This is a guest post from Robert Farrington at The College Investor.  He seeks to help young adults and college students get started investing, and has a great Investing 101 resource.  Though Robert’s audience is a bit younger than many of the readers of this blog his insights are useful to investors of all ages and experience levels in my opinion. 

When you describe yourself and your financial future, do you see yourself as a trader or an investor?  Did you know there was a difference? It’s true, they are often used interchangeably, but they are quite different.   And knowing yourself and the difference between the two can help you understand where you’ll be successful in the future.

Trading is Different From Investing 

Trading and investing have a major difference, and that difference has to do with time. If you are trying to multiply your money over the course of 30 or 40 years, then you are most likely investing. If, however, you are interested in buying a stock today and selling it tomorrow if it jumps a point or two, then you are almost certainly a trader, and not an investor. Trading is often a very short term action, while investing is performed over the long term.

While the terms are quite different, one can perform a trade while still being an investor. For instance, if you have a 401(k) account that isn’t performing as well as you’d like, you might decide to change your overall investment strategy and you would do this by making some trades. You would sell off the shares that no longer matched your investment plan and then you would purchase some new ones that do. With this, you would be trading in order to fulfill the long-range goals of your overall investment plan.

Give Into Temptation 

I think there’s a little piece in all of us that is intrigued by risk and excitement. This is why some people like to skydive and others like to swim with sharks. Still others love the thrill of a short-term trade built mostly on speculation.

We all have our investments, but you know what? Nobody talks about them. Why is that? Because they’re boring. What would we say? Something like, “My portfolio increased by 5.6% last year…” And that would most likely be the end of the conversation. But, what if you decided to make some trades and possibly make some short term cash? You story would turn into, “I evaluated the economy and I realized that this particular stock was undervalued, so I bought 100 shares and they just skyrocketed! I made $1,000 in just a couple of days.”

Because there’s a little need for risk and adventure in all of us, I say give into your temptation….in moderation. You definitely should not risk your entire investment portfolio, but feel free to use a small portion (something like 5%) and trade it as you wish. This will ensure that 95% of your portfolio stays safe within your planned strategy, but yet you can still have some fun with the 5% by making trades and taking a few risks here and there.

Making Trades

If you do decide to take a little risk and make some trades, there are a few basics you should know. First of all, most every trade carries a fee. So, if you sell a stock to make $5, but the trading fees were $10, then you actually just lost money.

Secondly, decide which trading method is right for you. Are you a fundamentalist or a technical trader? Meaning, do you trade based on the movement of the share price or are you making trades because of a certain ratio (like the debt-to-equity ratio, etc.)? Find out what makes sense for you and have a good time.

If you plan on trading at all, you need a strategy, and you need to stick to it.  Just like investing!  Invest in what you know, but also trade in what you know as well.  If you are interested in trading in a certain area of the market, say currencies, but aren’t knowledgeable step back, take an investing course, read up, and maybe use a practice account before you go for it with real money.

Final Thoughts

For some people, trading can be fun, but it’s just too much uncertainty and risk.  Just know that it’s not for everyone. If you aren’t comfortable with it, then don’t do it. But, if you feel like it won’t take over your life then maybe you want to give it a shot. Happy investing!

This was a guest post from Robert Farrington, from The College Investor.  He seeks to help young adults and college students get started investing, and has a great Investing 101 resource.  

Please feel free to contact me with your investing and financial planning questions.  Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.   

Please check out our Resources page for links to some additional tools and services that might be beneficial to you.  

 Photo credit:  Wikipedia

This infographic by the folks over at the Masters in Accounting site speaks volumes about the lack of retirement readiness here in the U.S.   What are you doing to ensure that you are on track for retirement?

Image created by www.MastersinAccounting.info

Please feel free to contact me with your retirement and financial planning questions.  Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.   

Please check out our Resources page for links to some additional tools and services that might be beneficial to you.  

A recent New York Times article discussed that a $1 million retirement nest egg isn’t what it used to be.  While this is more than 90% of U.S. retirees have amassed, $1 million doesn’t go as far as you might think.  That said I wanted to take a look at what it takes to provide $100,000 income annually during retirement.

The 4% rule 

The 4% rule says that a retiree can safely withdraw 4% of their nest egg during retirement and assume that their money will last 30 years.  This very useful rule of thumb was developed by fee-only financial planning superstar Bill Bengen, a NAPFA colleague.

Like any rule of thumb it is just that, an estimating tool.  At you own peril do not depend on this rule, do a real financial plan for your retirement.

Using the 4% rule as a quick estimating tool let’s see how someone with a $1 million combined in their 401(k) s and some IRAs can hit $100,000 (gross before any taxes are paid).

Doing the math 

The $1 million in the 401(k)s and IRAs will yield $40,000 per year using the 4% rule.  This leaves a shortfall of $60,000 per year.

A husband and wife who both worked might have Social Security payments due them starting at say a combined $40,000 per year.

The shortfall is now down to $20,000

Closing the income gap 

In our hypothetical situation the couple has a $20,000 per year gap between what their retirement accounts and Social Security can be expected to provide.  Here are some ways this gap can be closed:

• If they have significant assets outside of their retirement accounts these funds can be tapped.
• Perhaps they have one or more pensions in which they have a vested benefit.
• They may have stock options or restricted stock units that can be converted to cash from their employers.
• This might be a good time to look at downsizing their home and applying any excess cash from the transaction to their retirement.
• If they were business owners they might realize some value from the sale of the business as they retire.
• If realistic perhaps retirement can be delayed for several years.  This allows the couple to not only accumulate a bit more for retirement but it also delays the need to tap into their retirement accounts and builds up their Social Security benefit a bit longer.
• It might be feasible to work full or part-time during the early years of retirement.  Depending upon one’s expertise there may be consulting opportunities related to your former employment field or perhaps you can start a business based upon an interest or a hobby.

Things to beware of in trying to boost your nest egg 

• Avoid high cost financial products that often do more to boost the bottom line of the financial sales person than that of their clients.
• Likewise don’t give into the fear mongers peddling financial products like Equity Index Annuities or similar products “that can’t lose.” 
• Don’t be too cautious with your investments in retirement, inflation is a retiree’s worst enemy.
• On the flip side don’t take on excessive investment risk in an effort to catch up if you feel that you are behind where you need to be. 

The scenario outlined above is hypothetical but very common.  As far as retirement goes I think financial journalist and author Jon Chevreau has the right idea:  Forget Retirement Seek Financial Independence.

Please feel free to contact me with your investing and financial planning questions.  Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.   

Please check out our Resources page for links to some additional tools and services that might be beneficial to you.  

Photo credit:  Flickr

With the annual Morningstar Investment Conference coming up here in Chicago next week, my thoughts naturally gravitate to replenishing my office supply of high quality pens in the exhibit hall at McCormick Place.  Truth be known, my thoughts are more focused on preparing for my participation on a panel on Friday morning called Practical Solutions for a Challenging Retirement Landscape.  Morningstar’s superstar financial author and columnist Christine Benz was kind enough to invite me to participate in this discussion along with representatives from T. Rowe Price and Vanguard.

Pens and Trinkets

Ever since the first financial conference I attended in the mid 1990s I’ve never ceased to be amazed by the number of items that mutual fund providers and other financial services vendors can find to stick their names and logos on.  When my kids were younger they were the only ones in their school with backpacks from places like the Philadelphia Commodity Exchange and the London Stock Exchange.

At one point I had a whole section of T-shirts from defunct mutual fund companies like Strong and Berger.  Add an infinite number of logoed tote bags and baseball hats and you get the picture.  Our kids always liked the stress balls I found at many of the booths (we were obviously tough parents).

In recent years I’ve tried to be more practical at Morningstar and other conferences and focus on gathering a supply of pens for the office.  I always grab as many as I can because my wife and kids always seem to be on the prowl for these as well.

While strolling around the exhibit hall at last year’s conference I was really making a great haul on pens when it suddenly hit me:  There are a lot of companies that offer mutual funds and I’ve never heard of many of them.  And I’m a financial advisor.

How many mutual funds are there? 

According to the Investment Company Institute there were 7,596 mutual funds at the end of 2012.  This is down from the high of 8,305 at the end of 2001.  Add in 602 closed-end funds and 1,194 ETFs and there are lots of choices for investors.

How do you choose the right funds? 

Any selection of mutual funds, ETFs, or any other investment vehicle should start with an investment plan, which is ideally an outgrowth of your financial plan.  Once you have an asset allocation strategy you will want to fill these allocation buckets with funds and ETFs that are appropriate for your situation.

Here are six mutual fund selection mistakes to avoid:

• Assuming that a “brand name” fund from a well-known fund family is automatically a good investment choice.
• Relying on lists of top mutual funds from popular magazines or websites.
• Ignoring a fund’s history.
• Avoid mutual funds from fund issuers that you’ve never heard of.
• Assume that all index funds are created equally.
• Assume that mutual fund companies automatically have your best interests at heart.

Some additional considerations in selecting mutual funds and ETFs:

• Expenses matter.
• When using an index product make sure that you understand what index the fund is tracking and that it tracks that index closely.
• Avoid actively managed funds that are nothing more than closet indexers.
• When building a portfolio understand the concepts of diversification and correlation.
• Understand why you are choosing a given fund or ETF, where it fits in your portfolio, and what would cause you to eliminate this holding.

The Morningstar Investment Conference is a great place to catch some excellent educational sessions and to talk to fund and ETFs issuers to learn about their products.  I would be remiss in not mentioning the great work done by Leslie Marshall and her team from Morningstar in staging this conference.  The fact that it always runs smoothly is a tribute to Leslie’s organizational and management skills.

Please feel free to contact me with your investing and financial planning questions.  Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.   

For you do-it-yourselfers, check out Morningstar.com to analyze your mutual funds and ETFs and to get a free trial for their premium services.  Please check out our Resources page for links to some additional tools and services that might be beneficial to you.  

Photo credit:  Flickr

 The PBS Frontline documentary The Retirement Gamble continues to spark discussion, both pro and con.  In a prior post I discussed Winning The Retirement Gamble: Step 1 Adjust Your Mindset.  Once you have the right attitude you can start on your journey to retirement.

Saving for retirement is like any journey, it has a starting point and a destination.  No matter whether you are a 20 something with many years to go or you are in your 50s with retirement on the horizon, it is important to periodically take stock of your resources for retirement.  What have you accumulated, how much are you saving, and what other resources do you anticipate having available to fund your retirement?  You need to ask:  Where do I stand?

Take stock of what you have 

The first step in financial planning for any life goal is to determine where you are.  Ask questions such as:

• How much do I have in company retirement accounts such as a 401(k)?
• How much do I have in my IRA(s) both Traditional and Roth?
• How much do I have in taxable accounts such as a brokerage or mutual fund account?
• How much do I have in various bank accounts including savings accounts, money market, and CDs?

Determine what you can save for retirement 

Take a look at your budget at least annually and determine if you can increase your retirement savings.  Ideally this will be done in conjunction with a financial plan so you have an idea of what you will need to accumulate for retirement.  Ask yourself questions such as:

• Am I maxing out my company retirement plan contributions?  If not can I afford to increase my salary deferrals?
• Am I contributing to an IRA?
• Am I eligible for stock options or restricted stock awards?
• Can I afford to invest in a taxable account via methods such as dollar cost averaging or period contributions?
• Am I due a bonus in addition to my regular compensation?

The lists above are hardly exhaustive, but it is important that you periodically take a look at all of your assets.  Determine what has been or can be set aside for retirement.  This is the first step in your retirement financial planning.

The second step of this process is, of course, determining what you will need to have set aside for retirement.   This is the essence of doing a financial plan and we will cover that in a subsequent post.

Please feel free to contact me with your investing and financial planning questions.  Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.  

Please check out our Resources page for links to some additional tools and services that might be beneficial to you.

Photo credit:  Wikipedia

This is a guest post by author and financial journalist Jonathan Chevreau.  Jon is editor of MoneySense Magazine and the author of the book Findependence Day.  

While the media and the financial services industry seem equally obsessed with the concept of retirement, there is in my view a better more practical goal: one that is far less intimidating for newer investors just starting on their life and financial journeys.

Financial Independence vs. Retirement

This goal is Financial Independence or the short-form I’ve coined that means the same thing: Findependence. Note that Findependence is NOT synonymous with retirement.

Financial independence can and probably should precede traditional retirement by a decade or two. In these days of clean and healthy living and good prospects for longevity, it makes little sense to take “early” retirement in one’s 50s, if you define what follows as 30 or 40 years of doing little more than watching daytime television, playing golf and sailing.

By contrast, no age is too soon to establish findependence: if you can do so in one’s mid 20s, that’s a good thing, and many technology entrepreneurs have done just that: from Steve Jobs to Mark Zuckerberg to Tumblr founder David Karp, who just sold out to Yahoo at the tender age of 26. The first two did not stop working once their early payday arrived and I’m sure that will also be the case with America’s newest multi-millionaire, Mr. Karp.

What is Findependence?

As I note in my book Findependence Day, Findependence just means that total income from multiple sources – pensions, investments, rental income, employed or part-time work, etc. – exceeds earned income from the traditional sole employer.  I define Findependence Day as the day in the future when this magical moment arrives: henceforth you may continue to do exactly the same thing as before, except that deep down you know that you are choosing to continue to work, rather than feeling that one has no choice but to do so because of financial pressure.

To me, early findependence is a good thing, while early retirement may or may not be. Findependence means having the freedom and flexibility to pursue one’s heartfelt goals and dreams, without having to make financial compromises merely to make ends meet. Ideally, you want to achieve financial independence “while you’re still young enough to enjoy it,” which happens to be the sub-title of the new U.S. edition and e-book version of the book, which came out in April. (See www.findependenceday.com ).

For financial planners and investment advisers, such a paradigm shift would I think benefit their clients: average consumers and investors who use their services. And financial planning is a big component – fully a third – of what I’ve dubbed the Findependence Day model.

The other two aspects are online discount brokerages and index investing: either through index mutual funds or exchange-traded funds. And when I say financial planning, I mean primarily fee-only planning, although it can also encompass fee-based planning at least while clients are in transition from the traditional model to this mode of planning and investing.

In these days of ultra-low interest rates and volatile stock returns, I believe costs matter more than ever. Online or discount brokerages are one way investors can reduce transaction costs, while ETFs and index funds facilitate prudent diversification while minimizing investment management costs. But the third aspect of the model is also important, despite the perception by many that so-called do-it-yourself investors buying their own ETFs at online brokerages are in no need of third-party advice.

It’s true that in these days of online investing and so many online tools, financial blogs and social media, that do-it-yourself investors are more empowered than ever to make more of their own investment decisions. But there’s no reason why they can’t add a layer of financial advice, albeit on their own terms, and I believe the best of all worlds for such investors is through fee-only financial planners, the kind that can be found through NAPFA (the National Association of Personal Financial Advisors.)

In other professions, it’s perfectly natural for consumers to engage lawyers, accountants or physicians on a la carte basis, paying only for services as they are contracted for and provided. It shouldn’t be such a big leap for consumers to view the acquisition of financial advice in the same way, negotiating with the planner for a comprehensive financial plan at such and such a set price, or agreeing to tax and estate planning services on an hourly basis, or perhaps through monthly or quarterly retainers to monitor ETF portfolios and rebalance them yearly.

That to me is what financial independence is all about: a partnership with a financial life coach whose vision of your future findependence is perfectly aligned with their own values and skill-sets. You’re reading this guest article on the blog of just such a professional and I thank Roger for the opportunity. And by the way, the book – which some have described as a financial love story – is set in part in Chicago, which is where the action begins.

Jonathan Chevreau is editor of MoneySense Magazine and can be reached at jonathan@findependenceday.com.  His book Findependence Day  is available at Amazon.com, Barnes & Noble.com and Trafford.com.  Jon is a must follow on Twitter. 

Please feel free to contact me with your investing and financial planning questions.  Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.  

The stock market is in the midst of a 4+ year rally that has led to all-time highs for major market benchmarks.  It’s a bit of a strange rally in that the percentage of U.S. households owning stocks is at historically low levels.  Couple this with the raging market bulls we see on shows such as CNBC and it’s easy to see why many investors are confused as to how to precede.  Here are 5 investing lessons to keep in mind as you move forward.

Risk matters 

The potential downside risk should be a key consideration on how you allocate your portfolio.  This is especially directed at those of you readers over the age of say 45 who are within sight of retirement and certainly those of you who are retired.   Even in a well-diversified balanced portfolio if you haven’t rebalanced in awhile you allocation to equities might be higher than your plan exposing you to more risk than you might be comfortable with.

On the bond side it’s likely that the bond market’s best days are behind us.  While not advocating that you necessarily decrease your allocation to fixed income, this might be a good time to look at reducing the duration in your bond holdings.  Duration is a measure of the impact that a 1% increase (or decrease) in interest rates could have on a bond or a bond fund.  For funds you can find this on the morningstar.com website and elsewhere.

As for you 20 and 30 something’s I’m not advocating that you ignore risk, but I am saying that at your stage of life growth from the amount saved and from how your investments are allocated should be foremost in your mind, especially in your retirement savings strategy.

It isn’t different this time 

Prior to the 2000 market drop investors where touting tech stocks, including many companies with no real business plan or balance sheet.  They said it was different this time, it wasn’t.

Prior to the most recent recession housing was the magic bullet.  Real estate was the great hedge.  It wasn’t.

I’m not sure what is being touted as different this time, perhaps its all of the talking suits on TV telling us that it’s OK to increase our equity exposure even in face of these market highs.

The point is to let your own good common sense and an up-to-date financial plan be your guide to a reasonable investment strategy for your situation.  Ignore the hype.

Costs matter 

The deleterious impact of investment fees and expenses has been well-documented in the press of late, and were highlighted on the PBS Frontline show The Retirement Gamble.  The financial press is right.

• Index funds and ETFs can be a great choice for your portfolio, but make sure that you are buying the lowest cost index product that covers the area of the market that you are seeking to invest in.
• If you use actively managed mutual funds, make sure the added expense is justified by value added by the manager.
• As many funds offer multiple share classes try to buy the lowest cost share class available to you.
• If you work with a financial advisor understand how he or she is compensated and the true cost of your relationship with this advisor.  Besides high fees you want to understand if the compensation structure subjects you to potential conflicts of interest in terms of the financial products that the advisor might suggest for you.

Inflation is your enemy 

Inflation has been pretty benign in recent years but it won’t always be this way.  Even a relatively tame level can erode your purchasing power pretty quickly in retirement.  For example at 3% inflation your purchasing power will be cut in half within 24 years, a very likely life expectancy for a retiree today.  As I often say to those at or near retirement, your biggest investing risk comes from inflation versus the risk of actually losing money from your investments.

You have to play to win 

As I mentioned above the percentage of U.S. households holding stocks is at historically low levels.  What this means is that many families have not participated in this stock market rally.  While I am clearly not advocating that investors jump in to ensure they don’t miss any further gains, I am advocating that if you don’t have a financial plan in place get one done.  You can then gauge how to allocate your investment dollars as an outgrowth of your financial plan.  Jumping out of stocks when the market is at a low point as too many investors did in late 2008 and early 2009 and then jumping back in at a time like the present when it “feels good” is a recipe for fiscal disaster.  This is the value of having a plan.

Please feel free to contact me with your investing and financial planning questions.  Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.  

For you do-it-yourselfers, check out Morningstar.com to analyze your index mutual fund and ETF options and to get a free trial for their premium services.  Please check out our Resources page for links to some additional tools and services that might be beneficial to you.  

Photo credit:  Wikipedia

This is a guest post from Bob Richards, the publisher of The Retirement Income Blog.

Your broker may seem like he wants to help you make money and odds are he does.  Unfortunately, he works in a system that decreases the possibility he can help you.

Your Broker Does Not Give You the Best Advice

Your broker has positioned himself as your advisor, someone acting in your interest.  However, this is not always so.  If he works for a large firm, that firm issues his paycheck and he is beholden to that firm.  Say he works for ABC Financial.  Notice that he often recommends the mutual funds or annuities created by ABC Financial.  This allows his firm to not only get a commission when you buy the fund but also fees for managing the fund.  So even though there may be better-performing funds he can recommend, he is under no obligation to do so.  His legal obligation is only to sell you what is suitable, not what is best.  And he often recommends “packaged products” such as mutual funds, annuities, or wrap accounts rather than individual stocks and bonds.  It is much easier for his firm to bury high fees in a packaged product.

You Broker May Not be Competent 

In order to become a broker (now called financial advisors at many firms), one must take a test.  The exam is like most exams—you memorize a bunch of information and then regurgitate it.  The test is multiple-choice.  Any intelligent 12-year-old can pass the exam. In fact, many brokers attend a 40-hour cram course the week prior to the exam as their only preparation. Furthermore, the exam tests knowledge about rules and regulations and almost nothing about what it takes to help you make money.  From my experience as a former branch manager for a major brokerage firm, about 80% of the brokers know very little about the market or the investments they sell. The other 20% may have actually taken investment management, economics and finance classes in school but this is not a prerequisite for becoming a broker.   Alternatively, the 20% who are knowledgeable may have educated themselves.

Your broker sells you offerings he may not understand.  Investments come with a prospectus.  I have never met a broker who read the prospectus of the investments sold. The way he often learns about the investments is by attending a luncheon given by a wholesaler (a sales person to sales people) who provides the sales talking points for the broker to incorporate in his pitch.  Because the broker cannot distinguish between a “good” and “bad” investment, he generally sells what his firm recommends. 

A Better Investment Professional

Very few investors realize that there are two types of professionals in the investment business. I have described so far a registered representative, the technical term for a stockbroker who sells investments and earns commission. There is another type of investment professional called a registered investment advisor. This person has obtained a license that permits him to give investment advice for a fee. He won’t sell you something and earn a commission (though some brokers and registered reps are both sales people and registered investment advisors via their firms). He will give you advice in return for payment. He is also legally responsible to you as a fiduciary. The definition of fiduciary duty:

“A fiduciary duty is the highest standard of care at either equity or law. A fiduciary (abbreviation fid) is expected to be extremely loyal to the person to whom he owes the duty (the “principal”): he must not put his personal interests before the duty, and must not profit from his position as a fiduciary, unless the principal consents.”

The way that most registered investment advisors work is that they manage your investment portfolio for a percentage of the assets for which they are providing advice (e.g. 1% of the portfolio value would be $1,000 annually on a $100,000 portfolio). Because of the way they are compensated, they have no motivation to sell you this stock, that stock, that mutual fund or this bond. Their motivation is to retain you as a client and to make your account grow. Only in this way can they make more money from you by helping you grow a larger investment nest egg from which they can collect their 1%. Yet others simply work hourly much like an accountant or an attorney or via a fixed retainer. Again, they have no incentive to sell you the product-du-jour as does a broker.

Advice for Selecting an Investment Professional

So here’s the advice I’d like to give every investor.

• Do not buy packaged products because unless you read the 80 page prospectus, you are likely being ripped off in terms of high fees.
• Buy individual stocks and bonds and no load mutual funds which you must buy on your own because commission brokers don’t sell them.
• Either deal with a registered investment advisor who will charge you fees and not commissions or you’ll need to learn enough about investing to do it yourself.

This is a guest post from Bob Richards, the publisher of The Retirement Income Blog.

Please feel free to contact me with your investing and financial planning questions.  Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.  

Please check out our Resources page for links to some additional tools and services that might be beneficial to you.  

Photo credit:  Wikipedia

There was a recent article on the CNN/Money website entitled Amateur investors tap 401(k)s to buy homes that discussed an increasing trend of 401(k) investors who tap their accounts to buy houses.  The thought process is to take advantage of the hot housing market in some areas on the country with money that would otherwise be locked up in a 401(k) until retirement.  Home prices are appreciating in some markets, so what’s wrong with this strategy?

Plenty is wrong with it, let’s take a look.

You distrust Wall Street but you trust the housing market?  Really? 

The article cites the distrust that some of these investors have of Wall Street and a desire to own hard assets.  I get the distrust of Wall Street in the wake of the 2008-2009 market drop.  These same folks must have short memories regarding the role that the drop in housing values played in the recession and the lingering effects of on many families.  Yes prices are low, but they are rising.  Are you knowledgeable enough to know if the property that you are buying is really a good deal?  Distrust Wall Street all you want, but the fact of the matter is that investors who hold a reasonably diversified portfolio saw their 401(k) and other investments recover within a couple of years of the 2009 market bottom.

Are you getting in too late? 

According to the article, Wall Street Investors are also entering this market and in some cases have bid up the price of homes in many of these hot markets.  Much like the John Hancock TV commercial touting the idea of getting back into the stock market now that it is at new highs, is this an ideal time to be taking your retirement funds and investing them into a “hot” housing market?

Are you smarter than the professional investors? 

As mentioned above this opportunity has come to the attention of Wall Street investors.  Think what you want about Wall Street, these firms have the resources in terms of capital and research that you don’t.  I’m not saying that individual investors can’t outdo the professionals, but ask yourself are you one of these real estate investors who can?  Do you want to risk your retirement savings to find out?

Understand the potential costs and risks 

In order to get at your money in a 401(k) plan you will likely need to take a loan from the plan.  There are no tax consequences of doing this and as long as you repay the loan there won’t be any.  Understand, however, that if you leave your job before fully repaying the loan, any remaining loan balance could end up becoming a distribution which would trigger income taxes and a 10% penalty if you are under 59 ½.

Further there is a potential opportunity cost.  Are you convinced that your real estate investment will outperform what you might have gained in your 401(k) plan?  Additionally, if your investment goes south you might end up with a property that is worth less than you paid for it, you are paying back your loan on the 401(k), and the house might be underwater if there is a mortgage involved.

Look before you leap 

Let’s be clear, I’m not against investing in real estate, in fact many have made their fortunes from doing just that.  What I am against is a novice who has read about the opportunities in the housing market taking funds from their 401(k) and investing in something they barely understand.

Will this always end badly?  No.  This might be a successful route to take for someone who understands real estate investing and who understands the risks.  If this doesn’t describe you ask yourself is this a good use of my retirement funds?

Please feel free to contact me with your investing and financial planning questions.  Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.  

Please check out our Resources page for links to some additional tools and services that might be beneficial to you.  

Photo credit:  Wikipedia

The benefits of low-cost index mutual funds and ETFs are all over the news.  They were front and center in the recent PBS Frontline Special The Retirement Gamble.  Index funds are a great tool for investors of all ages; in many cases these passively managed funds beat the majority of their actively managed peers within the same investment style.  However, investing in index funds takes work, especially with the proliferation of new index products that continue to hit the marketplace.

Expenses matter 

Costs matter when investing.  One of the biggest lures of index fund investing is that many of these products provide a low cost way to investment in a given segment of the market.  If you are looking for an index fund that mimics the S&P 500 there are many great low cost alternatives such as the Vanguard 500 Index Fund (Ticker VFINX) with an expense ratio of 0.17% or the SPDR S&P 500 Index ETF (Ticker SPY) with an expense ratio of 0.09%.  On the other hand, there is also the Rydex S&P 500 A (Ticker RYSOX) with its expense ratio of 1.51%.  How big of a deal is this difference?

A $10,000 investment in the Vanguard 500 fund made on May 31, 2006 and held until May 15, 2013 would now be worth $15,064.  That same investment in the Rydex S&P 500 fund would be worth $13,798 or 9.2% less for an investment in a mutual fund tracking the same index as the Vanguard fund. 

Understand the underlying index 

In the wake of the 2008-2009 market downturn new index products, especially in the ETF space, have proliferated.  ETF providers are falling all over themselves to bring new index products to the market hoping to attract assets.  Like any investment, investing in an index fund or ETF requires that you understand what it is that you are buying.

When I think of indexing I think of the traditional, basic index products that track benchmarks such as the S&P 500, the total U.S. stock market, the total non-U.S. market, the domestic bond market, etc.  Additionally I typically use index funds to benchmark the U.S. small and mid cap equity spaces, real estate, and emerging markets equity among others.

Several months ago Market Watch’s Chuck Jaffe cited a Vanguard report that found “1,400 U.S. listed ETFs track more than 1,000 different indexes. But more than half of these benchmarks had existed for less than six months before an ETF came along to track it.”  

As an investor this should be a huge red flag.  What this study says is that many of these new index products were developed much like the monster in the Mel Brook’s classic Young Frankenstein.  Look back-testing is not inherently bad and many of these new index products are appropriate for professional traders.  However if you are looking to index in the fashion that Vanguard founder John Bogle and others espouse then you should consider sticking with index products that track known, battle-tested market benchmarks.

Asset allocation is still vital 

Whether you use index products as a portion of your overall portfolio in conjunction with other investment vehicles such as actively managed mutual funds or individual stocks, or if you invest in index funds exclusively you still need to develop and asset allocation for your portfolio.  As I say frequently on this blog, this should be done as an outgrowth of your financial plan.

Even a seemingly simple strategy of investing in a total U.S. stock market fund, a total international stock market fund, and a total bond market fund still requires that you determine how much to invest in each fund, that you monitor your allocation and rebalance when needed, and that you review and adjust your target allocation as you age or if your situation changes.

Index funds and ETFs are a great investment tool.  Like any tool it is important that you select the right index product and that you manage your portfolio properly.

Please feel free to contact me with your investing and financial planning questions.  Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.  

For you do-it-yourselfers, check out Morningstar.com to analyze your index mutual fund and ETF options and to get a free trial for their premium services.  Please check out our Resources page for links to some additional tools and services that might be beneficial to you.  

Photo credit:  Wikipedia