The Monthly vs. Annual lump-sum IRA contribution timing experiment April 2013 update.

Annual Contribution Roth IRA

Account Summary :

• 04/30/2013 – Reinvested $2.10 dividend for Vanguard Total Bond Market Index Fund

Monthly Contribution Roth IRA

Account Summary :

• 04/01/2013 – Contributed $458.33
• 04/30/2013 – Reinvested $1.37 dividend for Vanguard Total Bond Market Index Fund

Monthly vs. Annual IRA Account Comparison

Analysis :

• The market continues to move upwards with no real signs of slowing down, even with mixed economic news.
• There is still a lot of chatter about interest rates and fear that bonds will take a big hit when rates move upward.
• With the markets rising like they are, the Annual account is starting to etch out an almost 1% advantage over the Monthly account. This is mostly due to purchasing at lower prices at the beginning of the year.

A reader that wanted to emulate the portfolio brought to my attention Vanguard’s $3,000 minimum investment requirement that apply to a number of mutual funds. This hypothetical portfolio ignored the minimum requirements to be able to demonstrate asset allocation and and the effects of dollar-cost averaging. In order to construct the portfolio with mutual funds in a new IRA/Roth IRA account, you would have to start with one fund and then build on it over time. Otherwise, you can match the allocations using Vanguard ETF’s, which have no minimum.

*This is a hypothetical portfolio and will not meet the needs of every investor. Only you can determine what level of risk and the types of investments that are appropriate for your portfolio. If you have concerns about risk or have unique circumstances, you should consult a financial adviser who can help develop an appropriate investment allocation for your specific needs. The IRA contribution experiment is a simulated portfolio and is not meant to be representative of a real portfolio. My personal asset allocation is different than that of the IRA contribution experiment.

• Contribution Timing Experiment Updates

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What is the difference between Financial Freedom and Financial Independence? Most people will tell you that they mean the same thing. They’ll say that it’s just a difference in terminology that can be used interchangeably. I won’t say that those people are wrong, but I have a slight difference in opinion.

What Is Financial Freedom?

Financial Freedom is the financial state of an individual or a family. It is usually defined by the following criteria:

• Debt free – Absolutely zero debt. The money a financially free person makes goes to no one but them (and unfortunately through taxes, the government).
• Emergency Savings – Have a level of liquid (immediately available) savings that will sustain you during any period of income loss or cover unexpected expenses. The general rule of thumb is 6 months worth of expenses, but your goal should depend on your comfort level, stability of income, and strength of earnings.
• Retirement Savings – Saved (invested) enough to supplement social security or a pension at retirement so that you can live comfortably without downgrading your typical lifestyle. Again, a general rule of thumb for retirement savings is to sock away 15% of your gross income while you are working, preferably in tax sheltered or deferred accounts like a 401(k) or an IRA.
• Insurance – It may not apply to everyone, but there are a myriad of insurance choices out there. Home, auto, life, health, umbrella, and so on. The point is, you should have enough insurance to shield you from catastrophic loss.
• Long Term Care – Everyone grows old. It’s an unavoidable fact of life that I wish weren’t true. That said, be prepared for the most expensive part of your life. Health care, while being a worthwhile expense, will suck you dry. If you’re not ready to face the challenges of the future, you will have limited choices. Think about your preferences for home care, nursing homes, and rehabilitation centers. Most importantly, think about proximity to family and what role they can play. If you’re depending on your kids to take care of you financially, just be aware that you will be severely impacting their chances of financial freedom.
• Estate Plan – Everyone should have a plan in case they die or become disabled. Don’t let your loved ones deal with unnecessary red tape and bureaucracy trying to handle your affairs without legal documents. Trust me, it’s enough of a pain dealing with customer service. It’s a whole different realm dealing with them when they won’t talk to you because you’re not the account owner and they “can’t” talk to you. Plan for the worst even if you don’t think you’ll need it. You will need it someday. Basics include a Power of Attorney, Will, and Advance Health Care Directive.

What Is Financial Independence?

Financial Independence is the financial state of an individual or a family that meets the qualifications of Financial Freedom with a couple variations. The ultimate goal for a person or family striving to be financially independent is to have the option of retiring early, or continue to work/volunteer at will (under their own terms).

• Covered Debt – If used carefully, covered debt can be used to fund investments that can help create wealth. This means that you are using debt as leverage to fund an investment that is secured by an asset. A common example of covered debt is a mortgage on a rental property. The mortgage is the debt. The property is the asset that “covers” the debt. In other words, if the property was sold, it would pay off the mortgage in full. Covered debt is not necessary to meet the conditions of financial independence, but is frequently used to obtain it.
• Retirement Savings – Strive to save enough for the traditional retirement period so you do not have to count on supplemental income from social security or a pension. Income from social security or a pension is just the cherry on top. Maxing out tax-advantaged accounts may or may not be the best strategy for everyone, but it usually is. Savers who max out their tax-advantaged accounts usually do so to defer/avoid taxes or for estate/inheritance purposes.
• Investment Income – Those seeking to be financially independent usually have a significant part of their investments in taxable accounts. One technique is to have enough savings in taxable accounts to accommodate a withdrawal rate that will last until the period where one can start withdrawing from retirement savings. Then, withdrawals would start from the retirement accounts until the end of life. Another strategy is to have enough in taxable accounts where the income from investments would cover all expenses for life (travel and fun stuff included), thereby allowing for minimal withdrawals from tax-advantaged accounts later in life. Basically, the cash flow from investments replace working income, freeing you from relying on others to make a living.

What’s The Difference?

There isn’t much. Financial Freedom means you are debt free and are financially stable. You’re prepared to deal with what life throws at you without the worry of living paycheck to paycheck. You’re working, enjoying life, and getting ready for a comfortable retirement.

On the other hand, Financial Independence takes you to another level. You’re the epitome of living below your means and you want to build wealth. You’re saving as much as you possibly can and are investing, or running your own business. You’re going to retire early, do what you want, and answer to no one but yourself.

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By Catey Hill, courtesy of Zillow

The super-low interest rates mortgage companies are now offering make refinancing tempting. Who wouldn’t want a rate just around 3 percent? Refinancing can help build equity in a home faster, shorten the loan term, lower monthly mortgage payments, lessen the amount of interest owed and more. But refinancing isn’t always the right option and can be costlier than sticking with a current, higher-rate loan.

Borrowers can figure out whether refinancing is right for them by looking at the reason(s) they’re refinancing and whether these are viable ways to reach their goal.

Refinancing to Take Advantage of Lower Interest Rates

The primary reason homeowners choose to refinance is so they can reduce the cost of their mortgages, paying less to the bank in interest and lowering their monthly payments. Consider a homeowner with a 30-year, $200,000 mortgage at a 5 percent interest rate with a monthly payment costing about $1,074. They will pay more than $186,000 in interest over the life of the loan. Compare this to the homeowner who pays only 3 percent interest rate on the same mortgage. They will pay just over $103,000 in interest and have an $844 monthly payment.

However, the choice of whether to refinance is not as simple as just comparing interest rates. Homeowners also have to think about how long they’ll live in the home and the closing costs. Closing costs average about $3,700, and borrowers often pay them upfront, so they must weigh these costs into their decision. If they plan to move in the next few years, they likely won’t recoup these closing costs even though they’re paying less in interest and have smaller monthly payments. Individual homeowners can calculate whether refinancing makes financial sense for them based on how many years they plan to live in their homes. In general, refinancing with upfront closing costs makes the most sense for people who plan to stay in their home for about five years or more, though the exact time frame varies from person to person depending on how much lower the new interest rate is and the total cost of closing the loan.

That said, even homeowners who plan to sell their homes soon can benefit from refinancing, as many companies offer “no-cost refis,” which are refinance loans where borrowers don’t pay upfront closing costs.  This doesn’t mean that these loans are “free,” however: Usually the borrower pays a higher interest rate in exchange for not having to pay upfront closing costs or the lender rolls the amount of the closing costs into the total loan amount.  In both cases, the borrower will likely pay more in interest over the life of the loan than with an upfront-closing-cost refinance. That however, may not matter to a borrower who plans to sell soon, as the out-of-pocket closing costs will likely be more than he or she pays in interest over the next few years.

Refinancing to Change The Loan Term

Some homeowners refinance to change the terms of their loans. One way is to shorten the term of the loan, which can save borrowers tens of thousands of dollars in interest over the life of the loan, though it often dramatically increases monthly payments. Consider: Homeowners pay roughly $66,000 in interest on a 15-year, $200,000 mortgage at 4 percent, compared with more than $143,000 in interest on a 30-year, $200,000 mortgage at 4 percent. Though, monthly payments are higher on the 15-year mortgage, roughly $1, 480 vs. $955. Homeowners must think about how higher monthly payments will impact their monthly cash flow and whether they can truly afford their lifestyle and continue to save money for other goals. Then, weigh that against how much money a refinance would save them in the long term.

On the other hand, some people refinance their loans to longer terms to lower their monthly payments. So, these homeowners may have been paying off their 30-year mortgages for the past decade having 20 more years before they outright owned their homes. After they refinanced into another 30-year mortgage, they have 30 more years before they truly own their homes – essentially a 40-year loan overall. Though their monthly payments may be lower because they are paying the loan over a longer period, they will pay more over the life of the loan in interest than if they’d opted for a shorter term and will have to wait longer before their mortgage is paid off.

Refinancing to Get Cash

Some homeowners hope to do what’s called a “cash-out refinance,” which means they take out a new mortgage for more than they now owe and take the difference in cash. The benefit of this deal is near-instant cash. But homeowners pay more in the long term than they would with a traditional mortgage, as lenders often charge higher interest rates for cash-out refis, and borrowers have to pay interest on a higher total loan amount.  Borrowers must weigh their need for cash (could it be used to pay off a higher interest rate debt?) with the higher financial burden of a cash-out refi and the risk (the home is collateral on these loans).

Refinancing to Change the Loan Type

In today’s low-interest rate environment, many homeowners hope to switch their adjustable-rate mortgages (ARMs) to fixed-rate mortgages to lock in low rates. Fixed-rate mortgages give borrowers peace of mind in that they don’t have to worry about future rate hikes. On the flip side, if interest rates fall, ARMs can remain attractive, as they may offer lower rates than with a fixed-rate loan.

Bottom Line

Borrowers who decide that refinancing can help them reach their goals should get quotes from at least three lenders, looking at the interest rates, closing costs, fees, penalties and other terms for each loan.

Zillow is a home and real estate marketplace that provides consumers with information and tools to make smart decisions about everything real estate.

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Like most people, I grew up with a particular idea of what the “American Dream” should be. All I knew was that if studied hard and worked hard I could become successful and fulfill my dreams. It’s too bad that no one educates you on all the stuff in between and that the dream is a hoax.

You know that family who lives in that nice neighborhood in the big house with a big pool? Do you ever wonder what it would be like to drive nice cars like they do? Wear nice clothes? Go on perfect vacations? Are you wowed by all their nice furnishings and electronics?

Sure, one of them is a doctor and one of them is a lawyer. They make a great deal of money. It’s too bad they are in massive debt and are working long hours and living from paycheck to paycheck. “Smart and successful” doesn’t always translate to smart and successful. Don’t be like these people.

Envy the family who lives in the modest neighborhood with no pool. They’re the ones that own and drive the same cars until their odometer stops working. They’re the ones that still clip coupons and send their kids to public school. They go on vacations too, but they fly coach and look for discounts and deals, and maybe even free stuff to do.

The difference is, it doesn’t matter what kind of job they have. They can make a lot of money or make an average amount of money. They are smart and successful people. They just don’t feel the need to show off or present a false image of themselves to others.

Redefine success. Remove objects and tangible things from your definition of success. The American Dream doesn’t have to be a big house with a white picket fence. It doesn’t even have to involve having children. Remember where you came from and relish in the fact that you survived and can still overcome adversity. Make life about living. Make money to buy yourself more time.

What’s The Point?

Believe me, I’ve been there. I grew up poor. I literally lived in a tin roofed shack with concrete floors attached to the side of a garage when I was a child. I studied hard and worked hard. I even joined the Army to serve my country. I started making some decent money and started noticing that as I made more money, I started spending more money. My savings rate dropped dramatically and then I started taking on debt. I got married, and together, we had even more debt.

I knew things were only going to get worse if we didn’t change. So we did. We stopped doing home improvement projects cold turkey. We left our dining room table in its box and didn’t buy chairs for it. In fact, my computer still sits on a plastic folding table. We redirected all of our efforts into paying off our debt and streamlining our expenses. We are now saving more than 25% of our income and the only debt we carry now is our mortgage.

The Extreme Money Makeover Plan is about starting over. Over the course of this series I will help you reduce your monthly expenses and prioritize your debt payments. The ultimate goal is to start saving again so that you are working for you. So that you can become financially secure and are prepared to face challenges that may occur in the future without worrying about how you will continue to keep a roof over your head or where your next meal is going to come from. We’re going to move away from living paycheck to paycheck and give ourselves the freedom to live in the now, while being confident that our future will be secure. It’s not about becoming rich. It’s about living our reality and improving our prospects.

How Will We Do It?

We’re going to go step by step through a process that will get you on the road to financial stability. It’s not a quick process, and it will take some people longer than others. That’s OK. It’s not a race. There is no set time-frame which you must follow. The more you can pare down your lifestyle, the faster it will be. If you’re willing to make some simple sacrifices and be disciplined enough to put unimportant things off, you can be successful.

• Change your attitude about money and finances. It shouldn’t be a taboo subject. It’s OK to be open and honest.
• Prioritize your lifestyle and spending habits. Be realistic about how you want to live your life. You can’t avoid spending money, just do it wisely.
• Start saving a little bit of money. It’s important to start saving for retirement and have an emergency fund now, even if you can only start with a small sum.
• Pay off debt. Get rid of credit card debt, student loans, and any other extraneous debt that is weighing you down.
• Start saving a lot of money. Because you need to. You can only count on yourself when you need help the most.

Remember, I’ll be here throughout your journey and am always available to answer your questions (or direct you to who can) via comments, social media, or e-mail.

• The Difference Between Financial Freedom And Financial Independence

The post What Is The Extreme Money Makeover Plan? appeared first on Budget For Wealth.

I’ve been reading a lot of reports in the news that consumers are “feeling” richer, and as a result, they are increasing consumption and spending more. What the hell does that mean? What is it like to feel rich, but not actually be rich?

There are supposedly two factors that are making people feel richer. The first is the rise in the stock market. The Dow Jones Industrial Average and the S&P 500 recently broke records by hitting all-time highs. A rapidly increasing stock market always brings money back from the sidelines, drawing in “investors” (read: speculators) who apparently like to sell at lows and buy at highs.  But that’s not the point. The point is, how exactly does a rising stock market make you feel richer? Do you have so much money in strong performing investments that you can sell them at any given moment to go live in luxury for the rest of your life?

I’m going to guess the answer is no. Most of us common folk who are actually investing are pouring our hard earned money into tax sheltered retirement accounts that won’t let us withdraw our money until we’re at least 59 1/2 years old. Even if you started investing early in these types of accounts and have an unusually high balance (I’m talking hundreds of thousands or more), withdrawing early and eating the the tax penalty for doing so wouldn’t be worth it.

Remember, if you’re investing using a buy and hold strategy in low cost index funds, increased prices in the stock market only represent paper gains. You don’t make any money until the day you actually need the money, and can sell shares in your holdings to withdraw funds.

The second factor that is making people feel richer is the rise in home prices. Interest rates for mortgages are still low, inventory of existing homes has reduced, and investors are hungry to buy up single family homes. The result is a meteoric rise in real estate, driving power once again, into the hands of sellers. If you don’t have a huge amount of cash and an excellent credit score, expect difficulty shopping for a home in the current environment.

So what does that mean for homeowners who now have some equity? Nothing. Does your new found equity mean that you can now become debt free and completely financially sound? Don’t count on it. That’s right, equity means that you can take more debt that is secured with your property. However you want to spin it, it’s debt and it means that you will continue to slave away working for someone else making them richer and you poorer. Sure, you’ll have some nice stuff or nice renovations to live in – I hope that makes you happy.

On the other hand, rising home prices means your house is worth more right? Your house isn’t worth anything unless you can sell it and someone wants to buy it. Until those two events happen at the same time, your house is only worth what its function is – a place to live. Realize that a home is, and will continue to be a money sink for its lifetime. Not only will you be paying property taxes and insurance (sometimes HOA dues) every year, you will be constantly spending money on repairs and maintenance. If you add in all the interest you pay over the life of a mortgage, how much would you have sell your house for to make a “profit?”

So, what’s the moral of the story? Stop using “mental accounting” to think that you’re richer when you’re not. The behavior of spending more, or taking on more debt, because you feel like you have more money to spend will only lead to trouble the next time the economy takes a dive. Believe me, you’re not richer. If all of a sudden the commotion in the mainstream media is making you feel richer, pay down debt or save more. Saving money is the only way to actually be richer.

The post Feeling Rich, But Acting Poor appeared first on Budget For Wealth.

The Monthly vs. Annual lump-sum IRA contribution timing experiment March 2013 update.

Annual Contribution Roth IRA

Account Summary :

• 03/21/2013 – Reinvested $33.36 dividend for Vanguard Total Stock Market Index Fund
• 03/21/2013 – Reinvested $6.85 dividend for Vanguard Total International Stock Market Index
• 03/28/2013 – Reinvested $2.17 dividend for Vanguard Total Bond Market Index Fund
• 03/28/2013 – Reinvested $0.10 short-term capital gain distribution for Vanguard Total Bond Market Index Fund
• 03/28/2013 – Revinested $1.74 long-term capital gain distribution for Vanguard  Total Bond Market Index Fund

Monthly Contribution Roth IRA

Account Summary :

• 03/01/2013 – Contributed $458.33
• 03/01/2013 – Purchased mutual funds
• 03/21/2013 – Reinvested $20.23 dividend for Vanguard Total Stock Market Index Fund
• 03/21/2013 – Reinvested $4.17 dividend for Vanguard Total International Stock Market Index
• 03/28/2013 – Reinvested $1.32 dividend for Vanguard Total Bond Market Index Fund
• 03/28/2013 – Reinvested $0.06 short-term capital gain distribution for Vanguard Total Bond Market Index Fund
• 03/28/2013 – Revinested $1.06 long-term capital gain distribution for Vanguard  Total Bond Market Index Fund

Monthly vs. Annual IRA Account Comparison

Analysis :

• There was a lot of brouhaha about the Dow and the S&P 500 hitting all time highs in March. All in all, just a lot of noise.
• Money is flowing back into stock funds in large amounts. A major case of investors chasing returns and getting in at the wrong time. Stick with dollar cost averaging in this type of investing environment.
• Investors are still afraid of interest rates, bank stability, and the economy in Europe.
• Real estate is still going strong – jacking up prices while mortgage rates continue to rise slowly. A lot of activity is still fueled by investors buying homes to use as rentals.
• As of the end of March, the performance of the Monthly and Annual IRA’s are pretty much on par.

• Contribution Timing Experiment Updates

The post Monthly vs. Annual IRA Contribution Experiment – March 2013 Update appeared first on Budget For Wealth.

It’s three months into 2013, and I’m feeling more financially secure than I have my entire life. However, I’m feeling quite unhappy at work and I’m not sure how much longer I can keep it up. Trying to find a job in another field has been tough because starting over would mean quite a significant sacrifice in pay, which remains a huge obstacle for me since I live in an expensive part of the United States. Going back to school to train for another high-paying field means debt, and I’m not sure I’m prepared (or want to) go into debt. Plus, I don’t even have a clear idea of what I would want to do. I guess I’ll have to do some serious thinking.

At the start of the year, I put my family on a regimented savings program which is building up our emergency fund and our retirement investments quite quickly. It’s been quite satisfying watching most of our paychecks go into savings accounts instead of debt. In fact, we’re now saving 25% of our gross pay. I think that’s pretty nice, but I’d actually like to get it closer to 35% – 40%. Most early retirement gurus would probably urge more than 50%, but I just don’t think the balance I want between living well now and living well later would accommodate that huge of a lifestyle change.

What’s Happened So Far

• My wife and I contributed the maximum amount, $5,500 each, to a traditional IRA in January and immediately converted to our existing Roth IRA’s.
• I’m maxing out my 457 plan at work through regular bi-weekly pretax payroll contributions at a fixed amount.
• My wife is contributing 15% of her pay to her company’s 401(k) through regular bi-weekly pretax payroll contributions. Since her contribution can’t be a fixed amount, she may max out just before the end of the year.
• I finished balancing our retirement investment portfolio using all Vanguard low cost index funds. I’m very happy to finally solidify a permanent long-term strategy.
• My daughter received a small sum for Lunar New Year. All of it was invested in her 529 college savings plan.

Coming Up

• We’re still working on building our emergency fund. It can currently cover a little more than two months of regular spending. Deposits will continue until we reach the goal of six months of spending and expenses.
• I’m expecting a small tax refund from both state and federal entities. I’ll use some that money to open a taxable investing account at Fidelity. Then, I’ll be able to link my Fidelity American Express Rewards Card to start growing the cash back I receive in a mutual fund.
• We still have to go through our accounts and life insurance policies to update our beneficiaries. I missed my self imposed deadline which was the end of February.

Other News

• I wrote a guest post for Penny Pinchin’ Mom on How To Save For College. I promised her that I’d write a follow-up article on selecting and investing in a 529 plan, but have been a bit busy dealing with family issues. Look forward to that soon.
• I attempted to make regular posts out of my best financial blog post series, but it fizzled out after I got a bit disenchanted with the financial blogger community. The problem is that I see something written about, and then immediately see a lot of other writers posting about the exact same topic with their own spin on it. There’s nothing wrong with that, but it just gets a little boring to read. There’s also a slew of financial bloggers that are no longer dispensing good stories or advice and are just pimping products or writing about online marketing and how to make money online. So, again I had to re-evaluate where I’m spending my limited time and I’d just rather write then worry about filtering the thin selection of good articles to read.
• Sometimes I get bored writing solely about finance. With the desire to explore a greater freedom of expression, I started a blog that’s more personal so I could write about whatever I wanted to write about. Plus, I get to post about my one true love – food. Check it out at Phamily Man.

The post Personal Update – 1st Quarter 2013 appeared first on Budget For Wealth.

I’m not going to tell you how to protect your online accounts by not using passwords like God and “password,” or PIN numbers like 1234 and 0000. You already know that.

With the proliferation of hackers penetrating the security of major financial institutions and social media hubs, account security is being expanded beyond the user name and password. It’s common now to see challenge questions, device identification, and security images. These are all great improvements that vastly increase the security of your online presence. But what you may not know is that, if you are honest and tell the truth, you may be putting your password and account security at risk.

Think about some common prefabricated prompts that you can select from to use as password-reset questions:

• Where were you born?
• What year did you graduate high school?
• What high school did you go to?
• What was your high school’s mascot?
• What college did you attend?
• What is your mother’s maiden name?
• What is the name of your first pet?
• What is your favorite food?

You are putting your online account security at risk by being honest.

All of the answers to these questions can be found using a simple Google or public records search. It’s easy for a thief to yield plenty of self-volunteered information about yourself using social media as well. Finding one or two pieces of key information can reveal everything that is needed to reset a password or access an account.

So what can you do to protect your accounts from being hacked? Besides utilizing strong passwords and strict social media privacy settings, Lie. By using some creativity, you can ensure that the extra layer of security designed for your online accounts remains useful and can’t be compromised by searching for information that is publicly available. Lying removes the association from what you want people to know and what they shouldn’t know.

Here are the same challenge questions with sample secure answers:

• Where were you born? Mars
• What year did you graduate high school? 1812
• What high school did you go to? Hogwarts School of Witchcraft and Wizardry
• What was your high school’s mascot? An Empty Jar
  
• What college did you attend? School of Hardknocks
• What is your mother’s maiden name? She-Ra
• What is the name of your first pet? Hooch
• What is your favorite food? Gruel

What’s your take on password security? Do you have any tips to share? Will you replace your truthful challenge question responses with lies?

The post Protect Your Password And Account Security, By Lying appeared first on Budget For Wealth.

The Monthly vs. Annual lump-sum IRA contribution timing experiment February 2013 update.

Annual Contribution Roth IRA

Account Summary :

• 02/28/2013 – Reinvested $2.01 dividend for Vanguard Total Bond Market Index Fund

Monthly Contribution Roth IRA

Account Summary :

• 02/01/2013 – Contributed $458.33
• 02/01/2013 – Purchased mutual funds
• 02/28/2013 – Reinvested $1.14 dividend for Vanguard Total Bond Market Index Fund

Monthly vs. Annual IRA Account Comparison

Analysis :

• The market change in February was essentially flat.
• A sellers market in housing and the boost in stock prices are helping investors regain confidence in the market.
• Money is flowing back into stock funds, showing how finicky and emotional people really are. No matter how often financial experts tell people to hold on tight and keep investing through regular contributions, they still sell low and buy high.
• There is still a lot of talk about the bond market collapsing if interest rates move upward. Probably another reason why so much money is moving back into stocks.
• Finally, investors are worried what automatic budget cuts, known as “sequester,” will do to the market.

• Contribution Timing Experiment Updates

The post Monthly vs. Annual IRA Contribution Experiment – February 2013 Update appeared first on Budget For Wealth.

Sometimes I wish I was still in the military. I miss the camaraderie, doing something different all the time, and the chance of adrenaline driven action. Most of all, I wish I had access to the Thrift Savings Plan.

The Thrift Savings Plan (TSP) became available to the military in late 2001. It’s a 401(k) style retirement account where federal employees and military personnel can contribute and invest in several different index funds managed by BlackRock. Members of the military do not receive any matching contributions, but some federal agencies provide them for their employees. Members have the same maximum contributions as 401(k) accounts, which is $17,500 for 2013.

It’s very impressive that the government chose to only offer index funds, which are proven to beat the performance of actively managed funds 70% – 80% of the time. More private employers who offer 401(k)’s should take the cue and implement low expense index funds in their pool of investment options. Many still do not offer index funds or have a poor selection.

Index Funds For The Long Run

The idea is that there is a lot of risk in investing. By indexing, you accept a market return for the diversification of assets and a standardized investing strategy. Index funds make it easy to match target allocations without constantly trading or re-balancing. Unless the index changes, the investments you hold remain steady. You know what you’re invested in.

With active funds, the manager has discretion (up to the limits of the fund charter) on how assets are invested. You may not be invested in the holdings that you think you are, and may be overweight in some. Not all actively traded mutual funds report their trades immediately. That means you won’t know what you’re really invested in at all times. Your holdings may not match your asset allocation.

When investing for the long-run (i.e. retirement), it’s a good idea to be invested in index funds. You don’t have to worry if you’ve picked a good fund manager, deal with changes in management, consider portfolio turnover, or any of the other factors involved with investing. If you are investing for the long run, the funds you have in your tax deferred accounts will have the greatest chance to grow in index funds.

The problem with index funds is that they don’t always match the performance of their index. This directly relates to the expenses, or fees that the mutual fund charges to operate the fund. That’s why it’s important to choose low cost mutual fund providers like Vanguard and Fidelity when you can. The lower the expenses, the closer the fund gets to matching the index.

TSP Index Funds Are A Superior Investment

Here is where BlackRock emerges as a winner. BlackRock charges a super low expense ratio of 0.024% – 0.027% to manage the TSP funds. Compared to Vanguard Admiral Class shares and Fidelity Spartan Advantage shares, the cost of investing in the TSP clearly rivals that of anything available to the regular public.

But that’s just the start of where the TSP excels. In 2012, The C Fund (mirrors the S&P 500) and the F Fund (matches the Barclays Capital U.S. Aggregate Bond Index) outperformed the index by 0.07%. The extended and international stock funds also beat their benchmark indices. How did they do that?

Managers of index mutual funds and ETF’s earn money to run their operation and pay salaries through their administrative expenses, known as expense ratios. But they also earn extra money by lending their holdings to investors, mostly hedge funds, who bet on performance by borrowing shares of stocks and bonds. BlackRock doesn’t disclose the official amount of money they make from this activity, but experts suggest that they pay about 80% of lending income back into the TSP funds. That income, even if it is a small portion of the total earnings, is a great way for the company to earn additional cash on idle assets and line the pockets of investors.

This post is getting a little long, so I’ll write more about the TSP later. For now, if you have access to the TSP, I highly urge you to contribute as much as possible. Junior enlisted personnel should be taking full advantage of the Roth TSP option since they pay little to no taxes due to their low incomes.

Do you participate in the TSP? What has your experience been like?

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