The Security and Exchange Commission (SEC) is setting up a new division to oversee new financial products, and this group is starting with target date funds. These are mutual funds usually taking the form of baskets of other mutual funds, designed to target a certain year of retirement. As the year approaches, the fund automatically changes asset allocation, usually between stocks and bonds, to become less risky.
I’ve pointed out some of my concerns with target date funds here before. Mainly, they could be too conservative and it’s easy to hide fees. Mary Schapiro, the head of the SEC, pointed to the exchanges from stocks to bonds. The cost of the sales and purchases is buried in the daily price of the target date fund, and there is currently no good way for customers to understand how much they are being charged for the re-balancing of the portfolio they could do on their own.
Schapiro also noted that there is no standard across companies. A target date fund designed for those who plan to retire in 2050 with one fund manager may have a different allocation between stocks and bonds than a 2050 target date fund with another fund manager.
Here is a comparison of the asset allocations for the funds designed for those retiring in 2050 from Vanguard, Fidelity, and T. Rowe Price.
|
Vanguard |
Fidelity |
T. Rowe Price |
| Domestic Stocks |
72.0% |
69.5% |
67.2% |
| Foreign Stocks |
18.0% |
20.0% |
22.9% |
| Bonds |
10.0% |
10.4% |
7.2% |
| Other
| 0.0% |
0.1% |
2.7% |
The variation seems small but could have an significant effect on returns by retirement in 2050. If target retirement funds were standardized across companies, customers could accurately and easily compare returns between fund managers, understand the level of risk, and have the opportunity to make better investment decisions.
I am not convinced there is a need for this. Any fund’s composition is described in detail in the prospectus and in on a multitude of financial data websites like Yahoo Finance and Google Finance. What isn’t clear are the true fees. We do know that Vanguard’s fee for their 2050 fund is 0.19%, Fidelity’s is 0.82%, and T. Rowe Price’s is 0.79%, but that only tells part of the story. Whenever there is turnover — stocks are sold and other stocks, bonds, or other investments are purchases — fees are generated but wrapped tightly into the daily price of the fund so it is barely noticeable.
Asset re-allocation is the purpose of target date funds. Even if the underlying funds, those in the basket, are low-turnover index funds, the managers may be rearranging the index funds in the basket often. For those disciplined to handle the responsibility of occasional re-balancing themselves, and it’s not that difficult, I suggest avoiding target date funds.
Target date funds have lots of fans because it’s a form of automation, and automation in finances is usually a good thing. There is a danger of automation leading to complacency and a false sense of security. If you choose target date funds, familiarize yourself with the details and evaluate whether the pre-packaged re-allocation system is worth the thousands of dollars or more you could be losing in hidden fees and with a risk profile that doesn’t match your income needs and tolerance.
Would you like to see target date funds standardizes so a “2050 Fund” from one company matches a “2050 Fund” from another company? or should companies be left to determine what strategy is best for their customers?
Photo credit: viZZZual.com
‘Target Date’ Funds Get Senate Scrutiny, Daisy Maxey, Wall Street Journal, October 30, 2009
SEC to look at retirement investing risks, Marketplace, November 3, 2009
Peer-to-peer lending institution Prosper is offering a $50 bonus for new lenders who sign up for for the service and bid on two loans. Peer-to-peer lending is an interesting way for people to qualify for loans and to lend money to others. In an economy where savings account interest rates are under 3% or 2%, it’s tempting to put cash to better use through these direct loans. There is a possibility to earn much more than you would by putting cash in a savings account as long as loans are chosen carefully and you’re willing to accept risk.
There is something appealing about working outside the banking system. Peer-to-peer lending takes a specific power of the financial industry and puts in the hands of individuals.
I tried Prosper a few years ago. A friend of mine was looking to consolidate his credit card balances, but was looking for a better option that putting several thousand dollars onto one high-interest card. His plan was to apply for a loan on Prosper and use the funds to pay off his credit cards. He would then only need to worry about one payment each month with a lower total payment and a lower interest rate than what he would likely get with a credit card.
When he asked me about Propser, I offered to help him out by bidding to provide a portion of the funding for the loan. The idea of being an investor appealed to me, but unfortunately, the state of Texas prevented him from participating on Prosper at that time. It is my understanding that he would qualify only for an interest rate higher than allowed by the state.
My adventures with Prosper ended before they began. And I won’t be able to get started. As I began to research investing in a portfolio of loans at Prosper and bidding on individual loans, I was greeted by this message:
Unfortunately, at this time lenders in New Jersey are not able to bid or transfer money to Prosper. If you have portfolio plans, they have been paused. You may transfer money out of your Prosper account as they become available from loan payments.
If you reside in a state where Prosper is allowed to do business, consider signing up for an account and qualifying for the $50 bonus. What is your experience with Prosper?
I’ve been investing in a 401(k) retirement account since I joined the ranks of the corporate employed seven years ago. I started with a small percentage of my income, just enough to take advantage of the full company match. As my income increased, I diverted a larger percentage to the 401(k) with the hopes of retiring with a sizable nest egg decades later. I’m at the point now where I am contributing the full amount allowed by law.
This plan has worked well for a while. But like most people in similar situations, my 401(k) suffered damage over the past year or two. I figured that over the course of my career, I’d hit a recession at some point, and I suppose I am lucky that I am not forced to retire and begin drawing income right now, with the account value depleted.
Here is a graph that depicts my 401(k) account value since January 2004.
The cost basis, or the amount I invested, is represented by the line and the market value of the account is represented by the bars. Ignore the bump in the cost basis at the end of 2004. That should be a smooth curve. From 2005 through most of 2007, my account was performing quite well. Soon after that, the value fell below my cost basis. I was losing money on paper.
I continued to invest in my 401(k) every other week. Even with increased investments, my account has not caught up to my cost basis. The Employee Benefit Research Institute and the Investment Company Institute recently released a report that shows that many investors have been able to bring their 401(k) account balances above the level recorded at the beginning of 2008. I fall into this group, but at the beginning of 2008 my account value was higher than my cost basis. As of today, the total value of my 401(k) is below my cost basis.
In other words, if I had been putting the portion of my paycheck that I had been investing in my 401(k) into a bank account — or even kept cash under my mattress — I would have fared better. So far. The good news is that while I was investing throughout the past few years, I was, I hope, purchasing funds at relative bargain prices. If stock market performance returns to average over a long period of time, I should be in luck; those bargains will pay off.
What is the state of your 401(k)?
401(k) investors: Hit hard in ‘08, doing better now, Jeanne Sahadi, CNNMoney.com, October 6, 2009
Earlier this week, I reviewed common financial rules of thumb and offered a quick evaluation of how each rule would likely perform if accepted by an individual as the final word. One of these was the rule that convinces retirees they will be financially secure if they withdraw 4% of their nest egg for income one year and continue withdrawing the same amount adjusted for inflation each year.
Walter Updegrave has a much more detailed strategy for retirees who would like to make their money last from age 65 to 95 and beyond. He offers three alternatives that one can follow depending on their assets and their needs in retirement.
Three strategies for retirees
The first strategy is for retirees who have enough income from Social Security and pensions to cover basic expenses and who are confident in their ability to manage their portfolio.
For those in this situation the 4% withdrawal rule has a chance of succeeding — having your money last 30 years — 77% of the time. If you need more income than 4% would provide, you’re risking not having enough to last that long. For example, someone retiring today with a $1 million nest egg could withdraw $40,000 that first year. But if you’re 33 years old like me, you better plan on having much more than $1 million when you retire; thanks to inflation, an income of $40,000 thirty years from now will probably not be sufficient.
In order to maintain a 4% withdrawal rate, according to the article, is to maintain a portfolio of 50% stocks and 50% bonds. And by the way, a bad year in the stock market could wipe you out.
The second strategy offered by Walter Updegrave is for retirees who need more income for basic expenses than is provided by Social Security and pensions or who do not want to subject their portfolio to as much risk as required in the first strategy.
Take part of your nest egg and purchase a lifetime immediate annuity. This will provide you with steady paychecks for the rest of your life. According to the article, recent annuities pay out 8%, so you would only need $500,000 to make that $40,000 income mentioned earlier. These are most beneficial for people who live longer because money is pooled with other investors. Those who die earlier help fund the incomes of those who survive in retirement longer. The problem with annuities is your money is often locked inside them, and you can’t get it if you need it without paying steep penalties.
Walter Updegrave also offers a third strategy for retirees who need more income than Social Security and pensions provide but want access to more of their money. In addition to a portfolio of stocks and bonds, and an immediate lifetime annuity, add a variable annuity with a guaranteed lifetime withdrawal benefit to the mix.
Variable annuities are flexible but they are also expensive. Rather than 8% like the lifetime immediate annuity above, a 65 year old is likely to receive a 5% return. It is not rare for these accounts to charge a fee of 3% of your account balance each year. The author suggests that the optimal mix between these products and investments would be 25% of your portfolio in variable annuities, 25% in immediate annuities, and the remaining 50% in the diversified portfolio of stocks and bonds.
The problem with annuities
The sale of annuities, particularly variables annuities, is riddled with problems. These are very popular products for salespeople because they make a lot of money for the companies that sell them. It’s not rare for salespeople to misrepresent the product. Often customers are not given the full information regarding withdrawal penalties.
Here’s an example of an 86-year-old man who was pressured into buying a product he did not understand and would never benefit from. Dateline investigated annuities salespeople and found more deception in the industry. Ben Stein, however, credits variable annuities for making his parents rich, though it might be important to note that a Ben Stein’s long-time working partner is Phil DeMuth, a registered investment adviser (salesperson) who benefits financially when more people are convinced that annuities are good products.
How to make your money last, Walter Updegrave, Money Magazine, September 23, 2009
This is a guest article written by Clare, the founder of MoneyEnergy, where she writes about international dividend investing, DRIPs, and increasing your cashflow. If you like this post, consider subscribing to her RSS feed to get others like it in your reader.
DRIPs (dividend reinvestment plans) were fairly popular back in the 1980s I am told, but now that there are so many low-cost discount brokers, the argument goes, DRIPs are less desirable. Some don’t see what’s so special about them. For others, they’re just plain boring.
I’d like to give you a few good reasons why you should take another look at DRIPs — or check them out for real if you have never done so and aren’t familiar with them. If you don’t know what DRIPs are, you are about to find out.
1. Even with low-cost brokers like Zecco, the best DRIP plans are still cheaper: they’re FREE. They have no commission or reinvestment fees whatsoever. There are no minimum trades you need to make or minimum amounts you need to keep in your account. The cost doesn’t rise after the introductory offer expires. This means you save a lot of money.
2. Networking and computer technologies have enabled transfer agents to store account information and make it available to you online. There is no longer any reason to be concerned about folders and folders of account information and paper records that you need to keep track of yourself. Purchase price information, downloadable forms and tax documents can now all be had online, if you choose to do it that way. You can still, of course, just elect to receive your account information in the mail as always.
4. DRIP plans run through transfer agents like Computershare will reinvest 100% of your dividends back into the stock, not just the amount that will purchase a new share. This has always been a feature of DRIPs. Most brokers do not do this. The ones that do will only reinvest your dividends if they are enough to purchase at least one new whole share. With fractional reinvestment, your money goes to work for you sooner than if you had to wait to own enough stock to buy new shares with those dividends. This means DRIPs are still the best choice for young people or those just starting investing who might not have huge sums of seed money.
4. DRIP stocks are “pre-screened,” so to speak. Let me explain: First, the only companies who can offer DRIPs are those with dividend payouts. Second, companies with DRIPs tend to be well-managed and are interested in keeping their cash flow within the company (simply having a DRIP plan can save them numerous fees). DRIPs give them more flexibility and leverage in times of need as well as times of opportunity (such as acquisitions). Being dividend-payers, they are probably slightly more mature companies and are likely to be less volatile than the market average. Common DRIP stocks, for example, are utilities and consumer goods companies, like Proctor & Gamble. None of this means your DRIP stock is without any risk or that you shouldn’t do your homework, but I believe it does narrow down your selection and make it easier to spot value.
5. The best reason of all, however, that DRIPs are still attractive investment vehicles, is the ongoing discounts many provide on share reinvestment and optional stock purchases. Some companies offer anywhere from a 2-4% discount off the market value of their shares on the day of purchase. You won’t find that anywhere else! Companies do this as an incentive for you to invest and to use their DRIP plan, which, as mentioned in #4 above, benefits them considerably. Compound this benefit with the savings you’ll have on commissions, and you can see how much farther your money can potentially go, and sooner, with DRIPs.
DRIPs are no longer much of a secret in the investing world, but organized information on them can be hard to find. For a more detailed primer on how to get started in DRIP investing, take a look at this guide I wrote to commission-free investing.
I do very little stock trading. In fact, the only individual stocks I hold are Microsoft (MSFT) and Akamai (AKAM), both of which I purchased with free money for opening a brokerage account. Naturally, I think free cash is a perfect candidate for experimentation with the stock market and I most likely would not have made these purchases without this particular incentive.
Zecco Trading is offering a different incentive for those who have funds for trading stocks but would like to avoid pesky transaction fees that eat into your returns. For a very limited time, Zecco is offering 20 free traders. This discount brokerage normally offers 20 free trades each month for customers who maintain a $25,000 bonus in their account or execute 25 trades each month. Otherwise, each trade costs $4.50, still one of the lowest transaction fees available.
Here is how to receive 20 free trades without meeting the minimum balance or minimum trade volume. First, be a new customer. Only new Zecco customers are eligible. Apply for your Zecco account here, and use the code bonus1 when signing up for your account. Your application must be complete and approved by September 13, 2009.
As long as you meet the above criteria, you will see 20 free trades available in your account by September 16, 2009.
For more options, see this summary of five true discount brokerages.
For the last few years, I have been participating in my company’s stock purchase plan at the maximum level. Every paycheck, ten percent of my gross salary is withheld. At the end of each quarter the funds are used to buy my company’s stock at a 15 percent discount from the lower price of either the first day or last day of the quarter. As my company’s stock declined mostly due to the economy at large and the industry in which I work, this was a losing proposition. I decided not to sell the company stock until prices returned, rather than selling at the first available opportunity as I had been earlier.
So now I have company stock that I have been holding since December 31, 2007. About half of the shared purchased then and since then are in a losing position while half are now in a winning position. My only opportunity to sell this quarter is closing soon, so I should decide what to do. Here are some of my options:
- Sell all of it. It’s risky to hold so much in one stock, and I already have company stock in my 401(k). I can write off the losses against the gains to reduce tax liability.
- Sell the shares in a losing position. I can write off the losses against any realized gains if I sell stocks later this year.
- Sell nothing until they are held for two years. The stock will probably go up, and after two years, they will be long-term capital gains, taxed at a lower rate.
- Sell the shares in a winning position. This would help my cash flow, but I’ll owe income tax.
What would you do?
The option to convert a Traditional IRA to a Roth IRA has been around for a while. Here are the differences between a Traditional IRA and a Roth IRA for those new to these retirement accounts. As long as your modified adjusted gross income (MAGI) is under $100,000 you have qualified for this conversion. Contributions to the Traditional IRA is tax-deductible, which means that your tax bill is calculated after ignoring the amount you deposit into the IRA. You will pay those taxes after you retire and begin withdrawing these funds. If you have a higher tax rate now than you will in retirement, the Traditional IRA is a good choice.
On the other hand, the Roth IRA is not tax-deductible, so the deposits into this type of IRA are not exempted from your total income calculation for tax purposes. In effect, you use “after-tax money” to invest in a Roth IRA. This is a great choice for people who believe their tax rate now will be lower than it will be in retirement once they begin taking distributions.
There are two other benefits to the Roth IRA that often go unnoticed. The Roth IRA does not require distributions after age 70 1/2 like the Traditional IRA, offering more flexibility in retirement. The Roth IRA is better for estate planning; choosing a Roth IRA rather than a Traditional IRA for funds passed onto your heirs will allow them to avoid tax bills.
These benefits come with a drawback: if your MAGI is above $105,000 ($166,000 for those who are married filing jointly) your maximum allowed contribution begins to reduce and will completely phase out at $120,000 ($176,000 for married filing jointly). But there is now a law that will help you get around this for a short time.
In 2010, the $100,000 maximum for Roth IRA conversions will temporarily disappear. If you believe the Roth IRA is a better option for you but you have been prevented from investing in this type of account due to income limitations, now is your chance to make the change. Here is why this will be allowed: When you convert from a Traditional IRA you owe taxes on the amount of the conversion, and the government would really like that income.
If you must pay those taxes using funds from your IRA, the conversion might not be a good idea, but if you have cash saved for the tax bill you will be better off.
You can also convert accounts known as SEP IRAs and SIMPLE IRAs.
Here are some quality resources regarding Roth IRA conversions.
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