How do you begin the long process of analyzing mutual funds? Easy! Start with the name. This week Joe & OG share tips and tricks to glean hints from the name of the fund that’ll tell you whether you should research the fund or dump it. It’s far easier than you think…..promise.
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The original article this podcast came from can be found here.
I love the sound of the cash register ringing, don’t you?
If you’re going to be successful in your financial life, treat it as if it’s a business and you’re trying to hear that awesome cash register sound. If you don’t, you’ll always prioritize yourself behind more “important” activities like your job (nevermind that the job is there to help your net worth…that’s probably the subject of another post).
Every business has a mandatory list of activities that can’t be ignored. So does your financial life.
Here are five items that MUST be on that list this quarter:
1) Mutual fund capital gains. Even if you don’t have mutual funds outside of an IRA now, you should learn how these rules work. When the manager (or system, for an index fund) trades stocks or bonds inside of the fund a capital gain is generated. Someone has to pay it, and there’s no real fair method, so the mutual fund company declares a date and divides the gain among shareholders of record. Even if you didn’t sell the fund, you’re responsible for your portion of the manager’s buying and selling.
With results so far in 2012 looking up, there’s a good chance you might get hit with a tax bill this year. Avoiding this tax is legal and easy. Find the dates the fund declares capital gains and transfer your money to a different fund in the same family. This avoids fees for switching and the manager’s capital gains tax.
Grab a calculator before you move any money. You’ll still be on the hook for capital gains taxes you generate by selling as well. The cost of switching might outweigh the savings you’ll realize from avoiding any taxes created by the fund manager.
2) The lemon drop. Hoping to skim off some of that skyrocketing Apple stock? Cover a portion of your capital gain by also selling your brother in law’s “can’t lose” loser. There’s no time like now to weed your portfolio of positions that aren’t going anywhere. Although you’re only allowed to show $3k in net capital losses each year, leftovers can be carried over to deduct in future years.
3) Charitable giving. Hopefully you’ve given to your favorite community non-profits throughout the year, but if not (and especially if you itemize), you’ll want to make cash and in-kind donations in before December 31. Keep receipts for your gifts. The IRS has tightened charitable giving laws in recent years.
4) Estimate your taxes and decide when to pay property taxes. If you own a home winter taxes are deductible either in December or January, your choice. Did you receive a big bonus this year? Take the extra deduction now to help lower your tax due. If you make too much, it might be a better idea to wait until next year. High income earners aren’t allowed to claim all of their itemized deductions (ask your accountant about whether you’re subject to phaseouts).
5) Goal evaluation and setting. The 4th quarter is the perfect time to begin thinking about your short and long term goals. Did you hit your benchmark in 2012? If not, what are you going to change in 2013?
While people generally talk a good game about benchmarking, most of my clients were surprised when I pulled the actual number out of their plan to see if they’d hit the mark during a year. By sticking with actual data and avoiding the “Yeah, it feels like I had a good year” you’ll be able to make the necessary course corrections to save the right amount of money in the upcoming year.
I’ll be addressing each of these areas in more detail during the course of the quarter, but do yourself a favor and schedule these tasks now. These are five activities that you don’t want to miss!
What other events are on your 4th quarter financial calendar?
There’s baseball season, football season, the holiday season and, of course, earnings season. While the first three may fill you with happiness and (in the holiday case) good cheer, earnings season fills new investors with confusion.
Why do I bring this up?
I woke yesterday morning to a nerve-wracking CNBC.com headline: Investors Brace for Shaky U.S. Earnings Season.
The good news: earnings season affects you directly, but not in the harmful way you may think.
Earnings season is the time (quarterly) when the majority of companies that move financial markets with their results declare how well they’ve performed recently. This news is for the prior quarter.
It’s important, when listening to reports about earnings, to listen for any future forecasting and to also determine what might have been the culprit behind a great or lousy prior quarter. If it’s increased sales on the same-old widget the company’s always sold, fantastic! If the company had a one-time mistake, things might still be looking up. If products just aren’t selling or management is quitting, it might spell bad news.
Corporate earnings reports drive the stock market. Sure, financial markets respond to other pressures, but over time the stock market is simply a reflection of the economy. So, if you reread the headline above, Investors Brace for Shaky U.S. Earnings Season, what does that really mean?
Based on the information I told you above, it means this: companies didn’t have stellar profits last quarter.
That’s not nearly as shocking a headline, is it? In fact, I’ll bet you already knew that.
Many investors read the CNBC headline above and think: I’ve gotta sell right now! If you’ve read my ramblings before, you’ll know that I think the opposite. I’m looking to buy when prices are low and sell when they’re high.
Here’s what I recommend instead of having a panic attack:
1) Rebalance your portfolio. Here’s how it works: if you’ve determined how much stock and bond exposure you want (among other asset classes), skim off the areas that have done well to fill in non-performing areas. Low markets are ideal times to rebalance because you’ll reaffirm your long term strategy, take gains from performing spots and redeploy in assets you already own that are low today. Smart move. Then, schedule another rebalance six months from now on your calendar.
2) Look for buying opportunities. If you’re interested in investing, shaky markets are a great place to place your first buys. Make your list of stocks to watch. Wait for earnings reports. Read what companies report, and make your move! Don’t make a common mistake and go whole-hog on a “can’t lose” investment. I’ve been involved with too many “can’t lose” things. I also told my dad I couldn’t lose my hair like he did. Glad I didn’t bet on that….
Not excited to make your own stock picks? Read our pieces on how to evaluate mutual funds and how Exchange-Traded Funds work.
3) If you’re nervous, put defensive measures in place. Use stop losses on individual stocks and exchange traded funds. Monitor fund results more frequently and establish a “worst case scenario” strategy. Remember this: never buy or sell everything on one day or at one time. It’s safer to march in slowly and march out slowly. An orderly walk toward the exit beats a panicked race to the door. Often, down markets rebound quickly.
CNBC, like other publications, is in the business of selling advertising. If the elevator is labeled “Up” or “Down” it’ll be a smooth and steady ride, but I’m sure CNBC knows that “Soar” and “Plummet” garner readers…and then advertiser dollars.
Yesterday I posted a riveting story about advisor fees.
How do you know all the fees an advisor may charge?
The good news: this isn’t my first fee-rodeo, so I’ve meticulously prepared and will present to you, hot out of the oven, a fee checklist. Now when you meet an advisor you can ask intelligent questions about what fees you may pay.
Isn’t this exciting? Of course it is. Let’s begin:
___ Advisory fee. This fee is an umbrella fee for services rendered.
What services are included?
Often advisors say they will recommend new homes for assets, however, those new places are through them, garnering the advisor another fee. Will they make recommendations of funds/ETFs/other investments outside of their control?
___ Wrap fees on personally managed funds. Sometimes an advisor will charge fees based on the percentage of assets inside of an account. Often, these fees range from 0.5% to 2.0% Remember that funds inside these plans have fees also, so ask what the average fee is for funds inside the account and add it to the fee.
___ Wrap fees on outside managed funds. Often advisors will recommend outside advisors to manage all or a portion of your assets. Fees generally range from 0.5% to 3.0% of assets managed, per year.
Wrap accounts are easy to remember if you think of plastic wrap around your assets managed in the account. Instead of trading and holding fees, you’ll pay the “wrap” fee on the entire amount inside of the wrapper.
__ Trading costs. Are there commissions for trades? What would those be?
__ Commissions to buy funds. Does the advisor use mutual funds? Are there fees to buy, sell or hold the fund? What are those fees?
__ Insurance commissions. If the advisor completes an insurance analysis, are you expected to buy insurance through them or do you go outside? What types of insurance does the advisor make recommendations on?
When I was an advisor, I’d recommend an insurance amount needed. Then I’d prepare quotes through companies I represented and recommended my clients shop other firms, such as Zander insurance (Dave Ramsey’s company).
__ Annuities, Private REITs and Limited Partnerships. Does the advisor recommend these product types? Do they receive commissions when they recommend these products? Annuities may pay up to a 9 percent commission. Often REITs (real estate investment trusts) will pay nearly the same amount to the advisor.
__ Cash products. Do you recommend savings accounts, CDs and other similar cash accounts? Are these through you, banks or credit unions? How do they work?
__ Mortgages, auto loans and revolving credit. Do you recommend these products for a commission?
__ Other outside experts. Should I expect to pay other experts, such as attorneys (estate plan) or CPAs (tax review)? If so, it’s important to know that there may be even more fees after you write your first check.
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:
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.
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…..
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.”
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.
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.
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:
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.
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;
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.
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.
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.
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.
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.
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.
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!
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.
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).
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.
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.
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.
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.
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?
Okay, play before work: when theOtherGuy and I were designing the new site last Friday, it was a total nightmare. I wanted to get the Blog Post of the Week! up before midnight (so that Andrea from SoOverDebt.com could get both of our reader’s attention). Running out of time, I just grabbed a pic of my blog-writing friend Cooper. My cat.
Yesterday, my friend Doug—who has a lifetime of tech work behind him–was commenting on the new site layout:
(finally) Doug: …and one more thing, get rid of the cat picture.
me: Ha!
Doug: I know you think I’m joking. I’m not. It’s a deal breaker. Take down the cat.
me: (suddenly miffed for no reason whatsoever): Ha!
So now, completely out of spite, Cooper’s pic is going to stay on the site for the next seven days. Our Alexa site rank will probably plummet. No advertisers will touch us (nothing new there). But because Doug said “deal breaker”, Cooper gets his seven days of near-fame.
Now, on with the show……
SmartMoney.com yesterday published a list of the top 100 funds of the past 5 years. We’re inundated with these types of lists in January. I had a rare opportunity to read USA Today on my way home from Disney last week, and long-time finance writer John Waggoner penned a piece titled Fund Investors Ran in Place in ‘11. The story discussed what we already know: 2011 was a roller coaster year, with the average stock fund, according to Lipper, losing 2.9 percent. Investors are scrambling to find better results.
That wasn’t shocking.
What I found annoying was the story’s partner: “More on Funds, Quarterly, Yearly Results Tables….”. It was pretty much the same story I saw yesterday at SmartMoney. The obvious (unstated) connection I believe readers will make is that they’ll find better fund by reviewing the best ones from last quarter or last year.
USA Today and SmartMoney wouldn’t run stories featuring the top ten mutual funds (or 100….or whatever) if people didn’t search for this information. I don’t fault them at all. It sells. Turning to the USA Today piece, here’s a listing of the 4th quarter’s best and worst, as well as the 12 months’ best and worst funds. One page over I find the list of the top funds over 5 and 10 years.
Yuck.
Stop reading about the Top Ten Mutual Funds.
In his seminal investing book The Truth About Money 4th Edition’ target=_blank>The Truth About Money, financial advisor Ric Edelman discusses this thirst people have to throw money at last year’s winners. We want to own winning funds. Many of us have heard grandpa tell stories about the legendary returns of Fidelity Magellan back in the day, or of that high-flying Janus Twenty fund in the months leading up to the tech wreck. We want those days back. We’d love nothing more than to be invested with some manager who always makes us money. But as Edelman describes, history works against you if you’re trying to find great results this year by reviewing last year’s winners.
Looking at the top ten mutual funds rarely produces winning result.
Here are some top funds, ETFs and ETNs listed in “best of” 2010 publications and their 2011 results:
| Fund Name | 2010 Result | 2010 S&P | 2011 Result | 2011 S&P | Who Listed |
| M.S. Focus Growth B AMOBX | 25.87 | 15.06 | -6.43 | 2.11 | The Street |
| Fidelity Growth Co. FDGRX | 20.55 | 0.67 | The Street | ||
| Fidelity Contrafund FCNTX | 16.93 | -0.12 | The Street | ||
| Proshares Ultra Silver AGQ | 182.44 | -47.47 | USA Today | ||
| iPath DJ-UBS Cotton Index | 96.22 | -22.71 | USA Today |
In November of 2010, TheStreet.com listed the top performing funds competing with the S&P 500 here.
In January 2011, USA Today published a chart of the top performing funds of the year, which included ETFs and ETNs.
(Photo credit: Crosa: Wikimedia Commons)
