Marketplace

Capital Gains

Question: Hello! I'm 39 years old and was gifted a large amount of shares of Weyerhaeuser stock when my dad died 38 years ago. I recently got married and my husband and I started working with a financial planner. He was reviewing my individual portfolio and he pointed out that I have a large amount of Weyerhaeuser stock. He strongly advised me to sell the shares and diversify. I don't know the cost basis of the Weyerhaeuser stock off hand, but I am sure if I sold the stock, it would be a significant capital gain.

I do have another investment portfolio (mutual funds) and a 401k. I am a shareholder-employee of my family business, which is an S-corp. My 2007 salary was $90,000 and my 2007 AGI was about 67,000. However, I received a pay increase as of May 15th 2008, I am now earning a $120,00 annual salary.

I am worried about selling the stock and the resulting tax implications of the capital gains tax on the sale of the stock, my increase in income and corporate profits..

Furthermore, if the Democrats are elected to the White House in 2009, the capital gains tax is going to rise. Even diversifying my porfolio, I still am incurring risk. What would be the advantages/disadvantages if I held on to it. I know I will eventually have to pay the capital gain tax, but I want to minimize my overall taxes owed. I'm frozen by my indecision, please help if you can!! First Name: Jenifer, Seattle, WA

Answer: I don't have enough information on your portfolio and Weyerhaeuser to get into detailed specifics, but I do have strong thoughts about the idea that you should diversify at least a portion of your portfolio. I agree.

Remember Enron? Bear Stearns? How about Fannie Mae and Freddie Mac? These companies expose the risk of having too much of your portfolio in any one stock.

For instance, with Enron, not only did some 4,000 workers lose their jobs, but many more watched their retirement savings decimated by the energy company's collapse. Enron's employees had invested a big chunk of their tax-deferred retirement savings in Enron stock. The employees at Bear Stearns had invested a big chunk of their income into the well-regarded Wall Street firm, considered one of the savviest risk managers among investment banks. Yet the government ended up engineering a bailout of the firm, and employees lost much of their savings. Until recently, mortgage giant Fannie Mae was among the bluest of blue chip corporations in the world. Yet it has been caught up in the credit crunch and its stock price has cratered. According to a recent article in the New York Times, Fannie Mae "workers had $116 million in the employee stock ownership plan at the end of 2006. Today, it's more like $17.5 million. Ouch."

I could multiply the examples, but you get the point. This doesn't mean you have to get out of Weyerhaeuser completely, but that you should consider making one stock a smaller portion of your overall portfolio. I'd add that my philosophy is that while it's sensible to minimize the tax take, no one with a profit has gone broke paying taxes.

That said, there is a lot you can do to save on taxes. For instance, you may have some long-term capital losses to offset the gain. You may also try and time the sales to spread out the tax hit. But this is the kind of tax strategy a professional can help you engineer.

09/02/08 by Chris Farrell

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Extended Warrenty on a Car?

Question: I signed up for an extended warranty for my car. It has 75,000, the warranty costs $3000 and will cover me for 60,000 more miles. I asked my mechanic about it and he said he didn't think it was a good idea but told me to bring it in so he could see it. After he read it, he said it was a good warranty and should help me keep my car for another 60,000 miles. He also said he worked with the company before and they were reputable. He's not at all connected to this company. Am I stupid to do this? Lynda, Minneapolis, MN

Answer: You are definitely not stupid. Now, I'm with your mechanic when it comes to extended warranties: The insurance policy is usually not worth it. In many cases, you can do better on your own. One strategy is to put the money you'd pay in premiums aside as part of your overall savings, and then draw on your that pot of money for repairs. Another is to include car repairs as part of your overall financial plan. As a general rule, there are a lot of truly bad extended warranty plans out in the market that line the pocket of the seller and cost the buyer a bundle.

However, "usually" is not the same as "always." You've done what I always recommend with extended warranties. Do your research. Check out the policy terms. Make sure you're working with a reputable firm. Get some expert advice if you can. You've done all those things by tapping into your mechanic's expertise. Also, how reliable is your car and what is the track record of the make and model as it ages? We all know that some cars are highly reliable and others seem to start falling apart not long after the manufacturer's factory warranty expires.

Thinking through whether or not an extended warranty is worth it is like evaluating any other insurance policy. Will having the extended warranty give you peace of mind? How fragile is your budget to a major car repair? Is the actual policy both understandable and favorable to you? In other words, does the extended warranty do what you think it should do?

In most cases, the answers come out on the negative side of the personal finance equation. But in your case, going with your trusted mechanic, it looks like you bought yourself some peace of mind.

09/03/08 by Chris Farrell

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Credit Score: Carry A Balance or Not?

Question: My 23 year old son applied for a credit card and was turned down because of "lack of credit history." We had held a joint credit card with us but apparently that didn't matter. He had a history of both utilities and rent in his name. His bank suggested a guaranteed credit card. He has applied for one of those. Now he wants to establish his credit. My understanding is that he needs to use the card and pay off in payments. Our family has always paid in full. He is very reluctant to not pay off the total every month. Am I correct in having him pay off in payments? If that is right, what is the minimum amount he needs to carry over each month and how long does he have to do this. He really doesn't want to carry a balance at all. Nancy, Scotts Valley, CA

Answer: No, your son should regularly use the credit card to build up a history, but then he should go ahead and pay off the monthly bill in full. It's a good financial habit to get into, and when it comes to his credit score there's no need (or extra benefit) to carry a balance. He should be able to get a traditional unsecured credit card fairly quickly, too.

By the way, when it comes to creating and improving his credit score, he should keep his credit use to less than 30% of his credit limit--and preferably closer to the 10% mark. Again, it's a sound habit both from the financial and credit score perspective.

09/04/08 by Chris Farrell

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A Budget Toolkit?

Question: Can you recommend a good online budgeting tool? Suzanne, Thiensville,WI

Answer: My favorite budgeting quote:

Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

It's from David Copperfield by Charles Dickens.

There are a couple of good ones. Quicken Online is geared toward tracking where your money is going. (There are also the various Quicken personal finance software packages.) Others swear by Microsoft Money Plus. I have heard good things about Mint.com, but I haven't used it myself. There are plenty of good budget worksheets online, too. A basic one is offered for free by the Consumer Credit Counseling Service of San Francisco at www.cccssf.org. (It's under "forms".)

However, I know far too many people who have paid for a sophisticated computer-based budgeting tool only to have it gather cyberdust after a few months. The software and online programs work for anyone with a good reason to track their spending and saving patterns on an ongoing basis--and in detail.

But for a lot of us out to create a household budget, pen, paper, and a calculator is enough. It all depends what you're trying to do.

Whether you go online or use a notebook, the chore of creating and sticking to a budget is worth it. 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. Without a budget it's harder to control risk. Instead, you're more financially vulnerable to a sudden setback, such as car failure, job loss, or an illness. A budget is really where values are transformed into reality. The real payoff from a budget is when you spend your money where you want, and save for what you would like to do with your money.

Most of us don't need to spend an enormous amount of time tracking data. For a relatively small investment in time and effort upfront, a budget should become a lifetime of good financial habits. At that point, ballpark figures and estimates--with the aid of automatic bill paying and automatic savings programs--is enough.

In an interview I did several years ago with Eric Tyson, author Personal Finance for Dummies (and a number of other finance books) we talked about a couple that was making a budget, and they were eager to do all kinds of data entry on the computer. Tyson's response was "do they really need to be tracking all of their spending on a monthly basis? Because if they set a specific savings goal like we are going to save 10% of our income or 8% of our income each month and they are able to do that, then my feeling is who cares where it goes after you have accomplished that savings."

I vote for keeping a record of your spending for several months to find out where your money is going, and use that for creating a working budget. But once you have one, with time it's no longer necessary to minutely follow your expenses--unless there's a good reason to do it.

09/06/08 by Chris Farrell

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Hiring a Caregiver?

Question: On your show on 9/6/08, two families got together to hire a child care provider. Do these families need to pay social security tax and what about health insurance for that employee? I would like to do something similar regarding caregivers for a disabled brother. Lawrence, City: Oriskany, NY.

Answer: You can listen to the story here.

In essence, you're a small employer if you find and hire a person to take care of your disabled brother. Like all employers, you need to make sure the caregiver isn't an illegal immigrant. You're responsible for paying Social Security and Medicare taxes (assuming your wages are more than $1,600 a year in 2008). In many cases, you'll pay federal unemployment tax (in 2008 that's required if you paid total cash wages of $1,000 or more in any calendar quarter to the caregiver.) There might be state employment taxes, as well as a requirement to meet workman's comp and short-term disability insurance.

However, just as a small business isn't required to offer its employees health insurance you don't need to provide that benefit. One reason many families turn to an agency for a caregiver is to avoid all the small employer paperwork and filing requirements. It can be overwhelming

09/08/08 by Chris Farrell

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Emergency savings?

Question: I'm a 28 year old full-time graduate student, married, and proud parent of one son. I receive stipend from school which is not much and is our sole source of income, but with (super!) tight budget we make our ends meet.

One of the things that we'd love to do is to save, even if it's a very small portion of our income. I've heard a lot of good things about the Roth IRA and I think you recommended it to some folks who dialed in to your show. From what I've read about the Roth IRA so far, my understanding is that the Roth IRA allows us to contribute up to $4000 / calendar year and be able to withdraw from our contribution (but not the interest earned) in that same year.

Now, one "wild" idea I had is that since we don't have much of a savings yet but do want to start getting in the habit of doing so, AND also be able to have some level of liquidity with our savings, could I treat my Roth IRA account like a $4000 savings account from which I can withdraw in case of emergencies? I'm attracted to this idea because I'm told that IRA's (mutual funds) typically yield much better returns than conventional savings accounts. Do you think this is wise or am I missing overlooking something fundamental?

Thanks in advance for kindly sharing your wisdom! -John, Baltimore, MD

Answer: Congratulations on your money management skills. And I like your "wild" idea. It's an approach I promote it a lot.

You're absolutely right: A big advantage of a Roth IRA is that it is both a retirement savings plan and an emergency source of savings.

To briefly touch on the basics, Roth contributions are paid with after-tax dollars. The limit for 2008 is $5000. (a $5,000 maximum in 2008 if you're 49 and under and $6,000 if you're 50 and older.) Your investments gains will be tax free when you take the money out during retirement.

Still, in a pinch you can withdraw your Roth contributions without paying a penalty or taxes to Uncle Sam. The key is to leave the investment returns alone. You only tap your contributions. For example, let's say you contribute $3,000 into the Roth and in a pinch you need $1,000. You can take out that $1,000 without penalty or taxes.

09/09/08 by Chris Farrell

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Which Debt to Pay Down?

Question: My parents gave me a check to help with debt reduction. I am somewhat overwhelmed with the possible uses for this check. I have a loan with 12% interest which would be close to being paid off with their check; a credit card at 0%; and credit card at 10%. My first instinct is to pay off the loan and be nearly done with my 2nd highest monthly payment. However, credit card debt is less favorable to my credit than a loan. I also wonder if I should split the payment and pay off some debt and put the rest into a 2-year CD? Or finally, much needed home repair that I could pay up front rather than financing. What's best: loan repayment, credit card repayment; repayment and savings; or home repair? Kate, Minneapolis, MN

Answer: In a sense you can't go wrong. But there are trade-offs, and that's where the paralysis comes in. Here are some ways to think about it.

The standard advice--with good reason--is to attack the high interest debt first. By definition, it's the most costly. However, all of us need some positive reinforcement and there is a "whew" factor to consider when we finally get rid of a debt. That's why it can make sense psychologically to attack the debt with the smallest amount due even if financially the logical course is paying down the high interest rate debt.

Now, reminiscent of the fierce debate over whether to tie a kid's allowance to household chores, either approach has passionate advocates. I fall in the agnostic camp. Either way, you're getting rid of debt. The real question is, which approach will work best for you? Paying off a loan or tackling higher rate debt?

That's one big issue. The other one is the home repair. You say it's "much needed." I interpret that to mean the repair will help maintain the value of your home. I know that the housing prices are falling now and for the foreseeable future. But over a longer period of time your house is a major investment. In that case, using the money from your parents as investment money, and setting up a debt repayment plan to attack your other debts, seems sensible to me.

Last, understanding how you got into debt in the first place and how you plan to stay out of debt once you get all your debts paid off. Part of this process is the proverbial "know thyself" and part of it is creating a practical budget you can and will stick to over time.

So, with all this in mind, here is how I would approach it.

If you haven't done so already, take the time to make a realistic budget for paying off your (remaining) debts. Next, while in most cases borrowing to make home improvements is good debt that should pay for itself over time, it might be the best course to avoid taking on new debts. This way you can get your home fixed up, and focus on your debt reduction plan.

Does anyone have another thought or approach?

09/10/08 by Chris Farrell

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Under One Roof?

Question: After the death of my father, my siblings and I discussed one of us living closer to mom. She lives in SoCal and the cost of living is much higher there (duh). One option is going in on a place with my mother as co-owners, and I would live there. I am guessing I will need to locate some sort of contract, or meet with a real estate attorney to draw this up. Can you provide any advice on this topic, or just outline some of your thoughts? Andrew, Boise, ID

Answer: What you're thinking of doing could become increasingly common with the aging of the population. Indeed, many members of the "sandwich generation," who now find themselves responsible for the welfare of both their parents and children, are embracing such living arrangements that were more common a few generations ago. And even if young children aren't involved, living under the same roof offers less expensive independent living for older people and their adult children. It can be very good from a family perspective.

That said, the move represents a big financial and emotional commitment for an extended family. To make it work often takes many hours coming up with the right financial arrangement that not only are good for you and your Mom, but also take into account your siblings. You will need a lawyer to draw up legal documents, and in cases when substantial assets are involved working with a financial planner is common.

Among the questions to ask: How will you divide utility and other bills. Will you share co-ownership? Will you pay rent to your Mom or vice-versa. Who gets the tax deduction on the mortgages? Questions along those lines. All of this is routine in this market, and there is a fair amount of flexibility in making financial arrangement, but everything should be laid out and well-understood.

Family dynamics came into play, too. How will your siblings react to the financial arrangement?. Will they support you and your Mom? And what are the implications of living under one roof for the division of her estate?

Last, you will at some time in the future be the point person for dealing with disability and death. It's a good idea to talk them through, since you'll be living in the same place. You have to really think about the endgame, more than a lot of people are comfortable doing. That said, I do believe that this kind of arrangement can work for everyone.

09/11/08 by Chris Farrell

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Buying a retirement home

Question: My girlfriend and I are both in our mid 50s and thinking ahead to where we want to live when we retire. Here's a summary of our current financial situation. We each own our own homes and don't have any mortgages, car loans, or credit card debt. Her house has a tax appraised value of about $150K and mine is $390K..... She plans to retire in 5 years, receiving a pension from the state. But I will probably wait till full retirement age.

We'd like to buy a house about an hour North of us in a small New England resort town. The property taxes are low, and it will be an interesting place to live. I enjoy doing remodeling work, so we'd like to get something that is older that we'll be able to rehab to our liking, in particular making the property as energy efficient as possible, as well as completely handicap accessible. (We're able bodied now, but...) We're looking for properties in the range of $150K to $250K, although our hope is to keep it at the lower end to keep our future property taxes lower. (NH has no sales or earned income taxes, but property taxes can be a problem for retired folks.)

What I can't decide is how to finance the new property and budget for the renovations. Would it be better to finance the bulk of the new property, reserving my cash for the renovations. Or would it make more sense to use the bulk of my cash to buy the property, and then get a mortgage on the remainder and use a home equity loan to pay for renovations. For that matter, could we mortgage one of our existing homes to help pay for the new property, thereby owning it free and clear, and then pay off the remainder of the mortgage when we sell that house? Do you have any general advice on what would make the most sense in terms of making the most of our resources? First Name: Bill, Barnstead, NH

Answer: First of all, before getting to your financial question, I want to highlight your idea of making improvements now that will make it easier to stay in your home as you and your woman friend age. It's something homeowners should take into consideration with remodeling projects.

For instance, if the home has more than one story, you might consider putting in a bedroom and full bath on the first floor in case the day comes when stairs are too difficult to climb. Bathrooms can be made safer with high-quality non-slip tile, and showers installed with no lip for easy wheelchair access. Kitchen counters can be designed at different heights to accommodate sitting as well as standing. For people in the 50s and 60s, if they're doing a major remodeling, it's the ideal time to make changes that will let them remain independent.

That said, let's look at the finances. You and your woman friend have solid finances. I would not put the new home on to your existing homes. Let's not put the value of those assets at risk.

It reads as if the remodeling, fixer-upper project will take a considerable period of time. If that's the case, your best bet will be a home equity line of credit. It's ideal for home improvements done over a period of time, a project here, a project there. A home equity loan is better when there is a major renovation to be done within a certain time frame.

So, a conservative plan would be to put more money down and take on a smaller mortgage. I would worry less about reserving the cash for home renovations. You can do some smaller, more sweat equity-type projects at first, get to know the place well, really figure out what you'd really like to do it, and then get more aggressive--and have more fun--once you've sold your places and moved into your new house up north.

It's clear that you two have carefully thought through this move. Still, I'd emphasize that you're investing in this property together. I would have a lawyer draw up a legal document that spells out and protects both you and your friends investment and lays out the financial responsibilities.

09/12/08 by Chris Farrell

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Worried about financial safety

Question: My husband and I are 32 and 31. We have approximately 80K in retirement investments (SEP IRA, mutual funds) with Wells Fargo. We noticed recently that they have a disclaimer on their forms stating that investments are not FDIC insured. With the recent collapsing of investment firms and banks, and with the Lehmann Bros not being bailed out by the government, the uninsured FDIC investment makes me somewhat nervous. How do we know that our investment is "safe"? Should we consider doing something else with our money until we know Wells Fargo makes it through this time of turmoil? Renee, St. Paul, MN

Answer: I'm getting variations of your question from a number of folks. Checking, savings, money market deposit accounts, certificates of deposit, and other bank products are insured by the FDIC up to $100,000. (A CD in an IRA is insured up to $250,000.) You're absolutely right: There is no FDIC insurance when it comes to stocks, bonds, mutual funds, ETFs, commodities, and other market investments even if you bought them through a bank or a similar financial institution.

Still, there is a safety net. The biggest protection for your investments comes from the segregation of customer accounts from the finances of the bank or brokerage house. If a bank or brokerage house goes under, you still own the securities and your account will be sold or transferred to another institution. The Securities Investors Protection Corp. (SIPC) offers additional protection in case of fraud or malfeasance.

None of this investment safety net preserves the value of your money in the market. For example, if you own a stock mutual fund it's probably way down and odds are it's headed even lower. But you won't be wiped out if the financial institution you do business with fails.

That's only one aspect of financial safety. Another is taking a close look at the actual investments you're in. The key question is how well diversified are you? And, with all the turmoil in the market and no end in sight, do you feel that you have too much in stocks or some volatile asset. If the answer is yes, by all means trim back to a more conservative portfolio. .

09/15/08 by Chris Farrell

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Faster mortgage paydown?

Question: Hi! We have a 30 year fixed mortgage at 5.625% interest rate. We have $342,300 left to pay on the loan and currently pay $2,776 per month. We received an offer from our large mortgage lender to join their "equity accelerator" program, essentially contributing one extra mortgage payment a year. I'm seeing it as a way to free up cash flow for our bill juggling every month, instead of one whole paycheck devoted solely to the mortgage, I can divide up expenditures a little so we aren't so strapped until the next pay date after paying the mortgage. The fee is $49/one time fee and $9/month. In addition, this will probably be our retirement home as it is lakeshore in a large metro area. We have been surviving on one income for nine years while my daughter was young and then diagnosed with leukemia and now that she is well, I'll return work next September. What do you think of these programs? Thanks so much. Stephanie, Mound, MN.

Answer: I'm happy to hear that your daughter is doing better.

Now, on to the finance question: I'm not a big fan of these kinds of programs as a general rule. One reason is that you can do it on your own without paying the upfront and monthly fee. Just send in an additional check on your own with a note that the exra payment is to go toward principal only. By the way, money will get tighter if you're sending more of your cash flow toward your mortgage.

However, a listener once pointed out that while I was right, she participated in one of these plans because she was a single Mom and her life was incredibly busy. Despite her best intentions she always forgot to send in the check. The automatic program worked for her.

On a more fundamental level, as I've noted many times before, I'm wary of people taking their discretionary money and sinking it into their home. I'd prefer the money go toward building up an emergency savings fund, as well as a well-diversified portfolio of stocks, bonds, international equities, Treasury Inflation Protected Securities (TIPS) and the like. Of course, accelerate your mortgage payments once your home is a smaller share of your overall portfolio.

09/16/08 by Chris Farrell

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Is my Roth safe? How about my SEP?

Question: I have my Roth IRA with Merrill Lynch, in what they call an MFA account. Also have my SEP there. Since the Bear Stearns debacle, I've been wondering what happens to individual investor's accounts, but have been afraid to ask. What I don't understand is what happens to people with accounts in a firm that goes under? I know Merrill Lynch is being taken over, but I don't know what happens to individual small fry accounts like mine. B., Ancram, NY

Answer: Your account is safe. You may be a "small fry" like most of us, but you're still a valuable customer with assets.

Like any merger, there will be a (difficult) knitting of back offices, maybe a name change, perhaps a different logo, and some new employees. These are the kinds of shifts in business that typically accompany a merger.

But you still own the mutual funds, stocks, bonds, or whatever securities you have in the MFA that makes up your Roth. The same holds with your SEP.

I would keep a close eye on several things. First, watch to make sure the information about your account stays accurate. Problems can emerge in the aftermath of a merger, and it's always easier to get the information fixed if the mistake is caught early. Pay attention to any fee changes or investment charges. Monitor customer service. All of these could improve or get worse in the coming months or year.

09/17/08 by Chris Farrell

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Too big to fail?

Question: Is Bank of America too big now to fail??? Do we have to few institutions? Jeff, Arlington, IN

Answer: Yes, Bank of America is too big to fail.

I expect with the benefit of hindsight that the deal struck by BofA to buy Merrill Lynch for about 40 cents on the dollar will turn out to be shrewd move. For one thing, the bank has snapped up one of the most famous brands in the country--let alone on Wall Street--at a bargain basement price. For another, BofA has made sure after this acquisition, the purchase of Lasalle Bank, and the takeover of Countrywide Financial, that in the eyes of regulators the financial services behemoth is too critical to the U.S. financial system to fail. Indeed, management has spent $100 billion over the past 5 years on acquisitions, according to the Wall Street Journal. The buying spree puts BofA at the top of the U.S. financial services industry

To your second question, the financial sector is reorganizing and shrinking. But it was probably too large to begin with, growing at a rapid pace over the three decades or so. It has grown to a much larger share of GDP than we've seen in the past. Consolidation is long past due.

That said, when it comes to our own banking I don't see any reason to do business with the biggest. The real key is the FDIC (or its credit union peer). So long as there is FDIC insurance, and your business with the bank is covered by the government's insurance safety net, then you should feel free to bank at a community bank, a regional bank, or your local credit union. The question remains whether a bank the size of BofA can deliver good service at a low cost to its customers. The good news is that there are plenty of competitors eager for your business if it doesn't.

09/18/08 by Chris Farrell

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Credit unions

Got this nice note this morning. It's an important reminder.

For Chris: I'm a regular listener and appreciate your work. Just a reminder that when folks are looking for safe deposits, equivalent to a bank with FDIC insurance would be a credit union with NCUA (National Credit Union Administration) insurance. It has the same full faith and credit backing of the federal government, $100,000 limit per account and multiple account structure as FDIC. Virtually all credit unions have this federal coverage. Depositors can look for the blue NCUA logo in the lobby or on a website. Thanks. Bill Hampel, Chief Economist, Credit Union National Association

09/19/08 by Chris Farrell

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Money market mutual funds

Question: If the government is now going to insure money market funds, will the return go down as the risk does? Carolyn, Tallahassee, FL

Answer: Yes, the return should go down. It's an axiom of modern finance theory that the only way to create the potential for earnings a higher rate of return is by taking on greater risk. Money market mutual funds, which weren't covered by the FDIC, paid investors more than comparable FDIC insured deposits.

Now, the federal government has created the equivalent of the FMMMFIC--the Federal Money Market Mutual Fund Insurance Corporation. Of course, that really means the American taxpayer is backstopping the $3.5 trillion in money market mutual funds for the next year. (It also means that everyone--like me--who accepted a lower yield on their money market fund in return for parking emergency money in the most conservative option paid an unnecessary interest rate penalty. Those that reached for yield just got bailed out.)

The federal guarantee that money market mutual funds won't "break-a-buck" is for a year. But there is no way to put this financial genie back in the Wall Street bottle. Everyone knows the government will bail out the money fund business the next time trouble hit. What the year does is buy the authorties time to come up with a new regulatory scheme that takes into a account the federal government's explicit guarantee of our short-term savings.

For more information, check out Tess' conversation on money market funds with Marketplace' s Amy Scott on this week's Marketplace Money.

by Chris Farrell

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Tax exempt money market mutual funds

Question: I have a municipal mm mutual fund with Fidelity. It is spread across all 50 states. The prospectus shows that for instance Lehman is the "liquidity facility" sometimes Bof A is mentioned or Morgan or JP Morgan Chase. What does that mean about the safety of this mm fund? Susan, Irvine, CA.

Answer: Right now, money market mutual funds are among the safest parking places for cash available. That's because the U.S. Treasury has decided that the American taxpayer backstops the business. The details are still being worked out, but the guarantee is that any publically traded money market mutual funds won't "break-a-buck," the financial pledge that at a minimum the dollar you've invested in a fund will be worth at least a dollar tomorrow. Funds will pay a fee to participate in the program, and the insurance plan has been funded with up to $50 billion. It only includes money invested before Sept. 19.

The Treasury has also clarified that the insurance pledge includes tax exempt money market funds. So, your very short-term fund has the protection of diversification (across all 50 states), the financial soundness of Fidelity and the Treasury's insurance guarantee.

The Federal Reserve has also adopted several rules to make sure that there is sufficient liquidity in the market. (More liquidity means it is easy to buy and sell assets at their fair market value, and less liquidity means it gets harder to buy and sell.)

09/22/08 by Chris Farrell

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Fund 401(k)?

Question: I am in my 30's and committed to a long term investment in my retirement. I have decided not to look at my 401k during this terrible financial time, since I am in it for the long haul. I have heard some commentators on the show mention that they are doing the same.

My question is - should I significantly decrease my contributions or stop contributing to my 401k all together until this crisis has passed?

I understand that could be awhile. My plan would be to put the money that I would have contributed to the 401k into a regular savings account. I know it won't grow but it probably won't disappear. Thanks for your help! I love the show. Nicole, Brooklyn, NY

Answer: You're far from alone in your confusion and nervousness. We're all feeling the financial strain of the past few weeks. My advice is to continue to put money into your 401(k). Last week, here's what Michael Mauboussin, chief investment strategist at Legg Mason's said to me last week: "With a longer time horizon, say 10 to 20 years, even the crash of 1987 looks like a blip."

However, you can always change where the money goes. The best strategy for most people your age, say, 20 to mid-40s, is to stick with the existing asset allocation. Assuming you have a well-diversified portfolio you'll do better staying put than selling in a panic. But you might have learned the hard way that your portfolio choices are too risky. You don't like this volatility. If that's the case, I would figure out how you'd like to adjust your portfolio to a more conservative position, and then do it over time. For instance, I would look at putting some money into a safe harbor like Treasury Inflation Protected Securities. Many 401(k) plans now offer a mutual fund option that invests in TIPS. If that isn't available, another conservative option is a fund made up of short-term Treasury bills.

The exception to this overall approach is if you're holding a risky, highly undiversified portfolio. In that case, I would bite the bullet and make major changes fast.

A final thought: While I would keep funding the retirement savings plan no matter what--especially up to the company match--it can make sense to reduce your contribution if you don't have emergency savings or if you can sense you're at risk of getting laid off.

09/23/08 by Chris Farrell

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Federal credit unions

Question: On last Friday's show it was stated something to the effect: "congress will never let the FDIC run out of funds". What about the NCUSIF? PLEASE WITHHOLD MY NAME, Scotia, NY

Answer: Technically, the FDIC could run out of money. But I don't believe the Treasury or Congress would let that happen. The same holds with the NCUSIF (National Credit Union Share Insurance Fund), the federal insurance guarantee for federal credit unions.

09/24/08 by Chris Farrell

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Are IRAs safe?

Question: "Is our IRA account in UBS Financial Services Inc. safe during this wall street crisis?"..." If not, would you recommend taking the money out and putting it into treasury bonds or treasury money markets with an FDIC approved bank?" Thank you for your assistance Lynette, Chico, CA

Answer: There are two answers to this question. First, your IRA account is safe. Even if UBS got into trouble, another financial services firm would take over the account. Second, the value of the account depends on what assets you're invested in. To take an extreme example (just for the sake of illustration) lets say all the money had been invested in Bear Stearns and Lehman Brothers. You'd be wiped out. In sharp contrast, if all the money were in T-bills, you'd be sitting (relatively) pretty.

by Chris Farrell

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Money market mutual funds

Question: I have been told that I should transfer my cash into treasury money market funds (MMF) to protect them during the current crisis. As of now MMF's are not insured or backed by the goverment. Should I assume that treasury MMF's are safe since they are invested U.S. treasury notes? George, Baltimore, MD

Answer: Right now, the savings parked in money market mutual funds before September 19th is extremely safe. In essence, to stop a modern run on the Wall Street bank--an investor flight from money market mutual funds--the Treasury decided to backstop the $3.5 trillion business with the full faith and credit of the American taxpayer. Call it the Federal Money Market Mutual Fund Insurance Corp.

The regulatory rules of the new insurance fund are still being drawn up, the government is determined the traditional industry pledge that net asset value on money funds won't "break a buck" will hold. The dollar you put into a taxable or tax exempt money market mutual fund before September 19 will be worth at last a buck when you withdraw money from the fund. I've long argued for savers to use the money market mutual funds that invest heavily in Treasuries. Why take a risk with your emergency savings money? You want it stashed in a safe haven.

09/25/08 by Chris Farrell

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Retirement savings and debt

Question: I have a SEP plan. I make quarterly contributions. I commit a % for the year. At the end of the year if I have extra I contribute more. My question is would I be better off putting the extra into paying off my car? Or just putting it in savings? I am sticking to my quarterly contributions but it is hard when by the next quarter it has "vanished". I am looking at retiring in 15 years. My spouse has a 401K, company pension and separate investments. Would it be better for him to not contribute at this time to the separate investments and work towards paying off the house? He is looking at retiring in about 11 years. Elizabeth, Indianapolis, IN

Answer: I'm glad that that you aren't just looking at your retirement portfolio. It's really easy to get caught up in the downward gyrations of the bear market in stocks and the abrupt shifts in market interest rates. (Imagine, the yield on the 3 month T-bill went briefly negative last wee. That's right, less than 0%.) It's good to keep funding it too.

When it comes to managing household finances, the main message of the past year has been get household finances in good shape by spending less and paying down debt. That's why I like your thought of taking that extra cash in this tumultuous environment and putting it toward eliminating the car loan.

However, I'd recommend that your spouse continue to save for retirement, too, as well as build up household savings rather than take dramatic steps to pay off the mortgage early.

Of course, in the heart of most (all?) homeowners burns an intense desire to say goodbye to the bank for the last time and own a home free and clear. There are advantages to accelerating mortgage payments. You can get a good return on your money, especially in this market. Let's say your mortgage rate is 6%. In that case, by paying down your mortgage early you'll earn the equivalent of a simple 6% rate of return on your money. If your rate is 5%, the return is 5%. (This simple example doesn't take into account taxes and other factors.) You'll save thousands and thousands of dollars in interest payments. And it's important for most people to be debt free when they enter their elder years--and that's what you want.

That said, here's why I'm cautious about getting too aggressive with mortgage payments. My basic problem is that most people end up putting too much of their financial eggs in one basket -- a home. That's another way of saying that your financial health is now increasingly dependent on how one asset performs and, as we are witnessing right now, home prices can go down as well as up. Diversification pays.

For me, the key is building up a well-diversified portfolio of cash, stocks, bonds, commercial real estate, commodities, and international equities--even in a market like this one. I especially like investing in Treasury Inflation Protected Securities (TIPS) and I-bonds. Both of these default-free securities sold by the federal government will protect you against the ravages of inflation. The value of your home shrinks as a percent of your net worth over time. Once you've built up a well diversified portfolio, then pay off the mortgage by all means.

A sensible way to shorten the life of your mortgage without taking drastic action is to make an extra monthly payment a year. By writing 13 monthly mortgage checks instead of 12 you'll pay off that loan faster. Just be sure to tell the bank in writing to put that extra payment toward principal.

by Chris Farrell

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Refinance mortgage?

Question: Yes, I'm one of those people with a sub-prime mortgage. When I got divorced and took over my mortgage, money was tight, so I got a 5 year ARM at 4.625. The lower rate expires in April of next year, and goes to LIBOR plus my margin of 2.25. Right now, that would mean a rate of about 5.5%, which would mean my monthly payment would go up about $100.00, which I'm not crazy about, but I could manage. My mortgage is about 40% of my take-home pay. However, who knows what the LIBOR is going to do, and my rate continues to adjust each year on the anniversary. If I refinanced right now to a fixed rate, I think I could get something like 6.6%, which would raise my current payment about $175 dollars, plus I would have to start over at 30 years.

Here's the kicker: my mortgage is held by WASHINGTON MUTUAL! Am I exposing myself to anything dangerous by not going with a different lender? What should I do? When should I do it? I feel paralyzed with indecision. Victoria, Los Angeles, CA

Answer: Ouch! From the subprime to WaMu, the largest bank failure in U.S. history. You've had quite a window into the making of recent financial history. On a more serious note, you may feel paralyzed with indecision, but you've already started the process of calculating how much your monthly mortgage payments would go up if you kept your adjustable rate mortgage at current rates. You're right to be wary of what rates will be in the future. You've also figured out what a fixed rate will cost you. That's a good start. To jump to my bottom line, I would refinance at a fixed rate at the new WaMu/Chase--or another bank. But it won't easy.

Now, for some elaboration on why I say that. Regulators seized and sold most of WaMu to J.P. Morgan Chase & Co. The transaction went remarkably well. The mismanaged Seattle thrift was going under as depositors withdrew money at an accelerating pace. (As an aside, the one agency that has performed admirably throughout the financial crisis has been the FDIC. Indeed, if Washington had listened earlier to Sheila Blair, head of the FDIC, and her prescient persistent calls for a comprehensive mortgage solution we wouldn't be in the current financial catastrophe contemplating a $700 billion bailout. The FDIC is no FEMA and Blair of the FDIC is no Brown, the incompetent former head of FEMA during hurricane Katrina.) WaMu customers were getting money from ATMs this morning.

You're now a customer of the JP Morgan Chase, the largest bank in the U.S. measured by deposits. There's no rush to refinance right now, not with the bailout negotiations continuing in Washington D.C. But I would go to your branch and talk to a loan officer. I would have him or her look at your mortgage and see what options will be available to you and at what cost. You should also check out what competing institutions will offer you, since the takeover gives them an opportunity to nab some new customers that want to say goodbye to Wamu--even in its latest incarnation--for the last time. Hopefully, Chase will want to keep you as a customer (they did spend several billion buying WaMu's customers, after all). So see what kind of fixed rate refinancing mortgage is available to you after taking into account your credit score, the value of your home, and market conditions.

What's more, to break the paralysis I would play a financial version of Pascal's wager. Pascal is famous for saying, "Is there a God, or is there not a God?" Of course, there is no real answer to the question. But Pascal argued that we can rationally decide to act as if there is a God or act as if there isn't.

Peter Bernstein, the dean of finance economists, has long argued that people should think through a financial version of Pascal's wager. First, he says, we can't piece the investment fog of the future. There's no certainty--it's in the nature of the beast. Instead, he recommends focusing on how serious will be the financial consequences if it turns out that your wrong in your bet? If the bet goes wrong, how bad could it be and how much will it matter to your finances.

You could gamble that LIBOR will stay low. And if it does, you'll be just fine. But what if LIBOR soars, how much will it impact your finances? My own feeling is that with 40% of your income already going toward housing the downside risk is big. I would focus on getting into a fixed rate mortgage. And its fine if it is with your current lender.

09/26/08 by Chris Farrell

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Stockholders and a failed bank

Question: I know WaMu depositors are insured, but what can WaMu stock holders do now? I’m relatively new to investing, and this is the first time I’ve seen my stock drop to $0.16! Andy, Ankeny, IA

Answer: The FDIC engineered takeover of Washington Mutual by JPMorgan Chase protects depositors, not shareholders. Shareholders are essentially wiped out. At this point, the real value of your WaMu stock could come on your tax bill, using the loss to shelter capital gains or ordinary income from Uncle Sam.

09/29/08 by Chris Farrell

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A SEP-IRA in troubled times

Question: This is the first year I have actually made a profit, after five years of self-employment in New York City. And I'd like to keep as much of it as possible, seeing as the future is rather uncertain! My accountant has been advising me to get a $10,000 SEP IRA in order to not give all my money away to the IRS. She insists that "the market is on sale" and that I am under no risk by investing my money this way.

She has suggested that I look up a few different companies that do SEP IRA's, so I know she isn't advising me to do this out of self-interest. Still, I can't help wondering, is it safe to invest in a SEP IRA at this moment in time when banks are failing and investment companies are in such trouble? How will I know who to get it with? And what, if anything, makes a SEP IRA safe or not safe?

I'm advised I must do this before tax year is over, so that I can avoid paying taxes on the income that I will be investing in the IRA. So, can you help? I'm sure I'm not the only one who needs this kind of advice! Thanks in advance! Carolita, NY, NY

Answer: Congratulations on making a profit. That must feel good.

A SEP-IRA is a low cost and simple retirement savings plan for the self-employed. Almost any financial institution, including banks, credit unions, mutual fund companies, discount brokers, to name just a few will be glad to open a SEP for you.

The contributions you make into a SEP are with pretax dollars, so your tax bill will be lower. The money compounds tax deferred until it's withdrawn in retirement. You'll pay ordinary income taxes on the money you withdraw during retirement.In most cases, you have until April 15 to make a contribution. For the self-employed in an unincorporated business, annual contributions to your SEP can range between 0 and 20% of your net adjusted self employment income. You can always skip making a SEP contribution in a bad year without any penalty.

Question is, where to put the money? These are confusing times and the list of unthinkables that have become reality is long and growing. Still, the most important thing is to make the contribution. You're young and time is on your side.

It's absolutely fine to park the retirement money into super-safe, low-yielding Treasury bills. (And I'm not kidding when I say low yield: Following the rejection of the $700 billion bailout by the House, rates on 3-month Treasury bills fell to 0.29%. We haven't seen rates like this since World War Two. According to the Bloomberg news wire, yields did reach 0.01% January 1940, four months after Adolf Hitler's invasion of Poland.) Other safe havens include bank certificates of deposit and Treasury Inflation Protected Securities.

Now, I assume the statement the "market is on sale" refers to the stock market. Problem is, we are in a bear market that could get worse, which is another way of saying that the "discount" could get even bigger. Even if true, it's important to know whether you're comfortable with the stock market? Will the volatility bother you? Can you sleep at night? Don't worry about it if you aren't knowledgeable about the stock market. You have plenty of time to learn. Keep the IRA money safe. But please spend the time learning more about stocks, bonds, retirement savings strategies, and diversification.

Although they have different messages you can't go wrong looking at two books: The Random Walk Guide To Investing: Ten Rules for Financial Success by Burton Malkiel and Worry-free Investing by Zvi Bodie and Michael J. Clowes. Both are in paperback.

by Chris Farrell

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CDs and the FDIC

Question: I understand that CD's are FDIC insured, but what about the interest on them?

Are you guaranteed just the principal amount or the principal plus interest, too? Mary, Waukesha, WI

Answer: The basic insurance amount is $100,000 per depositor, per insured bank, and that includes principal and accrued interest up to a total of $100,000.

When a bank fails, here's what the FDIC has to say in more detail about the effect on accrued interest.

The FDIC's insurance coverage includes principal and interest through the date of the bank failure up to applicable insurance limit for each deposit. The accrual of interest ceases on all accounts once the bank is closed. If an open bank acquires deposits from the failed bank, the acquiring bank becomes responsible for re-establishing interest rates and beginning the accrual of interest after the date of the failure of the bank. The acquiring bank may change the interest rate on the acquired deposits, but the depositor may withdraw their insured funds without penalty if they chose to do so. If no acquiring bank is found for the deposits and the FDIC pays the depositors directly for their insured amounts, interest does not accrue past the date of failure.

by Chris Farrell

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Investing during a Great Depression

Question: How do you *depression-proof* your assets. My husband says there's no way; that's what a depression means. My grandmother who survived the Depression said to just keep working and hang onto what ever real property you can; she never has believed in stocks, bonds, or anything "that I can't see". Nancy, Columbus, OH

Answer: I don't think we are going into another Great Depression. That said, it's a question I've been getting more and more. The bottom line is that if we were heading into another deflationary depression the best assets to own are default-free Treasury bills and Treasury bonds, with some other very high quality fixed income securities thrown into the mix.

In my book, "Deflation: What Happens When Prices Fall", I looked into what investments did well during the Great Depression. Here's what I found out:

Now, mention deflation and the markets, and most people will recall the stock market crash of 1929. Stocks had been lurching lower after reaching a peak in September, and on October 29th the Dow plunged by 30%. Volume reached a record 16.4 million shares, an infamous benchmark that held for 40 years. From its 1929 peak of 381.17, the Dow Jones industrial average plunged to 41.22 in July 1932. At the end of the decade the Dow stood around the 150 mark, and equity investors had earned a mere real 1.43% from 1929 to 1939. It wasn't until 1954 that the benchmark index passed the level it had reached before the 1929 Crash.

Like the 1990s, the stock market seemed everywhere during the go-go years of the 1920s. Yet despite colorful tales of cab drivers, bootblacks, clerks, housewives, doctors, lawyers, and other ordinary folk gambling their life savings in the stock market, historians now believe that no more than 8% of the population owned stocks, and most of those investors were well heeled. Wealthy or not, many investors lost fortunes. Comedian and singer Eddie Cantor supposedly lost a million dollars. Songwriter Irving Berlin didn't heed the advice of Charlie Chaplin to get out and lost a bundle. Irving Fisher, widely ranked among America's greatest economists, damaged his reputation by loftily predicting shortly before the 1929 crash that stock prices had reached "a permanently high plateau." Worse, a large part of his wealth disappeared in the crash.

Again, reminiscent of Enron, WorldCom, Global Crossing, and other current examples of corporate greed and malfeasance, the reputations of Wall Street's leading lights were also tattered. Richard Whitney, acting president of the New York Stock Exchange during the crash and a famous broker with the prestigious firm J.P. Morgan as his client, grandly lived well above his means. When insolvency loomed, he defrauded customers, his wife's trust fund, and the New York Yacht Club. He was caught, convicted, and sentenced to Sing-Sing prison. Charles Mitchell, known as "Sunshine Charley" and head of National City Bank, relentlessly pushed the salesmen in his financial supermarket with branches in more than 50 cities to peddle junk bonds and junk stocks on to an unsuspecting public. He was forced to resign in 1933, and indicted for income tax evasion the following year, although acquitted.

Obviously, stocks did horribly during the Great Depression. But bonds did well. Interest rates and bond prices are two ends of a seesaw. When bond yields are rising (usually from investors anticipating higher inflation), bond prices go down--and vice versa. Bond prices soared as bond yields came down sharply during the depression. For instance, the prime corporate bond yield average went from 4.59% in September 1929 to 3.99% in May of 1931. By June of 1938 the average corporate bond yield fell to a new low of 2.94%. Bonds returned 6.04% during the 1930s. Short-term fixed income securities or bills returned 3.39% over the same time period. But even fixed income investors are wary of deflation since unwary creditors absorbed huge losses during the 1930s as cash-strapped corporations and municipal governments defaulted on their debts.
Two Wall Street tycoons that ended up with "pockets full of money" after the Crash were Alfred Lee Loomis and his partner and brother-in-law Landon Thorne. The two had been leading financiers for the new electric power industry in the 1920s. Loomis was also a scientist, and he became a major supporter of some of the century's greatest scientific minds at his Tuxedo Park home. By early 1929, the two partners had liquidated all their stock holdings and put the gains into long-term Treasury bonds and cash. The reaction by their peers, so many of them forced out of business, seemed more like envy than admiration since "in the midst of so much despair, with the economic situation deteriorating day after day, Loomis and Thorne continued to profit handsomely," writes Jennet Conant, author of the Loomis Biography Tuxedo Park: A Wall Street tycoon and the Secret Palace That Changed the Course of World War ll.

Continue reading "Investing during a Great Depression" »

09/30/08 by Chris Farrell

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