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Custodial Accounts

Question: I opened brokerage accounts for my 16 and 17 year old girls last year. I am the custodian for these accounts and the daughters had and still don't have any idea about these accounts. The older is now 18. A month ago I called the brokerage firm and requested that these accounts to be closed, but was told these type of accounts once opened, cannot be closed.... Can you advice? Thank you: AbdelFatah

Answer: There are two kinds of custodial accounts that go by the acronyms UGMA and and UTMA. The initials stand for Uniform Gift to Minors Act and Uniform Transfer to Minors Act. In essence, the two accounts are very similar although the rules are more flexible with the UTMA. Both accounts allow a child or minor to own securities. You--the adult--controls the account, but the child owns the assets. You can't take the money back or change your mind. It's their money, and they take control of the account once they reach age 18 or 21, depending on the state.

You can find a comprehensive review of the rules at www.fairmark.com/custacct/index.htm

Over the years, I've taken a lot of calls from parents regretting setting up an UGMA or UTMA. And the reason is usually the same: The realization that it's the child's money. You may have set it aside for college (a very common reason), but your child may want to buy a car with it.

However, I've also become convinced that the problem, while real, is exaggerated. For instance, most children going to college are well aware of the steep price tag and they're more than willing to contribute more than their fair share when it comes to finances.

No, I've learned that the real problem is often not talking to your children about money set aside in their name. I think it's important for you to discuss the accounts with your daughters. Tell them why you set aside the money in their name. Discuss your expectations. Listen to their ideas. Engage them in your finances and money expectations. I bet you'll be satisfied with the outcome.

01/02/08 by Chris Farrell

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Savings for a Stay-At-Home Mom

Question: I'm currently not in the paying workforce while I take care of my infant son. Besides the obvious large loss of income, I'm concerned about my curtailed ability to contribute to my retirement funds. Are there avenues to move money into retirement funds beyond a $4000 IRA contribution?

Answer: This is a pet peeve of mine, and I don't understand why Congress and the White House don't combine forces to dramatically simplify the pension system and make it more equitable. The current private retirement savings system is capricious. It includes 401(k)s, 403(b)s, 457s, SIMPLEs, SEP-IRAs, IRAs, and Roth IRAs to name only the best-known plans. The rules, income limits, and restrictions vary significantly among most of these tax-advantaged savings programs.

For instance, if you were working at a company with a 401(k) you could set aside $15,500 in pre-tax dollars in 2007. An employee at a small company with a SIMPLE plan has $10,500 limit. A stay-at-home spouse running the family household can save at most $4,000 in an IRA. If you are over 50, the plan limits are somewhat higher in each case. But the overall disparity remains.

Why not attach the retirement-savings plan to the individual and have just one rule for everyone--say, 15% of income, or $30,000? The figure could be less or more. The key point is that the rules should be uniform. And the retirement plan system should include parity for working and "nonworking" spouses (an oxymoron if there ever was one).

All right, I'll clamber off my soap box. But unless you bring in an income through freelance projects or a consulting business or some other income generating sideline that you run out of the house, you're out of luck when it comes to the pension system.

But all is not lost. Here are a couple of suggestions. First, you could buy I-bonds from the Treasury. You buy them with after-tax dollars. You pay no commission costs. Your money compounds free of taxes until you cash them in (you'll then pay your ordinary income tax rate on the gain). These bonds are specifically designed to protect your portfolio from the ravages of inflation. The dollar you put in to today will be worth a dollar plus interest 10 years, 20 years, or 30 years from now.

Another strategy is to set up an automatic payment account with a major mutual fund company and buy a broad-based equity index fund. You'll outperform most professional money managers year-in and year-out by matching the underlying index, you'll pay very little in fees, and your tax bite is limited compared to an actively managed mutual fund since there isn't a portfolio manager constantly buying and selling stocks.

An alternative to an index fund is a tax'managed mutual fund--one that is run by the a pro with an eye toward minimizing Uncle Sam's tax take. An added benefit to investing regularly in an index fund or a tax managed fund is that if you need the money before age 59 1/2 you can cash it in without paying the 10% surcharge attached to defined contribution savings plans like 401(k)s and 403(b)s.

In other words, you can make some long-term savings on your own that offer their own advantages even though the money isn't in a pension plan.

01/03/08 by Chris Farrell

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The Bi-Weekly Mortgage Payment

Question: I have a monthly mortgage of $786.33. I've been offered a deal where I pay $394.17 every 2 weeks, or $1 more per month. They state I'll save $33,039.25 and knock off 8 years and 11 months. It sounds like a wonderful deal. Is there something I'm missing? Why would the mortgage company want to save me this money? Thanks, Mark

Answer: I can think of two reasons. The benign reason is that lenders are responding to the desire of many customers to shorten the life of their loan, and this is one among several options. Taking out a 15-year mortgage is another common tactic. The other reason for the service is that it's profitable. Lenders have made a nice sideline business setting up this kind of program, and they usually charge an initial registration fee and a stream of ongoing charges.

Since you're paying back principal faster through a bi-weekly payment plan, the life of a traditional 30 year fixed rate mortgage is typically shortened by about 10 years (with the program the mortgage will last somewhere between 18 and 22 years depending on the interest rate). Now, the mathematics of a bi-weekly payment means that it's the equivalent of writing 13 mortgage checks during the course of a year.

I prefer that people interested in this strategy do it themselves. It's a perfectly acceptable D.I.Y financial maneuver with no extra fees or additional charges. The easiest way to accomplish your goal is to make a 13th monthly payment on your own. (You can divide the money into a couple of payments if that eases the strain on cash flow strain.) In either case, put a note with the payment saying it's to go toward paying down principal only. By the way, another advantage of this approach is if money does get tight during the year you can always skip the extra payment.

That said, several years ago I got a similar question from a listener on the radio, and I gave a comparable answer. The next week I got a call from a woman who strongly disagreed with me. If I remember the details right, she was a single mother with a demanding job. She wisely turned as many financial obligations as possible into automatic payments. Otherwise with her hectic schedule it was far too easy to forget a bill or to put money aside in savings. She signed up with her bank's bi-weekly mortgage program because it was one less thing to worry about. It worked for her.

01/04/08 by Chris Farrell

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Retiring in Europe

Question: My wife and I are 60 and plan to retire at 62. My question is this: We're considering selling our home upon retirement and basically pocketing that tax-free money to finance the first five or six years of retirement. We plan to rent during that period, perhaps in a European nation. We would not touch our 401K savings during that period, which currently total about $550,000 and would hopefully continue to grow at a healthy rate. We would both draw Social Security at 62 and I would also receive a pension of about $1.000 per month from my current employer. We would also be covered by a health insurance plan provided by my employer. Does this sound like a reasonable plan? Thank you. David

Answer: It's a great idea, assuming the numbers work. This kind of adventure has always made a lot of sense to me. You're still young. You'll have fun.

A couple of years ago a certified financial planner I know told me that a number of his clients had moved to France for the first 5 to 10 years of their retirement. (This was before the Euro soared and the dollar tanked). Although they lived comfortably, these weren't wealthy folks, either. They loved their time living and traveling abroad.

On a practical level, my one piece of advice would be to hire a certified financial planner (CFP) to runs some numbers and scenarios for you. This way you can be sure that you're comfortable with the financial side of the equation. Have fun.

01/07/08 by Chris Farrell

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How Safe Are Money Market Funds?

Question: In the past few years of following the financial news and your program, I've come to see the Money Market fund as a stable place for short-term emergency fund money. Very limited risk of loss of principle, and the very few times it has happened, investors got out with almost all of their money anyway.

Talking with a coworker recently, she said that she had experienced a money market fund dropping in value (presumably some 25-30 years ago). Was she just one of the unlucky ones or is the mantra of "only one money market fund failing" a story limited to the last 25 years? Adrian

Answer: Money market mutual funds, despite their billing, are not risk free. These funds are on the safe side of the risk spectrum because they invest in Treasury bills, short-term U.S. government agency securities, commercial paper certificates of deposit, and other very short-term debts. The security in the fund comes from diversification and the quality of the short-term debt the fund invests in.

There's the rub. In order to attract more money, some mutual fund companies take on riskier short-term debts to boost yields. And then the industry gets roiled by the risk that a money market mutual fund will "break a buck" during a market squall like now. In other words, the promise of a money market mutual fund is that if you put a dollar into it you will at minimum get a dollar back at withdrawal. As far as I am aware, the value of no major money market mutual fund has fallen so much that withdrawals have been worth less than a buck. However, I am aware that in some cases the parent company has injected cash into the money market mutual fund to preserve its value.

That's why I like money market mutual funds attached to a major brandname financial institution with the money to shore up a fund and a reputation to protect if there is a risk that the fund will break-a-buck. I also prefer lower yielding money market mutual funds composed primarily of U.S. Treasury securities and U.S. agency debt. I just don't think the risk of a slightly higher yield is worth it.

01/08/08 by Chris Farrell

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Student Loans

Question: A few weeks ago you advised a woman with a college-age daughter that there was not a big advantage to paying off her student loan early. I have a related question.

I recently went back to graduate school and had three separate loans for about $18,000 each, one for each year I was in school. I consolidated the first two years into one loan at an interest rate of about 3.5% but didn't consolidate for the final year because that year's interest rate was already getting very high. So I now have two repayments of about $250/month, one for the first two years, one for the final year by itself. I was considering an early repayment of that final year's loan which is currently at about 5.5%, higher than the average savings account interest, and which I assume will go higher.

But your earlier advice made me wonder if that was wise in my case, or did it only apply to college loans? Thanks! Becca

Answer: Every situation is slightly different. If I remember the earlier question right, it involved a short-term trade-off between husbanding savings and paying down debt. In your case, my impression from your question is that it's a savvy move to get rid of the higher interest rate student loans. As you know, it's always a relief to get rid of debt.

01/09/08 by Chris Farrell

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IRA or Vacation?

Question: Ten years ago, I left my previous employer with a 401K worth $2,500 and invested the money in an IRA. Its value at the time of this e-mail is around $3,100. In my opinion, that's a very low return. In your view, should I just take the money, pay the penalty and take a vacation? Or should I leave it alone? Mr. Angel, Milford, NH

Answer: I'd rather you leave it alone. Sure, it hasn't grown much. But thanks to the power of compound interest it will add up if you leave it alone. For instance, $3,100 earning a return of 5% annually over 20 years is worth $8,225. The same figures compounded over 30 years equal almost $13,400. Those aren't huge sums, but a little bit here and a little bit there eventually add up.

Still, the main reason it doesn't pay to withdraw the money to pay for a vacation is that you'll owe Uncle Sam income taxes, plus a 10% penalty. Ouch.

01/10/08 by Chris Farrell

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Trading Stocks and Taxes

Question: I'm a weekly listener via podcasts and thank you for all the good advice. So the question: My co-worker mentioned that I could trade my stocks in an IRA and not have to pay capital gains taxes with this type of account. Currently, I trade within a taxable account so my gains are taxed. Is there any drawbacks with trading stocks within an IRA and what is the best way to learn about the process. Thanks a bunch! David

Question: Your co-worker is right. You don't pay any capital gains taxes on trades within an IRA. If it is a traditional Individual Retirement Account, you will pay ordinary income taxes on the money when you withdraw it during your Golden Years.

Here's the main drawback to trading stocks in an IRA. When it comes to saving for the long haul there's no evidence that all that trading activity will line your pockets. There is abundant evidence that a disciplined, long-term approach with minimal trading and low fees will increase the odds that you'll reach your long-run financial goals. So, my response is restrain your trading impulses in an IRA--it's a hazardous habit for long-term wealth accumulation.

That said, I don't want to be a spoilsport. Picking stocks is fun. You get to match wits in the most competitive market in the world. But I think the tax code encourages you to do trades in a taxable account. Here's why: Let's say you make some unprofitable trades. The market goes against you. Uncle Sam limits your losses through the tax code. Now, let's say you have made some smart moves and share prices have moved up. You still get to decide when to trigger the capital gains tax rate. You could sell tomorrow--or 30 years from now. That's a powerful tax shelter. (There are a few complicated exceptions where you can take a tax loss on an investment in an IRA, but they're the exception, not the rule.)

One more point: Bill Gross, the investment guru and founder of the mutual fund giant Pimco, once suggested that investors play with no more than 10% of their portfolio. He reasoned that it's just enough to make a difference if you win on the upside, and not enough to make a difference if you are wrong on the downside. I've always found that sound advice. This way you're not putting your standard of living in retirement at risk.

01/11/08 by Chris Farrell

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Financial Information Over the Phone

Question: I got a personal call from my bank the other day: they lowered their interests rates and could give me a home equity loan for 7.5% ... as opposed to the 10% I have now on my line of credit with the same bank.

All they needed to know was what my home was worth, how much I had left to pay on it etc etc, a lot of questions I didn't feel like answering on the phone. But is this really a good deal (the rate can and will change, right?) and does it affect my credit report to apply for more credit? Otherwise I would be tempted. Thanks for your advice, Sabrina.

Answer: I don't answer any personal finance question that comes my way over the phone or on the Internet. Period. (This approach seems to annoy unsolicited calls from charities asking for money the most. Tough.) It's too risky in an era of identity theft to give away financial information away to strangers on the phone or the Web.

Still, it sounds like your bank may be offering you a good deal--or at least one worth investigating. I would walk over to a branch of your bank and ask to talk to a bank manager. If that's inconvenient, you should initiate the call and solicit the information you want yourself.

01/14/08 by Chris Farrell

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Budgeting

Question: I will finish my Ph.D. in June 2008 in business. Because my income over the past five years has been variable (from unpredictable teaching assistant and research work), I have not really created a "budget" per se. I'd like to avoid tracking every penny I save, but I also want to start saving for retirement and paying off my $30,000 educational debt. I've saved about $10,000 in the last year in an ING Orange Account. I wanted to put it in an index fund but need access to it in case of medical issues (I have had 7 surgeries during grad school). Also, if I get a job paying a high salary as a visiting professor, I am wondering if it would be stupid to try to pay off all my debt in one year. After all, I'd like some security if the academic job market does not go my way in 2009. Thanks. Susan

Answer: I don't think it would be stupid for you to pay off the debt. But I do agree with your concern that you could end up in a cash flow bind if the academic job market doesn't go your way or if your health deteriorates again. I would plan on spreading out debt repayments over a few years, which is still fairly aggressive.

By the way, for some reason "cash" is often looked down on as an investment. Yet in the current troubled economic environment cash is king. Plus, you only want to put money that you won't need for, say, five years or more in a broad-based equity index fund (like the Standard & Poor's 500, the Russell 3000, or the Wilshire 5000).

On the budgeting side, I wish I could write the line that budgeting is fun. But I can't. However, the chore of creating and sticking to a budget is worth it. I can emphatically state that within a relatively short period of time the result from fashioning a budget is genuinely liberating rather than constraining. For one thing, a household budget is the starting point for taking control of your finances. It's the baseline for all your saving, investing, spending, and giving decisions. For another, a budget is really where values are transformed into reality. The real payoff from budgeting is this: you spend your money where you want it to go and save for what you would like to do with it.

You don't need to spend enormous amounts of time tracking data. For a relatively small investment in time and effort upfront--usually a couple of months--a budget will become a lifetime of good financial habits. At that point, ballpark figures and estimates are fine for most people. One last point: make as much of your savings automatic as possible, from participating in a retirement savings plan at work to having a portion of your checking account automatically siphoned off into a savings account every month.

01/15/08 by Chris Farrell

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Taxes and the Ex-dividend Date

Question: When selling a stock or bond mutual fund, is it better to: Wait a few days to the Ex-Dividend date, receive the dividend and sell at the lower Ex-Div price? Or Sell before the Ex-Div date, receive the higher pre-Ex-Div price and forego the dividend? Very thankful for your program and your advice. Phil

Answer: The ex-dividend date means that owners of record are eligible for all dividends and capital gains distributions. Even if you sell your shares on or after the ex-divident date you'll receive the distributions. The distribution of mutual fund dividends and capital gains has an impact on the share price of a mutual fund. On the ex-dividend date the share price drops by the amount of the distribution (that is, plus or minus change in the market). So, if the share price is $10 and the distribution is $1.00, the mutual fund's net asset value (NAV) should drop to $9.00 (the price will depart from that value depending on what happens in the market that day).

The main implication to keep in mind when buying and selling mutual fund shares around the ex-dividend date is taxes.

On selling: The key question is to look at the tax bill from the distribution (where the federal rate can climb as high as 35%) versus long-term capital gains if you've owned the mutual fund shares longer than a year (where the tax bill is 15% or less). It often pays to sell before the distribution if you qualify for the 15% federal capital gains tax rate--but not always. The hated phrase is "it all depends" is right it this case. It all depends on comparing the actual tax bills and see where you come out ahead.

On buying: The Wall Street jargon is that you don't want to "buy the tax liability." For instance, lets say you purchase some mutual fund shares just a few days before it goes ex-dividend. The new investor will then watch the value of their shares fall by the amount of the distribution and owe taxes on the distribution. Ouch.

Here's an example on buying courtesy of mutual fund giant Vanguard

Say you invest $5,000 on December 15 (record date), buying 250 shares for $20 each. If the fund pays a distribution of $1 per share on December 16, its share price will drop to $19 (not counting market change). You still have $5,000 in value (250 shares x $19 = $4,750 in share value, plus 250 shares x $1 = $250 in distributions), but you owe tax on the $250 distribution you received--even if you reinvest it in more shares.

In other words, the long-term investor enjoys the payoff from dividends and capital gains (and pays taxes on the gain). The short-term investor mostly gets to write a check to Uncle Sam.

01/16/08 by Chris Farrell

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Kids and Investing

Question: I started savings accounts for all three of my kids after they were born, putting a small amount of money from my paycheck into their accounts. I have about $2,000 to $3,800 in each of the accounts and think perhaps I should think about doing more than a simple savings account. I have thought about purchasing stock; some time ago, I almost purchased Pixar for Bobby, but then they remarried Disney. I thought purchasing stock may get them interested in the market and finances, etc. I also have information on the Vanguard 529 plan. My husband and I have approximately $37,000 in my 403(b) and a Roth IRA. We also have some Apple stock, but that's it besides the checking account. I am 40 years old; my children are 7, 6 and 4 years old. I would love your input. Ellen

Answer: What you are already doing is wonderful. One suggestion going forward is to divide your children's money into two pots. One pot is for a 529 college savings plan. You can invest in a 529 college savings plan in your state or any other state. And the savings can be used at any college--public or private. The savings plan is funded with aftertax dollars. But the money grows tax free.

Now, there is a fair amount of choice when it comes to the investment portfolio. But most choices involve mutual funds type options. The choice I like the most is called age-based investing. When your child is young, the portfolio mix is heavily oriented toward riskier stocks. As your child ages--far too quickly, I might add--the portfolio becomes more conservative. And the portfolio changes automatically. You don't do anything. Anyone can contribute the child's account--including parents, grandparents, relatives, and friends.

Now, here's the real kicker: When you withdraw the money it's tax-free, so long as it is taken out to pay for qualified educational expenses--like tuition. 529s even get favorable treatment under the current financial aid formula. If the money is counted at all, it's assessed as a parental asset. That means only 5.6% of it is counted in the financial aid package.

The big drawback of a 529 plan is that it doesn't really teach your kinds about investing. And that's where the second pot of money comes in. I would encourage you to buy individual stocks with your children. The stock market also opens up a whole new way of looking at the world, from the creativity of designing new products to the economic bridges linking the globe. Along the way, exploring the world of investing with your youngster might lead to another activity and conversation to share together.

Picking stocks is a lot more fun than putting quarters into a piggy bank or dollars into a savings account. What shoes are your children's friends wearing--and what company makes them? Do they prefer Pepsi or Coca Cola? Who's going to win the video game wars--Sony, Nintendo or Microsoft? Concerned about the environment? Whatever your children's passion or interest, there are public companies to research and follow on the Internet and in the newspaper.

To be sure, I have no clue whether your children will make much money, although they will probably do okay. But they have the excitement of identifying with a product, researching the company, watching the stock fluctuate, and reading articles about the company. And the Internet has truly cut down on the costs of buying and selling stocks. Have fun.

01/17/08 by Chris Farrell

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Payoff Mortgage Early?

Question: I plan to retire most likely sometime next year. I have a 30 year fixed at about 6.5%. I'm 5 years into the payments. If I have the liquidity to do so, should I pay off my mortgage?

Answer: One of my favorite financial advisors, Henry "Bud" Hebeler, recently sent me his answer to this question. I've answered this question on the blog so I thought I'd like to share his response to give you another perspective.

Bud was president of Boeing Aerospace, and when he retired he was disgusted with much of the financial advice offered to future and current retirees. He now runs a website--www.analyzenow.com--that's full of good advice.

Here's his answer: The technical answer is that IF the after-tax earnings on your investments is more than the after-tax interest on the debt, you shouldn't pay down the mortgage.

The problem is that you have to guess at returns over the next 20 to 30 years and hope that there are no huge market drops. Also, you have to guess whether you'll be able to deduct mortgage interest over a long period. For those reasons, many financial planners believe you should pay off the mortgage early. I think you also have to consider the amount of money you have left after paying off the loan, and whether you could get as good a deal on a new loan should you ever need one considering such things as the future interest rates and paying closing costs again. You might want to make a side-by-side comparison of your two alternatives using one scenario starting in 1948 (a very good year to retire) and then changing to a 1965 (a very bad year to retire) comparison using the Dynamic program on www.analyzenow.com.

When things are uncertain, I'm often in favor of a compromise. Perhaps you could pay off half of your loan or accelerate payments should you be able to do this without loan penalties.

I like the compromise idea. Too much of personal finance is divided into an either/or construction when compromise is often the best solution.

01/18/08 by Chris Farrell

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Martin Luther King, Jr. holiday

An important day for remembrance. I'll be back answering questions tomorrow.

01/21/08 by Chris Farrell

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Market turmoil and 403(B) Contributions

Question: I am thinking of increasing my 403(b) contributions to lessen my tax obligations. However, I am concerned about increasing my contributions while the market is heading downward. I am 29, so I am not planning to retire anytime soon. My employer offers a flat rate towards my retirement fund regardless of my contributions so that wouldn't be a factor. Should I wait till the market heads up before increasing my contributions? Thanks, David

Answer: At your age, you have little to nothing to fear from a down stock market in your retirement savings plan. Indeed, there is even reason for cheer since you have three decades before you tap into the money. You're buying good companies on the cheap.

Look at it this way. Every time you put money into the stock market out of your retirement savings plan you are "dollar cost averaging" your portfolio. Technically, dollar cost averaging means putting the same amount of money into an investment on a regular basis. So you purchased fewer shares when the market was up, say a year ago, and more equity now that when stocks values. So, let's say you're putting $1000 a month into your 403(b) stock mutual fund choice. When the market is strong, maybe you could buy only 100 shares. But now that the market is taking a nosedive, perhaps you can pick up 150 or 200 shares. Since stock prices rise over time, this technique allows you to build up a stock portfolio worth more than the price you paid for it.

Another benefit of dollar cost averaging is psychological. The time-tested stock buying method takes emotion--fear, greed, and panic--out of investing. You are regularly socking money away in all markets, bull and bear alike.

If it were me, I would hike my 403(b) contributions.

01/22/08 by Chris Farrell

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Refinancing Mortgage

Question: Hi, I have an ARM which is just adjusted to 5.75% (and it'll increase to 8.5% next December). I owe $120,000 on this. I have a 2nd mortgage which has an 8.5% interest rate. I owe $23,000 on this. I want to get out of my adjustable rate and into a fixed rate but do not know the best way to do this. My mortgage broker told me to sit tight and advised this is not the time. However, I really feel I need to refinance before December 2008. Also, I paid about $163,000 for my condo 3 1/2 years ago. At that time it was appraised at $173,000, but the mortgage broker believes the appraisal value now may only be $145,000 - $150,000. What should I do? Please HELP. Thank you, Jeanie

Answer: Ignore your mortgage broker. He's probably correct that the value of your condo is down. But you're right to be aggressive about your mortgage situation. The same goes for anyone who's stressed out about their future mortgage payments.

For one thing, the recent cut in interest rates by the Federal Reserve may make it more practical for many homeowners to refinance. The conventional fixed rate mortgage is currently at 5.7%. It's at the lowest rate since the fall of 2005. For another, banks and other financial institutions are under a lot of federal, state, and regulatory pressure to work with financially stressed homeowners. It pays to reach out now when they have every incentive to treat you right (at least compared to the past).

I have a couple of suggestions. Do some of your own research and familiarize yourself with the mortgage market at a couple of online portals, such as www.hsh.com. HSH has a good articles library, and for a fee you can get the loan terms of lenders in your area.

Next, while I'm a big believer in doing research online, it always pays to talk to people in person when it comes to money. If you have a checking or savings account at a brick-and-mortar bank or credit union, introduce yourself to the loan officer. Spend time with her (or him). Let her run some numbers for you. If the numbers don't quite add up, stay in touch and work with her. In other words, develop a professional relationship.

Lastly, there are non-profit institutions in most metropolitan areas that specialize in helping troubled or confused homeowners cope with their mortgage issues. Contact them.

01/23/08 by Chris Farrell

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The Market Fall-Out

Question: Help! I retired a couple years ago and the market was going up. Now it's going down, down, and more down. How do I stabilize my savings and IRA money that I'm living on? I'm not on Social Security just yet (I'm 61). Do I need to go back to work for awhile? Ickkkk, I hope not! Kojis

Answer: You're far from alone in your concerns. It's frightening right now with the stock market wildly plunging one day, recovering the next, only to lose even more ground in following days. The housing market continues to tank. The consumer credit default wave is spreading from subprime mortgages to home equity loans, credit cards, auto loans, and other types of consumer credit. A recession is likely.

Truth is, while we're in the midst of turmoil, it's usually a mistake to make any dramatic moves. That doesn't mean you shouldn't go more conservative. But I would use this as a wake-up call to reassess your whole portfolio. You should always pay attention to the downside--what could go wrong. And if you lock in the essentials by investing safely you can sleep at night.

So, as you know, one way to protect yourself is to diversify. Right now, while the stock market is down about 16% from its October 2007 high, the U.S. government bond market has strongly rallied.

It can also mean putting money into cash (by cash I mean U.S. Treasury bills, conservative money market mutual funds, and other creditworthy short-term securities). To be sure, the investment price you pay for credit quality is a lower yield. But cash will hold its value.

My next thought has to do with this question: What is the biggest risk confronting savers? Recessions? Bubbles? Bear market? Yes, all these traumatic events batter savings and undermine confidence. But inflation, a sustained rise in the overall price level, tops the list. The purchasing power of a dollar declines year after year when inflation drives up the costs of goods and services. One hundred dollars loses half its value in 20 years with a 3.5% average annual rate of inflation. The same sum falls by about a third over two decades even at a modest 2% inflation rate.

That's why I'd put money into Treasury inflation protected securities, or Tips. For practical purposes, it's a completely safe asset that adjusts to changes in the consumer price index. The CPI might not exactly match your basket of spending, but its pretty close. Tips can protect your money from inflation for 20 years.

Now, a well-known drawback to TIPS for individual investors is that taxes are paid on the unrealized annual inflation-adjusted gains. Yet there are plenty of ways to avoid the tax on phantom income, such as owning TIPS in a tax-sheltered account like an IRA. Another alternative is the inflation-protected U.S. savings bond, the so-called I-bond. The investment compounds tax deferred until the bonds are cashed in.

Certified financial planners (CFPs) are expensive. There's no way around it. But one of the best investments someone can make in your circumstances is to spend the time finding a fee-only certified financial planer that can go over your portfolio, assets, goals, dreams, and give you a true sense of the trade-offs you face.

And, yes, going back to work may be one of those options.

01/24/08 by Chris Farrell

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IRS Email

Question: This e-mail appeared in my in-box and I want to verify whether or not it's legitimate. The language seems off and I don't know any reason the IRS would suddenly send such an email. The form asks for the last 4 digits of SSN, and other personal information.

It was sent by: "Internal Revenue Service"

After the last annual calculations of your fiscal activity we have determined that you are eligible to receive a tax refund of $340.60.

Please submit the tax refund request and allow us 3-9 days in order to process it.

A refund can be delayed for a variety of reasons. For example submitting invalid records or applying after the deadline.

To access the form for your tax refund, please click here."

Answer: DO NOT ANSWER THE EMAIL. SPIKE IT. The email is a scam. Period.

01/25/08 by Chris Farrell

Comments (12)

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Too Much Debt

Question: I'm ashamed to say that I am one of those Americans who have used credit cards to make ends meet. Mostly they've been used for moving expenses due to health reasons, and financing school supplies. I'm now having trouble paying off these cards, and worried about calling those groups that advertize debt consolidation services on late night TV. Who do I contact to help me get the interest rates on these cards to a reasonable level and organized so I can make a single payment each month? Maureen

Answer: You have no reason to feel ashamed. At some point in our lives, most people take on too much debt. They end up with big credit bills for good reasons--medical bills, a move, a lost job, helping out a child--and not because they're living the champagne lifestyle on a beer salary.

The real question is: What lessons do we take away from the experience of carrying too much debt? In other words, will you leave your debt burdens behind and change your money habits? Or will you go on a roller coaster, zooming into too much debt, followed by a period of getting rid of it, only to take on more debt once your balance reaches zero?

Finally, you're so right to steer clear of the fly-by-night outfits that advertize on late night TV. Don't dial their 1-800 numbers.

I wish I could say that there's a magic wand to wave that will get you out of debt fast. There isn't. But here's a two-step formula:

First, get a copy of a book such as Gerri Detweiler's "The Ultimate Credit Handbook: How to Cut Your Debt and Have a Lifetime of Great Credit." It's in its third edition. Gerri is good at dealing with debt issues, and her book will give you a practical lay of the credit landscape. You could also check out Nolo, a leading financial self-help information organization. It's at www.nolo.com.

If you want to work with an organization--a good move for many people--I would contact the National Foundation for Credit Counseling (NFCC). It's the largest and oldest national nonprofit credit counseling service. You can find a branch near you at www.nfcc.org. If you like working online, by the way, I know that one branch--the Consumer Credit Counseling Service of San Francisco at www.cccssf.org--offers all the financial basics, plus an online debt counseling service and debt management plan.

Good luck.

01/28/08 by Chris Farrell

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Refinance?

Question: I purchased my house three years ago with a 5-year ARM and a second mortgage to cover the down payment. My credit was (and is) good, and the interest rates and payments on both loans are low (about 5%-6% on the loans). I purchased my house just before property values climbed here, so the value has appreciated and the market has not crashed as in other places. When I purchased my home, my job was only supposed to last two years, so I expected to move long before the interest rate started to adjust. My job has now lasted 3 years, and it is no longer certain that I will move out of town before the 5 year mark. Should I refinance the house now just in case I don't move, or wait to see what happens with interest rates and lenders? The interest rate will start to adjust in October of 2009 and I have heard that 2009 might be a better time to refinance a home because the market is expected to have stabilized. Thank you.

Answer: Clearly, you have a good rate and the time to decide. By the way, I'm also a fan of 5-and 7-year adjustable rate mortgages. The rate is usually attractive and you buy time to decide on your next move.

Of course, I have no idea where interest rates will be in 2009. I do think the recent drop in mortgage rates makes refinancing over the next couple of months an attractive proposition for anyone with a good credit score and borrowing record--like you. The rate on a 30-year fixed rate mortgage has dropped to 5.54% (the last posting I saw). If I were you, I'd be running some numbers now to see whether you can 1) get rid of the second mortgage and 2) calculate the point where it makes sense for you to buy an "insurance" policy and long-term piece of mind by refinancing into a conventional 30-year fixed rate mortgage.

Of course, I don't have the answer, but my guess is that it's sooner rather than later.

01/29/08 by Chris Farrell

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Fellowships and IRAs

Question: My husband and I are currently on National Research Council fellowships, working at a government lab. The nature of the fellowship is such that we are neither employed by NRC, nor by the lab we work in, yet we are not required to pay self-employment taxes. Someone told me that in that case, we cannot contribute to our Roth IRA accounts either. Is this true? I'm concerned because it's the only retirement saving vehicle we have right now, since we don't qualify for a 401(k). If we can't contribute to our Roth IRAs, do you think getting Treasury I-saving bonds are our best alternatives? Thanks! Nandita

Answer: As I understand it, IRS rules prevent scholars on fellowships like yours from technically counting the money as "earned" income. So, you can't contribute to your Roth if the fellowships are your only source of income. However, if you have any part-time work (I realize that's probably unlikely given your schedules) then you can use that money to fund the Roth-IRAs.

If that's not the case, I do like the idea of investing money in I-bonds, the inflation protected savings bond. You don't pay any commissions buying and selling them. Your money compounds tax free until you cash them in. And the dollar you put in today is worth a dolla--plus interest 10, 20 or 30 years from now. The other thing you can do is also direct some money into a broad-based equity index fund, like the S&P 500, the Russell 3000, or the Wilshire 5000. That will give you an exposure to the equity market in an investment that keeps fees razor thin and your annual tax liability low.

One advantage of this home-brewed retirement savings approach--bonds plus equity index fund--is that it's easier to pull money out early. Yes, you'll have to fork over capital gains tax and income taxes, but you won't have to pay Uncle Sam the 10% penalty imposed on early withdrawals from retirement savings plans like IRAs or 401(k)s.

01/30/08 by Chris Farrell

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College Choice

Question: My son, a high school senior, was accepted to one of Minnesota's private colleges. We have been fortunate in that we invested over the years and have saved enough for about 3 years of his education at this school. He also received scholarships to a different MN private college that would pay for about 66% of his costs for 4 years, leaving him with a substantial amount of $ at graduation. I have 2 questions. He wants to turn down the scholarship and go to the other school. There is a difference in the 2 schools, one has a very strong regional reputation and the other a national reputation. He wants to forgo the scholarship for the national reputation. From a long-term $ perspective, what advice would you give to him? Second, assuming that he forgoes the scholarship, I am considering keeping the $ we saved for him invested and taking out loans to cover the cost of the education and then paying off the bulk of the loans at graduation. Is that a solid strategy? The investment has averaged 10% over the long term. Thank you for your advice. John

Answer: This is one of those times when the outcome of a financial decision is positive no matter what, yet people strongly disagree about the answer. Some of my friends are adamant that it doesn't pay to attend the more expensive, nationally known school. They'd leap at the scholarship money. Over the course of a lifetime, the importance of that degree shrinks, and the dollars saved add up. Other friends believe the national reputation is worth it if the student expects to attend graduate school, move to another part of the country upon graduation, or enter certain professions, like investment banking. To them, the extra money you're paying is the price of an "option" on a particular career choice and geographic mobility.

So, where do I come down? What strikes me over the past 30 years is just how good college and universities have become, including small private liberal arts colleges. The gaps in performance and quality have really narrowed even if national rankings haven't kept up with the transition. But your son has also expressed a clear preference for the better known school. One way to make this decision is insist that your son "own" more of his education. If he goes to the regional school, he graduates debt free--and that is a genuine advantage these days. He'll be in a position to choose a job at graduation based on desire (and perhaps a low income) rather than face the pressure to take a less desirable job that pays more because he has student loan bills to meet.

If he still wants to go to the other school, then I would have him borrow at least some money to pay the difference in costs himself. He won't graduate debt free. Instead, along with his diploma he will get a student loan repayment booklet. I think making the decision this way is a good life lesson.

That said, I would limit how much he borrows so that he still has a choice at graduation. For one thing, you have the savings. For another, you don't want him too burdened by debt. By the way, it can be a good strategy to borrow, even if you have the money, if there is a reason to keep your options open. You can always help them pay off their student loans at that point.

01/31/08 by Chris Farrell

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