Ask The Money Coach

Posts Tagged ‘Investing’

Congratulations on getting started investing. You’re not too late to the investing game: you’re right on time. A lot of 36, 46 and 56-year olds wish they’d started when they were 26, as you are. So don’t beat yourself up at all about your age. Glad to hear you’re starting a Roth IRA. It’s a great way to save for retirement. Regarding the 401(k), your investment options will be dictated primarily by the offerings that your employer has available. I can tell you in general that Edward Jones has a good reputation and is known for quality financial advice. However, the mutual funds you choose are equally important. So the main question you need to find out tackle is: based on my investment objectives, how much of my 401(k) should be in stocks, bonds, and cash? Then you can think about what funds or stocks to buy to match those objectives.

If you don’t have an adviser helping you, I’d strongly suggest that you get a professional to create a financial plan for you and offer you some specific recommendations based on your goals, risk tolerance and personal circumstances. You can get good help from the National Association of Personal Financial Advisors (www.napfa.org) or from the Financial Planning Association (www.fpanet.org).

You are correct in your assumptions. Yes, you can open two IRAs (one for 2009 and one for 2010), and safely convert them into a Roth this year because of the removal of the income limits on Roth conversions. I double-checked with an expert on this, David Mendels, who is a Certified Financial Planner and the President-Elect of the New York Chapter of the Financial Planning Association. David is also an adjust faculty member at New York University, as well as the head of the fee-based financial planning firm, Creative Financial Concepts, LLC. So he is very well-credentialed and I’m confident in his knowledge ane expertise. He told me to offer you two caveats, just to make sure your efforts go smoothly.

First, if you have any existing IRAs that are traditional IRAs or IRAs other than the new ones you plan to open, be aware that your basis will be calculated over the combined IRAs that you have, not just the ones you are opening now. Second, to make sure you don’t experience any future issues if any questions ever arise, keep very clean records about this for the future. Here’s how: wait a brief period after you open the non-deductible IRA before you do the conversion. David suggested that you wait a week or so – or as long as it takes until the IRA custodian has a record that your original contribution was a non-deductible IRA. After that’s done and you have written confirmation, then go ahead and do the conversion.

A final tip: you can open two IRAs if you want, but you certainly don’t have to. If you prefer to keep things simpler (again, from a paperwork and record-keeping standpoint), you can just open a single non-deductible IRA. Put in your contribution for 2009 — you have to do it by April 15, 2010 — and make sure that the contribution is specifically designated for 2009. Then you can make another, separate contribution that is specifically earmarked as a 2010 contribution. Either way (one or two IRAs) accomplishes your goal and allows you to ultimately convert two years’ worth of IRA contributions into a Roth. Good luck!

By all means, start contributing to your company’s 401(k) plan immediately. Even if you leave the company or take another job elsewhere, you will have access to your 401(k) funds and can transfer them later – if you decide to – into an IRA. There are six big benefits to taking advantage of your 401(k) plan right now.

Lower Your Tax Bill
First, you will immediately lower your taxable income and start paying fewer income taxes to Uncle Sam. This is because you contribute to a 401(k) plan right out of your paycheck, on a pre-tax basis. By contrast, you fund an IRA with after-tax dollars. Your ability to take an IRA tax deduction is based on several factors, including your income.

Matching Contributions
Additionally, you may get additional retirement dollars from your employer, if your company offers any kind of matching program. Some companies match dollar-for-dollar, up to a certain percentage of your salary. Others offer 50 cents on the dollar. No matter how much or how little your company match might be, it’s still a great benefit, because it’s free money.

Flexibility
Thirdly, since you are a contract worker, you may be better off initially using a 401(k) plan, instead of an IRA, because the 401(k) generally offers you more flexibility and options to access monies without penalty. For example, you can take a loan from your 401(k) if necessary. But you generally can’t take loans from IRAs. You can take distributions from IRAs, but if they aren’t paid back within 60 days, the IRS imposes a 10% penalty, and you pay ordinary income taxes on the money too.

Higher Contribution Limits
401(k) plans have higher contribution limits than do Individual Retirement Accounts. Under federal law, the maximum amount you can put into a 401(k) in 2010 is $16,500; individuals age 50 and older can stash away an extra $5,500 in a 401(k). The limit is subject to cost-of living increase after 2010. The maximum you can put into an IRA in 2010 (either a regular IRA or a Roth IRA) is $5,000; those 50 and older can contribute an additional $1,000 into an IRA. The ability to sock away substantially more money is a 401(k) is a huge benefit that should be taken advantage of whenever possible.

Disciplined Investing
Making investments through your 401(k) plan is a great way to make you consistent and dedicated to the process of investing. Because the money is taken automatically out of your paycheck, you might not think about it as much and you won’t be as tempted to just stop investing when the markets get volatile. All too often, when people put their money into Individual Retirement Accounts, at the first sign of trouble on Wall Street, they simply stop investing. That’s not a good way to invest.

Ease of Implementation
As a final note, there’s also the speed of execution factor, which shouldn’t be ignored. You can literally go enroll in that 401(k) plan today. Just pop over into your Human Resources office and fill out some brief paperwork. You’d have to do quite a bit more homework and paperwork to open an IRA. Sometimes, when things take too long and seem like to much work, we tend to procrastinate and not get them done. That won’t be the case with your 401(k).

You stated that you’ve already been working at your company for more than a year. So now is a great time to get into the habit of saving early and often for retirement. The 401(k) plan offered by your employer will help you do just that.

First, let me congratulate you for having the diligence and savings ethic at your relatively young age to amass more than $20,000. That’s great! You’ve clearly taken advantage (in a good way) of the financial benefits afforded by living with your parents. That’s precisely the right thing to do: sock away as much as possible while your living expenses are very low. You also mentioned your 401(k) at work. By all means, do max out your contribution there to the full extent allowed, and collect your employer’s 6% matching contribution in the process.

Consider No-Load Index Mutual Funds

Regarding your investment options, I would suggest that you not invest all $20,000+ of your savings, but rather just a large portion of it. Keep $5,000 or so in your checking account. Hopefully that will be enough to help you still qualify for that nice 4.0% Annual Percentage Yield. Then take the other money and invest in no-load index mutual funds. Some good fund options exist at companies including Vanguard, Fidelity and American Century, to name a few. You’ll want to do your homework, of course, and research any fund carefully before making an investment choice. Additionally, you should let the specific mutual funds you choose be tied to specific goals.

For instance, let’s say you want to buy a house of your own in three or four years. Well, you can choose moderately aggressive funds, at least for the first two years. Within a year of when you think you’ll need the money, you’ll want to become more conservative in your investment picks. However, let’s assume you want to stash away more money for retirement. Since that’s several decades away, you can afford to be far more aggressive in your investment options when you decide where to put that $15,000.

Finally, keep up the great work you’ve already put into saving and learning about managing your finances well. That’s so very impressive and admirable.

When you think about the assets you own, does your house immediately spring to mind? It should, if you made any down payment on the house. That down payment – whether it was from funds out of your own pocket or money secured elsewhere – represents equity in your house. Your equity in a home is defined as the market value of the property minus any mortgages or liens on the home. If you just bought a house worth $350,000, and you had a 10% down payment, your current mortgage balance is $315,000, which means you have $35,000 in equity in your house. Knowing how to skillfully manage that equity – and properly maintain both your home and your finances so that you avoid financial loss or foreclosure – is part of the job of being a successful homeowner.

Why Your Home Is an “Asset” and Not a “Liability”

First, let’s take a look at why you should consider your home an asset – because not everyone views your primary residence as an asset. Some people say a home that you occupy isn’t really an asset because a home is constantly taking money out of your pocket with mortgage payments, insurance, taxes, and so forth. For this reason, you might hear various assertions that a home is not really as asset, but a liability.

I agree with the obvious conclusion that owning a home entails ongoing out-of-pocket expenses. However, I don’t concur with the notion that just because something costs money, it doesn’t qualify as an asset. Using that line of thinking, one could argue that the $250 sitting in your checking account isn’t an asset since having a low balance means your bank is going to charge you $5 or $10 a month for that account, or nickel-and-dime-you to death with service charges. Although we know that getting nickel-and-dimed happens all too often, has anyone ever told you that your hard-earned cashed sitting in the bank is a “liability” instead of an “asset” simply because your checking account actually costs you money each month. That would be ludicrous, right?

It’s an Asset if You Can Sell It for Cash

Your home is, indeed, an asset for several reasons. First of all, you can sell the house whenever you choose and put cash in your pocket at closing. (Obviously this assumes that you sell your house for more than you paid for it). In such a case, those are real dollars, not phantom profits. The fact you’ll likely pay a real estate commission on the sale doesn’t diminish your home’s status as an asset, just like paying a commission to a stockbroker when you sell a mutual fund doesn’t negate that fund’s standing as an asset. By the same token, it might take you one month to sell your house, whereas unloading the furniture in your house could be done in one day, at a garage sale. In both cases, a sale is a sale and you’re still making money off the assets that buyers agree to purchase.

It’s an Asset if You Can Borrow Against It

You can also borrow against the value of your home – via home equity loans or lines of credit, attesting to the fact that all bankers consider your home an asset and will allow you to use it as collateral. Yes, I know we’re in a credit crunch and bank lending standards are strict now. But you get the point. If your house is worth more you’re your loan (i.e. you have equity in it), then you can borrow against that house.

It’s an Asset if it Has Increased in Value or Can Increase in Value

Moreover, the home you’ve bought – or may be about to purchase – will likely appreciate in value over time, holding out the potential for a good return on your investment. Clearly, real estate markets don’t go up every year. One need only look at home prices in 2007 through 2009 to see that. However, homes have historically risen at a rate of 6.6% annually, according to the National Association of Realtors. This growth has represented a significant form of wealth for countless homeowners nationwide. Meanwhile, stocks have experienced annual appreciation rates averaging 10% when you look at 10-year investment cycles for every decade going back to the 1920s.

Your Home Can Be a Great Asset, But Don’t Make It Your Primary or Your Sole Asset

When you think about your assets, you should now definitely count your home among them, just like the value of any car you own, the cash value of your life insurance policy, or any retirement money you’ve squirreled away in stocks, bonds, or mutual funds.

As with all assets, you don’t want all your wealth tied up in your home. You’ve no doubt heard the investing advice that you shouldn’t pour all your money into a single stock. Whether you’re talking about a house or stocks, “putting all your eggs in one basket” is neither safe nor prudent in terms of diversifying your assets. That’s one reason why, if you’re every going to tap your equity, it might be wise to utilize that equity in your home – after careful consideration and planning – for other investment purposes. I’m not suggesting that you tap into your equity to go play the stock market or make an unwise business gamble. But I am pointing out that for any asset you have – home equity included – you must always think about “opportunity costs,” or what you might be sacrificing by tying up your money in one investment when another, higher-paying alternative might be available elsewhere.

Excerpted from Your First Home: The Smart Way to Get It and Keep It