Archive for the ‘Retirement’ Category
Reverse Mortgages
Posted by: Todd Metheny in Real Estate, Retirement on September 3rd, 2009
Quick - Name who's on the $50 bill!
What are reverse mortgages? In what situation would I need one or use one? How do they differ from a home equity loan?
I got the question above via email from a reader. I know the basics of what a reverse mortgage is, but, being a man who owns a bunch of old law textbooks that have very little value to me now that I’m out of law school (other than looking cool on my shelf), I turned first to my Nelson/Whitman text, Real Estate Finance, Transfer and Development.
It’s an excellent book, and has a wealth of legal knowledge. In fact, when I was in school I would have told you with a straight face that it would tell you everything you needed to know to be a practicing attorney in the area of real estate law. That’s a very naive thing to think, but it is a very good text if you’re in the market (and why would you be). The book doesn’t have much to say abut reverse mortgages, just a couple pages (out of over 1200).
According to the book, a reverse mortgage, or a reverse annuity mortgage (RAM), (also known as a home equity conversion mortgage) allows retired people with lots of equity in their homes to borrow from that equity on a regular basis to pay living expenses. The lender basically makes monthly disbursements to the homeowner, which essentially bleeds the equity they’ve built. The lender predetermines the maximum amount they are willing to lend out of the house, preserving enough equity to ensure that eventually they can sell the house and get their money back.
The book says this as well, “The balance will ultimately reach the maximum level acceptable to the lender, at which time the loan will have to be repaid, presumably requiring the sale of the property.”
These guys know more about this stuff than I do, but I think that’s misleading. That seems to suggest that as soon as you reach that maximum level, the loan has to be repaid – and that the house will be sold. This would be based on the specific terms of the agreement that you enter into, but I think most reverse mortgages are predicated on the fact that you can take the money until you reach the limit (they’re not going to give you an endless supply of money), and then you can stay in your house until you die or vacate it. I doubt this is an error on the part of Professor Whitman (who taught my Property law bar class a little over a year ago and a leader in this field) or his coauthor. I think this is probably just worded in a way that’s a little bit ambiguous;)
There are multiple ways these sorts of agreements work. Sometimes an annuity is purchased from a lump sum disbursement. Sometimes they just make monthly payments. In either case, you’re borrowing money, and the money you’ve borrowed is accruing interest. That’s one way the people making these loans. The other way is through closing the loans (here’s a guide to some of the different types of payment options). When one of these loans is made, there are closing costs just like with any other loan. Before you consider taking one of these, ask for a term sheet with all of the estimated closing costs. Keep this in mind when you’re shopping for a reverse mortgages – it’s not just the interest rate that matters, it’s the total amount of money involved.
If this sounds a lot like a home equity loan – it is, but with one fundamental difference…you don’t have to start making payments immediately after getting the loan. This works more like a balloon loan. All of the money will be due at some point in the future, usually from the sale of the home.
Finally, these loans are only for retirees (you have to be at least 62 to take one). Ideally, you’ll be in a position during retirement where you don’t need to take one of these (if you wanted to know more, here’s a comprehensive guide to reverse mortgages). If you haven’t started saving for retirement, start now! Even if you can only afford to invest a small amount of money each month, get in the game if you can. If you end up having to rely on a reverse mortgage, the option is there, but it’s a worst case scenario. Thanks for reading.
Don’t Chase Returns
Posted by: Todd Metheny in Retirement, Value Investing on September 1st, 2009
Chasing returns usually won't bring them to you.
A friend who was considering changing retirement funds called me recently to ask what I thought about the change. I didn’t have much to say, except that it’s probably a good idea to try to find the lowest fees possible and invest in index funds. After checking the year to date (YTD) returns for each fund, he realized that the fund that he was already in was up almost 10% more than the fund he’d been moving to. He me back and asked if he should stay with the old fund to gain the extra returns for the remainder of the year.
Of course, I don’t know the answer to that. Over the remainder of the year, his old fund might go up 1000%. I don’t know anything about it. I don’t know what it’s invested in, or how it’s gained it’s market beating returns, or whether it’s likely to continue. I can, however, spit out some famous investing maxims. These are some of the ones I hit him with: (1) past performance isn’t an accurate predictor of future success, (2) it’s easy to confuse genius with a bull market, (3) don’t chase returns, and (4) don’t focus more on the return than the risks undertaken to earn that return.
When I think of the past performance maxim, I think of growth. Companies can’t grow at 30% a year forever. This makes sense. Eventually things become as big as they can be. Once you put a Starbucks or a McDonald’s on every corner, it’s hard for those companies to grow in the same way they have in the past. They can come up with new ideas and new ways to use their capital – but eventually growth is going to slow and even decline. Companies don’t last forever.
The don’t chase returns rule is one that I’ve learned first hand in the past. When I first started investing, I looked up the Money 70, a recommended list of mutual funds made by the magazine. On that list, at the time, they told you the one year return, followed by the projected annual returns over 5 years and 10 years. The one year return for one of the funds (it was technically an index – for REITs) mentioned was 35%, their 5 year was 31% and their 10 year was 29% per year. When I saw that, I thought to myself, “What a great investment! Even if I make half of that I’ll be making out pretty well!” Of course, what I should have been thinking was, “how can this fun make 29% per year for 10 years? Those are ridiculous returns.” You know how this story goes right? The fund lost about 50% the next year. The price of the fund had been driven up to ridiculous levels because these returns were being advertised all over the place. Luckily, we ended up having very little money in this particular fund, but the credit for that goes to my wife. I believed the magazine. Of course, I’m older, wiser, and more knowledgeable now. I’ve read more, studied more, and talked to more people who know more about investing than I do.
Risk is an important consideration, too. Everyone has risk tolerance to spare when markets are doing well. Seth Klarman and Warren Buffett are known for keeping about half of the value of their entire portfolios in cash. This puts them in a position that enables them to take advantage of great opportunities (like market crashes), and insulates them from market dips. It might decrease their returns in the strongest market conditions, but they are also undertaking less risk by keeping that money on the sidelines (the big risk is inflation). Having less money in play also allows them to focus on their best ideas and not over-diversify into their ideas that aren’t as good. Don’t chase returns and thanks for reading.
How to Invest in TIPS
Posted by: Todd Metheny in Retirement, Value Investing on July 1st, 2009
Not too long ago, I was at a dinner party listening to someone expound on how incredibly inflation will rage in the coming years and how he’s been moving most of his money into commodities (I assumed through ETFs or a commodities index). When he started talking about gold, I excused myself and moved on from the conversation (I like a good debate as much as the next person in my profession, but I don’t bother unless the person meets a few predetermined criteria).
Lots of people I talk to lately are worried about inflation. The word “gold” is never far behind that worry. Here are some of my thoughts on gold. So let’s talk about inflation for a minute. Inflation erodes the buying power of a currency. It can have a negative economic effect, because it creates an incentive for some not to save or invest. Goods will be more expensive tomorrow, so perhaps I should buy them today. Of course, it can also have some positive effects. For one, it can make your country a more attractive exporter to countries with stronger countries, and can lessen the demand for imports.
Inflation also happens to be the main risk involved when it comes to investing in bonds and other fixed income investments. If you’re investing in a bond or debenture of some sort, and the bond pays 4% per annum, but inflation occurs at a rate of 3% per annum, you’re only putting 1% worth of buying power in your pocket as a return on your investment. This is a serious risk if you’re an investor. What if inflation were to occur at a rate of 10%? In 1980 inflation occurred at a rate of 13.58%. That would cause you to get back less buying power than you started with. If you believe that inflation could occur at that rate, there’d obviously be no reason to lend money to the government today at 4%, would there?
To combat these fears, the Federal Government offers you the ability to invest in Treasury Inflation Protected Securities. These are essentially treasury bills that are indexed for inflation. They pay a smaller yield, but offer to guarantee that you will be able to have a positive increase in your buying power. So, if you invest $100 with a 2% yield, and inflation occurs at 3%, you’ll get back 2% of $103 instead of 2% of $100.
If you believe in the creditworthiness of the US Government, this offers you a safe vehicle for capital preservation. If you’re looking for a fixed income investment to keep in your retirement account, TIPs may be the way to go. So how do you invest? The government sells these at auction, the same way they sell treasury bills. I think the easiest way for your average investor to invest would be through and ETF (there are several) that specializes in investing in TIPs or through a TIPs index fund such as Vanguard Inflation Protected Securities. As with anything else, read the prospectus and make sure you understand what you’re investing in (many investors don’t). Good luck and thanks for reading.
Compound Interest
Posted by: Todd Metheny in Managing Finances, Retirement on February 18th, 2009
Anyone who has ever read a personal finance book (or blog!) is probably familiar with the concept of compound interest. It’s one of those basic fundamental principles that most people understand because they’ve heard or read about it. One of the challenges I face as a personal finance blogger is knowing how many of the basics I need to cover. I think it’s important to understand things like compounded interest and other basics. Those things, however, aren’t necessarily of the most interest to me. The good news is that there are only so many of them. I decided that I couldn’t have a personal finance blog without delving into compound interest at some point. Plus, in the future, I can reference this post instead of linking to someone else.
Albert Einstein is alleged to have said (though it’s been disputed by some):
The most powerful force in the universe is compound interest.
I can’t contribute to the argument regarding whether he said it or not, but if compound interest could impress a brilliant man like Einstein, we should probably pay attention to it as well. Compound interest is, quite simply, the idea that money will grow faster and faster as it is reinvested. In other words, if you invest $10 at a 10% annual interest rate, in one year you’ll have an extra dollar. The next year, however, you’ll be making 10% on $11 ($1.10) instead of $10. This assumes that interest is compounded once a year, for the purpose of simplicity. If interest were calculated more often, of course, your money would grow even faster.
Check out a compound annual growth rate calculator by clicking here: Financial Calculator. For instance, if you have 30 years until retirement, and can afford to invest just $2k/year ($167/month, or $41.75/week), at the end of 30 years you’ll have a tidy sum of almost $265k (assuming an 8% return). Up that contribution to $5k per year and you’ll have $662,042.62. Play with the calculator. It’s fun. My suggestion would be to set your contribution at a fixed amount of your income (say 10-20% – but the higher the better). That way, as your income rises, so does your contribution. Another way to do it would be to try to keep living off of the same amount of money as your income rises and divert the rest to savings. Just because you get a raise doesn’t mean your house has to get bigger – a lesson that many people wish they had learned before the housing crisis.
Compound interest is your best chance to fight inflation and retire comfortably. Keep that in mind in this market. You can’t change the fact that you just lost 30% + out of your retirement account, but you can control whether you keep investing in a down market. You can dollar cost average your way back into the game if you stay the course. That doesn’t mean you can just pick any investments, but if you can keep your costs low and use the tax advantages of the retirement vehicles at your disposal, you can still get there. Of course, depending on your age, you may have to work a little longer and save a little more, but what’s your alternative? Don’t wait for a personal bailout – your lobby isn’t strong enough. Any personal finance writer will tell you that personal finance can essentially be broken down into one rule: spend less than you earn. Do your best. You can find an article about compounded interest at whatever your favorite personal finance blog is, but if you want to read more and would like a suggestion, check out this one. Thanks for reading.
Rolling Over Your 401(k) into an IRA
Posted by: Todd Metheny in Retirement on January 31st, 2009
Lots of Americans are finding themselves out of work or looking for jobs. 100,000 jobs were lost this week alone. Losing your job is a big event. Hopefully this doesn’t happen to you. If it does, hang in there. I got this email from a reader on Friday:
Todd,
My company has stopped their 401K match. I was previously putting 3% each check (I make about 40k/yr) and they were matching with an additional 3%, I have now reduced this to 0%. My investments have been performing poorly. What should I do? In the past I wasn’t that concerned because with the match I could afford to lose some. Now that there is no match and I may be out of work soon (my company is downsizing and my division seems to be on the block) I’m wondering if I should make some changes. Over the past year I have had 100% in an aggressive portfolio as I didn’t have much to lose. Do you think I should change this? I’m not contributing now but I want to protect what I have (I’m 28 years old). Maybe I should leave the % as is and wait?
Thanks,
Advice Seeker
That sucks that they cancelled your match…it’s nice to be making that guaranteed 100% on your money. Since you’ll likely be leaving your company, I would roll the 401(k) over into an IRA – you could wait until you leave to do this. You’ll have more control over your investments and more investment options. I would check one of the lower cost mutual fund brokerages, like Vanguard, Fidelity, T Rowe Price, etc. and see what their minimums are for rollovers. You can roll it over without a penalty. It should be fairly easy, just talk to one of their reps. Another thing you might consider are incentive packages. I know that some brokerages (TD Ameritrade comes to mind) will give you some amount of money to convert your 401(k) to an IRA with them – sometimes people will give as much as $500. This way, if your company goes down or contracts, you know where your money is and can easily make changes to your investments.
You could even convert to a Roth, but Roth IRAs are funded by after tax money and reg IRAs and 401(k)s are pre-tax money. If you chose to do this you would have to go ahead and pay taxes on the money currently in your 401(k). This might be a good move, anyway, though, to go ahead and go with the Roth, because right now you are likely in the lowest tax bracket you’ll be in for the rest of your life. You’re certainly (hopefully, rather) in a lower one now than you likely will be when you start making withdrawals (in your 60s). If you decide to roll over into this option, I would set up an automatic contribution to your new Roth with the money you’re contributing now. When you finally do make withdrawals from a Roth, you don’t pay a cent of taxes on the gains or the contributions (whereas you’d be taxed at your regular rate with a 401(k) or regular IRA). Plus, by that time, who knows what the tax rate will be?
As far as protecting your money, you have several tools at your disposal. You have a long time horizon, dollar cost averaging, and rebalancing. Because of your long time horizon, I wouldn’t stop contributing as long as you are able to. The stock market sucks now, but all that matters in terms of your retirement account is where it will be when you start making withdrawals. You have 30+ years to come back. Plus, while prices are low, you’ll be buying more shares with your normal contribution.
Dollar cost averaging is just what you’re already doing, making set monthly contributions. This ensures you buy fewer shares when the market is high and more when the market is low. It doesn’t make your returns better but it protects you from buying in too high. It slightly mitigates the risk in stocks.
Rebalancing simply puts your allocation back where it belongs. If you decide to go 80% stocks and 20% bonds, for example, and the stock market has big gains – your new allocation might be 90/10. You would then sell until you were back at the 80/20 mark. This forces you to take some gains when the market is high and mitigates risk. You would only rebalance once every 6-12 months or so.
If you don’t want to mess with rebalancing yourself, you could invest in a target date retirement fund – and they automatically rebalance for you. They also make your allocation more conservative as you get older. So, if you’re at 75/25 (stocks/bonds) when you’re 25, they might change it to 70/30 by the time you’re 30. By the time you retire, you’d have a very conservative balance – heavily weighted towards bonds and fixed income investments.
If you wanted to rebalance yourself, that’s not too hard to do, either. Target date funds are just a way to put it on autopilot. The key, no matter what you invest in, is keeping your costs low. Some mutual funds have fees as high as 3% – we want to avoid those at all cost. And index fund with Fidelity or Vanguard will perform just as well and only cost you 0.2% or so – and 71% of actively managed mutual funds don’t beat indexes, (in part because a majority of people sell when the market is plummeting, forcing managers to sell when they don’t want to or shouldn’t….like now). It’s the conundrum money managers face with the old “buy low sell high” mandate.
As for your asset allocation, determining that depends on your specific risk profile. There are a lot of resources out there to determine this – here’s a risk calculation tool that I found in a Google search. More than anything though, determining your tolerance for risk is something you’ll have to find over time. Ask yourself the question, how would I react if my portfolio lost 50% of its value in one year? Would I buy more? Sell it all? Stop investing? The market fluctuations going on right now have been a good gut check for a lot of people. Some people that thought they had a high risk tolerance have backed off from that stance.
Check out this article as well, and this one, and maybe this one, too. Also see my article about retirement accounts in general for a brief overview. There are a lot of great resources out there for people looking to move. I hope this helps. Let me know if you have any problems. Thanks for reading.
Protecting Your Retirement Account From Your Company’s Stock
Posted by: Todd Metheny in Retirement on January 20th, 2009
This weekend, while visiting my wife’s family in Florida, I went to a local Bank of America (BAC) to get some documents notarized. The notary was a friendly, witty woman who has been working for BAC for almost 30 years. I mentioned that I was a shareholder in BAC (I’m embarrassed to admit that), and that I had voted my paltry number of shares against the Merrill merger. She responded by saying that she would bet she had more shares…and that she had voted against the merger, too. (If we all voted against it, how did it happen?) She went on to say that her retirement account, a 401(k), was full of BAC stock…one of the worst performing stocks in the S&P over the last 12 months.
Why does this always happen? Everyone has heard the importance of diversifying spiel. It seems like common knowledge, I feel like I knew you were supposed to diversify when I was a little kid (long before my first investment). In fact, when it comes to stocks, I think many people diversify more than is necessary. So why am I always coming across people that have 75% (or more) of their 401(k) in their companies stock?
I think there are a couple explanations for this. For one, companies create incentives for employees to purchase their stock. The theory behind this is obvious, companies believe that employees will be more productive to further the goals of the company if they have an interest tied to those goals. Research has shown that this does in fact make employees more productive. The incentives vary from company to company, but I know of at least one company that offers a 20% discount on their stock to their employees’ retirement accounts. According to this woman that I met in FL, BAC matches 100% of whatever they put into company stock (there’s probably a cap/max for this, I didn’t ask). This ties the fate of the employee to the fate of the company, and it’s almost too good of a deal to pass up.
There are several other reasons for sticking almost exclusively with your company’s stock. Choosing stocks or funds may seem like a daunting task for the unsophisticated investor. Some people without much knowledge of stocks or investing don’t feel comfortable seeking advice. Even if they do, it probably isn’t from a professional. They are more likely to look to a friend or relative, whose advice may or may not be sound. The old “blind leading the blind scenario.” Companies may also set a large part of a retirement portfolio as a default piece of your retirement portfolio.
For whatever reason, this is an extremely common occurrence. If you were in BAC with a large portion of your portfolio, you just took a loss that will be difficult to recover from. I wish it hadn’t happened. People have been doing it forever. GM stock was once considered a “sure thing” investment for the long haul. The fact of the matter is, you can’t predict the future, and putting too much money/faith into any one company is putting your financial future at risk. I want America to be financially healthy, and it starts with its people. If you take care of your finances and keep your investments in line with your actual appetite for risk, a lot of other things will fall into place. You can combat a lot of things with education. Read financial books, articles, and blogs. Learn – you can do most things on your own if you’re willing to put into the time to learn them. If you aren’t willing to learn, then hiring a financial planner or investment advisor really is a good investment. Find someone you personally like and investigate them (no blind faith!). Ask a lot of questions, and weigh the questions they ask you. Good luck, and thanks for reading.
So I have a retirement account, now what do I invest in?
Posted by: Todd Metheny in Retirement on December 24th, 2008
You can’t have a blog and not mention the fact that it’s Christmas Eve. Personal finance blogs everywhere have been buzzing for the last month or so with Christmas themed posts. Sites like The Simple Dollar, Get Rich Slowly, and Broke Grad Student (a few of my favorites) offer Christmas notes and ideas. I especially enjoyed the story at Get Rich Slowly. Stubbornly, I am not going to stray for a Christmas themed post. But Merry Christmas.
The answer to the question in title of this post is the answer to most questions, it depends. It depends on a wide range of factors, including your age, your risk tolerance, and how much money you have to invest. Read the rest of this entry »
Types of Retirement Accounts
Posted by: Todd Metheny in Retirement on December 23rd, 2008
In my previous post, I encouraged anyone without a retirement account to start one as a New Year’s resolution. Today I am going to go over some of the basic differences between the types of accounts in a simple and straightforward manner.
There are two basic retirement vehicles, the 401(k) and the IRA. Each of these vehicles takes several forms, i.e. 401(k), 403(b), Roth 401(k), Traditional IRA, Roth IRA, SEP, Self Directed IRA. I will briefly touch on most of these at one point or another during this discussion, but I am going to focus on the forms that are relevant to the most people. Read the rest of this entry »
New Year’s Resolution Suggestions, Pt 1.: Start a Retirement Account in 2009
Posted by: Todd Metheny in Retirement on December 22nd, 2008
You can’t have a personal finance blog without occasionally talking retirement. If you don’t already have a retirement account of some sort, 401(k), IRA, Roth IRA, SEP, etc., make a (New Year’s) resolution to start one. If you have one, try to up your contribution by 1% – I bet you won’t even miss it.
In upcoming post, I’ll walk through the retirement basics. Most people inclined to read a personal finance blog probably already know the basics of starting a retirement account (because they have one!), but I am going to start with the assumption that you don’t know much about saving for retirement and move forward from there.
Note: I don’t really have any readers yet, so I’ll also consider it a refresher for myself and a way to stay current on maximum contributions and other relevant, ever-changing information. I’ll go through the different types of retirement accounts and their tax advantages, sharing my opinion of a particular strategy along the way. In a follow up post to that I’ll share some recommended providers and steps to take to actually open your account. I intend this to be part of a short series of financial New Year’s resolutions. Stay tuned.
