Marketplace

Credit counseling

Question: I have, unfortunately, managed to rack up about $30,000 in credit card debt. Financially I'm okay and working to pay off the debt and not in danger of bankruptcy or anything right now. I am considering using a credit counseling service to help me negotiate a lower interest rate on some of my cards, and am wondering how it works if you have a balance on a card but close the account? How does it reflect on your credit report? Thank you, Mark, Ashburn, VA

Answer: The answer lies in a world of "sometimes," "maybe" and "not always." Fair Isaac, the 800-pound gorilla of the credit scoring industry, explicitly states that participating in credit counseling doesn't factor into your credit score. That's the right approach. Problem is, there are other credit scoring companies and it could show up elsewhere. Closing a credit card account will usually nick your credit score.

Of course, my reaction is "so what"? The real concern is getting rid of the debt, and congratulations on working so hard to pay off your credit card bill. Your credit report and your credit score will rebound with good debt habits.

One last thing: Be careful when you look for a credit counseling service. It's an area ripe with fraud, malfeasance and fly-by-night operators. The nonprofit affiliates of the National Foundation for Credit Counseling are legitimate. The quality of the service can vary, but it's a good organization and a good place to start. The United Way and a number of churches also offer honest services.

By the way, they may tell you you're doing fine on your own. But it's always good to talk to someone knowledgeable and have them review your situation and go through your options.

04/01/09 by Chris Farrell

Permalink

Community bank

Question: I am trying to decide which lender to use to refinance my home mortgage. The small, neighborhood bank is offering the lowest rate with mortgages backed by Fannie Mae/Freddie Mac. Their closing costs are slightly less than the big name mortgage lenders in my home city. Is there anything else I should consider in this decision regarding which lender to choose? I like the personal service and convenience of the neighborhood lender, but are there any risks that I'm overlooking with using a smaller lender? How is the smaller lender able to offer lower rates? Thanks. Elsa, St. Louis Park, MN

Answer: There is no reason why you shouldn't go with your community lender so long as you've shopped around (which you have) and it's a bank insured by the FDIC. The risks are the same. There could be a number of reasons why they're offering lower closing costs, from a business strategy to compete against the big banks to having a healthier balance sheet. When the numbers line up, it's good to support neighborhood institutions.

04/02/09 by Chris Farrell

Permalink

Buy GM

Question: I have a little bit of money that I wouldn't mind speculating with. (Nice way to say gambling) But I don't want to just throw it away. For that I can go to the casino. I was actually thinking of buying GM stock. It's certainly cheap enough. But I wonder about bankruptcy and how that affects stock owners. I understand bankruptcy is not the same as ceasing to exist, indeed if I understand it correctly it is one of the first steps to ensure it continues to exist, but how do stock holders fare in the process? Do they face the same kinds of risk that bondholders and creditors do? Thanks for taking the time. Michael, Harshaw, WI

Answer: Putting money into the battered, beleaguered automaker is speculating at the extreme. As you well know, this is making a bet on a wing and a prayer, pulling the slots on the corner of Wall Street and Broad.

On October 1, 2007 GM's stock price peaked at $42.64 a share. Today it trades a few pennies over $2.00 a share. Here's a chart of GM's stock price over the last two years from Marketwatch.com.

The risk of GM declaring bankruptcy is very high. If GM does go into Chapter 11 bankruptcy existing shareholders will probably be wiped out. That's what typically happens with Chapter 11.

Creditors usually come out much better. Depending on the terms of the loan contract, bondholders, bankers and other creditors have far better financial protections. Still, odds are that many creditors won't recover their whole investment in GM. Creditors will negotiate for a big chunk of the new equity in a reorganized GM. These former-debtors turned equity-holders will own much of the company when it emerges from bankruptcy.

If you want to speculate in the stock market how about putting the money into a broad-based low-fee equity index fund. I know it isn't exciting. But if the recent market rebound--the best four weeks since 1933--is for real you'll pocket a nice gain. Of course, it's impossible to know if the market has hit bottom or whether the gain is nothing more than a traditional sucker's rally in a bear market. If it's the latter, at least you'll own a stake in real companies while you wait for the recovery.

Of course, if you bet on GM and it avoids bankruptcy its stock should sizzle, at least or awhile. But I'd bet on the market and not a fallen giant.

04/03/09 by Chris Farrell

Permalink

A tenure decision

Question: I am an Assistant Professor beginning my tenure process. The short story: depending on the tenure process, this time next year, I may or may not have a job a year after the tenure decision. Currently, I am "maxed" out on my supplemental giving.

Is this the wise thing? Should I continue to max out for the future, or should I be building a nest egg for the near future that is also liquid? To me this is a tricky question, because now is a good time to be investing for the long run. But having cushion might be a smart thing to do. Thanks, Jake, Doylestown, PA

Answer: Good luck with the tenure review and decision.. I would continue to participate in the retirement savings plan. This way you'll continue to invest for the long haul. But I would back off on investing extra into the supplemental portion of your pension plan. Instead, I'd focus on building up short-term savings. The reason is that you may have to move in the next year or two if you don't get tenure. Its always expensive to pull up stakes and set up home in another part of the country. Of course, I hope the tenure decision goes your way.

04/06/09 by Chris Farrell

Permalink

Mortgage vs. savings

Question: Should I be making additional payments on my mortgage? We live in California and bought our home about 3 years ago, near the peak of the market. At the time, we put down 10% and took out an 80/10 30 yr fixed, and could well afford the house. We make pretty good money and normally paid extra on the loans. We finished paying off the 2nd late last year. In a normal environment, we would have moved our extra payments to the 1st mortgage, but given the current economy I have been hesitant to do so. The value of the house is down some 60%, so we are very underwater, and I feel like I'm throwing money down the tube if I make extra payments. My thought is to just ride out the market and put the extra money away in case some other opportunity or emergency arises. To further spook me, I was laid off in December, but thankfully managed to get another job in about a month. Otherwise, we are debt free, fully fund all of our 401k's, IRA, and have six months of emergency savings. Donny, Suisun City, CA

Answer: I like your thought: Stockpile the extra savings for now in a safe place, such as an FDIC insured savings account or certificate of deposit. You are in good financial shape overall. But it sure doesn't hurt to add to savings while the economy is in a tailspin. I imagine you still face some real job insecurity since you haven't been employed at your new place for very long, either.

Your job circumstances will improve and the economy will get better some time in the (hopefully very near) future. At some point, you'll figure out the best use of that savings. Don't let it burn a hole in your pocket. You've worked hard for it. The money could go toward accelerating mortgage payments, to pay for a career change, additional training and education or some other investment. What's important for now is that you're creating both a flush emergency savings account and a flush opportunity fund. They're really two sides of the same coin.

04/07/09 by Chris Farrell

Permalink

A home? a Master's? both?

Question: My son wants to buy a home and get his masters degree in the next five years. He is single and in his early 30s. He has excellent credit, very little debt, earns about $80K gross a year, and has cash for a 20% down payment. He has been with his current job for less than two years and is going to school part-time. If he gets laid off in this economy, he will have trouble paying his mortgage but it will put him back into school full-time and get him through his degree quicker. He is making a career change with the Master's degree program, which will take 2 years if full time and will leave him with $20K in student loans. When he graduates, he will have to look for a job in another field with a starting salary that is lower than his current job.

What suggestions do you have for him in terms of timing of his home purchase and education vis-à-vis the economy and his personal circumstances? I had suggested that he postpone his career change until the economy rebounds, but these days you can't convince kids to hold down unsatisfying jobs just for the sake of income and financial stability. Thank you. Ellie, Fitchburg, MA

Answer: Your son is making a big investment in his new career. He knows he'll probably graduate with student loans to repay, and he'll end up with a lower paying job once he has his Master's in hand. The return on investment comes from entry into a career he will enjoy and higher pay as he gains experience in his new field. He's making a big investment in his future.

I would advise against making an additional investment in a home. Sure, home prices look increasingly attractive. But he will be creating a high-risk personal balance sheet if he goes into debt to buy a home and takes on debt to get an advanced degree. He might come out okay if everything goes well. But the unexpected always happens--another bear market? a spike in interest rates?--sometimes on the upside and sometimes on the downside. He'll be at risk with all that debt if it's the latter.

He can always buy a home when he's embarked on his new career. Instead of using his savings for a 20% down payment, I'd use the money to reduce or even eliminate any student loans. He could also tap into that savings to help fund his career shift once he reenters the job market. I'd encourage him to invest in his career now, and buy a home later on.

04/08/09 by Chris Farrell

Permalink

Getting rid of escrow

Question: My mortgage (with GMAC) has an escrow element tied to it. Every year, the amount collected exceeds the amount needed for the tax payment, but when the annual Escrow Analysis statement comes in, the mortgage company declares there is a shortage, and the amount of my mortgage payment will go up whether I pay the shortage or not.

First of all, what is up with that? If I paid in more, how is there a shortage?

And secondly, can I remove the escrow from this mortgage without refinancing? I know I can easily save for this tax payment throughout the year, and collect interest for myself. Thanks very much. Diane, Milwaukee WI

Answer: I wish you luck. The money that goes into an escrow account is used to pay for expenses such as real estate taxes, property taxes, and homeowners insurance. Lenders require an escrow account if you put less than 20% down. That's a lot of people in the 2000s when a 20% down payment became the exception. The fluctuating payments could reflect a number of factors, ranging from higher bills to changes in the amount the lender requires as a cushion. Whatever the reason, some homeowners love escrow for its convenience and others can't stand it.

Here's the thing: If you have 20% or more equity in your home you can approach your lender. They may waive it for a fee. But lenders like escrow accounts so they aren't eager to make the change. That's why many homeowners with 20% or more in equity in their house end up refinancing to eliminate escrow (or perhaps more accurately, getting rid of escrow is an additional benefit to refinancing).

04/09/09 by Chris Farrell

Permalink

I-bonds for Roth?

Question: I was told by my bank that it is not possible to put I-Bonds in my Roth IRA. If not, why not? I want to make a contribution that will not shrink like my mutual funds. Suzanne, Los Angeles, CA

Answer: That's right. There are technical and legal reasons why it's almost impossible to do. For instance, the U.S. Treasury rules say you can't open an account to buy savings bonds electronically through Treasury Direct in the name of an IRA.

Here's the thing: I don't think you should do it anyway. It isn't a good idea even if you could convince a bank to go through contortions to do this transaction for you. In essence, you're wasting a valuable tax shelter with the I-bond. You buy an I-bond with after-tax money. The savings compounds tax free. That is, until you cash it in and then you pay ordinary income tax rates on the gain. The I-bond is like a non-deductible IRA.

By the way, I-bonds are a terrific fixed income investment for most people. I like owning I-bonds, just not in an IRA.

Another inflation-indexed security is the Treasury Inflation Protected Securities, better known as TIPS. These default-free securities are also designed to hedge the value of your money against the ravages of inflation. The big drawback with TIPS is that Uncle Sam requires owners of TIPS in a taxable account to pay income taxes on the inflation-adjusted gains before getting any of the inflation-adjusted money at maturity. That's why TIPS work best in a tax-sheltered account, like an IRA or Roth-IRA.

It would be a better idea to use TIPS in your Roth.

You do need to go through a broker if you want to own the TIPS directly. A number of brand-name mutual fund companies sell funds made up exclusively of TIPS, too.

You could also buy short-term CDs insured by the FDIC at your bank for your Roth. You wouldn't have any credit risk with the FDIC insurance. You'd earn a decent rate of interest. And by keeping the CD terms short you could always be earnings something around the prevailing rate of market interest rates.

04/10/09 by Chris Farrell

Permalink

I-bonds vs TIPS

Question: I have the opportunity to buy $10,000 worth of I-bonds this year, or $10,000 worth of TIPS in an IRA account. Which is better--or is it more or less the same risk and return? Is it better to by a TIPS bond directly, or in a bond fund?

PS: Your book was great and I enjoy hearing you on public radio. Ken, Swarthmore, PA

Answer: Thanks a lot. Just a quick definition: TIPS are Treasury Inflation Protected Securities. These inflation-indexed bonds come in 5, 10 and 20 year maturities. TIPS offer a fixed interest rate above inflation, as measured by the consumer price index. TIPS are designed to protect the value of an investment dollar against the ravages of inflation (as measured by the CPI). Uncle Sam levies income taxes on the inflation-adjusted gains before you get any of the inflation-adjusted money at maturity. That's why you're right to see TIPS as the better investment in a tax-sheltered account, like your IRA.

Taxes aren't an issue with I-Bonds, a savings bond that is the federal government's other inflation-protected security. There are no commission costs when you buy or sell savings bonds, and your savings compound tax deferred. I-bonds redeemed before the 5 year mark forfeit the 3 most recent months' interest, but after 5 years that there is no penalty at redemption.

The key to answering this question is when do you need the money? It's advantage I-bond if you might tap the savings at some point in the future but before retirement. You can sell the I-bonds without incurring a penalty even if you're under 59 ½. You just pay Uncle Sam whatever you owe in taxes after the sale (and I'm assuming you'll own them for 5 years).

In sharp contrast, if you buy TIPS in your IRA, you can't get at that money without paying taxes on it plus a 10% early withdrawal penalty if you're under 59 ½. You'll have to pay a broker a fee to purchase the TIPS for you in an IRA (although the charge should be very small.) If you're okay with the extra work and monitoring the bonds then I would lean slightly toward owning individual TIPS. This way you know what you have and when the bond will mature. You could care less about fluctuations in the bond market. But a very low cost TIPS mutual fund is just fine for those who favor its convenience.

04/13/09 by Chris Farrell

Permalink

Long term stock market returns

Question: I have just read several books on investing in mutual funds for retirement. I am 35 and would be investing about $300 a month. I want to invest in a Vanguard mutual fund and am having a hard time deciding on one. Part of the problem is that I am suspicious of the yearly return figures that are always used as examples in these books and that are posted on the "performance" window of a mutual fund's overview (like on the Vanguard website). So many authors say things like, "your investment should be able to average an 8% return per year". The historical return charts on a typical mutual fund seem to support this statement, but when I played a few examples out on paper it didn't add up!.... My question is...Are proponents of mutual fund investing misleading me with their claims of 8% yearly returns?? Does the 5 or 10 year return percentage (found in the performance section of mutual found websites) actually give me any valuable info in selecting a fund? Natalie, Sedro Woolley, WA

Answer: You're right to be suspicious. There are a number of different series that capture long-term stock market returns. My favorite is the series put together by Professor Jeremy Siegel of the Wharton School. Since 1802, he figures, the compound average annual return on stocks adjusted for inflation has been about 7%. The same average return figure holds for the post World War 11 era. However, on average Lake Eerie never freezes. For instance, the bull market of the 1990s lasted for much of the decade and the stock market rose by some 300%. But the stock market is currently down 45% from its October 2007 high. Yet it's up 27% from its March, 2009 low. Even a cursory glance at history shows that stocks fluctuate wildly.

The return figures you're seeing at the mutual fund websites do tell you how the fund has done over time. It's useful information. I also like to send time studying even more detailed return figures published by mutual fund rating services Morningstar. A number of factors account for the difference between an equity mutual fund performance and the stock market. Among the most important are fees and the composition of the portfolio.

Congratulations on setting up an automatic savings plan. For the stock market portion of your portfolio I am an advocate of investing in a broad-based equity index mutual fund. The fund will mirror the results of the underlying index, such as the total stock market index or the Standard & Poor's 500. It's also important to diversify among a number of different assets. A good, short primer on the investing basics is The Random Walk Guide to Investing: Ten Rules for Financial Success by Burton Malkiel.

04/14/09 by Chris Farrell

Permalink

Socially responsible retirement savings

Question: My retirement begins 01/10. I will receive $148,000 in Feb. 10 and my monthly state retirement check will begin. I must roll-over the lump sum into an IRA, which I do not have. I've never heard of a socially conscious IRA! How can I be sure my hard earned money is only invested in socially responsible ways? (I will be 60 this summer and want to wait til 66 to get my whole SS.) Diane, Perry, FL

Answer: You want to be part of a growth business. The Social Investment Forum estimates that total industry assets were closing in on $3 trillion in 2007 (the latest data available). That's up from $639 billion in 1995. Most of the socially responsible money is managed for institutional investors and high net worth individuals. But assets managed by socially responsible mutual funds, exchange traded funds (ETFs), and the like are also up, to over $200 billion in 260 funds last year. Investing in socially responsible funds remains popular despite the bear market in stocks.

To take a slight detour, the biggest rap against the movement is the belief that marrying personal values to an investment portfolio cuts into returns. In other words, doing good and making money don't mix. I don't agree. A number of studies suggest there's little difference between pooling money to make money and pooling money to make money and express values. This came home to me in a series of papers by Meir Statman, a finance economist at Santa Clara University. Among his conclusions, the risk-adjusted return on socially conscious index funds is roughly comparable to the Standard & Poor's 500 index. His research also showed that the performance of actively managed socially responsible mutual funds is about equal to their conventional mutual fund peers.

Put somewhat differently, socially responsible index funds do better than their actively managed socially responsible peers. One troublesome aspect of the industry is that socially responsible funds tend to have high fees that cut into returns. It always pays to shop around, but it's especially true with these funds.

To your specific question, any socially responsible mutual fund company will open a rollover IRA for you. Two websites for researching socially responsible investing from your computer are socialinvest.org and socialfunds.com. The mutual fund and investment research company morningstar.com also has good information on socially responsible funds and ETFs.

04/15/09 by Chris Farrell

Permalink

Cash is king--for now

Question: I have saved up about $50K in after tax money that, after selling some battered Stocks recently, is now sitting in Money Market fund. I want to keep about $20K for the rainy day fund and would probably need easy access to $20K of it. I have considered ETFs, Mutual Funds, Bond Funds, TIPS, Money Market Fund, and other such products but cannot make my mind. I am also afraid that if this keeps sitting as is, as the Market picks up, I may venture into Stocks again. Could you advice what are best choices for investing all of this $50K with pros/cons? Vivek, Charlotte, NC

Answer: I don't know what the best investment choice is for your money. Any of the investment choices you mention could make sense, depending on your circumstances and your financial goals. There are plenty of pros and cons to each. But here are three ways of thinking about investments that might help narrow the choice for you.

It's useful every once in awhile to look at your household portfolio as a whole. All of us tend to segregate our money by its purpose--retirement, college, emergency savings, and so forth. Fact is, such "mental accounting" helps us save. But years ago, Jeffrey Schwartz of the asset allocation firm Ibbotson Associates, gave me this example to illustrate the advantage of taking a step back. Let's say you've saved $100,000 in your college education account. Your child is going off to college in five years, and you have divvied up the portfolio into 20% equity and 80% fixed income. You also have $100,000 in a retirement account, split into 75% equities and 25% bonds. The asset allocation in each account sounds about right on its own. But taken all together, your overall asset mix is 52% fixed income and 48% equity. That may be too aggressive overall. It might be too conservative. But a calculation like this is one way to figure out where the money might best shore up your household finances.

What are you trying to accomplish with this savings? Forget the market and the specific investment products. Instead, what are you planning on spending the money on and when? Is this savings eyed for home improvements, college expenses, retirement goals, funding a career shift? The eventual use of the money often dictates the smart way to save it.

While you're mulling over what to do with the money I would keep it as safe as possible. A money market fund that invests primarily in U.S. government securities and federal agency debt is fine. So are buying Treasury bills and FDIC insured CDs. Cash is king during downturns. And it seems that your need to get easy access to the money suggests that these are probably the right kind of investment for you.

04/16/09 by Chris Farrell

Permalink

Investment grade corporate bonds

Question: Most investment grade short term corporate bond funds contain about 30 % financial holding in their portfolio. Would this stop you from investing 20% of your portfolio in this type of fund in retirement for income? Milton, Albuquerque, NM

Answer: Outside of the U.S. Treasury-only bond funds, a majority of funds in the bond market mutual fund category posted losses in 2008. The performance has been better in so far this year. To take one representative example, the Vanguard Short-Term Investment Grade mutual fund had a total return of -4.7% in 2008, according to Morningstar, the fund rating service. It has sported a total return of 3.13% year-to-date in 2009.

Investment-grade short-term corporate bond funds are increasingly popular. These are the debt obligations of brand-name blue-chip companies. The risk of the owning the debt is further reduced by short-term nature of the I.O.U. The yield on these funds is much better than the yield on comparable Treasuries. And you're diversified within the corporate bond sector with a mutual fund.

Still, there is credit risk with the downturn. Some of the companies in the portfolio might be downgraded, and others could fall into financial trouble. That's why owning a portfolio with nearly a third of the IOU's the obligation of financial institutions gives me pause--as it does you.

A fifth of your portfolio in retirement exposed to one sector seems like a lot to me.

I imagine you want the higher income. The questions I'd be asking are: Am I being compensated enough for taking the risk? How much of my portfolio do I really want to expose to this sector? What is my downside if the economy takes another step down, inflation picks up or something else happens that affects the value of this investment? How much would a poor performance mean to me and my income in retirement?

I think the economy is doing better, thanks to a combination of fiscal stimulus, Federal Reserve policy, mortgage refinancing, TARP funds, lower inventories, and fiscal spending and monetary easing overseas. It's one reason why more investors are feeling confident enough to put money into corporate bonds. But the economy remains fragile. My bias is to stick with financially safe investments and only take greater risks if your household balance sheet is strong enough to ride out another round of bad times. This is especially true for retirees.

04/17/09 by Chris Farrell

Permalink

The education IRA

Question: My wife and I had our first baby in January of 2009 and are looking into saving for her education. I have heard a lot about 529 plans but very little about Coverdell accounts. So far I have learned that both 529s and Coverdell's allow money to grow and be withdrawn to pay for the education of the beneficiary tax-free. While the Coverdell does have a $2k/year contribution limit, contributions are also tax deductible while 529 contributions are not (at least in California). Why haven't I heard more about Coverdell accounts? Is there a reason why I would not max-out my Coverdell contribution and then put additional money into a 529? My wife and I make a combined taxable income of about $150k. Hans, Sherman Oaks, CA

Answer: The Coverdell Education Savings Account is one of the least understood ways to save for college. It used to be known as the Education IRA. In essence, it acts much like a Roth-IRA. You contribute up to a maximum of $2,000 in after-tax dollars--contributions are not tax-deductible--at a financial institution of your choice. There income phase outs and limits to the Coverdell. Joint filers with $190,000 or less in modified adjusted gross income qualify for the full $2,000 contribution. The income limit for single filers is $95,000 for single filers. For joint filers the contribution amounts is reduced for modified adjusted gross income between $190,000 and $220,000--after that you're out of luck. The comparable figures for single filers are $95,000 and $110,000.

The money compounds tax free. If it is used to pay for qualified educational expenses withdrawals are tax free too. Unlike a 529 plan, the account can be tapped tax-free to cover qualified education expenses at primary and secondary schools as well college.
Here's the rub: The annual contribution limit is $2,000 until 2010, when the figure drops to $500. A number of other college savings attractions attached to the Coverdell will end that year, too. I'm not sure why Congress liberalized the rules surrounding the 529 college savings plan in 2006 but left the Coverdell vulnerable to changes in its treatment in 2010. After 2010, the Coverdell will be a much less attractive way to save for college compared to the 529. That's why I favor the 529 plan.

But there is no reason why you couldn't contribute to the Coverdale to the maximum for now, in addition opening up a 529 plan. You can learn much more about the details of the Coverdell at savingforcollege.com.

04/20/09 by Chris Farrell

Permalink

File taxes

Question: I have not filed a return this year because the preparer told me that I did not have enough taxable income that I needed to file. Comment, please. James, Hastings, NE

Answer: You're probably fine. Some people don't have to file if they make under a certain sum of money and can't take advantage of any refunds, credits, deductibles and the like. (An exception was the tax year 2007 when you had to file to get your tax rebate.) "Many people will file a 2008 Federal income tax return even though the income on the return was below the filing requirement," according to the IRS

Here's how to make sure: The IRS has a section of its website that asks a series of questions to help you determine if you need to file a federal income tax return. Check it out.

04/21/09 by Chris Farrell

Permalink

Transfer retirement savings?

Question: I know that we're supposed to do an "institution to institution" transfer when we roll over our 401K from one employer's plan to another, but I'm wondering if I should be rolling over my 401K balance from my previous employer at all in this current economic climate. I'm still fairly young (I'm only 41), so my 401K plans are still heavily weighted toward stocks, and I can't help but feel that if I transfer funds out of a mostly stock-based 401K I'm essentially "locking in my losses," even if I'm transferring those funds into another mostly stock-based fund where I'd be buying in at bargain prices. Is the convenience of having all my eggs in one employer's plan worth ignoring my (possibly irrational) fear of locking in losses? Packy, Jersey City, NJ

Answer: You shouldn't be locking in losses with the transfer, although there will be some minor "frictional" costs that will fade with the passage of time. I'm assuming you'll be able to transfer the money reasonably quickly from your previous 401(k) plan into your new 401(k). I'm also supposing that you'll transfer the savings into comparable investment portfolios. The frictional costs come from the inevitable time gap from moving the money, and the market could move agasint you during that time. Of course, it could also shift in your favor. There may be some other minor cost incurred if the investment options aren't exact mirror images of one another.

My general bias is for you to take control of the money by transferring it into your new 401(k) plan at work. (I'm assuming your new employer allows the new money to come into the plan; if not you can always do a rollover IRA.) Now, your previous company will live up to its obligations and behave ethically toward your retirement portfolio. That's not my concern. (And if there is a worry about management I'd get the money out as fast as possible.) It's really a question of control. It's your money and if it's under your control you'll watch it more carefully.

To emphasize a point you made, there are no tax consequences or penalties imposed by Uncle Sam if the money is transferred from your former plan directly into the your new 401(k). Check with human resources at both companies before you do anything to make sure you understand any transfer requirements.

There is one good reason for keeping your money in your former employer's retirement plan: If it has good low cost investment options, perhaps even better than your current plan. If that's the case leave the money alone for now.

04/22/09 by Chris Farrell

Permalink

401(k) withdrawals

Question: Has the law been changed to allow employees vested under an employer pension plan (401K) to withdraw up to $10,000 without penalty? I am 51 years of age and I have been working for the same company for 28 years. Thank you for your attention and your time. Madeline, Miami, FL

Answer: No, the rules weren't changed. The proposal to allow for penalty-free withdrawal from a 401(k)-type retirement savings plan was one of many options debated in the weeks leading up to the fiscal stimulus package. It never really gained traction. Since you're under 59 ½ you would pay a 10% penalty of the withdrawal, plus ordinary income taxes--a big hit to savings.

04/23/09 by Chris Farrell

Permalink

An adventure travel

Question: Hi, I can already hear you replying "are you nuts? Worry about reducing debt and stockpiling your emergency fund first!" But I feel that it's one of those things that you must check off the list, before I am tied down with kids. Do you have any suggestions on how I can fit this in without dropping the ball on my financial, educational and career goals? I am about to start graduate school, and could take some time in between semesters or wait until after I graduate. I was thinking 4-6 weeks of adventure backpacking. 1-2 weeks at a time wouldn't work for this type of excursion. PS -- I do love listening to your show! Thank you. Mia, Marlborough, MA

Answer: Go! You're not going to hear from me that taking an adventurous backpacking trip is nuts. (I might say I'm jealous but that's a different story.) The economy may be down, but that doesn't mean your spirits should spiral lower, too. You want to take a break to refresh your mind and body and spirit before during or after graduate school? That's wonderful. So let's make that happen without taking on any or much debt.

One questions is how to hike and walk for several weeks frugally? A trip with a backpack should be a low cost excursion anyway. Better yet, there are plenty of deals in the travel business right now, from low cost flights and cheap excursions to price cuts on rental cars and hotel rooms. Travel is down, and businesses of all kinds are cutting deals to stay in operation.

The real trick is to carefully plan ahead. Map out your route. How will you get to where you are going? Where will you stay? What is your budget? It's so much easier to be frugal when you take the time to do research and planning. We all end up spending more than we should when we rush to book a flight or dash off to the grocery store at the last minute. With research and planning you'll be able to find and book deals, create a tight budget that you can live with during the trip.

If the numbers still don't quite work out, consider hiking for 4 to 5 weeks rather than 6 or choosing a less expensive spot for your adventure. It will still be worthwhile, and you'll have plenty of opportunity to go on long trips later in life--even with kids in tow.

Of course, there are the bigger financial questions, such as the debt burden you're taking on at graduate school and the kind of income you'll earn when re-enter the job market. Still, with careful planning and a frugal budget you should be able to come up with a trip that's both cost-effective and soul nourishing. It's also good to go off on a trip like this before you embark on your new career. That's an adventure in itself. .

Have fun with your frugal adventure. Let us know how the trip goes, and relay any "frugal" tips you pick up along the way.

04/24/09 by Chris Farrell

Permalink

A target date fund or CD?

Question: I retired from teaching in Michigan in 2005 and immediately took a job teaching in China. I'm now 62 and currently receive my teaching pension of $30,000. I'm fortunate to still have approx. $350,000 in high-fee mutual funds, 403(b), and IRA.

I'm also fortunate to be able to save approx. $20,000/year from my job in China. I want to invest this money and would like to hear your opinion about CDs versus a target retirement fund. Is it "too late" for me to do a target retirement fund? I don't think I will need this money for several years and I plan to teach for another two years. What are the advantages and disadvantages of each - other than the obvious one that the CD will hold its value and the target fund might not? Should I be considering something else instead of these two investments? Thank you. Janet, Kalamazoo, MI

Answer: Teaching in China must be a fascinating job. On the financial side, target date funds and a CD are two very different investments. You've hit on the key distinction: Risk.

There are target date funds for people at or near retirement. Yet it's apparent the risks of these funds are greater than the marketing of their conservative reputation suggests. A number of target date funds dropped 25% or so in value during the bear market thanks to a hefty exposure to stocks. The fund companies justify the large stock portion by emphasizing that most retirees live another 20 years or so, a fairly long time horizon. The observation about longevity is right. That doesn't mean the "conservative" target fund portfolio should hold much in the way of stocks. Remember, this is supposed to be the retiree's conservative investment option. As one money manager put it to me, maybe the mutual fund companies should market target date funds as death funds instead. Somehow, I don't think savers would embrace them as readily.

The advantage of the CD in an FDIC insured institution is that the safety of those savings is guaranteed. The drawback: You'll make a pittance in interest on your money.

The question of "how to invest the money" is actually quite complicated, depending on how your going to spend money when you get back to the States. You have a pension, savings, you'll eventually start taking Social Security, and so on.

That said, one thought is to take the savings from teaching in China and decide how much of it you want to be safe for when you come home and how much you'd like to put at risk to the stock market. The "safe" money could go into Treasury bills (no default risk; will hold its value against inflation if it rises), short-term CDs (no default risk; can reinvest at higher interest rates if inflation surges) and teh U.S. Treasuries I-bonds (no commission costs; no inflation risk; compunds tax deferred but should be held for at least 5 years to get the full interest benefit). Then, with the remaining portion you're comfortable with putting at risk to the vagaries of the stock market, invest it in a very low cost broad-based stock equity index fund. This way you can tailor a low-fee portfolio to what you'll need over the next several years.

04/27/09 by Chris Farrell

Permalink

A Roth-IRA conversion in 2010

Question: As I understand it, Congress has lifted the income limits for Roth IRA roll-overs starting in 2010. How likely do you think it is that Congress will leave that tax change in place? Paul, Seattle, WA

Answer: My best guess--and it's just that, a guess--is the shift in the Roth-IRA conversion rule will hold for 2010. After that it all depends on whether the Obama Administration pursues dramatic tax reform and manages to get Congress to agree to a major overhaul of our Byzantine tax code. The Administration has appointed a tax reform commission headed up by former Federal Reserve Board chairman Paul Volcker, but with everything that is going on in the economy and markets it hasn't had much traction.

For the moment it looks like 2010 is fast becoming the equivalent of a conversion gold rush. Here's why: Up until now, you could only convert a traditional IRA into a Roth-IRA if your modified gross adjusted income was under $100,000. The income limit lifts in 2010. What's more, when you convert from an IRA to a Roth you owe income taxes on the amount converted. The reason is a traditional IRA is funded with pretax dollars while a Roth is funded with after-tax dollars but withdrawals are tax free in retirement. Well, the 2010 conversion amount may be included as taxable income in 2011 and 2012. That helps spread out the tax bite. It's a one-time perk.

To convert or not to convert, that is the question. There are many factors to consider, but for many people the answer will be yes. The benefit of tax free withdrawal is huge. The argument for converting strengthens the longer your money can compound after conversion and before retirement. It's also important to have other savings on hand to pay the tax bill. Another advantage of the Roth is there is no required minimum distribution at age 70 ½ as there is with a regular IRA. For those with substantial assets converting to a Roth may make financial sense simply from an estate planning perspective.

There are many twists and turns to this conversion story. For instance, should you pay the tax tab in 2010 or spread it out depend on whether you believe the money you make off the delayed payment will offset the risk of a higher tax bill. What will happen to your income in 2012? Maybe your income will plunge in which case you'd probably elect to pay the tax over two years. But if there's a chance of a big bonus in 2012 you'd get rid of the tax liability in 2010.

One place to get started researching the economics of conversion for your household is at web-based calculator, like this one.

04/28/09 by Chris Farrell

Permalink

Economic stimulus check

Question: I turned 62 on April 5, 2009, and I will receive my first Social Security check in June. Will I get the $ 250.00 stimulus check or will I miss out on it? I have not been able to determine the eligibility requirements. Thanks for your help. Thomas, Chesapeake City, MD

Answer: No, it looks like you will miss out. According to the Social Security Administration, only "individuals eligible for Social Security, SSI, Veterans, or Railroad Retirement benefits at any time during the months of November 2008, December 2008, or January 2009 may be eligible for the one-time payment."

04/29/09 by Chris Farrell

Permalink

Credit freeze

Question: My question involves job applications and my social security number. When I fill out a job application, I need to submit my social security number. If I place a credit freeze with the credit companies, would this still allow an employer to access my credit report to see that I am financially responsible, but also prevent an unscrupulous person from abusing my credit? Jeff, Portage, MI

Answer: A "credit freeze" or "security freeze" lets you block the disclosure of your credit report by the credit bureaus. It's standard practice for anyone that is a victim of identity theft, and more and more consumers are embracing the tactic these day.

You're right, a credit freeze can be an issue depending on where you live. About a third of the states allow landlords and employers to check out a frozen credit report. That said, even if you live in a state that doesn't permit employers to take a look freezing may be a sensible strategy. It just means you'll have to plan ahead if you're in the market for a new job, apartment, credit card, mortgage, refinancing or other large financial transaction. The thaw typically takes several days. In most cases the thaw fee is in the $10 range for each bureau, and you'll pay another fee to put it back in the freezer.

You can look at the different state rules about credit freezes here. The web sites of state attorney generals also have good information about a credit freeze. In Michigan there is no state credit freeze law so you'll follow the rules established by the three credit reporting bureaus, Equifax, TransUnion and Experian.

04/30/09 by Chris Farrell

Permalink