and disabled veterans
* One-time refundable tax credit of $250 for some government retirees not eligible for social security benefits
Bottom Line: Retirees and people who need a little more will get a little more.
Remember a tax credit reduces the amount of taxes owed on a dollar for dollar basis. It is far superior to a tax deduction.
What's missing? Incentives aimed at reducing mortgage rates is missing. Since it is missing, it means that now is a good time to refinance your mortgage if you have a mortgage rate over 5.5%. It is very easy to get a 5.0% rate on a 30 year loan and a 4.75% rate on a 15 year loan.
Personal Finance Tax Changes
* $400 payroll tax credit for workers earning up to $75,000; married couples filing jointly get $800 for income up to $150,000
* Increase in earned income tax credit for working families with more than three children
* Increased eligibility for refundable child tax credit, with all income over $3000 qualifying
* Tax credit of up to $2500 for tuition and college expenses
* Computers and computer technology will qualify for inclusion in tax-advantaged savings plans * A tax credit for first-time homebuyers increases from $7500 to $8000, and will not have to be repaid
* Taxpayers earning less than $125,000 can deduct sales and excise taxes paid on new cars
* $2400 of unemployment benefits will not be subject to federal income tax
* Middle-income taxpayers get an exemption from the alternative minimum tax of $46,700 for an individual and $70,950 for a married couple $69,759
Bottom Line: More money will be coming your way this year. Incentives are in place for cars, first time homebuyers, and education. The bill is pro family. The impact of these changes can be more precisely computed once the specifics are known.
Energy Tax Credits
* 30% cap on tax credit for energy efficiency purchases by homeowners, up to $1500 per residence
* Credit for purchase of residential solar, geothermal, wind and fuel cells
Bottom Line: Before purchasing any major appliance for your home, you need to determine if the appliance qualifies for the energy efficiency tax credit. You can get a tax credit for alternative energy options.
Additional Income
* One-time payment of $250 for retirees, disabled people, SSI recipients, railroad retirees and disabled veterans
* One-time refundable tax credit of $250 for some government retirees not eligible for social security benefits
Bottom Line: Retirees and people who need a little more will get a little more.
Remember a tax credit reduces the amount of taxes owed on a dollar for dollar basis. It is far superior to a tax deduction.
What's missing? Incentives aimed at reducing mortgage rates is missing. Since it is missing, it means that now is a good time to refinance your mortgage if you have a mortgage rate over 5.5%. It is very easy to get a 5.0% rate on a 30 year loan and a 4.75% rate on a 15 year loan.
Tuesday, February 10, 2009
Federal Reserve To The Rescue - TALF
Today the government announced the game plan for the economy. The total amount being thrown around was a staggering $3 Trillion. About $1 Trillion each for Treasury, Federal Reserve, and Legislative branch.
Treasury: Separately, Treasury Secretary Timothy Geithner outlined plans for spending much of the $350 billion in financial bailout money recently cleared by Congress. (TARP)
Federal Reserve: It announced it would commit up to $1 trillion to make loans more widely available to consumers. (TALF)
Legislative: The vote was 61-37 in the Senate to pass the stimulus, with moderate Republican Sens. Susan Collins and Olympia Snowe of Maine and Arlen Specter of Pennsylvania joining Democrats in support. The total was $830 Billion.
Treasury: One element of the administration's approach calls for using as much as $100 billion in federal bailout funds to give banks, hedge funds or other investors the incentive to purchase so-called toxic assets carried on the books of other financial institutions. The goal is to return struggling banks to health so they can resume making loans, and an administration fact sheet said the amount of government and private funds combined will be "on an initial scale of up to $500 billion, with the potential to expand up to $1 trillion."
Federal Reserve: The Federal Reserve announced it would commit up to $1 trillion to purchase bonds or other assets backed by consumer loans. The Treasury will guarantee a portion of the Fed investment by putting up $100 billion, an increase from a $20 billion commitment that Bush administration had announced.
Of all of the news, having the Fed announce a commitment of $1 Trillion in the TALF program to back consumer loans was the best. This will have the greatest impact in creating growth. While the news from the Treasury and the Legislative branch makes good headlines, it will not be as effective.
The stock market had a big drop today which was supposedly related to a lack of clarity by the Treasury. While this makes headlines and lots of press coverage it makes little difference to a long term investor.
Treasury: Separately, Treasury Secretary Timothy Geithner outlined plans for spending much of the $350 billion in financial bailout money recently cleared by Congress. (TARP)
Federal Reserve: It announced it would commit up to $1 trillion to make loans more widely available to consumers. (TALF)
Legislative: The vote was 61-37 in the Senate to pass the stimulus, with moderate Republican Sens. Susan Collins and Olympia Snowe of Maine and Arlen Specter of Pennsylvania joining Democrats in support. The total was $830 Billion.
Treasury: One element of the administration's approach calls for using as much as $100 billion in federal bailout funds to give banks, hedge funds or other investors the incentive to purchase so-called toxic assets carried on the books of other financial institutions. The goal is to return struggling banks to health so they can resume making loans, and an administration fact sheet said the amount of government and private funds combined will be "on an initial scale of up to $500 billion, with the potential to expand up to $1 trillion."
Federal Reserve: The Federal Reserve announced it would commit up to $1 trillion to purchase bonds or other assets backed by consumer loans. The Treasury will guarantee a portion of the Fed investment by putting up $100 billion, an increase from a $20 billion commitment that Bush administration had announced.
Of all of the news, having the Fed announce a commitment of $1 Trillion in the TALF program to back consumer loans was the best. This will have the greatest impact in creating growth. While the news from the Treasury and the Legislative branch makes good headlines, it will not be as effective.
The stock market had a big drop today which was supposedly related to a lack of clarity by the Treasury. While this makes headlines and lots of press coverage it makes little difference to a long term investor.
Tuesday, February 3, 2009
What Diversification Can Do For You
During 2008, the principle of diversification failed to protect investors from losses as virtually all classes of investments lost money. So what does diversification do for an investor?
What Diversification Can Do for You
The first thing you should know is that it can't guarantee you the highest possible return. In fact, it guarantees you won't earn the highest possible return. By spreading your money around you assure that you will have at least some of your money in lagging investments, which will reduce your portfolio's potential return.
By the same token, diversification can't totally immunize you from losses. To do that, you would have to do the opposite of diversifying -- i.e., plow all your money into the most secure investments, such as Treasury bills or short-term bank CDs.
What diversification can do for you, though, is give you a shot at higher returns than you will get in the most secure investments while limiting your risk somewhat.
Notice I said "somewhat." Fact is, if you want the value of your money to grow more than it will in T-bills and the like, you've got to invest in asset classes that have the potential for higher long-term returns, such as stocks and bonds. But those higher returns come with more risk. In the investment world, that risk can take several forms, but generally the riskier an investment, the more volatile it is, the more its value will jump around from year to year.
You can't eliminate that risk. But by investing your money in a mix of secure and more volatile assets, you can reduce the potential downside in a given year. For example, if you'd had all your money in a diversified portfolio of U.S. stocks last year, you'd have lost just under 40%. If, on the other hand, you'd had 60% of your money in stocks, 30% in a broad bond index fund and 10% in cash last year, you would have lost roughly half that amount, or around 20%.(See editor's note.)
That kind of cushion is important for a couple of reasons. For one thing, it makes you less likely to panic in a bad year and sell off riskier investments with higher long-term return potential at what may be the worst possible time. A less volatile portfolio is also less likely to take a devastating hit that may be difficult to recover from. That's an especially important consideration when you're dealing with 401(k)s or other retirement accounts and you're nearing retirement age or are already retired and withdrawing money from such accounts.
So the key to getting the benefit of diversification is settling on a mix that's right for you.
Ideally, your mix should consist of assets that don't all move in sync with each other or, to put it in investing terms, that aren't too highly correlated with each other.
It's okay for gains in some investments to offset losses in others in some years. But on balance your gains should outweigh losses most years. And, while down years are inevitable with growth-oriented investments, whatever assets you're investing in should have a positive long-term return. Diversification isn't a magic formula that can turn recurring sizeable losses in your investments or your portfolio overall into long-term wealth.
What Diversification Can't Do for You
But as big an advocate as I am of diversifying among a variety of asset classes, I also feel that the concept has been stretched out of shape over the years, in some cases even beyond recognition.
Specifically, I think the benefits of diversifying have been oversold by some advisers who seem intent on making themselves come off like investment wizards capable of creating all-upside-no-downside portfolios. But I'm wary of these supposedly more sophisticated portfolios.
So I suggest keeping things simple. Start with a realistic sense of how much risk you can handle and then build a diversified portfolio of stocks, bonds and cash. If you want to get more fancy, you can throw in some foreign stock funds and maybe some REITs or real estate-related mutual funds. But don't go overboard. The more complicated your portfolio is and the more wide-flung your holdings, the more attention and care it will need.
Finally, remember that to get the full benefit of diversifying you ought to rebalance periodically to restore your portfolio to its proper proportions.
Of course, you can always take the other route you suggest and just buy CDs. But unless you have so much money that you can accumulate a large enough nest egg despite their low yields, I'm not sure that you can do this and also not worry.
What Diversification Can Do for You
The first thing you should know is that it can't guarantee you the highest possible return. In fact, it guarantees you won't earn the highest possible return. By spreading your money around you assure that you will have at least some of your money in lagging investments, which will reduce your portfolio's potential return.
By the same token, diversification can't totally immunize you from losses. To do that, you would have to do the opposite of diversifying -- i.e., plow all your money into the most secure investments, such as Treasury bills or short-term bank CDs.
What diversification can do for you, though, is give you a shot at higher returns than you will get in the most secure investments while limiting your risk somewhat.
Notice I said "somewhat." Fact is, if you want the value of your money to grow more than it will in T-bills and the like, you've got to invest in asset classes that have the potential for higher long-term returns, such as stocks and bonds. But those higher returns come with more risk. In the investment world, that risk can take several forms, but generally the riskier an investment, the more volatile it is, the more its value will jump around from year to year.
You can't eliminate that risk. But by investing your money in a mix of secure and more volatile assets, you can reduce the potential downside in a given year. For example, if you'd had all your money in a diversified portfolio of U.S. stocks last year, you'd have lost just under 40%. If, on the other hand, you'd had 60% of your money in stocks, 30% in a broad bond index fund and 10% in cash last year, you would have lost roughly half that amount, or around 20%.(See editor's note.)
That kind of cushion is important for a couple of reasons. For one thing, it makes you less likely to panic in a bad year and sell off riskier investments with higher long-term return potential at what may be the worst possible time. A less volatile portfolio is also less likely to take a devastating hit that may be difficult to recover from. That's an especially important consideration when you're dealing with 401(k)s or other retirement accounts and you're nearing retirement age or are already retired and withdrawing money from such accounts.
So the key to getting the benefit of diversification is settling on a mix that's right for you.
Ideally, your mix should consist of assets that don't all move in sync with each other or, to put it in investing terms, that aren't too highly correlated with each other.
It's okay for gains in some investments to offset losses in others in some years. But on balance your gains should outweigh losses most years. And, while down years are inevitable with growth-oriented investments, whatever assets you're investing in should have a positive long-term return. Diversification isn't a magic formula that can turn recurring sizeable losses in your investments or your portfolio overall into long-term wealth.
What Diversification Can't Do for You
But as big an advocate as I am of diversifying among a variety of asset classes, I also feel that the concept has been stretched out of shape over the years, in some cases even beyond recognition.
Specifically, I think the benefits of diversifying have been oversold by some advisers who seem intent on making themselves come off like investment wizards capable of creating all-upside-no-downside portfolios. But I'm wary of these supposedly more sophisticated portfolios.
So I suggest keeping things simple. Start with a realistic sense of how much risk you can handle and then build a diversified portfolio of stocks, bonds and cash. If you want to get more fancy, you can throw in some foreign stock funds and maybe some REITs or real estate-related mutual funds. But don't go overboard. The more complicated your portfolio is and the more wide-flung your holdings, the more attention and care it will need.
Finally, remember that to get the full benefit of diversifying you ought to rebalance periodically to restore your portfolio to its proper proportions.
Of course, you can always take the other route you suggest and just buy CDs. But unless you have so much money that you can accumulate a large enough nest egg despite their low yields, I'm not sure that you can do this and also not worry.
Sunday, February 1, 2009
Increased Savings Rate
On Friday, the government reported Americans' savings rate, as a percentage of after-tax incomes, rose to 2.9 percent in the last three months of 2008. That's up sharply from 1.2 percent in the third quarter and less than 1 percent a year ago.
Like a teeter-totter, when the savings rate rises, spending falls. The latter accounts for about 70 percent of economic activity. When consumers refuse to spend, companies cut back, layoffs rise, people pinch pennies even more and the recession deepens.
The downward spiral has hammered the retail and manufacturing industries. For years, stores enjoyed boom times as shoppers splurged on TVs, fancy kitchen decor and clothes. Suddenly, frugality is in style.
Americans are hunkering down and saving more. For a recession-battered economy, it couldn't be happening at a worse time. Economists call it the "paradox of thrift." What's good for individuals -- spending less, saving more -- is bad for the economy when everyone does it.
Grace Case, 38, of Syracuse, N.Y., is a self-described recovering creditaholic. For 13 years, she charged it all -- cars, clothes, repairs, vacations. She'd make only the minimum card payments to sustain her buying spree for her and her family, which includes her husband and two children.
But after being laid off 2 1/2 years ago from her job as an accountant, she landed another accounting job that cut her salary from $60,000 to $40,000. It was impossible to meet minimum payments on her card balances.
Now, the Cases are on a strict budget. They take "staycations," grow their own vegetables, buy only used cars and pre-pay cell phones. Case hasn't used a credit card in two years. And she's saving more. "It's really a liberating feeling," she said. "If you want something, you have to have the money for it."
This is a great example of stewardship. Keep it up!!!!!!!!!!!
Like a teeter-totter, when the savings rate rises, spending falls. The latter accounts for about 70 percent of economic activity. When consumers refuse to spend, companies cut back, layoffs rise, people pinch pennies even more and the recession deepens.
The downward spiral has hammered the retail and manufacturing industries. For years, stores enjoyed boom times as shoppers splurged on TVs, fancy kitchen decor and clothes. Suddenly, frugality is in style.
Americans are hunkering down and saving more. For a recession-battered economy, it couldn't be happening at a worse time. Economists call it the "paradox of thrift." What's good for individuals -- spending less, saving more -- is bad for the economy when everyone does it.
Grace Case, 38, of Syracuse, N.Y., is a self-described recovering creditaholic. For 13 years, she charged it all -- cars, clothes, repairs, vacations. She'd make only the minimum card payments to sustain her buying spree for her and her family, which includes her husband and two children.
But after being laid off 2 1/2 years ago from her job as an accountant, she landed another accounting job that cut her salary from $60,000 to $40,000. It was impossible to meet minimum payments on her card balances.
Now, the Cases are on a strict budget. They take "staycations," grow their own vegetables, buy only used cars and pre-pay cell phones. Case hasn't used a credit card in two years. And she's saving more. "It's really a liberating feeling," she said. "If you want something, you have to have the money for it."
This is a great example of stewardship. Keep it up!!!!!!!!!!!
Investing in Gold
Last week, I saw 2 commercial on TV involving gold. The first commercial was to turn in your gold jewelry for cash. The second commercial was to buy gold as you could make lots of money since gold was going to rise to $2,000 per ounce.
Which one is most likely correct? If you have gold jewelry that you no longer need convert it for cash. Little justification exists for having gold at $900 from a supply demand or commodity price perspective. Gold is at this level because investors need a place to invest as investors are currently avoiding the stock market and get no return by investing in short term bonds.
Once the investing environment changes money will flow from gold to other more reasonably priced alternatives.
It makes no sense to believe that all other metals and commodities can drop by at least 50% and think that gold can maintain this elevated price.
Which one is most likely correct? If you have gold jewelry that you no longer need convert it for cash. Little justification exists for having gold at $900 from a supply demand or commodity price perspective. Gold is at this level because investors need a place to invest as investors are currently avoiding the stock market and get no return by investing in short term bonds.
Once the investing environment changes money will flow from gold to other more reasonably priced alternatives.
It makes no sense to believe that all other metals and commodities can drop by at least 50% and think that gold can maintain this elevated price.
Financial Change is Coming
More changes to Personal Finance rules will occur during the first 100 days of the Obama Administation than any other time in our countries history. The governmental entities that impact personal finance rules: Federal Reserve, Treasury Department, House of Representatives, Senate, and the President.
This week was very busy and events are unfolding that will impact your future. Here are some of the highlights:
1. Federal Reserve: Their big announcement was to buy long term treasury bonds to lower long term interest rates. The intent is to lower mortgage rates with a goal of having a 30 year mortgage rate of 4.0%, a rate not seen since the 1950 - 1960 era. This is done to stimulate the economy by having people refinance their home and have more spending money as well as to encourage people to purchase a new home. What does this mean: Get ready to refinance and use the savings to shorten the length of the loan rather than spend it.
2. Treasury Department: Yes we have a tax challenged Treasury Secretary. It is beyond me how someone this smart can somehow forget to pay taxes and then get special treatment by the government. Treasury has $350 Billion to spend, the other half of TARP. This will be used to help the banks get undesirable assets off of the books in some fashion and this helps the bank loan more money. This also helps to lower mortgage rates as it should reduce the spread between the long term treasury rate and the mortgage rate.
3. House of Representatives: The Democrats literally ignored every Republican request and passed a Democratic only designed $819 Billion Spending bill. For some reason the Republlicans were upset and voted against it. This bill significantly increases government spending and will provide growth to the economy. The auto industry is working to have people buy new cars where people will get a tax deduction for buying a new car. One option is a program called cash for clunkers.
4. Senate: It is their turn on the spending bill. The bill gets modified somewhat because of a higher ratio of Republicans and eventually something will get passed. It will be good to see what happens.
5. President: Is talking bipartisanship and actions say that his agenda is the only game in town. What is not in the news is the health care agenda and other campaign promises. Franklin Roosevelt would certainly be proud.
What does this mean for us? Get ready to refinance your mortgage. Make no major purchases in the near term as the government will be giving incentives on cars and other major purchases. The economy will grow with $1.2 Billion going into the economy with an emphasis on new autos and homes. The stock market will rise as the economy grows.
This week was very busy and events are unfolding that will impact your future. Here are some of the highlights:
1. Federal Reserve: Their big announcement was to buy long term treasury bonds to lower long term interest rates. The intent is to lower mortgage rates with a goal of having a 30 year mortgage rate of 4.0%, a rate not seen since the 1950 - 1960 era. This is done to stimulate the economy by having people refinance their home and have more spending money as well as to encourage people to purchase a new home. What does this mean: Get ready to refinance and use the savings to shorten the length of the loan rather than spend it.
2. Treasury Department: Yes we have a tax challenged Treasury Secretary. It is beyond me how someone this smart can somehow forget to pay taxes and then get special treatment by the government. Treasury has $350 Billion to spend, the other half of TARP. This will be used to help the banks get undesirable assets off of the books in some fashion and this helps the bank loan more money. This also helps to lower mortgage rates as it should reduce the spread between the long term treasury rate and the mortgage rate.
3. House of Representatives: The Democrats literally ignored every Republican request and passed a Democratic only designed $819 Billion Spending bill. For some reason the Republlicans were upset and voted against it. This bill significantly increases government spending and will provide growth to the economy. The auto industry is working to have people buy new cars where people will get a tax deduction for buying a new car. One option is a program called cash for clunkers.
4. Senate: It is their turn on the spending bill. The bill gets modified somewhat because of a higher ratio of Republicans and eventually something will get passed. It will be good to see what happens.
5. President: Is talking bipartisanship and actions say that his agenda is the only game in town. What is not in the news is the health care agenda and other campaign promises. Franklin Roosevelt would certainly be proud.
What does this mean for us? Get ready to refinance your mortgage. Make no major purchases in the near term as the government will be giving incentives on cars and other major purchases. The economy will grow with $1.2 Billion going into the economy with an emphasis on new autos and homes. The stock market will rise as the economy grows.
Investing and the Impact of Obama Stimulus Package
The Obama Administration and the Democractic Senators and Representatives are rolling out a $825 Billion stimulus package. Since investing is about making decisions based upon financial events, what moves if any should be done?
This amount is roughly equal to $3,000 for each citizen. I doubt that my family will see $12,000. Who will get the money? Businesses and banks will be the primary benefactors rather than directly to the citizens.
In order to share in this money you need to buy stock in businesses and banks.The next question is should the stimulus package increase stock price? Stock price is a function of interest rate and growth rate. Stock prices increase as the growth rate is higher than the interest rate. Currently, stock prices are at a negative growth rate indicating a future deep recession. The stimulus package will increase the growth rate of business and banks which means that the long term impact of the stimulus package should raise stock price. Virtually all segments of our economy will get money, kind of like putting butter on toast. Companies that provide infrastructure products will do really really well, such as basic materials, electrical power infrastructure, and wireless communication.
Another result will be higher interest rates. The risk from the stimulus package is to create inflation which would result in an interest rate above the growth rate. Higher interest rates are great for short term bonds such as a money market fund and kills long term bonds. Stocks should be balanced with short term bonds and long term bonds should be avoided.
Stock prices around the world are linked to the US economy as we import more than we export. We are the biggest consumers of any other country in the world. Global stock prices will rise as our stock price rise. This means that a portfolio of US and International stocks should do well in the future.
This amount is roughly equal to $3,000 for each citizen. I doubt that my family will see $12,000. Who will get the money? Businesses and banks will be the primary benefactors rather than directly to the citizens.
In order to share in this money you need to buy stock in businesses and banks.The next question is should the stimulus package increase stock price? Stock price is a function of interest rate and growth rate. Stock prices increase as the growth rate is higher than the interest rate. Currently, stock prices are at a negative growth rate indicating a future deep recession. The stimulus package will increase the growth rate of business and banks which means that the long term impact of the stimulus package should raise stock price. Virtually all segments of our economy will get money, kind of like putting butter on toast. Companies that provide infrastructure products will do really really well, such as basic materials, electrical power infrastructure, and wireless communication.
Another result will be higher interest rates. The risk from the stimulus package is to create inflation which would result in an interest rate above the growth rate. Higher interest rates are great for short term bonds such as a money market fund and kills long term bonds. Stocks should be balanced with short term bonds and long term bonds should be avoided.
Stock prices around the world are linked to the US economy as we import more than we export. We are the biggest consumers of any other country in the world. Global stock prices will rise as our stock price rise. This means that a portfolio of US and International stocks should do well in the future.
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