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Archive for the ‘Retirement’ Category

Free Iphone, fixing your 401k, and evil mutual fund managers (via expense ratios and fund fees)

Monday, February 4th, 2008

I know, first thing you are wondering is FREE Iphone? WHERE CAN I GET IT!? Well, just hold on a few and read through. I was talking to one of my friends from work about viking death metal (no joke) and rock band (pretty much the best video game ever) and somehow the conversation drifted toward the 401k plan at our company. He said he had been dabbling in a few of the funds offered and seemed surprised when I said I was dumping 90% of mine (and my girlfriends) into our one index fund. So of course he asked me why? Well, its very very simple. Nearly every mutual fund available in our plan has an expense ratio greater than one.

Mutual Fund fees ruin returns

What the hell is an expense ratio and why do I care?

The expense ratio is the percent of total assets that the investor is charged just to be in the fund. This is supposed to cover the costs of running the mutual fund…but honestly it really is how mutual fund houses and managers steal your money to make themselves multimillionaires. Here is the simple version:

The Penny Saved IphoneMutual fund from your 401k you are in:

BIG MUTUAL FUND: expense ratio: 1.50%

Lets say youve been working for a few years so you have 20k in your 401k. Lets say you get a return this year of 10%. Wow sweet an extra $2000! But wait a minute, your mutual fund that are in has an expense ration of 1.50 so they keep 15% of that. You only get $1700 and they keep that other $300.

Lets say you were instead investing in the index fund with an expense ratio of .10 (actual number for mine). Instead of the fund keeping $300, they would be keeping $10. That extra money, why, thats your free iphone right there. Ok so maybe you can’t actually pull that $300 out and buy an iphone (though you could if it was a Roth IRA) but you get the point.

But dont mutual funds make more money than index funds?
No, 85% of mutual funds fail to beat the market average.

Other types of expenses that mutual funds might charge:

Front-end load
This is basically a fee paid when shares are purchased. It is also known as a “front-end load,” and this fee goes to the brokers that sell the fund’s shares. Front-end loads reduce the amount of your investment. A good example is if you have $1,000 and want to invest it in a mutual fund with a 5% front-end load. The $50 you pay comes off the top, and so only $950 will be invested in the fund.

Back-end load
This is where the brokers take their cut when you decide to sell shares. This is even worse because they take part of your capital gains as well. Some mutual funds let you out of these if you stay with them long enough but its just one more robbery trick.

Level load / Low load
The only difference between level loads and low loads as opposed to back-end loads, is that this time frame where charges are levied is shorter.
Load of Crap
Most of the above fees.

Something wicked this way comes…

Tuesday, July 10th, 2007

As much as possible I try to keep politics out of this blog because for the most part I try to reach out to every audience.  I think everyone has a right to be informed financial matters, and for the most part politics have nothing to do with it.  However once in a while, something comes up that absolutely frightening.  Something that has the ability to absolutely destroy our financial freedom in this country, to destroy any hope you have of retirement.  Here is a quote from Nancy Pelosi:

When questioned about recent stock market highs she responded “Only the rich benefit from these record highs. Working Americans, welfare recipients, the unemployed and minorities are not sharing in these obscene record highs”.

“There is no question these windfall profits and income created by the Bush administration need to be taxed at 100% rate and those dollars redistributed to the poor and working class”.

And that my friends, is one of the scariest quotes I have ever seen from someone in a position of power in the United States. Social Security WILL run out before most of us retire.  In fact, it will be, by definition, bankrupt by the year 2042.  What does that leave us with?  Our Roth IRAs and 401ks.  For anyone currently under the age of 60, we are at least partially banking on our retirement savings growing in the stock market.  Even if you don’t care at all about politics, at least pay attention to this because this has the potential to ruin your retirement.  It doesn’t matter what party is trying dig into your pockets, this is something to fight back on.

 You and I, as a working americans, DO share in these record highs.   

Roth IRA Basics

Thursday, March 29th, 2007

What is a Roth IRA?
Its an individual retirement account named after William Roth Jr of Delaware, the chief sponsor of the legislation that created it. It is a relatively new entity, it wasn’t established until 1998. A Roth IRA, unlike the 401(k), is not something that is employer sponsored, it is an extra retirement account the government will let you create (if you make under $99,0000 per year). Just like the 401(k) you must be 59.5 to withdraw your earnings without penalty.

What are the advantages of a Roth IRA?
-Because you contribute money after the government has already taxed it, withdrawls of contributions are tax free. Even better, the earnings grow tax free. In other words, if taxes are higher in the future, your Roth IRA doesn’t care. At retirement you still get to withdraw your money without paying higher taxes on it.
-It is very flexible in how it can be managed. In other words, you can have a big mix of investments in it.
-Because you have already paid income tax on it, you can pull out your contributions (not your earnings) at any time. This is a huge advantage over the 401(k).
-Most people will be in higher tax brackets as they get older, meaning that you will pay less on your contributions now than you will when you retire.

What are some disadvantages?
-You still have to be 59.5 to withdraw earnings without heavy penalties.
-It is not tax deductible
-There is always the risk that congress will decide to tax earnings on Roth IRAs between now and your retirement.

What is this about restrictions on how much I make?
You can only contribute to a Roth IRA if you make less than $99,000.00 per year.

What is this about restrictions on how much I can put in?
As of right now you can only put in $4000.00 a year if you are under the age of 50, and $5000.00 if you are over the age of 50.

Should I max out my Roth IRA or my 401(k)?
First max out your employer match of 401(k) and then max your Roth IRA and then back to the 401(k) if you can afford it. This is an effective way of hedging your bets on paying taxes now versus in the future. Roth is taxed now, 401(k) in the future.

People have their priorities wrong when it comes to retirement saving

Tuesday, March 27th, 2007

Yesterday I was browsing around various personal finance forums and I just could not get past how many people were giving terrible terrible advice. Not just bad advice, we are talking the kind of advice your friends give you after 14 or so beers. Whats worse is that a lot of these people eat up the advice like they’re plastered too. Here is a direct example of a question asked:

“I am 33, my husband is 36. As stated above, we save $29,200 per year for retirement. Add our company match and our retirement savings reach about $35K per year. We hope to retire in our mid 50’s. My husband will have a pension, I will not. We don’t have credit card debt, but have a mortgage (200K), one car loan (18K) and student loans (16K). Should we be paying down this debt instead of maxing out our retirement savings? Basically, is it foolish to save for retirement and have current debt???”

So what is the very first response to this?

“The first thing you need to do is pay off debt. I would stop contributing to the 401(k) and Roth IRA at this time.”

The poster then went on to say some other crap which I ignored because it was all I took not to register and post a reply. (Later I noticed the thread was over a year old.) In any case this is a great example of 1) the wonders of the interwebben to spread false information and 2) people being so debt-phobic that they fail to really analyze financial situations. In this case the student loans and car loan were both around 4%. Lets see, tax deferred compounding interest with company match or pay down debt at a 4% interest rate?

Roth IRA and 401(k) retirement saving versus debt pay off

Here is my suggested flow as far as money allocation:

401(k) max company match —> High interest debt —> Max Roth IRA —> More 401(k) —> Low Interest Debt —> other investments

Lets break this down a bit becaues you might be wondering about my priorities. There is a specific reason for each step here.

401(k) max company match – If your company matches every dollar up to say, 3% then you are getting a raise of 100% on that money contributed. Lets take Joe Graduate who makes $60,000.00 a year. That 3% match is $1800.00 per year.

High interest debt – This one is fairly self evident. If you are paying 25% on your credit card that is a ton of money down the drain.

Max Roth IRA – Its important to contribute to the Roth IRA while you can. There are contribution limits (currently $4000 if you are under 50, $6000 if over 50) as well as income limits ($99,000.00 currently) to be able to contribute. For more information read my Roth IRA basics.

More standard 401(k) – Tax deferred? Compounding interest? What a deal!

Low Interest Debt – The truth is you could probably come out with more money doing various investment strategies rather than using the money to pay off low interest Debt, especially considering things like student loans and mortgages being tax deductible. However, things like low interest car loans/credit cards are good things to pay off because they are liabilities, and missed payments could mean interest rates rise. Plus there is the peace of mind factor.

Other investments – If you are a young professional and still have money left over I applaud you, you’re way way way ahead of the game. This means its time to save up an emergency fund and if you’d like, find a discount broker and ease your way into buying some other securities.

Another reason to keep tabs on your 401(k)

Friday, March 23rd, 2007

For a long time I had been meaning to have a look at my girlfriend’s 401(k).  She knew she was putting money into it but other than that she hadn’t looked at it much.  Both of us assumed that it was just chugging away piling up and doing what it should.  She is a very smart woman with good financial sense but doesn’t have the interest in personal finance that I do…so when we got online and looked at her current portfolio we both had a bit of a surprise.  Her money was doing almost nothing.

 In fact, it was automatically putting her money 100% in a default money market fund.  Oh it gets worse.  I did the calculations and she returned around a whopping 3% for the year!  Thats right, a little over half of the return on high yield savings account.

To put this in perspective if she had been index fund that is available through her company she would have returned roughly 10%.  When I showed her the difference in cash she was uh, “not pleased” to say the least.  I went ahead and reallocated her funds into a mix of the index fund, a small market cap fund, and an overseas fund.  The latter two just being a small portion for fun.  Just for fun I showed her a scenario of what we might have just saved her.  At her current rate of return, versus a 10% return on JUST the money that was already in there (ie not counting any new contributions) off the top of my head, she would have had about $70,000 more by age 60.  I should have told her I will be charging a 10% fee.  Hey, that’d buy a boat…and when I retire, I would like to have a boat. 

Also as it turns out she was also not maxing out the company matching so we added her extra 2% to get the extra company 1%.  What difference did this all make in the end? To take it one step further, with continuing contributions, if she never got a raise in her life, and worked until 60, with proper allocation (assuming the market keeps rising at its average that is has risen at for the past 100 years) it made literally a million dollar difference.  Thats right $1,000,000.00.  Talk about a change in personal finance.   

There are lessons to be learned here:
 
1) Just because you are contributing to your 401(k) does NOT mean you are doing your due dilligence toward having a good retirement.  Don’t assume that the company is doing the right thing for you.  If you are young you should not be completely invested in a low risk portfolio.

2) Max out your company match.  It is free money, and compounded over 40 years it is a TON of free money.  It’s a truckload of free money. 

I imagine a truckload of free money to look something like this:

Personal Finance Money Truck

Just in case you are wondering, and since the name of this blog is The Penny Saved …that truck is a standard 18 wheeler and if you do not count the weight of the truck itself, it could legally carry about 14,514,955 post 1983 pennies.  That comes out to $145,149.55

So really that million dollar savings would take more than more than 7 of these trucks full of pennies to haul. 

401(k) Basics

Wednesday, March 14th, 2007

Nearly everyone has heard someone mention “401k” at some point in their lives.  Chances are if you are reading this you have at least an idea of what it is, and if you don’t, you will soon! 

So what exactly is a 401(k)?

The 401(k) plan is a type of retirement plan that is named after a section of the U.S. Internal Revenue Code.  It is a plan that is employer sponsored that allows you the worker to save income from your paycheck before taxes are taken out by the government.  Now, this doesnt mean you won’t have to pay taxes on it, our kind and generous government simply doesn’t take out taxes right now but when you actually collect your money at retirement. This is what people mean when they say it is tax deferred

Generally this money is then put into an account that can be invested in an assortment of mutual funds that can emphasize stocks, bonds, money market investments. Most 401ks are what is called participant-directed meaning that the employee is the one who gets to allocate the money.  There is another, less common scenario called trustee-directed where the employer has trustees who decide how the money will be invested.

Another very important point is that most companys match a portion of the employee contribution.  For example a company might match 1% for every 2% contribution up to 6%.  In this case if the employee contributed 6% per paycheck, the company would contribute 3%. This is one area where the 401k is vastly superior to other traditional retirement plans.

When can you withdraw the money?

There is a long answer, but the short answer is 59½. If you withdraw the money before then there is an extra tax on it of 10% and this is only under very specific circumstances.  Its not meant to be something that you can take money out of because you want to buy a boat or pay off some credit cards or go to south padre island…  It is meant to be something that is saved for retirement.

Whats the deal with the taxes?

The employee does not pay federal income tax on the amount of current income that he or she defers to a 401k.  So if you earn 30,000 in a year, and defer $2000 into a 401k plan, you only pay taxes on $28,000 that year.  Assuming a yearly return of 8% (which is actually lower than the market average over the last 100 years), if you are 25 when you put that money in, by retirement that 2000 will have become $30,000 and only then is it taxed. 

What happens if I leave my job?

Your 401(k) plan can be “rolled over” into the new job’s 401(k) plan, an IRA, or it can be cashed out.  However, cashing out is a terrible idea….all that money could have sat and compounded.