If you can fully fund either a traditional IRA or Roth IRA, then a Roth IRA probably makes the most sense. The below article gives good information for a Roth IRA.
Tips for Managing Your Roth IRA by Sue Stevens
Roth IRAs differ from traditional IRAs in that you put away aftertax money, you are not required to take Required Minimum Distributions, and when you take out the money in the future you won't owe any tax at all. Because you use aftertax money to make your contributions, you don't get a tax deduction like you would with a traditional IRA.
Eligibility to Make Contributions
The contribution maximum is the same for Roth IRAs as it is for traditional IRAs. For 2007, you can contribute $4,000--or $5,000 for investors over age 50. (You have until April 15 to make a 2007 contribution.) The contribution limit goes up for 2008--to $5,000 for those under 50 and $6,000 for those over 50. The income thresholds, however, are higher than they are for deductible contributions to a traditional IRA.
Singles may make at least a partial contribution to a Roth IRA if modified adjusted gross income is less than $114,000 (in 2008 that increases to $116,000). Married couples filing jointly may contribute as long as their modified AGI is below $166,000 (in 2008 that increases to $169,000). Married filing separately may only contribute if modified AGI is less than $10,000.
You can contribute past age 70 1/2 as long as you have earned income and are otherwise eligible. You do not have to take Required Minimum Distributions at age 70 1/2.
Contributions can be made in the year the income is earned or up to the filing deadline of your tax return, not including extensions (April 15 in most cases).
Tax Penalties on Roth IRAs
There are fewer potential penalties for Roth IRAs than there are with traditional IRAs. Because you are not required to take RMDs, you won't run into that nasty 50% penalty that you'll face if you don't take distributions from a traditional IRA on time.
You may, however, bump into the 10% early distribution penalty if you tap your Roth IRA before you're age 59 1/2. Here are the exceptions to that penalty:
You're disabled
You're an IRA beneficiary
You're a first-time homeowner and need to cover certain expenses
You have significant unreimbursed medical expenses
You're paying for medical premiums after losing a job
You have qualified higher-education expenses
IRS levy of a qualified plan
You're taking substantially equal periodic payments (same rules as under traditional IRA)
Claiming a Loss on Your Roth IRA
It is possible to take a deduction for a loss on your Roth IRA, but it may not make sense in every situation. The loss you can take revolves around your "basis," or the amount you've invested with aftertax money. You must withdraw the entire amount in your Roth to be eligible to claim a loss. Because the money you withdraw is a qualified distribution (a return of your own contributions) you would not owe a 10% penalty.
This type of loss is not like a capital loss on a taxable investment. With taxable capital losses you can deduct as much as $3,000 against ordinary income on your tax return and carry the rest of your loss forward indefinitely. With a Roth loss, you must use it in the year you generate it. So, if you sold your Roth in 2007 and realized a loss, you would claim it on your 2007 tax return. It goes on Schedule A and is subject to the 2% miscellaneous itemized-deduction threshold.
Think carefully before you liquidate your Roth IRA, however. For example, if your Roth is worth $20,000 and you pull it all out to recognize a loss, you'll only be able to put back $5,000 this year--the Roth contribution limit for 2008 ($6,000 for people over age 50). You would lose the advantage of having accumulated a greater balance in your account.
The same principle of taking a loss applies to nondeductible traditional IRA contributions, but not tax-deductible contributions. For more information, see IRS Publication 590.
Roth Distributions
You can always take out your contributions without paying income tax. After all, you paid the tax on that money before it was contributed to the Roth IRA.
For the earnings to be distributed tax-free (that is, qualified), you must hold for at least five years plus one of the following:
Attain age 59 1/2
Be a beneficiary of the IRA
Be disabled
Be eligible for a qualified first-time homebuyer withdrawal of as much as $10,000
There are ordering rules for taking nonqualified distributions out of a Roth IRA. To figure out how much tax you owe, you first subtract your regular contributions. If your distribution is more than your original contributions, then you look to any conversions you did, and finally to earnings on contributions.
Should You Convert Your Traditional IRA to a Roth IRA?
If you think income tax rates may go up in the future, you may want to consider taking part (or all) of your traditional IRA, paying tax now, and converting it to a Roth IRA.
To convert a traditional IRA to a Roth IRA, you pay the tax on the traditional IRA up front with money from a separate account. If you have to use money in your traditional IRA to pay the tax on the conversion, it will be considered an early withdrawal (assuming you are under age 59 1/2), and you will owe a 10% penalty on it.
Converting to a Roth doesn't have to be an all-or-nothing proposition. You can convert part of your traditional IRA. You should consider a conversion if you expect tax rates to go up, to avoid taking Required Minimum Distributions at age 70 1/2, or to be able to contribute longer.
There can be several advantages to converting your traditional IRA to a Roth, but what has stopped many people (until recently) is the fact that if your AGI is more than $100,000, you can't convert.
Begining in 2010, however, anyone will be able to convert a traditional IRA to a Roth, regardless of income level. To take advantage of that opportunity, more people are now making nondeductible traditional IRA contributions so that they can build up the amount they will be able to convert in the future (in this scenario, you would only pay tax on the earnings of the nondeductible contributions because the contributions are made with aftertax dollars).
Keep in mind there are always potential disadvantages of converting a traditional IRA to a Roth IRA--like the possibility of a totally new tax system that would change the rules. If we have a flat tax or a consumption tax in the future, it may turn out to be a mistake to pay more income tax now.
Roth 401(k) Accounts
In 2006, companies started offering Roth 401(k) options. A Roth 401(k) is a variation on a traditional 401(k) retirement plan with some of the characteristics of a Roth IRA. More and more firms are now offering this type of plan.
Just like the traditional 401(k) plan, Roth 401(k) contributions are limited to $15,500 in 2008 ($20,500 if over age 50). Your contributions can be split between the traditional and Roth plans.
You'll get an income-tax savings through traditional 401(k) contributions, but not with Roth 401(k) contributions. But unlike a Roth IRA, there are no income limitations on contributions to a Roth 401(k). So for those of you with higher incomes, this may be an alternative to making nondeductible traditional IRA contributions. A Roth 401(k) does require that you take required minimum distributions at age 70 1/2, but you can avoid that if you roll your Roth 401(k) over to a Roth IRA.
Wednesday, February 27, 2008
Gameplan to Become a Millionaire
If someone gave you a gameplan on how to become a millionaire, would you follow it? I found this article that gives good advice and deserves your attention. Notice it involves preparation, hard work, wisdom, and discipline.
12 steps to become a millionaire
You don't have to own the company or be a CEO. Here's how to build a rich nest egg one paycheck at a time.
By Kiplinger's Personal Finance Magazine
A number of the people profiled in "Millionaires tell how they did it" made their millions as entrepreneurs. But working for the Man doesn't mean you have to be a wage slave or resort to buying lottery tickets to strike it rich. The trick is to maximize your income on the job (and know when to move on), make the most of your employee benefits and tax breaks and use that extra money to start investing.
1. Keep your eyes peeled for better ways to do your job. Streamline a procedure, shave costs, create a new profit center, become an expert on a specific topic, volunteer for a company committee -- anything that will make you stand out as a prime candidate for a promotion or a pay boost.
2. Don't be afraid to negotiate. In a study of master's degree graduates from her university, Carnegie Mellon economics professor Linda Babcock found that those who negotiated their first salary boosted their pay by 7.4% compared with those who didn't bargain.
3. Get your ducks in a row and your numbers on paper. If possible, quantify how much your efforts add to the company's bottom line. If that's not feasible, spotlight your value with comparable salaries for workers in your position from a Web site, such as Salary.com, or from a professional association.
4. Plot your strategy when it's time to move on. Create a professional-looking page on MySpace that tells prospective employers why you're an exceptional candidate, recommends John Challenger of the outplacement firm Challenger, Gray & Christmas. And don't neglect more conventional networking: Join a professional association or show up at school reunions toting business cards.
Milk your benefits
5. Contribute as much as you can to your 401(k) and other tax-deferred retirement plans. You'll not only build a bigger nest egg, but you'll also cut your tax bill. In the 25% federal tax bracket, every $1,000 you contribute to a 401(k) trims your taxes by $250. And you'll save on state income taxes, too.
6. Flex your tax-saving muscle. Contribute pretax dollars to a flexible spending account to pay for dependent care or out-of-pocket medical expenses. If you set aside $1,500 per year and you're in the 25% bracket, avoiding federal income and Social Security taxes means Uncle Sam will subsidize almost $500 of your expenses.
7. Review your tax withholding. If you're expecting a refund this spring, you're having too much tax withheld from your paycheck -- and making an interest-free loan to Uncle Sam. That's no way to become a millionaire. Put more money in your pocket and then filling out a new Form W-4.
8. Stash savings in a Roth IRA if you're eligible. Withdrawals in retirement, including decades of compounded earnings, will be tax-free. This year, income-eligibility limits for a Roth increase to $114,000 for individuals and $166,000 for married couples.
Invest like crazy
9. Don't delay. The quicker you get a jump on putting money aside, the easier it will be to stuff a seven-figure cushion. If you start at age 25, for example, investing $286 per month will get you $1 million by age 65, assuming you earn 8% annually.
10. Invest automatically, either through your employer's retirement plan or by setting up a regular deposit to a mutual fund or broker. You'll never miss the money, and you'll avoid two big mistakes: buying too much when stock prices are high and not buying at all when prices fall.
11. Watch for fund fees. The more you pay, the tougher it is to earn an above-average return. The typical hedge fund, for example, takes 20% of any gains, a huge hurdle to overcome. A better bet: no-load mutual funds with expense ratios of 1% or less. If you trade individual stocks, watch those commissions.
12. Keep it simple. Be wary of get-rich-quick schemes or sales pitches for complex investments, such as oil-and-gas partnerships, that trade on the millionaire cachet to lure investors into buying high-fee products they don't understand. Most millionaire households accumulate their wealth over the long term by sticking to a regular investing plan in a balanced portfolio.
12 steps to become a millionaire
You don't have to own the company or be a CEO. Here's how to build a rich nest egg one paycheck at a time.
By Kiplinger's Personal Finance Magazine
A number of the people profiled in "Millionaires tell how they did it" made their millions as entrepreneurs. But working for the Man doesn't mean you have to be a wage slave or resort to buying lottery tickets to strike it rich. The trick is to maximize your income on the job (and know when to move on), make the most of your employee benefits and tax breaks and use that extra money to start investing.
1. Keep your eyes peeled for better ways to do your job. Streamline a procedure, shave costs, create a new profit center, become an expert on a specific topic, volunteer for a company committee -- anything that will make you stand out as a prime candidate for a promotion or a pay boost.
2. Don't be afraid to negotiate. In a study of master's degree graduates from her university, Carnegie Mellon economics professor Linda Babcock found that those who negotiated their first salary boosted their pay by 7.4% compared with those who didn't bargain.
3. Get your ducks in a row and your numbers on paper. If possible, quantify how much your efforts add to the company's bottom line. If that's not feasible, spotlight your value with comparable salaries for workers in your position from a Web site, such as Salary.com, or from a professional association.
4. Plot your strategy when it's time to move on. Create a professional-looking page on MySpace that tells prospective employers why you're an exceptional candidate, recommends John Challenger of the outplacement firm Challenger, Gray & Christmas. And don't neglect more conventional networking: Join a professional association or show up at school reunions toting business cards.
Milk your benefits
5. Contribute as much as you can to your 401(k) and other tax-deferred retirement plans. You'll not only build a bigger nest egg, but you'll also cut your tax bill. In the 25% federal tax bracket, every $1,000 you contribute to a 401(k) trims your taxes by $250. And you'll save on state income taxes, too.
6. Flex your tax-saving muscle. Contribute pretax dollars to a flexible spending account to pay for dependent care or out-of-pocket medical expenses. If you set aside $1,500 per year and you're in the 25% bracket, avoiding federal income and Social Security taxes means Uncle Sam will subsidize almost $500 of your expenses.
7. Review your tax withholding. If you're expecting a refund this spring, you're having too much tax withheld from your paycheck -- and making an interest-free loan to Uncle Sam. That's no way to become a millionaire. Put more money in your pocket and then filling out a new Form W-4.
8. Stash savings in a Roth IRA if you're eligible. Withdrawals in retirement, including decades of compounded earnings, will be tax-free. This year, income-eligibility limits for a Roth increase to $114,000 for individuals and $166,000 for married couples.
Invest like crazy
9. Don't delay. The quicker you get a jump on putting money aside, the easier it will be to stuff a seven-figure cushion. If you start at age 25, for example, investing $286 per month will get you $1 million by age 65, assuming you earn 8% annually.
10. Invest automatically, either through your employer's retirement plan or by setting up a regular deposit to a mutual fund or broker. You'll never miss the money, and you'll avoid two big mistakes: buying too much when stock prices are high and not buying at all when prices fall.
11. Watch for fund fees. The more you pay, the tougher it is to earn an above-average return. The typical hedge fund, for example, takes 20% of any gains, a huge hurdle to overcome. A better bet: no-load mutual funds with expense ratios of 1% or less. If you trade individual stocks, watch those commissions.
12. Keep it simple. Be wary of get-rich-quick schemes or sales pitches for complex investments, such as oil-and-gas partnerships, that trade on the millionaire cachet to lure investors into buying high-fee products they don't understand. Most millionaire households accumulate their wealth over the long term by sticking to a regular investing plan in a balanced portfolio.
Wednesday, February 20, 2008
Preparing for Retirement Expenses
In the past some wisdom was that a retiree during retirement needed about 70% of their pre-retirement income. I think this is wrong and under estimates what will actually be needed. I think you need to plan for a higher amount. The key difference now is the future cost of medical expenses that are growing much faster than inflation. It is better to plan for a higher level of expenses and have money left over than come up short.
Bottom Line: Save early, save often, & get professional help.
Most Americans Unprepared for Retirement by David Goldman
A majority of American workers will not be able to maintain their current standard of living after they retire, according to a report released Tuesday.
The Center for Retirement Research (CRR) estimates 61% of households are "at risk" of being unable to live the way they would like and pay for their health care when they get old.
CRR considers consumers to be "at risk" if their savings, Social Security and pension benefits combined will fall at least 10% short of the income needed in retirement to support the same standard of living they enjoyed while working.
Previous reports have considered health care to be a cost that retirees factor in by "rearranging their basket of consumption" - that is, spending less on consumer goods.
CRR's study assumes that people want to spend the same amount on goods in retirement that they do now and that they consider health insurance and the added health care costs associated with growing old to be an additional expense.
"People take the notion of health care for granted," said Andrew D. Eschtruth, associate director for external relations at CRR. "The basic assumption of this report is that retirees think they will eat the same kind of foods, travel the same - or more - and buy the same clothes."
If that's the case, then there is cause for concern. Health care costs continue to increase dramatically, far outpacing wage increases year over year.
Additionally, out-of-pocket health care costs for most consumers rise significantly upon retirement. The report assumes that people recognize the burden of health care costs once they retire; however, those retirees to whom the added expense comes as a surprise will have to reduce their spending on consumer goods and spend much more on health care.
Many workers do not have a realistic estimate of how much they will need to spend on health care when they retire, according to a 2007 study by the Employee Benefit Research Institute (EBRI).
The study shows that 84% of employees estimated they and their spouse will need to accumulate less than $250,000 for retiree health costs, 32% of whom thought they would need less than $100,000.
But according to the EBRI, couples will need to save about $300,000 in retirement to cover health expenses, assuming they live to average life expectancy and Medicare benefits remain at current levels. For those who live to 95, that amount jumps to $550,000.
Why are people so inadequately prepared? With the shift from traditional pension plans to 401(k)s, the burden of preparing for retirement has shifted from employers to the employee.
Some workers aren't saving enough to prepare themselves for their golden years. Also, 30% of employees simply fail to sign up for 401(k) plans, according to insurance company Nationwide.
"A lot of people say, 'Oh yeah, my company told me to sign up for my 401(k); I'll do it tomorrow,' and they forget to sign up," said Eschtruth.
As a result, the government passed the Pension Protection Act in 2006 to encourage businesses to automatically enroll employees in their retirement plans.
But there are steps beyond saving that people can take to make make retirement planning easier and more affordable.
"Good physical health matters a great deal," said Paul Ballew, senior vice president of consumer insight and analytics at Nationwide. "Physical and financial health are connected, as being healthy lessens your chance of having high, unexpected medical expenses."
Households planning for retirement are also encouraged to seek professional advice."Save early and often, and take advantage of what's available to you," said Ballew. "But also speak to a professional who can help you achieve an adequate investment strategy for your golden years."
Bottom Line: Save early, save often, & get professional help.
Most Americans Unprepared for Retirement by David Goldman
A majority of American workers will not be able to maintain their current standard of living after they retire, according to a report released Tuesday.
The Center for Retirement Research (CRR) estimates 61% of households are "at risk" of being unable to live the way they would like and pay for their health care when they get old.
CRR considers consumers to be "at risk" if their savings, Social Security and pension benefits combined will fall at least 10% short of the income needed in retirement to support the same standard of living they enjoyed while working.
Previous reports have considered health care to be a cost that retirees factor in by "rearranging their basket of consumption" - that is, spending less on consumer goods.
CRR's study assumes that people want to spend the same amount on goods in retirement that they do now and that they consider health insurance and the added health care costs associated with growing old to be an additional expense.
"People take the notion of health care for granted," said Andrew D. Eschtruth, associate director for external relations at CRR. "The basic assumption of this report is that retirees think they will eat the same kind of foods, travel the same - or more - and buy the same clothes."
If that's the case, then there is cause for concern. Health care costs continue to increase dramatically, far outpacing wage increases year over year.
Additionally, out-of-pocket health care costs for most consumers rise significantly upon retirement. The report assumes that people recognize the burden of health care costs once they retire; however, those retirees to whom the added expense comes as a surprise will have to reduce their spending on consumer goods and spend much more on health care.
Many workers do not have a realistic estimate of how much they will need to spend on health care when they retire, according to a 2007 study by the Employee Benefit Research Institute (EBRI).
The study shows that 84% of employees estimated they and their spouse will need to accumulate less than $250,000 for retiree health costs, 32% of whom thought they would need less than $100,000.
But according to the EBRI, couples will need to save about $300,000 in retirement to cover health expenses, assuming they live to average life expectancy and Medicare benefits remain at current levels. For those who live to 95, that amount jumps to $550,000.
Why are people so inadequately prepared? With the shift from traditional pension plans to 401(k)s, the burden of preparing for retirement has shifted from employers to the employee.
Some workers aren't saving enough to prepare themselves for their golden years. Also, 30% of employees simply fail to sign up for 401(k) plans, according to insurance company Nationwide.
"A lot of people say, 'Oh yeah, my company told me to sign up for my 401(k); I'll do it tomorrow,' and they forget to sign up," said Eschtruth.
As a result, the government passed the Pension Protection Act in 2006 to encourage businesses to automatically enroll employees in their retirement plans.
But there are steps beyond saving that people can take to make make retirement planning easier and more affordable.
"Good physical health matters a great deal," said Paul Ballew, senior vice president of consumer insight and analytics at Nationwide. "Physical and financial health are connected, as being healthy lessens your chance of having high, unexpected medical expenses."
Households planning for retirement are also encouraged to seek professional advice."Save early and often, and take advantage of what's available to you," said Ballew. "But also speak to a professional who can help you achieve an adequate investment strategy for your golden years."
Job Change Protect Retirement Assets
Changing Jobs? What to do with your 401(k), 403(b), etc.? The answer is do not spend it, keep it invested for the appropriate timeframe. When you are changing jobs, it is a great time to seek professional guidance.
Three Ways to Protect Your 401(k) in a New Job by Kelsey Abbott
At any given time, millions of Americans are in the process of changing jobs, with millions more thinking about taking the leap.
The average U.S. worker has held 10 jobs by the time he or she hits age 40, U.S. Secretary of Labor Elaine L. Chao recently noted.
When you move from one job to another, you have the opportunity to improve your financial situation on several fronts.
But job changes can be complicated. If you're not careful, your 401(k) and medical benefits can suffer some damage in the transition.
When you leave a job, you might be tempted to cash out your 401(k) plan. That's a bad idea. If you're under age 59 1/2 -- as most people who change jobs are -- you'll have to pay a 10% penalty for taking an early withdrawal.
What's more, you will have to pay taxes on the money you withdraw -- and the money might push you into a high tax bracket, making the hit even worse. And you'll give up the potential for future tax-deferred growth on those savings. In short, you'll be shooting yourself in the foot.
Here are three options that make more sense:
1. Leave your money in your former employer's retirement plan.
Most employers will give you this option as long as you have at least $5,000 in your 401(k) plan. This option may be a good one if you won't immediately be eligible for your new employer's plan -- or your new employer doesn't have one. Otherwise, most financial advisors recommend consolidating your retirement savings into your new account for simplicity's sake.
2. Roll your current 401(k) or other retirement savings plan into your new employer's plan.
Ask your new employer when you will be eligible for the firm's retirement savings plan, and find out what you should do to facilitate the transfer of assets from your old plan to your new one.
Make sure that your old employer writes rollover checks to your new plan administrator -- not to you. Reason: If the check is in your name, the plan administrator must withhold 20% of the account balance for taxes.
True, you can get that money back when you file your income taxes, but only on two conditions: You must deposit an amount equal to 100% of the original amount into your new account, and you must do so within 60 days of receiving the check. That means you'll have to come up with 20% out of your own pocket while you wait for your refund!
Worse, if you fail to make the rollover within 60 days, the transfer will be treated as a withdrawal -- which means you'll owe taxes on all of it, and you will have given up the chance to defer future taxes on the money those savings earn.
Your new employer will give you a form that lets you select "direct rollover" (or something similar), which means that the money will go directly from your old account to your new account.
3. Move the money from your old employer's 401(k) into a rollover IRA.
A rollover IRA might be for you if your new employer doesn't offer a retirement savings plan. Again, make sure the check is written to the new account rather than to you. That way you'll avoid withholding -- as well as the risk of missing the 60-day deadline and being forced to pay taxes on the full amount.Keep your rollover IRA separate from any other IRAs and don't make any new contributions to it. (You can maintain another IRA for future contributions.) That way you will retain the option of rolling the money in your rollover IRA back over into a future employer's retirement savings plan.
Three Ways to Protect Your 401(k) in a New Job by Kelsey Abbott
At any given time, millions of Americans are in the process of changing jobs, with millions more thinking about taking the leap.
The average U.S. worker has held 10 jobs by the time he or she hits age 40, U.S. Secretary of Labor Elaine L. Chao recently noted.
When you move from one job to another, you have the opportunity to improve your financial situation on several fronts.
But job changes can be complicated. If you're not careful, your 401(k) and medical benefits can suffer some damage in the transition.
When you leave a job, you might be tempted to cash out your 401(k) plan. That's a bad idea. If you're under age 59 1/2 -- as most people who change jobs are -- you'll have to pay a 10% penalty for taking an early withdrawal.
What's more, you will have to pay taxes on the money you withdraw -- and the money might push you into a high tax bracket, making the hit even worse. And you'll give up the potential for future tax-deferred growth on those savings. In short, you'll be shooting yourself in the foot.
Here are three options that make more sense:
1. Leave your money in your former employer's retirement plan.
Most employers will give you this option as long as you have at least $5,000 in your 401(k) plan. This option may be a good one if you won't immediately be eligible for your new employer's plan -- or your new employer doesn't have one. Otherwise, most financial advisors recommend consolidating your retirement savings into your new account for simplicity's sake.
2. Roll your current 401(k) or other retirement savings plan into your new employer's plan.
Ask your new employer when you will be eligible for the firm's retirement savings plan, and find out what you should do to facilitate the transfer of assets from your old plan to your new one.
Make sure that your old employer writes rollover checks to your new plan administrator -- not to you. Reason: If the check is in your name, the plan administrator must withhold 20% of the account balance for taxes.
True, you can get that money back when you file your income taxes, but only on two conditions: You must deposit an amount equal to 100% of the original amount into your new account, and you must do so within 60 days of receiving the check. That means you'll have to come up with 20% out of your own pocket while you wait for your refund!
Worse, if you fail to make the rollover within 60 days, the transfer will be treated as a withdrawal -- which means you'll owe taxes on all of it, and you will have given up the chance to defer future taxes on the money those savings earn.
Your new employer will give you a form that lets you select "direct rollover" (or something similar), which means that the money will go directly from your old account to your new account.
3. Move the money from your old employer's 401(k) into a rollover IRA.
A rollover IRA might be for you if your new employer doesn't offer a retirement savings plan. Again, make sure the check is written to the new account rather than to you. That way you'll avoid withholding -- as well as the risk of missing the 60-day deadline and being forced to pay taxes on the full amount.Keep your rollover IRA separate from any other IRAs and don't make any new contributions to it. (You can maintain another IRA for future contributions.) That way you will retain the option of rolling the money in your rollover IRA back over into a future employer's retirement savings plan.
Tuesday, February 12, 2008
Optimize Retirement Funds
Below is an article about how to optimize a 401(k) plan. In reality this advice applies all retirement accounts. The emphasis in this article is that you need to know the specifics in your investments and your time horizon. If the time horizon is greater than 8 years, the minimum and maximum return of stocks outperform bonds. You need to invest to meet your time horizon.
Four Ways to Optimize Your 401(k) by Mike Woelflein
The stock market's wild gyrations make this a good time to check on your 401(k).
No panic moves, mind you.
Instead, put your portfolio through its paces to make sure it's doing what it needs to do to help you reach retirement in good financial shape.
Here are four pieces of advice worth taking:
1. Consider Being More Aggressive
Recent events notwithstanding, stocks perform better than other investment vehicles over time. The typical stock fund averaged a 10.4% annual return from 1926 to 2005, compared with 3% for inflation, less than 6% for bond funds and less than 4% for Treasuries. And while stocks can be volatile, the risk of holding them diminishes over time.
Stocks have outpaced both bonds and Treasury bills during more than 75% of rolling five-year periods since 1926, according to Ibbotson Associates, a Chicago-based investment research firm owned by Morningstar. Look at 10-year periods, and stocks won 85% of the time. For 15-year periods, the percentage jumps to 92%. Your allocation to stocks should match your time horizon and risk tolerance.
Remember: your target date should not be the year you retire. Your retirement may well last for decades, and during that time your portfolio will need to grow enough to stand up to inflation, including rising health-care costs. Bottom line: Even as you approach and pass the end of your working years, don't be afraid to emphasize growth -- meaning stocks.
2. Expand Your Horizons
Today's 401(k) plans tend to offer a broad array of investment possibilities. Consider whether your portfolio is taking advantage of them. Investment vehicles such as emerging-market stocks, high-yield "junk" bonds and small company stocks offer superior growth over the long run. They may seem risky -- and in isolation they are. But when you hold them with other investments, they can actually reduce your overall risk. That's because these asset classes tend to zig when other segments of the financial markets zag. As a result, they can help smooth out the year-to-year returns of your portfolio even as they increase your potential for long-term gains.
3. Identify Losers and Overlapping Funds
Review each fund in your portfolio, and compare it to others in the same category both inside and outside your plan. For example, how does your small-cap growth fund compare with other funds that hold shares of small growth companies? (You can find this info at websites such as Lipper.com, Morningstar.com and fund-company or 401(k) plan sites.)
Compare both returns and volatility over one, three and five years, with an emphasis on the longer term. While you're at it, look for fund overlap, which occurs when two funds are concentrated on the same stock or sector. For example, if you hold several funds that have invested heavily in technology stocks or long-term bonds, you could be overexposed to a decline in those sectors.
4. Coordinate Your 401(k) With Other Accounts
Let's say that your plan's options in some categories aren't appealing. In that case, consider investing in the plan's strongest funds, then diversifying into other categories through an IRA or taxable accounts.The bottom line: As a retirement account, your 401(k) should focus on the long term. But tweaking your holdings can improve that long-term outlook -- and might also offer some shelter from the market gyrations that will occur in the meantime.
Four Ways to Optimize Your 401(k) by Mike Woelflein
The stock market's wild gyrations make this a good time to check on your 401(k).
No panic moves, mind you.
Instead, put your portfolio through its paces to make sure it's doing what it needs to do to help you reach retirement in good financial shape.
Here are four pieces of advice worth taking:
1. Consider Being More Aggressive
Recent events notwithstanding, stocks perform better than other investment vehicles over time. The typical stock fund averaged a 10.4% annual return from 1926 to 2005, compared with 3% for inflation, less than 6% for bond funds and less than 4% for Treasuries. And while stocks can be volatile, the risk of holding them diminishes over time.
Stocks have outpaced both bonds and Treasury bills during more than 75% of rolling five-year periods since 1926, according to Ibbotson Associates, a Chicago-based investment research firm owned by Morningstar. Look at 10-year periods, and stocks won 85% of the time. For 15-year periods, the percentage jumps to 92%. Your allocation to stocks should match your time horizon and risk tolerance.
Remember: your target date should not be the year you retire. Your retirement may well last for decades, and during that time your portfolio will need to grow enough to stand up to inflation, including rising health-care costs. Bottom line: Even as you approach and pass the end of your working years, don't be afraid to emphasize growth -- meaning stocks.
2. Expand Your Horizons
Today's 401(k) plans tend to offer a broad array of investment possibilities. Consider whether your portfolio is taking advantage of them. Investment vehicles such as emerging-market stocks, high-yield "junk" bonds and small company stocks offer superior growth over the long run. They may seem risky -- and in isolation they are. But when you hold them with other investments, they can actually reduce your overall risk. That's because these asset classes tend to zig when other segments of the financial markets zag. As a result, they can help smooth out the year-to-year returns of your portfolio even as they increase your potential for long-term gains.
3. Identify Losers and Overlapping Funds
Review each fund in your portfolio, and compare it to others in the same category both inside and outside your plan. For example, how does your small-cap growth fund compare with other funds that hold shares of small growth companies? (You can find this info at websites such as Lipper.com, Morningstar.com and fund-company or 401(k) plan sites.)
Compare both returns and volatility over one, three and five years, with an emphasis on the longer term. While you're at it, look for fund overlap, which occurs when two funds are concentrated on the same stock or sector. For example, if you hold several funds that have invested heavily in technology stocks or long-term bonds, you could be overexposed to a decline in those sectors.
4. Coordinate Your 401(k) With Other Accounts
Let's say that your plan's options in some categories aren't appealing. In that case, consider investing in the plan's strongest funds, then diversifying into other categories through an IRA or taxable accounts.The bottom line: As a retirement account, your 401(k) should focus on the long term. But tweaking your holdings can improve that long-term outlook -- and might also offer some shelter from the market gyrations that will occur in the meantime.
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