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How I Chose My High Yield Bond Fund

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Last week I described the ultra-thrilling process of how high yield bond funds work. The reason I penned that particular post was simple. I was in the process of buying one.

In today’s entry, lets look “over my shoulder” to see the method I used to pick my new fund. Many people don’t get to see how someone with 16 years of professional experience chooses an investment in their portfolio. Choosing a high yield mutual fund is a little like exploring through a wasteland of worthless investments (as you’ll soon see), and I think there’s a few crucial basics beginners can learn from my adventure.

Why? Like reading a map, you’re going to be surprised by how straightforward and simple the process is. Buying funds isn’t complicated and you too can find a good mutual fund within minutes while feeling comfortable that you performed adequate due diligence.

The key part of the process is spending some good time with the map first. If you know what you’re looking for, exploring for the fund is the easy part.

Leading up to choosing a fund, I determined the following:

  1. I knew my end goal. I wasn’t just throwing money in the general direction of my problems or praying for high returns. I didn’t use a “more is better” approach. That usually lands investors in an ugly spot, when their greed turns profits to huge losses. I was looking for retirement, and needed to maintain at least a 6 percent return to get there.
  2. I had already determined my asset mix to reach my goal. On our podcast and in previous posts, I’ve discussed finding the appropriate diversified asset mix for your goals. Mine included high yield bonds, mostly because they have a history of achieving my target return.
  3. I knew how much money I needed in high yield bonds to meet my goal. Normally, I’m not a fan of mutual funds. But, because it was a small amount and a manager can oversee the process of avoiding defaults, I decided one mutual fund would do the trick. For more sizable chunks, I’d hire multiple managers or switch from a mutual fund to individual bonds.

Why is it important to determine these three criteria first?

Like deciding which size ice cream cone you’re getting, it’s best to look at your current situation, or waistline, first. Plus, there’s another, overreaching reason:

I’m lazy.

Could you imagine the horror of searching through a gazillion mutual funds in a trillion different asset classes to find the one that fit my needs? Why would I spend countless hours oogling different investments I’ll never buy. I want to narrow the search as much as possible before investing. Why waste all that time I could be watching Cake Boss or Millionaire Matchmaker sorting through countless asset classes that I’ll never use?

I’m not going to waste time searching for investments. I’ll figure out the map first and then choose the right vehicle to get me to my goal.

…and that, class, is how we reached this point: choosing the vehicle.

Let’s begin.

My search began at TD Ameritrade. That’s because the IRA holding the cash I was going to use is housed there. If you’re not familiar with IRA custodians, you have a choice between many different places. Some decide on a bank, others a financial brokerage firm. I chose TD Ameritrade because I’m comfortable choosing investments alone but appreciate their stock and bond tools. They aren’t the cheapest provider, but I’m comfortable with the fee structure.

Fees

 

Just like a trip to the grocery store, every asset search begins with a discussion of “how much is this going to cost.” In many cases, I don’t want a mutual fund at all because they’re expensive, but in the high yield asset class, I want one. I don’t want to guess if one of the companies I own is going to go bankrupt. I also don’t want to do the homework necessary to avoid picking a loser (remember the lazy part above?).

Some mutual funds manage your cash for a reasonable fee, while others might as well be carrying a gun and wearing a mask.

But they’re not the only robbers.

It turns out that TD Ameritrade also is in on the “let’s gouge our customer” game. They’ve forged deals with some fund companies to offer their mutual funds at a lower cost. To tell you just how much lower, I was originally eyeing a Pioneer high yield offering. Imagine my surprise when I found out that I’d have to pay $49 when I bought AND AGAIN when I sold. Ouch.

As an aside, why not just round this ridiculous fee to $50? Wouldn’t anyone dumb enough to pay $49 shrug at a dollar more? If they want to play the psychological game make it $49.99. They’re leaving $10 on the table. I should work for TD Ameritrade…..

 

Screening: Expenses

 

So, armed with the list of funds that are available on my platform, I visit TD Ameritrade’s mutual fund screener site. There are many of these all over the web. The Wall Street Journal has a good one, as do Morningstar, Yahoo and MSN.

I used TD Ameritrade’s own screener for one reason. The first screen for me should be called “funds that avoid the ridiculous fee.” Because that’s too obvious, they named it, “No trading cost fund list.”

Screening: Manager

 

The second screen is for manager. If I have a manager at all, I want one who’s a little seasoned, but different than most investors, I also don’t want one who’s crusty. A fund manager nearing retirement might be milking her reputation at this point. Well-known managers such as Bill Gross at PIMCO are going to survive a couple down years with their portfolio if they decide to take a mental vacation at this point in the game. I don’t want that person.

I want them hungry.

There is no “avoid managers who have been around too long” screen, so I’m stuck using one based on minimum tenure. I don’t want one with less than three years in the saddle, personally, so I choose that screen.

Screening: Star Rating

Like I said, I’m lazy. I want Morningstar to do most of the heavy lifting for me. Although I’m smart enough to know that many lower-ranked funds could do well next year, I don’t have the time to search through them all.

In other areas, where I’m looking for more than a consistent dividend check and a fairly stable value, I might screen for more complex areas. In high yield, that’s it.

I press the “search” button.

Examining the List.

Now I feel like a kid in a candy store. Laid out in front of me is a shortened list of candidates for the title of “good enough to examine up-close.”

My attention now turns to fund evaluation company Morningstar, where I’m going to dig into each fund in detail.

I’m particularly interested in:

  • how each fund performed against it’s competitors,
  • what the dividend looks like, and
  • how the fund is managed.

I dig into these areas quickly. Simple internet searches lead me to mines of information. I’m too lazy to waste time flipping through funds, but when I’ve found my potential targets, I dig in like a rib-lover at the barbeque cook-off.

What Did I Choose?

Ultimately, the USAA High Income Fund won the day.

Why?

For an average fee of .90%, the dividend to me approaches 7% (6.93% as of this writing). The fund manager, R. Matthew Freund, has 21 years of experience (with USAA since 1994), so is mature yet not quite at retirement age. There’s been a co-manager named Julianne Bass since 2007, so there is younger blood overseeing day-to-day operations as well.

The fund has beaten the high yield sector over the past five years, but not by a ton. For the most part this fund’s performance has been slightly above or below the index. When it’s missed, it missed well above its asset category. It hasn’t had a major hiccup.

At this point, I like to guess what I’d rank the fund. I’d give it four stars out of five. It’s a winner, but not a thoroughbred. It won’t be the “hot thing” anytime soon. Perfect for this job.

Morningstar agrees, rating the fund four stars out of five. It’s an above average competitor with average fees and solid management.

Perfect. Often five star funds attract scads of assets, forcing me to look elsewhere as the management can’t invest all of the cash it’s attracted. I’m less concerned with the management of the fund over the past five years as I am over the next five. Because this fund isn’t meant to be the “go baby go” part of my portfolio, I’m fine with boring. In fact, I expect it and hope for it. Let’s get my 7% return so I can focus my energy elsewhere.

That’s how I picked the fund.

Complex? Nope.

I’d be willing to bet that this little 1000 word example is more homework than 95 percent of people complete when choosing investments. Even if a professional picks funds for you, there should be a list of screens you use to oversee picks.

It’s your portfolio. Take charge. It isn’t difficult.

(photo credit: Statue, Eusebius, Flickr;

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High Yield Bond Investing for Beginners

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Imagine investing in a fund that built bigger and bigger dividends until you were ready to use them. Sound good?

I’ve always been a fan of high yield bonds as an asset class for this reason. My clients and I earned solid results by investing in these products.

Today, boys and girls, we’ll explain what a high yield bond is, how it reacts to different pressures and the method I’d recommend to buy a high yield bond if I were a beginner.

 

What is a High Yield Bond?

 

Let’s begin with the word “bond.”

Most people are comfortable with the idea of a stock. If you own stock in a company, congratulations! You are now the proud owner of a piece of that firm. How will you make money? Like any company owner, you’ll generally come out ahead as the company’s business prospects improve. If the company takes a downturn, you could stand to lose your entire investment.

A bond is better for people who don’t want that roller coaster ride. Instead, bond holders are more comfortable loaning a company money. The company gives you specific terms (for example: five years at a six percent interest rate), and you agree to loan them the money.

In essence, you aren’t a company owner. You’re Louie the Loan Shark. Sweet!

How Do I Decide Which Bond to Buy?

 

Well, Louie the Loanshark, what’s the first question you’re going to ask if you’re loaning someone money?

That one’s easy: How likely is it that I’ll get my money back?

In the case of High Yield bonds, it’s pretty shaky. If these companies were regular people, they’d be the type that’ve had their American Express Card taken away and their house payment is two months behind.

When I said Loan Shark, I meant it.

So, when you see bad credit, what do you do? You jack up the interest rate. If I’m going to risk my money, I’m going to need to see a good return. High yield bonds are the highest returning bond type on the market. You’ll receive much higher returns than any other type of bond because you’re taking more risk.

High yield bonds used to be called junk bonds. To dress up the category, somebody decided “high yield” was a prettier name. I’d agree.

 

Is This Category Too Risky For Me?

 

Maybe. It depends on your goals. But let’s mitigate the risk of buying a single bond.

If you’re a new investor, I wouldn’t try to purchase an individual bond (loan money to one company). Frankly, the risks in that arena are too high for a beginner, unless you’re completely open to the risk of losing all of your capital.

In this case, I prefer a mutual fund. With a fund you have humans buying and selling positions on the open market. Fund managers diversify the portfolio like an ETF would, but also can sell when a certain company starts to turn for the worse. You don’t want to worry about that.

 

Let’s Talk About Performance and the Dividend

 

In high yield bond funds the dividend usually is classified as interest, so this asset class is best used in your tax sheltered plan (RRSP or IRA).

First, you can expect the value of your fund to fluctuate. With a high yield bond fund, I’ve always considered this the roll of the ocean. If I still own the shares  and they’re pumping out a dividend, I have one goal: make that dividend grow.

Therefore, I reinvest dividends.

That purchases more shares, which I reinvest in the mutual fund. I’m always looking at the size of my dividend payment that’s reinvested and asking “is it large enough to supplement my income yet?” Until it is, I continue to reinvest.

One of my clients pretended the dividend was a little man who worked alongside him each month. Every dividend would head back into the factory to help make the next payment a larger amount.

 

Popular High Yield Bond Investor Questions

 

How much should I invest?

With any investment, you begin by finding the return you need to meet your goal. For some investors, high yield bonds will be too risky for their portfolio. For others, they’ll need growth in their portfolio and high yield will rarely give you huge returns.

How risky is a high yield bond fund?

I present the risks of a high yield bond as “high” because I want investors to understand the risk versus other bonds. However, on a long-term risk/reward pyramid, high yield bonds are less risky than large cap stocks. If you’re comfortable investing in stocks, a high yield bond mutual fund historically has been less risky.

If I Don’t Have an IRA or RRSP Should I Still Invest?

I prefer to use tax advantaged investments outside of a tax shelter and tax-creating assets inside of shelters. High yield bonds are heavily taxed when compared to other asset classes that earn a similar return. You can use a high yield bond mutual fund outside of a tax shelter, but realize you’ll pay more tax than you will with many other investment classes.

How to I Find a Good High Yield Bond Mutual Fund?

Read our pieces on using Morningstar to find good funds:

Part I: Researching Mutual Funds (or how to cure insomnia)

Part II: Evaluate a Mutual Fund in 10 Minutes

 

Not only will you see past performance, but this website will tell you about fees and how much you’ll need to invest to meet fund minimums.

 

(Photo Credit: Payday Loan Store, Swanksalot, Flickr; Loan Shark, Jesse Wagstaff, Flickr)

 

Okay, that’s my story. Do you use high yield in your portfolio? Are there criteria or tools you use to choose high yield bonds that are appropriate for a new investor that weren’t presented here? We’d love to hear them.

5 Good Reasons to Hire a Financial Advisor and 2 Bad Ones

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The decision to hire an advisor to help with your financial planning isn’t a step I recommend lightly. I’ve been lucky: over 16 years of practice I was hired mostly for good reasons, although some others were….not so much.




Most people don’t need a financial advisor.

I’d tell individuals before they hired me that 90 percent of what I did, they could do themselves. My job was to guide them through sometimes stormy financial waters. As a bonus, I’d save them time and money by already knowing tricks they could probably find online. My staff would fill out annoying paperwork, and we had access to the best professionals in related fields. If you needed good advice, I either could provide it or knew how to find it fast.

In fact, at some points I was more of a concierge than a financial advisor….while most of my contacts were finance-related, I knew good babysitters and how to get a table at the top restaurants in town!

Here are five good reasons to hire a financial advisor:

 

1) You don’t have time.

I worked with many successful people who could have easily completed their plans alone. Most of my clients were engineers or executives working for Microsoft and Chrysler. These were intelligent people (often financially savvy, too).

They recognized that they needed a good plan drafted that they could examine and sign off on. They also needed someone to facilitate the legwork. It had to be someone knowledgeable who had their back. They needed to be able to review everything on a plane or between meetings.

 

2) You aren’t going to look at the stuff yourself.

Some of my clients were smart people, but in completely different areas. I had a client who was a very well-known artist. He needed to be forced to have consistent meetings about his meetings. Without me, he wouldn’t ever review how he was doing.

 

3) You don’t want a full financial education.

This type of client would sometimes frustrate me, but I had a large number of them as clients. Different from my artist and executive clients who were generally well educated, financially savvy people, these clients would just rather pay me to do it.

These clients were very happy to meet with me and talk financial planning. They’d listen and nod. I was pretty sure that they were getting the basics about what we were talking about. I tried to keep it entertaining, because I knew they hated being in my office.

Some were looking for the concierge treatment. For those people, we had client dinners, good coffee in the lobby and occasionally went to sporting events or concerts. They didn’t care about how the money was managed, as long as it was done with as little input on their end as possible.

These clients sometimes scared me, because if things went wrong, they had no idea why and didn’t want to learn from anyone but me. If this sounds like you, it’s better to hire a good advisor than wreck your financial ship because nobody’s at the helm.

 

4) You want a smart coach in your corner…

…to steer your plan in the right direction.

Some of my clients I knew were only going to be with me for a short time. My job was to educate them how to do it themselves. Some advisors won’t do this. I was happy to help. I liked talking strategy anyway, so if I had a willing client who was coachable, I’d take them through the process. As a bonus, I handled most of the annoying parts (like filling out Roth IRA forms) because they were paying me a fee. It wasn’t why they wanted me as an advisor, but it was definitely icing on the cake.

 

5) You want an ally to point out flaws in your strategy.

This was probably my least profitable type of relationship, but the one I appreciated the most. I had a few Do It Yourself investors who already had a complete strategy and just wanted to hire me for a couple of hours a year so they could tell me their strategy. I always had questions, then feedback, and nearly always, adjustments I’d recommend.

One client, Paul, said he specifically hired me because our philosophies clashed and he wanted to make sure his strategy looked good from the other point of view. He thought about his plan so often that he usually had a winning approach, even though I definitely would have rarely completed the plan the way he did.

 

 

There are a couple of important reasons NOT to hire an advisor:

 

1) You want someone to do it for you.

There’s a subtle difference between this person and the one in #3 above. The person in #3 was happy to meet with me every few months and talk about money. They wanted some small amount of “here’s why we’re doing this.”

Then there’s the person who just wanted “take this cash and make it work.”

I care about my former clients. I never can care about your money more than you do. I’m the money babysitter, you’re the parent. Act the part.

 

2) You want to day trade with a partner.

I had two clients who could never get through their skull that I was very happy that they day traded…but leave me out of it.

Initially we’d separate the portfolio into two sections: the “long term investment” portion, that I’d help steer, and then the “play money” portion that they’d day trade. I’d make clear that they were on their own with the play money account.

Invariably, these two clients would call in a panic and tell me that Jim Cramer had just said something on television and they needed to sell…but what did I think first? Should they sell? Should the go contrarian and buy more? Could I look up some charts for them? Maybe call a couple fund managers and ask their opinion off the record?

No thank you.

The math on my practice worked this way: 150 families, all of whom paid for and should demand my attention.

If I met with each client on average 3 times per year for an hour and a half, that meant 675 hours of meetings. Additionally, I’d call each client twice a year minimum and talk for 20 minutes (assuming there weren’t urgent financial events afoot or you hadn’t called me first). That was another 50 hours.

We won’t even approach all of the emails I sent or returned daily. Remember that I mentioned Microsoft employees? Those people love email.

After 10 hours of preparation time a week and 10 hours of strategy/internal and analysis time (not to mention any marketing we were doing), that left 30 hours for client meetings. After holidays, I worked about 48 weeks a year.

Where was I going to find time to day trade your account?

 

 

That’s my story. Now it’s your turn: have you interviewed advisors? How did the meeting go? What did you like/didn’t like about their approach?

 

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College Savings Simplified: The Best Places to Save Money For Education

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While I tend to do things the hard way, finding college savings isn’t one of the areas where I complicate a task. For some reason, my sixteen year old twins helps me focus on whether a 529 plan, Roth IRA, or savings bonds will treat me right.

So, even though I’ll generally remember to add softener to the washing machine just after it’s finished, I understand how college plans operate up and down.

If you’re saving for college, it’s important to categorically work through the details of each plan to determine which best fits your needs.

…because there IS A right way to save for college, and a wrong way to save.

The bad news? The BEST way to plan college savings differs depending on who you are and what your circumstances may be.

I know that sounds generic and evasive, but it’s true: the best way to save for college will depend on your own income, current savings and college goal, so the best course of action will be this:

Know what plans exist and how they’ll affect your ability for financial aid before investing a dime.

If you haven’t yet, you should read the pieces on:

– 5 Steps to a Successful College Plan – This will guide your plan of attack when creating a college plan.

– Narrow Your College Search – This will focus your college search to those schools which are the best fit, both financially and for your particular interests.

After reading these two thorough primers, you’ll be armed with an idea of the cost and feasibility of your favorite school.

 

Let’s now save for the goal: education.

 

Complicated Ways to Save For College

 

Some methods of saving for college are so fraught with risk that I’m reticent to ever recommend them to people. That doesn’t mean that these college savings plans are bad; on the contrary, they all have some huge upside potential, provided that all the right conditions exist. Here are a few:

 

In-State Tuition Reimbursement Plans – Many states offer plans which reimburse the cost of college credits at a later date. This can be a fantastic way to lock in the price of a college, provided that everything goes according to plan.

Upside: Paying today’s rates for in-state public institutions. Don’t have to worry about market conditions or returns on investment.

Downside: Have to worry about state plan solvency. More than one state has already notified participants that they might not be able to meet their obligation. In fact, some plans no longer guarantee that your dollars will lock in present rates. Instead, these plans invest your money with state funds. Who wants their state government as a money manager?

 

 

Life Insurance – Some life insurance plans, such as whole life and universal life are presented as attractive options for education savings vehicles.

Upside: These plans are financial-aid friendly. When completing a FAFSA application, money inside of life insurance policies doesn’t count against your savings, acting as a nice shelter. Also, if for some reason the insured passes away, money is available for education.

Downside: You may have to cancel your life insurance policy to withdraw education funds. What if you still need the policy? Also, do you really need life insurance? If the answer is yes, and you’re sure that you will no longer need coverage after this incident, then this might be a good option.

Watch out for fees, too. Not only will you pay for insurance, but often a policy which offers stocks and bonds are filled to the brim with fees to manager and (maybe more importantly) to withdraw funds.

Still want life insurance in your account? Read this good article at FinAid.org for a more in-depth argument: Variable Life Insurance Policies.

 

Annuities – Tax deferred savings may seem like a good option for education planning. Why save into an account that’ll be taxed every year when you can shelter your money?

Upside: These accounts are FAFSA friendly, meaning that they are not usually counted in the equation for financial aid. Many annuities offer some flexible savings options.

Downside: Too many to mention here, but mostly: fees and penalties. Make sure you’re going to be over age 59 1/2 before you remove money, because if not, there’ll be IRA penalties on top of whatever the annuity company may charge.

Taxes can be a bear. Here’s why: when you withdraw cash, dollars in the account are removed in a LIFO (last in-first out) accounting manner. This means that all interest on the account must be taken before principal is removed. Why is this a big deal? Taxes. You’ll pay taxes as if you earned the money in the year you remove the money. This income may also make your chances of receiving financial aid worse in the following year.

 

Less Complicated But FAFSA or Tax Return Unfriendly

 

Stocks or Stock Based Mutual Funds – These accounts can be used whenever you wish, assuming the dollars aren’t inside of a tax shelter. In some years there’s a chance of nice returns, too.

Upside: Returns. While there are no guarantees, over long periods of time the instability of a stock or stock-based exchange-traded fund or mutual fund can be countered with a high average annual return.

Downside: Risk. There is a chance you could lose a substantial amount of principal if you don’t monitor or manage your money. Also, this type of investing isn’t FAFSA-friendly. Dollars that aren’t sheltered count directly against your chances of financial aid.

 

 

 

Bonds or Bond-Based Mutual Funds – More stable than stocks, these types of funds have performed attractively over the last ten years.

Upside: Returns with generally less risk than stocks above. Because bonds throw off dividends as one of the main methods of creating returns, these investments often perform more consistently than stocks.

Downside: Taxes. Bonds often throw off an attractive dividend that savers often reinvest. This money, unless it comes from a special type of bond such as a municipal bond fund, is taxable every year, slowing down your return. While there has been tax reduction with capital gains taxes, these are taxed as income, which is a much higher tax bite. These are also FAFSA unfriendly investments, unless you use government savings bonds. These can be good to you tax-wise, as long as they’re titled correctly and cashed in the same year as you’re paying qualified education expenses.

 

The Easy Way To Save For College

 

Roth IRA Plans – A Roth IRA is generally a retirement savings vehicle. Money invested gives you no tax benefit today, but can be taken tax free during your retirement years. You’ll have to follow a few rules, but you are allowed to withdraw funds for college. You may also use nearly any time of investment you choose inside of a Roth IRA.

Upside: Tax shelter. This money can grow tax deferred for education, and if you end up not using it can be used later for retirement, tax free.

Downside: Retirement savings. The best use of a Roth IRA is clearly as a retirement savings vehicle. While money can be used for college, why miss out on the main Roth opportunities around retirement?

 

Coverdell Education Savings Accounts (ESAs) – These plans allow you to save not only for college, but also for earlier years of private school expenses.

Upside: Flexibility. This tax shelter allows you to use money for many types of education options, so it’s great if you’ll have elementary, high school and college savings needs.Classroom

Downside: Funding. Man, these accounts are small. Because you can only place $2,000 per year into this type of account, they often don’t make sense. I’d also meet people with very limited funds in a few different Coverdell IRAs. Who can manage all these little accounts effectively?

The IRS page on Coverdell ESAs is very helpful. Find more details here.

 

529 Plans – State sponsored education plans offer a good tax shelter, are somewhat FAFSA friendly, and eliminate taxation of dollars as long as funds are used for qualified education expenses.

Upside: Amounts of savings. You can pack tons of money into these plans. Most allow as much as $300,000 to be invested into a 529 account. These accounts can either be in self-directed fund options or can be in age-based options. If you don’t use the money for the primary beneficiary, funds may be used by siblings, parents, children or other close relatives. In these plans your choice of education institutions isn’t limited to a single state. You may use these dollars in any state and still receive the tax benefit.

Downside: Money earned in a 529 plan must be used for education expenses or you’re slammed with penalties. If you aren’t sure about saving for college, funding your Roth IRA first might be a better idea, because while these funds are flexible for college funds, money will be trapped here.

 

Of these, the savings option I like best is a 529 plan, because of its flexibility, range of schools that accept funds, and tax treatment. While it isn’t best for everyone, for the vast majority it’s where you should save for college.

 

Here’s How To Evaluation 529 Plans

 

Just like we’ve told you previously that Morningstar is the best way to evaluate mutual funds, I like savingforcollege.com to evaluate 529 plan options.

Here’s a link to savingforcollege.com. Have a look around to see how thorough this site is on investing for education.

The Good – Lots of information on FAFSA and college savings options. Great reviews on the fees associated with 529 plan savings accounts.

The Bad – While fees are certainly important, I’m about returns. Savingforcollege.com does a poor job of comparing how money managers work unless you’re willing to fork over some money for a premium membership. When compared to more robust money management sites such as Morningstar.com, there’s no reason to pay for this information.

 

Can I recommend a single-best 529 plan?

 

Absolutely not.

Check your state’s plan options at savingforcollege.com to see how they stack up. Always evaluate a few national plans to see how they compare against your own state’s options.

My favorite national plan is UPromise, though I also like the T. Rowe Price option.

Why Upromise?

I’ll attack this next week, but here’s a preview: not only is the plan managed better than most options available, but if you sign up your credit and debit cards, but using the Upromise Rewards program (which you can sign up for whether you use a Upromise 529 plan or not) you’ll receive points which can translate into extra money into the 529 plan later. Combine the benefits of low cost investing, good management and extra money, and you’ve found a plan that’s hard to beat.

If you want to compare Upromise with your state’s plans, here’s a link for more information: Upromise is the smart way to save for college!

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When Charts & Graphs Lie

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Today is Part II of our discussion on charts and graphs. For Part One, you’ll want this link to:

Boner of the Week: Have You Been Lied To By Charts and Graphs

Sometimes, before jumping into an argument on how you feel about data presented in a graph or chart, it’s a good idea to focus on whether the data presented is actually showing you something truthful.

Our friend PK at dqydj.net (which is a fantastic blog on economics, politics and investing), helped us out with his wizard-ly chart skills and created a graph that hid four lies.

Here it is again:

DQYDJ1UnemploymentRate

There are FOUR lies PK is telling in this graph. Did you guess all four?

Okay, let’s reveal them:

 

Lie #1: Long Trend Line

 

Marketers are funny. They’ll draw some pretty long-range conclusions from very short term data. That’s true in this case. PK has taken the general line from October 2011 to December 2011 and—as if using a ruler—decided the next several months would follow similarly.

How does this apply to your financial picture?

– According to Bloomberg Businessweek, the stock market has had it’s best run in 23 years to begin a year. It’s a mistake to think that less than 40 days of good news will create 365 days of stock market bliss.

– Often, government statistics are revised. Basing any financial move on short-term and possibly short-lived data could wreak havoc on your financial life.

Lie #2: Small Sample Size

 

Check out PK’s graph again. He’s basing the entire graph on FOUR MONTHS of data before he gives you the equally tragic long trend line. In politics, where trends seem to change every three minutes, people often draw conclusions about an election many months into the future based on short term data:

– After Huffington Post (among others) reported on Rick Perry’s quick surge in the polls, articles such as this one that appeared in The New Republic—declaring that Rick Perry is going to be hard to beat—dominated editorial pages. There were only 15 days between the Huffington Post “surge” article and the “he’s probably gonna win” New Republic story. I wonder if any of these writers ever go back and read how reactive this seems several months later? Probably not, because using a small sample size to predict future results sells subscriptions.

– In the financial world, marketers of securities predict the bottom of an investment based on short-term data. It also holds with bloggers. Check out these predictions from the website Trading Authority. In the commentary, the “expert” uses short term data to predict an upswing in these stocks, predicting they “Could Jump 50 Percent”. Wow! Sounds like returns I’d love to have in my portfolio.

 

How did he do? Let’s look:

 

 

TradingAuthority Predictions on 6/3/2011
TickerPrice 6/3/11Price 2/5/12Change% Loss
SCHW16.7612.74-4.02-24%
WFR9.645.39-4.25-44%
GHL51.5547.61-3.39-6%

 

Ouch.

These results weren’t graphed, but both the “Rick Perry is Uncatchable” and “These Stocks Are Going to the Moon” cases could easily have been presented to an unaware public in chart or graph form to make a bigger (untrue) statement.

(By the way, finding this site wasn’t hard. I just performed a Bing search for “Upturn in Stock That Failed” and clicked on the first link that matched what I was looking for.)

The point? Don’t take short-term results and use them to predict long-term trends.

 

Lie #3: X Axis Compression

 

If you want to take fairly small results and turn them into “Wow!” returns, just compress the graph. Look at how thin PK has made this graph by squeezing months together across the X (bottom) axis. That “black diamond super difficult ski hill” drop would look more like a “bunny hill” if he’d stretched the graph across the page. Since your eye is drawn to the slope, a skilled marketer will change the degree of descent to reiterate whatever point she’s making.

 

Lie #4: Y Axis Stretch

 

Similar to lie #3 above, marketers will stretch data across the Y Axis (up/down) further to prove that there is far more movement than there truly should be.

– Beware people showing a stock “bouncing around” and then showing a chart which stretches the distance between prices.

– Remember, the inverse is also true: If a marketer wants to show a position as safe, they’ll compress the numbers to reduce the perceived volatility.

 

Here’s the Actual Chart PK Started From

 

DQYDJ2natlunemployment

 

 

The actual Bureau of Labor Statistics-derived chart has little in common with the “trend” chart we displayed above. But because PK wanted to show you quickly declining unemployment, he was able to manipulate this (true) graph to create a very, very wicked lie.

Want more on avoiding manipulative charts and graphs? Try this book: How to Lie With Statistics – get it for $7.44 at Amazon.

charts and graphs
Amazon

Okay, that’s my story, now it’s your turn. Have you had to create graphs you knew were “untrue” in your work? Have you been presented with graphs that weren’t completely accurate? How many of PK’s tricks were you able to find before reading today’s post?

(I’d like to again thank http://www.dqydj.netfor his help on this two-part series. I wish I had his ability to show timely and accurate charts like he and his partners have at dqydj.net. For more great charts, graphs, politics, economics and investment discussions, visit his website.)

Emergency Fund or Roth IRA?

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If you’re teetering on the edge of a trip down investing lane–but aren’t sure that you’re ready to begin locking money away–a Roth IRA just might be like two tickets to paradise. Pack your bags, we’ll leave tonight.

I just made that up. I know it sounds familiar. Deal with it.

Unlike its nasty cousin, the “For Retirement Only With a Couple Exceptions” Traditional IRA, a Roth has some attractive properties for people who need money in a safe place but are thinking “I’d like to start slipping some cash into a retirement account.” Two tickets to paradise.

Of course, this paradise has some weeds, but what do you want? I never promised you a rose garden.

Just made that up, too. I know…it’s a gift. Thank you.

 

Paradise Ticket #1: Emergency Fund

 

While it still makes absolute sense to have “need it right now” money outside of a Roth IRA, here’s the magical property that makes this shelter a fine second tier cash reserve emergency fund: you’re allowed to take principal back out whenever you want. If you remove funds contributed during the current year, it’s as if you’d never made a contribution in the first place. If it’s beyond the first year, you may take out up to the amount you’ve contributed.

That’s awesomesaucewithacherryontop because if you need money quickly, there’s no reason why you can’t access the cash you contributed.

Before you fight me on this, let’s work through it logically:

– When you make a Roth IRA contribution, do you receive any immediate tax benefit? No.

– How can the government penalize you for something that you received no benefit from? They can’t.

You want proof? Okay, here’s the IRS applicable document, Publication 590, Individual Retirement Arrangements. Check out the chart on page 63 and then the ordering rules on page 64.

More proof? At the bottom of the page I’ve included links to two less well written articles than mine. No charge.

When will you get into trouble? If you try and take any interest the account has earned, you’ll pay penalties to receive this interest unless it’s been in the account for five years and you’re 59 1/2 (whichever is later) OR qualify for one of the few exceptions to the penalty (you’ll still pay tax on the money when you withdraw it).

 

Paradise Ticket #2: Retirement

 

If you don’t end up needing the money, because your car didn’t break down, junior didn’t need to be bailed out of jail (again), and the dog stayed out of your neighbor’s trash bins for a change, this money can be used for retirement. At some point, once you’ve completely secured the reserve, you can switch these funds into more appropriate investments for retirement.

Ultimately, of course, this is what a Roth IRA should be used for: retirement savings. By easing into the Roth IRA plan, you’ll build the account early so there’s plenty of money available when you’re ready to begin in earnest.

Like Steve McQueen you’ll have a fast Roth IRA machine and they’ll never catch you tonight.

 

The Downside

 

Oh, yeah, you weren’t thinking about having a Roth IRA as your only emergency fund, were you? A Roth IRA is, to put it bluntly, an absolutely rotten place for a first tier reserve.

Here’s just a sample of our problem:

–  Remember when I said you can get money in a hurry? It’s not like the payday loan shop down the street or Louie on the corner. If your money is at an institution close by (like a neighborhood bank), you can probably take out funds now. If not, you’ll either have to wait for money to be transferred to a non-IRA account or until they can mail you a check. That’s not instant money. It’s “we’re going on an emergency trip to visit ailing Grandma in her cottage in the woods, and I paid for it with my credit card but don’t want to pay interest on the charge” money.

– If you take out all of your principal, you’ll only have some interest in the account. This money MUST stay in a Roth IRA for five years or until 59 1/2, which ever is later (as mentioned above). To take it out early, you’ll pay an IRS penalty. Although this may be a negligible amount on a small interest amount, it’ll make your tax return more complicated.

For these two reasons, I wouldn’t start a Roth IRA as your main emergency fund. Instead, only use it as second tier money.

 

What Type of Investment Should I Use, Joe?

 

It’s your cash reserve, silly. We don’t want to use anything that fluctuates at all. I know interest rates are poor, but if you’re only beginning, you’ll need the highest paying account the bank will allow while still keeping your money safe.

Don’t lock up the funds in a CD or you won’t be able to access the money, ruining why you used this strategy in the first place. It has to be a liquid account, like a savings account.

Once you have enough, transfer your money to a higher paying money market. Often this is between $500 and $2,000.

As soon as your cash reserve emergency fund is full, begin saving money into real retirement accounts that match your long term goals. Use a 401k for tax advantages today. Open a 529 plan for your children’s college.

Before long you’ll have so much cash they’ll be lining down the block just to watch what you’ve got.

So delicious.

 

How to Get Money In There Without Stealing It

 

The only way you’ll successfully save money is if you leave it outside of those pockets of yours. You know the ones. The I-can’t-hold-cash-for-longer-than-a-couple-minutes-without-spending-it pockets. Instead, make saving a bill.

Better yet, make it an automatic payment bill.

By setting up an automatic payment into your account you won’t have to remember to fund your account. Instead, money will flow directly from a checking or savings account into the Roth IRA, building it while you focus on other areas.

If possible, set up a separate direct deposit into your first tier reserve at your bank and then an automatic payment from the first tier reserve directly into the Roth IRA reserve account. That way, you’ll never have the money in your hot little hands.

If you want money in your hands AND to make Roth IRA contributions systematically, it’s going to be much harder, and there’s a good chance you’ll fail.

You can’t always get what you want. But if you set up an automatic payment plan you just might get what you need.

 

A Good Strategy

 

Once you’ve achieved your first tier reserve ($1,000 fast if you’re a fan of the bald dude on the radio, or other similar “quick cash” amount), split your automatic investment between your first tier reserve and a Roth IRA. This will help you ease into the investment world without the fear that the money is untouchable.

I’ve used this plan with nervous beginners to help calm them into rolling toward doing the right move: investing in their 401k where the money IS untouchable. It’s a good way to ease your mind.

…and before you know it you’ll be on your way to a million dollars. Then you could buy yourself a green dress.

But not a real green dress; that’s cruel.

No, I can’t stop.

 

 

Other Documents That Totally Agree With Me:

The Motley Fool: All About IRAs

My Money Blog: Can I Really Withdraw My Roth IRA Contributions at Any Time Without Tax or Penalty?

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How to Think Like an Old, Crafty Cat

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Yesterday ended The Cat Picture Stays Up For 7 Days Protest. I know, it felt like 8 days, and maybe it actually was, but our timing here at the Blog has always been less-than-stellar. I scored my first 8 track player in 1982, right as cassettes were becoming popular. I heard a rumor that you can heat up food using some microwave machine now. Just sayin’.

Why was there a protest? I’ve detailed part of the conversation, but here’s the rest:

Doug: I’m serious. Dog people hate cats. Don’t you think of those crazy cat ladies every time you see a cat?

Me: Dude, I own a cat. Are you calling me a cat lady?

Doug: I’d call you crazy, but you’d take it as a compliment.

Me: Touche’

Doug: People need to respect their financial professionals. Dog people won’t respect you if you’ve got cat pictures all over your site.

…and that’s when I decided the silly picture I’d only stuck on the blog page as a placeholder was going to stay up for 7 whole days. In spite. For no real reason. Surely not to offend “dog people”, but maybe to prove to Doug that though they may not respect me, BOTH of my readers will stick by the site, even with a cat picture or two.

But minions, you know I can do better than that. MUCH better.

SO! My friend Emily Hunter, from MillionWaysToSave.com has agreed to write a Goodbye To The Cat Picture tribute piece, discussing the myriad of crazy things cats can teach us about financial planning. This is our FIRST guest post on the AverageJoe Money Blog, so please give a big, warm welcome to Emily! I’d like to dedicate this piece to my good friend, Doug.

******* ******* *******

I recently wrote a post about how to plan your financial life like a kitten, because kittens are fearless, brave, and bold.

…but a case can be made for the opposite: sometimes it’s far better to be the wise old cat. Here’s how:

Move with Deliberation
Have you ever noticed that the old cats wait until the red dot of the laser pointer is nearly upon their paws before they pounce?  They calculate the move, waiting for minutes until the time is right for their finely honed claws to sink into the imaginary irritation.

With your financial picture, planning is absolutely essential if you’re going to formulate and maintain a path toward financial freedom.  Deliberate on all of the consequences, then move.

Teach Others
When faced with the nearly boundless energy of a kitten, an older cat will do one of two things: tell the kitten that it wants to be left alone, or teach it in the ways of felinity.  After all, the older cat has been around for years and is knowledgeable about  the ways of the world.

As someone on the path to your own financial freedom, you’ve learned a number of things along the way (and maybe the HARD way).  You’ve learned the zen of budgeting.  You’ve found some great online tools to use for your purposes.  You’ve probably even learned the folly of having a rash spending week.  These are things that you learn through experience, and they should be passed to the younger generation.

Play to Strengths
Older cats have done their homework and already determined the best methods of finding goodies.  They have learned that their human really enjoys it when they curl up into a ball and expose their belly.  They have also learned that some play is good for pushing the agenda now and again.  As a smart older feline, learning these ropes was essential at the time, and you’ve practiced them to the point of superiority.

There are some parts of the financial path which you simply knock out of the park.  They were lucrative stock trades, coupon clipping forays that saved you a boatload of money, or timely budgeting that helped bring you peace and tranquility within the house.  Playing toward those strengths (though still retaining a tiny bit of that feisty kitten-like experimentation) is essential.

After all, if it really works, why do anything else?


Make FriendsMake Friends
Cats decidedly are NOT pack animals, but they do conspire to get the larger score when it suits them.  When there are other cats in the house, there is an initial play to establish dominance, but after that phase ends, they still have to live in at least semi-harmony with the new additions.  Each feline has its own personality, and there’s always the potential for learning.

Make friends with people who are on the same path as you, whether they’re financial bloggers, fellow mommies or people who like rainstorms.  They might be able to teach you some new tricks that will help speed your learning curve.  At the least, they will more than likely let you share your journey to make your days more enjoyable.

Lay in the Sun
Older cats have perfected the skill of sunbathing down pat.  They manage to capitalize on the largest, longest lasting sunny spot and milk it for all it’s worth.  They work as smart as possible to find this ideal position, and then only move when it’s absolutely necessary.  No matter the age, a cat is still adorable when stretching in the sun.

You’ve honed your skills to the point where you believe that you can take a brief rest from the never-ending pursuit of financial freedom and financial relevancy.  As you become an older cat, you will be able to take breaks and truly enjoy the knowledge and wisdom that you have accrued.  There is NO sin in laying in that sunny spot for a day or two and reaping the rewards. Find your dream space and bathe in it. You earned it, baby.

Whether you are a kitten or an older cat, there is always something to learn on your path to financial freedom.  While kittens may be simply adorable, they lack the knowledge to contemplate complex strategies beyond where their next pouncy toy might come from.  Older cats seem to laze around, but it’s deceptive. Maybe the older cat appears to be sitting too long, watching the world pass him by….but just maybe he’s figured out the secrets of the universe.

That’s my story, now it’s your turn:  What type of kitty are you?

Photo credits: (Cooper sitting on my damned keyboard: Me; Cat pouncing: Jennifer Barnard, Wikimedia Commons; Two cats sleeping: Ildar Sagdejev, Wikimedia Commons.)

About our guest author:  Emily Hunter is a for-hire writer and the principal blogger at http://www.millionwaystosave.com, an encyclopedic blog of ways to save money on everything from books to water. She lives in the south with one boyfriend, one kitten, and over a thousand ink pens.  To contact Emily directly, whether about this guest post or something else, send an email to justyammer@gmail.com.