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Managing Your 401k or IRA: Does Moving Money Around Every Day Help Your Returns?

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I was invited to speak to a nice group of people at Walsh College in Troy, Michigan last night. One woman asked, “What do you say to someone who messes with their 401k non-stop?”

btw: Thanks, Greg, for the invite! Hopefully I didn’t bore your students silly.

Let’s face it:

90% of us fall into one of two camps:

1) You obsess over your 401k and tinker with it constantly.

or

2) You only remember you have a 401k or IRA plan when the statement arrives.

I’d say that nearly 90% of the 90% number above fall into the latter category. So, when I hear about someone tinkering with their 401k or IRA all the time I think, “Why?” and then I ask “Would it help to tell them to stop?”

 

Why People Do It

 

I don’t have any scientific evidence, only years of experience with people. Here’s the complete list I can imagine:

– Natural worrier.

– Concerned they won’t reach retirement.

– Anxious to get every last penny out of investments.

– Intensely interested in investing.

– Secretly always wanted to be a day trader.

I can’t think of any others (fill in my blanks in the comments below).

 

Would It Help To Tell Them To Stop?

 

I think the answer to this question largely depends on how the individual answers the question “Why People Do It”.

 

Natural Worrier

 

I could tell this person all day that he isn’t helping himself, but the only method that actually has worked for me in the past is DATA. If I explain how funds in a 401k plan work, it’s easy to see how much damage you’re doing to your retirement.

First, a 401k plan is a professionally managed investment. This doesn’t guarantee success, but it does mean there are people who work with money all day managing the funds.

Second, each investment is a collection of stocks that largely move with the market. Do you really think you can beat the market? According to a New York Times article, investors spent over $100 billion dollars in 2008 trying to beat the market, and largely lost due to fees. You would have been better off buying and holding low cost index funds.

Besides fees, your ability to time the market isn’t probably as good as you’d hope. According to one of my favorite Kiplinger articles: Can You Time The Market?, there are certainly some good indicators you can track, but the pitfalls are enormous. Going with your “gut” feeling about the market isn’t going to pave the way for a successful retirement.

 

Concerned They Won’t Reach Retirement

 

This person needs data, but instead of information on investment returns, they need a financial plan. I’ve found that once this person sees in writing that they’re okay (or not okay) they largely settle down.

Not only can you use the Planwise tool imbedded in our site, but many retirement calculators exist on other (less) popular sites, like Yahoo! Finance, CNNMoney, and MSN Money.

 

Intensely Interested In Investing

 

These are some of my favorite people. They want better returns and are willing to go the extra mile to learn more about investments. They’ve dove (dived?) into the 401k because it’s available and easy to understand.

I recommend this person reviews the same data presented above on investment returns (and that his chance of helping his return is going to prove more difficult than just “moving money around”). Then I recommend he take community education classes on investing rather than experiment with hard-won retirement dollars.

 

Secret Day Trader

 

I try to present the data above on how hard it is to add to your investment returns first (but this rarely works for the person who is sure they’ll beat the market in their spare time). Once this tactic has failed, I’ll recommend developing a small Roth IRA to use as a “sandbox” to play day trader in. These people are usually placated if they have a “play” account to go along with their professionally managed “backstop” account. How much do I recommend people place in the day trader account? First, we look at what the goal will cost, then I recommend taking money that isn’t crucial to the goal. You don’t want to miss your goal because you thought today was a great time to buy Facebook and it turned out you were wrong…..

Americans Are Worried About Retirement. Really?

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Yesterday’s USA Today featured a study commissioned by the Consumer Federation of America and Certified Financial Planner Board of Standard, which revealed that more households are struggling financially than 15 years ago.

I’m not shocked by this “revelation.” Talking to one of my favorite bloggers, Len Penzo (from the aptly named Len Penzo dot Com) a couple weeks ago, Len commented that a “big” financial blogger is lucky to find 700-800 unique visitors per day. I know that financial blogs don’t always have the money answers, but on a recent visit to web-traffic website Compete.com, I saw that another favorite, humorist writer The Bloggess receives about 1400 unique visitors a day.

So, using my extraordinary math and non-scientific research skills, it appears that about double the number of people enjoy humor during their day than seek out financial management techniques and discussion.

 

Are we really worried?

 

People sometimes think that financial plans are for the rich. “I don’t have money to plan,” you may be telling yourself right now. But how can you get out of debt if you don’t plan your financial future?

The survey shows that when low-income families put together a financial plan, they’re able to stay out of debt and pay credit card bills in their entirety. However, only 31% of people surveyed have put together a financial plan (with or without an advisor’s help).

31%? And the headline reads that we’re “worried about retirement?”

More evidence of financial ennui from the study: more people are living paycheck to paycheck, less are saving toward their college-bound children’s education, less can retire at age 65 and more think they won’t be able to cover basic expenses in retirement.

It sounds like we have big financial headaches and 69% of people aren’t attacking the problem.

Normally, I’m a “glass half-full” kind of guy. However, in this case, I think the headline “Americans Worried About Retirement” should be replaced with “Americans Screwed and Not Doing Much About It.”

I’m glad you’re visiting today to be the few…the proud…the 31%!

Captain America photo: Gage Skidmore

 

Let’s vote: Glass half full? Half empty?

How to Split an IRA or 401(k) in a Divorce

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Divorce is ugly.  Except under the most limited circumstances, no one wins in the divorce game.  Then, you add the complexity of money into the equation and it gets downright hideous.  In that emotional time, it’s easy to understand why so many people divide IRAs, 401(k)s, and other retirement accounts sub-optimally.

You can’t just “take the money out and give it to my spouse”  That would be a big mistake.  Let me count the ways:

Let’s assume you own a $250,000 401(k) balance.  The judge rules that you’re required to split that 50/50 with your spouse, so you decide it would be easiest to make a phone call and take the money out.  Ouch.  If you do that, you’ll be hit with a 10 percent early withdrawal penalty (yes you, not your spouse, and only if you’re under 59 1/2) and then the amount you removed is added to your taxable income for the year.  Now, for many reading this blog, you’ve just lost 35-45%.

So how do you give $125,000 to someone?  Oh that’s easy – you gift that to them.  But in your haste, you didn’t do this correctly either. To gift it, you either need to reduce your lifetime exemption by filing a form 706 with your income taxes next April, or pay a gift tax of 50%.

Long story short: “taking it out” could be a massive financial mistake.

Instead, consider asking for a QDRO, or Qualified Domestic Relations Order (pronounced quad-row).  A QDRO put together by a competent attorney and signed off on by the judge makes this transfer a ton easier.

First, it directs your retirement plan company to establish another qualified plan in the name of your spouse.  Then, it directs a tax-free transfer to that newly established account.  No taxes, no penalties.  Easy as pie.

Once you’ve begun working on that, you’ll want to make sure the QDRO says that your soon-to-be ex-spouse can’t make any loans or transfers from the account until it’s been split; or you could just pick a date to make the transfer effective on (retroactive) and put a fixed dollar amount based on that date’s plan balance.  This would protect the new beneficiary from being bamboozled by his or her ex.

Finally, don’t forget about pension plans.  A lot of those can be “QDROed” too.  For example, let’s assume your spouse earned a pension at his job of $4,000 during the 30 years he worked.  He was married to you for 20 of those 30 years – making you the owner of 2/3 of his $4,000 per month.  By putting the QDRO in place before he retires, she can have her own pension plan – quite the deal!

At the end of the day, divorce planning with money is just as important as married couple planning.  If you don’t do it, you’ll regret it.  Take the time to review everything – hire a professional and don’t try to cut corners.  The costs are too severe.


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Homeowners Insurance: My Friend’s Best Friend

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Here’s the best way to score a table at a busy restaurant. Walk up to a table of nice people and say, “Let’s talk about insurance!” Within seconds, the table is yours.

Nobody enjoys the topic, but I think we all recognize the need for homeowners insurance.

I was reminded why again last week.

I received a message that good friends of ours who lived around the corner from our house had their home burn down. They’d recently relocated to Colorado.

Those forest fire pictures you’ve been seeing in the news? Those are the flames that destroyed nearly everything our friends owned.

We don’t like to talk about insurance, but events like this are a good reminder that we should revisit the policy periodically to make sure we know what protection we own.

 

5 Important Homeowners Insurance Provisions

 

1) Replacement value coverage– Most homeowners policies are replacement value coverage, but it’s worth checking. If yours isn’t, you’ll receive the fair market value of each item you claim. That five year old computer? Probably not worth the $1,000 you spent on it anymore….

2) Valuables itemized and insured separately? Although policies will replace your belongings, high value jewelry, artwork and personal items should have a separate endorsement. Insurance industry friends tell me to check with your agent or company because competing insurers have different levels of personal endorsements.

3) Renters? Roommates? Here’s a sticky point. If you’re living in a home but don’t own it, you’ll need renters insurance for your personal items. Many people rent because they have a tight budget, but this is one important area to spend the money (and hopefully never have to use it).

4) Deductible. Remember that recommendation some crazy website made about funding a cash reserve emergency account? Partly, that’s so you can self-insure and tell the insurance company to take a hike! As your deductible grows, the amount you have to pay for insurance declines. That’s the good news. The bad news? You’ll owe a larger amount when you have a claim, so don’t raise your deductible until you’ve funded your emergency fund.

5) Inflation protection. Because thinking about your homeowners insurance is feared worse than a trip to the dentist, inflation protection increases the value of your coverage over time. This way, even if you forget, you’ll have protection that keeps up with rising costs.

While I can’t say that you’ll be the hit of the neighborhood by having a great homeowner’s policy, you will be able to relax a little after disaster strikes. I’m glad my friend’s family is okay. You can always replace a house.

Let’s keep the discussion going in the comments. Now that we’ve covered some important homeowners insurance provisions, how do you score a good deal buying it?

Photos: Fire Fighter: Roby Ferrari; Forest Fire: National Guard

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You’re Half Way Done! How’s Your 2012 Goal Setting Progress?

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Congratulations!

As we roll into July, you’re nearly half way through your 2012 goals.

How are you doing? If you’re a planner by nature, then you already know the answer to that question. Heck, you probably have a bar chart in your bedroom!

…you’re so romantic….

But, if you’re like the 90% of us who don’t actually keep day-to-day tabs on exactly how we’re doing relative to the things we said were important at the beginning of the year – this weekend’s a great time to reset the meter.

You probably started out 2012 with a list (check that: an idea) of what financial goals you’d like to accomplish. Items such as: pay off debt, build a cash reserve, save for a down payment, increase your retirement savings – important goals. But, did you actually capture it in writing? We’ve all heard it before – writing your goals down makes you more likely to hit them.

Let’s complete a little goal setting exercise to achieve the goals we set out to accomplish only six months ago.

 

Goal Setting In Five Easy Steps

 

Step 1: Make four columns on a piece of paper. Label them 1 year, 3 year, 10 year, and Lifetime. Now, for the next three minutes, think about all the things you want personally (toys, cars, houses, etc.) – we call these (“thing” goals) – and list each in the appropriate category. For example, if you want a Ferrari, but you’re thinking in the next 10 years, put “Ferrari” under the 10 year column.

After three minutes are up, spend another three minutes on money goals and another three minutes for spiritual / well-being goals. After nine minutes, you should have a list of all the 1, 3, 10, and Lifetime goals you could think of in the three areas of your life: things, money, and spiritual.

Step 2: Now, take 5 minutes to go through your columns, move things around and clean up your brain dump. Now your list should look a little more legible and it should be somewhat realistic.

Step 3: For our goal setting exercise, let’s take a look at all of your 1 and 3 year goals. Go through them and pick out one “thing” goal, one personal goal, and one money goal for each.

Step 4: You now have a total of 6 goals, three of which you’d like to accomplish in the next year. Never leave a goal setting session without taking action toward that goal. So, what you should do is make a list of the three to four action steps that must happen to make those goals a reality. Of those action steps – pick one that you will do TODAY to move forward.

Step 5: Here’s the final litmus test – you have to ask these questions:

1) Can I afford it? Meaning – can you do what’s necessary to make it happen? Can you actually do it?
2) Will you do it? Goals are nice, being able to accomplish them is nice…but if you won’t do what’s necessary…then what’s the point?

If you’ve gotten this far and you’ve found 3-6 goals that are reasonable you must take at least one little action step now. Don’t leave the goal planning table without taking at least one little step!

Do it now!

Congratulations. You’ve gone through a 30 minute goal planning session that will put you in position to reach your goals!

Great job!

How are your goals coming along? Let’s talk about our goals in the comments? Which ones are you on track for and where is your focus the second half of the year?

 

Photos: Woman writing: Risager; Life in 10 Yrs: lulumon athletica

5 Summer Activities to Create Money Savvy Kids: High School

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Ah, we made it! It’s most rewarding yet the most challenging to work with high school students on money management.

While these activities are the most fun for parents, high school students are more difficult to engage than younger children.

If you don’t have high school age children yet, you may not know this, but your brains will disappear for about four or five years.

Looking for tips for younger children? Try:

5 Educational Summer Activities For Kids – Early Elementary

or

5 Summer Activities to Create Money Savvy Kids: Upper Elementary to Middle School

 

5 Great High School Activities

 

1) Family book club. Right now, my 17 year old kids and I are reading I Will Teach You To Be Rich by Ramit Sethi. If you haven’t read this book yet, by all means, start now. It contains powerful advice wrapped in easy-to-understand language.

Every day the kids read a chapter. Then, at dinner, we discuss that day’s reading. Sometimes these conversations devolve (“why does a stock go up or down?” “what’s a good Roth IRA investment?”), but I love it. Who doesn’t want to have relaxed conversations about money with a curious 17 year old?

Why I like it: I get to ensure my kids get to college with some clue about money before they arrive. Because I made sure the book was fun and easy to read, and because I don’t preach, we’re able to have great talks about money.

2) Engage kids in the Family Meeting. If you’ve read this blog before, you’ll know that I love the idea of a family meeting. Budgets within a family are more about good communication than about counting pennies. If everyone is on the same page spending each day will be more careful, and life is made up of these little crisp 24 hour periods.

Some people have a violent reaction to this advice. “Show my kid my bills and my savings? That’s none of their business.” You are correct, but lets challenge your assumptions: why is it taboo to talk about your financial situation with others, especially those as close as your teenager.

Boundaries must be drawn. You’ll have to explain what happens when the whole street learns about your finances. But in the bigger picture, if they help you pay the bills, evaluate savings and plan large purchases, you’ll hand them a lifetime of knowledge that they’ll appreciate down the road.

Why I like it: When we began talking frankly with our children about bills and savings, they began to see how tight every month is for the average family. Next year we were planning on going to France for their graduation. The reality of two children in college at once has set in and we’re downgrading the vacation plan to a rental house on Lake Michigan for seven days. No groans from the kids because they understand the math behind the decision.

 

3) Find a job. I’m not talking about grabbing the local Dairy Queen gig (if I had that summer job I’d weigh about 750 pounds!). I’m talkin’ about helping junior through the process of fighting for a summer internship at a resume-building position. If they’re interested in engineering, try to find opportunities with a large local company. If law or medicine, apply at  the hospital, a law firm, or the local doctor’s office.

There’s a ton that junior learns while creating a resume, dressing appropriately and speaking well. The training involved in competing for these positions is a good primer in adult life skills.

Why I like it: By working in a professional environment, high school kids get a first hand look at how business works. Studies have shown that people who work in “real jobs” before college are more likely to do well in the classroom because they know how their learning might apply in the real world.

4) Scholarship hunt. Finding money for college is a full time job. The internet is brimming with opportunities for money, but you have to know who to ask and what scholarships to pursue. Most high schoolers only scratch the surface when it comes to searching for scholarships.

Instead of one-offing each opportunity, we found quickly that many of the scholarship opportunities were similar. My kids could write a couple of basic essays and then modify them to fit each particular offer. Most needed references from teachers and community members. We didn’t just learn about scholarship, we learned about creating systems to efficiently attack more quickly.

Why I like it: By formulating essays and asking for letters of reference, kids learn about the importance of written and verbal communication. They also realize that “going it alone” isn’t usually a good idea. It makes sense to find some powerful friends to help you….AND my kids were surprised that most powerful people want to help.

5) Board games. I’m back with more board games to teach the family about money. This time the games are downright fun for adults. Games such as Acquire can teach simple mergers and acquisitions. Power Grid is a modern-day version of monopoly involving power companies. And, in this year when the politics of the nation are up for grabs, 1960: The Making of a President is a good primer on the campaign process while also serving as a fun way to learn some history.

Why I like it: Board games are a great way to spend time with your kids. Instead of arguing or fighting about curfews and money, you’ll enjoying each other’s company over a communal activity.

How do you teach high school kids about money? Let’s have some more ideas in the comments below!

 

Photo Credit: Reading: NannySnowflake; Internship: ChesCrowell

How Much Wood Could a Woodchuck Chuck?

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Anyone know the answer to that?  As we all know, that all depends, right?  No, it doesn’t depend on whether or not the woodchuck could chuck wood, but rather whether he was healthy enough to do so.  So my question to you, dear reader is this: If, God forbid, you weren’t able to get up and go to work tomorrow because you were too sick or hurt…how much chucking would you get done?

We’ve all seen the quacking Aflac commercials, I know I’ve laughed at most of them.  But when was the last time you actually thought about the implications of what that magical duck was saying?  Here’s a little exercise I go through with all my clients – you can play along at home.  Assume the following:

  • You’re an average white-collar worker making $60,000 per year and you get a $10,000 per year bonus
  • You have a nice ‘n comfy group disability policy that pays 60% of your base salary if you’re too sick or hurt to work
  • You’d really like to retire – and your family is counting on you being able to work so that you can save to reach that (or any other) goal

Here’s how I go through this little exercise – it kinda drives the point home:

Mr. Client.  Play along with me a second.  Let’s assume you head into work in the morning and your boss says, “Jim, you’re a wonderful employee, but we have to let you go.  Pack up your desk.”  Just like that you’re unemployed.  Since it’s only 11:30 A.M., you decide to head out to get something to eat before heading home to break the news to your lovely wife.  What’s your favorite fast-food restaurant?

McDonalds.

Excellent.  So, you’re at McDonalds and you see they’re hiring.  A nice little help-wanted sign stares you right in the face.  So, since you’re now jobless, you ask the manager for an interview.  After a short period of time he says, “Jim, you’re super awesome and we’d love you on the team.  We can’t pay a whole lot, but we’d be happy to pay you $60,000 per year.”

Figuring you’re in some kind of third dimension you run across the street to your 2nd favorite restaurant…which is…

Wendy’s.

Right, Wendy’s.  A quick chat with the manager and he wants you there too!  This is your lucky day!  He says, “Jim, we’d love you on our team, too.  We can’t pay a lot, but we can pay $58,000.”

Which job do you take?

McDonald’s right?  (all other things being equal)

So, before you sign your professional McDonald’s contract you ask the sixty-four thousand dollar question:

“What happens if I get sick or hurt and unable to work for an extended period of time?”

“Great question Jim.  We can’t pay you a lot of money – but we can pay you $30,000.”

Armed with this info, you dash over to Wendy’s.  You ask the same question.  The Wendy’s manager says, “Great question Jim.  We can’t pay a lot, but we can pay you $48,000.”

Now what?

If you’re like most clients, looking at this issue in the big picture helps solidify it.  It generally makes a lot of sense to forfeit a small amount of income today in exchange for guaranteed income forever.  There are hundreds of bells-and-whistles that make disability insurances different between companies, but suffice it to say, your group coverage isn’t good enough.  Generally speaking, group policies:

  1. Are considered taxable income when you receive the benefits
  2. Are canceled as soon as you leave employment
  3. Only cover base salary
  4. Require you to visit “company” doctors

I’m not saying group policies are bad – they’re not.  What they are, however, are incomplete.  Consider adding an individual disability policy to supplement your group disability policy.  When you own an individually purchased contract:

  1. The benefits are tax free
  2. Are guaranteed renewable through age 65 (or 67 depending on the company)
  3. Can cover all your income – including bonuses and retirement plan matching
  4. You can use your own doctor for reviews

Disability insurance policies are like car and home owner’s policies.  The premiums suck until you need to collect.  And trust me, you’re not going to be on your death bed saying “What the heck.  I paid $800 per year for 65 years and never had a house fire.”  Instead, you’ll say, “Boy was I lucky.”  Disability is the same way.  Go check out a couple companies and get some quotes.  My bet is you’re talking about less than $100 per month.  Not chump change, I know.  But the price is so much less than the risk.  Go get it done.

It’s all about chucking that wood.

Are You an Overnight Success Waiting to Happen? Our Cuppa Joe Discussion.

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Having found out today that the Zune is probably dead, I look at Microsoft and think “this was a good idea gone wrong.” From outside appearances, Microsoft never really identified what the brand “Zune” stood for. At one point it was a music player. Then it was a music service. Now, because Microsoft couldn’t make up it’s mind, it’s soon to be nothing. It seems to be a textbook case of jumbled product design.

The iPod never had that problem.

From the beginning, there was clear differentiation between the iPod and iTunes. One was a service, the other a little sexy looking hard drive that Apple marketed as a music player.

 

Cool Design Alone Doesn’t Win the Day

 

But people forget that the first iPod wasn’t a blockbuster; quite the contrary. Initially, in 2002 iPod sales were about 40,000 units a month. That may sound like a ton, but not when compared to the 56 million iPods sold in 2008. The product took some time to catch on. It took consistent backing of the manufacturer and a laser-like focus on the end product without distractions.

In the short time I’ve been blogging, a good number of well-designed and well-written sites have disappeared. I’ve watched blogs implode under the weight of the writer’s unrealistic expectations that if they wrote something (anything) the market would come running immediately.

This “quick success” isn’t limited to blogging. Restaurants open daily without any real planning and end up highlighted on the Gordon Ramsay show Kitchen Nightmares. Viewers like me ask “what were they thinking?” as you see people ill-suited for prime-time trying to run a restaurant.

There are other industries: tech gambles, films, online stores, retail and B2B operations. In each category you’ll find businesspeople who were hoping for quick riches. Success

In forums I’d see new owners complain that people weren’t coming to their site/restaurant/store. They’d rail against the injustice of lesser companies gaining the traction that they’d wished for. I wasn’t ever surprised when these businesses were gone in a hurry. Inspiration is great, but it doesn’t create an overnight success.

I think you start to understand business when you realize: you won’t be an overnight success. At that point, you’ll go into business with a clear understanding of what it’s going to take to succeed: tireless effort and a long-standing belief in your product.

The band Silversun Pickups was nominated in the Best New Artist category at the 2009 Grammy Awards. The band had been around since 2005….four years! Lead singer Brian Aubert, when asked about the three-year-late New Artist nomination answered: “It’s not lost on us how lucky we are.”

 

People want instant success, but the wise entrepreneur is ready for the long haul, and feels lucky when they finally find their audience. In most businesses, you don’t have to fall into the “get rich now” trap.

Instead, you can take the longer view:

1) Revisit your product. Do you have a jumbled message or a well-designed idea?

2) Realize that you have a cool product and treat it every day as awesome.

3) Interact with your audience in a way that cool companies would interact with their fans.

4) Be patient, but continue seeking out opportunities to invest in yourself and your chance of success.

Sure, sometimes you run out of patience or money. But if you’ve gone into business with the long view, rather than the “I’m gonna get rich quick” attitude, you’re far more likely to win because you’ve set up your business plan expecting it to be a marathon, not a sprint.

Who knows, four years into your new venture, like the Silversun Pickups or the iPod, you might be the next overnight success.

 

How do you remain patient about your business?

Meeting an Advisor? Understand Fees by Bringing This Checklist

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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?

  • Financial plan?          Yes  /  No  (how often is the plan updated?)
  • Budget review?         Yes  /  No  (will you advise on line items?)
  • Net worth review?     Yes  /  No  (do you make suggestions on assets for the fee?)

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?

  • Insurance review?     Yes  /  No  (In many states advisors can’t review insurances for a fee. However, they can make recommendations on appropriate amounts of insurance.)
  • 1040 review?             Yes  /  No (Again, advisors have to be careful here. Some aren’t allowed to give specific tax advice.)
  • Tax strategy?             Yes  /  No (Will you recommend comprehensive tax plan?)
  • Asset allocation?       Yes  /  No (Many advisors will calculate where your assets lie on an Ibbotson efficient frontier and recommend asset changes based on your goals.)
  • Estate review?           Yes  /  No

 

___ 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.

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How I Chose My High Yield Bond Fund

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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:

  1. I knew my end goal. I wasn’t just throwing money in the general direction of my problems or praying for high returns. I didn’t use a “more is better” approach. That usually lands investors in an ugly spot, when their greed turns profits to huge losses. I was looking for retirement, and needed to maintain at least a 6 percent return to get there.
  2. I had already determined my asset mix to reach my goal. On our podcast and in previous posts, I’ve discussed finding the appropriate diversified asset mix for your goals. Mine included high yield bonds, mostly because they have a history of achieving my target return.
  3. I knew how much money I needed in high yield bonds to meet my goal. Normally, I’m not a fan of mutual funds. But, because it was a small amount and a manager can oversee the process of avoiding defaults, I decided one mutual fund would do the trick. For more sizable chunks, I’d hire multiple managers or switch from a mutual fund to individual bonds.

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.

Fees

 

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…..

 

Screening: Expenses

 

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.”

Screening: Manager

 

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.

Screening: Star Rating

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.

Examining the List.

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:

  • how each fund performed against it’s competitors,
  • what the dividend looks like, and
  • how the fund is managed.

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.

What Did I Choose?

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;

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