Getting Personal
Savings Archives
Safe Savings
Question: Hello, My husband and I are hoping to buy our first home in about 8-12 months, and we are trying to figure out how best to invest our extra cash in order to make a down-payment.
We expect that we'll be making a 20% down-payment of about $100,000 when we buy. We've currently got about $25,000 in cash to invest. In addition, we'll invest everything from our salaries after living expenses -- we're a lawyer and a graduate student.
Here's our question: What's the appropriate investment vehicle? We need a high-yield, low-risk product that won't smack us with serious tax penalties. We're thinking a short-term bond fund or a CD? Or should we simply park the money in our high-yield checking account, which gets 4% interest? What say you? Cheers, Elizabeth, Washington D.C
Answer: Bravo. I like your conservative financial strategy of putting the money in a low risk product. Since you'll need the money soon, you're right to seek an investment that preserves the value of your $25,000 in savings while making some interest on it.
I have two votes: First, the high-yielding checking account you have that is paying 4% is just dandy in today's market. Plus, your money is fully protected by the Federal Deposit Insurance Corporation (FDIC). There is no risk of you losing the money to bank mismanagement or a disastrous fallout from the current credit crunch.
Second, you could park the cash in a money market mutual fund at a brand-name mutual fund company. You'll earn a higher rate of interest on your money than you would in most bank savings account, and if short-term interest rates go up, you'll participate in the higher rate. The money is easily accessible, too. Most money market mutual funds, for example, offer limited check writing.
However, in the current troubled economic and financial environment I would favor a money market mutual fund made up primarily of U.S. Treasury bills and short-term government agency debt. It's the most conservative choice (and you'll pay for the increased safety through a slightly lower interest rate) but this way you to avoid the risk of any unwelcome subprime debt showing up in the mutual fund. The federal government and its agencies won't default on their debts.
Savings for a Stay-At-Home Mom
Question: I'm currently not in the paying workforce while I take care of my infant son. Besides the obvious large loss of income, I'm concerned about my curtailed ability to contribute to my retirement funds. Are there avenues to move money into retirement funds beyond a $4000 IRA contribution?
Answer: This is a pet peeve of mine, and I don't understand why Congress and the White House don't combine forces to dramatically simplify the pension system and make it more equitable. The current private retirement savings system is capricious. It includes 401(k)s, 403(b)s, 457s, SIMPLEs, SEP-IRAs, IRAs, and Roth IRAs to name only the best-known plans. The rules, income limits, and restrictions vary significantly among most of these tax-advantaged savings programs.
For instance, if you were working at a company with a 401(k) you could set aside $15,500 in pre-tax dollars in 2007. An employee at a small company with a SIMPLE plan has $10,500 limit. A stay-at-home spouse running the family household can save at most $4,000 in an IRA. If you are over 50, the plan limits are somewhat higher in each case. But the overall disparity remains.
Why not attach the retirement-savings plan to the individual and have just one rule for everyone--say, 15% of income, or $30,000? The figure could be less or more. The key point is that the rules should be uniform. And the retirement plan system should include parity for working and "nonworking" spouses (an oxymoron if there ever was one).
All right, I'll clamber off my soap box. But unless you bring in an income through freelance projects or a consulting business or some other income generating sideline that you run out of the house, you're out of luck when it comes to the pension system.
But all is not lost. Here are a couple of suggestions. First, you could buy I-bonds from the Treasury. You buy them with after-tax dollars. You pay no commission costs. Your money compounds free of taxes until you cash them in (you'll then pay your ordinary income tax rate on the gain). These bonds are specifically designed to protect your portfolio from the ravages of inflation. The dollar you put in to today will be worth a dollar plus interest 10 years, 20 years, or 30 years from now.
Another strategy is to set up an automatic payment account with a major mutual fund company and buy a broad-based equity index fund. You'll outperform most professional money managers year-in and year-out by matching the underlying index, you'll pay very little in fees, and your tax bite is limited compared to an actively managed mutual fund since there isn't a portfolio manager constantly buying and selling stocks.
An alternative to an index fund is a tax'managed mutual fund--one that is run by the a pro with an eye toward minimizing Uncle Sam's tax take. An added benefit to investing regularly in an index fund or a tax managed fund is that if you need the money before age 59 1/2 you can cash it in without paying the 10% surcharge attached to defined contribution savings plans like 401(k)s and 403(b)s.
In other words, you can make some long-term savings on your own that offer their own advantages even though the money isn't in a pension plan.
Have Fun
Question: My husband and I are in our mid 30's, no kids, both have good incomes and we're putting money away towards our retirement through our employers (so pretax) as well as other sources (Roth). My husband has about maxed the amount he can contribute. I have not, but my employer puts in a substantial amount as long as I put in the minimum required. My husband thinks I should try and max mine out as well, but I want us to put some in shorter term investments so we can enjoy some of the money now to travel, etc. We have a decent amount in savings for emergencies. First, as long as both of us are putting away at least 15% of our income, is it fine to stockpile our savings so we can enjoy some of it now? And second, is there something else besides savings/CD that have a better return rate, but that we can access (within a few months to a year like CD). Thanks. Heather
Answer: My standard advice is to max out your retirement savings plans, and you clearly can afford to do it. However, you and your husband are saving a good chunk of your income every year. You're money smart with a good financial safety net. In this case, I'm on your side. Take that trip (or trips). Go out to dinner. Have fun.
Where to put this money? I would take two very different approaches with the money. First, I'd put the bulk of it into a conservative money market mutual fund with brandname national or international financial institution. (These big companies have a reputation to protect, so the odds are good they'll do whatever it takes to preserve the value of the fund, even if it faces financial difficulties).
I would also consider putting a sliver of the money into a broadbased equity index fund or a tax-managed fund. Your annual tax burden on the savings is low with either product. The money should compound over the years. When you do tap into it, you'll pay low capital gains taxes on the gain.
Mother-in-Law Finances
Question: My mother-in-law, who is in her mid-50s, just got a nursing degree and her first job as a medical professional. She has no savings, some minor credit card debt, and has, up until now, always lived paycheck to paycheck. What should be her priorities for getting onto good financial footing so that she doesn't have to work for the rest of her life, and so that my wife and I don't have to be the sole source of support for her once she retires? I've guided her towards establishing an emergency savings fund, paying off her debts, opening a Roth IRA, and starting up with her employer's 401k. Does this sound right? What would you recommend? Thank you! Alex
Answer: You've given you mother-in-law good advice and covered the basics. Here are a couple of additional suggestions, or at least ideas to think about.
Education matters. Assuming that your mother-in-law's health holds up, she'll have to work longer than many of her peers. She should continue to invest in her profession, continually improving her nursing skills, and making herself a valued employee at work.
Her health is critical, too. Luck plays a role when it comes to health, especially as we age. But there is a lot we can do to improve the odds of living long and healthy. I would encourage to "invest" in staying healthy.
I would open up a conversation with her about living arrangements. Will she rent? Does it make more sense for her to buy, perhaps with you and your wife as equity investors in the home? What about an assisted living center or a continuous care community?
Last, keep doing what you're doing. It's important to maintain a low-key and ongoing discussion about finances between you and your wife and her mother. The three of you can figure out what needs to be done, but it's much easier when the money conversations are a non-judgmental part of your relationship and conversation--instead of a subject that comes up in a crisis.
Saving for a Home
Question: I am 27, married with my fourth kid on the way. I'm currently a full time student and working 30hrs a week at Starbucks, and my wife is a stay at home mom. Within this situation, we do not make a lot of money, but I do receive quite a few scholarships and grants that more than cover school and bills, and we don't have any debt. We'd like to start saving some of this extra cash for our future home, which we plan on buying in about 5-7 years. I have looked at putting the money into CDs, but I want to know if there is a better way of maximizing a return on the money. Thanks for your time, Glen
Answer: I think you and your wife could teach all of us a lesson or two about the art of living well with little money--without taking on debt. In your situation and with your homeownership goal, there's nothing wrong with parking cash in bank certificates of deposit. And as long as the value of the CD is under $100,000 there is no credit risk, either, since they're FDIC insured. I'd would look at the after-tax yield you're earning on the CDs to the aftertax yield you could earn on a comparable Treasury security. I would put my savings into whichever one is paying you a better aftertax yield.
But let me toss out a couple of other options for you to consider.
First, in this period of uncertainty, when the Fed is combating recession while crossing its fingers when it comes to inflation, putting money into a brand-name, conservatively run money market mutual fund can pay. The reason for putting money in "cash" is if inflation stirs and interest rates go up, the money market fund will start paying you those higher interest rates quickly.
Another option is a short-term bond index fund. Fees are low with bond index funds, and the portfolio itself is well diversified. You should earn a slightly higher yield in a fund like this, but at the cost of increased volatility.
My last idea is to consider adding a thin stock market layer to your savings, say, through a broad-based equity index fund. My thought is that quality stocks are getting progressively cheaper (they'll probably head even lower in the months ahead). Your time horizon is long enough to justify taking on some extra risk to meet a specific goal. If everything works out, the finances of home buying will be that much easier. But if the market is down when you're putting together a down payment--and it doesn't make sense to sell stocks--the stock market portion of your portfolio won't be big enough to prevent you from becoming a first time homebuyer.
02/20/08 by Chris Farrell
Saving Too Much
Question: I would like your opinion on the retirement goals set by my investment firm. I'm 54 years old and have no debt at all. My house, car, etc, all paid in full. I have a job I love, making $90k annually plus I still have a small income from a former business - approx $10k annual. My house is worth approx. $340k and I have $350k invested in mutual funds through an advisor (Wachovia - fee based plus commission). I've had a miserable history with advisors - this group is my third. I'm currently putting 56% of my job salary into savings, plus I have 401K and a pension through my employer.
The 56% is getting a little tough but my advisor says to be in the "safe range" at retirement, I need to be this aggressive. I don't know if they are telling me the truth or if they just want me to beef my portfolio so they can charge a higher fee.
I would like a little breathing room and enjoy life a little. I worked hard to get everything in this comfy state but now I can't even have a small splurge occasionally... Advice? Please? Kate, Charlotte, NC
Answer: You're savings 56% of your income? No wonder you feel strapped. I'd really loosen the spending reins, and enjoy yourself. Obviously, in an email communication I can't know all the ins-and-outs of your finances. But by any measure, setting aside 56% of salary in savings is steep. I'm puzzled--no, I don't understand at all--the advice to save such a large percentage of your income. What am I missing?
Put it this way: The old financial planning advice was to salt away some 10% to 15% of income in savings. In recent years that figure has been upped to 15% to 20%, largely reflecting greater volatility in the markets and higher healthcare costs. But that's still way below 56%.
I don't understand the reasoning behind saving any more than 10% to 20% of income unless there is a particular goal in mind. What's more, unlike most people your age, you don't have any debt. Let's not turn the smart idea of saving for tomorrow into meaning little more than hoarding cash and collecting regrets today. Saving to save is just as bad as spending to spend.
Savings for Child
Question: my wife and I just had our first child. We are wondering what sort of investment/saving plan would be the best to start for him. We are looking to invest $100 a month. Thanks. Michael, Seattle.
Answer: Congratulations. First of all, you can't go wrong putting money on a regular basis into a tax-sheltered 529 college savings plan. That said, I have one other thought. How about putting the monthly savings into a broad-based equity index fund with razor thin fees (such as the Standard & Poor's 500 index, Russell 3000, Wilshire 5000, and the like). The savings is in your name. In 16 to 18 years, you'll have accumulated a nice pot of change. You can spend it on your child's college education. But maybe your child will get good scholarships. Then you can spend the money on yourselves, or perhaps create the family trip of a lifetime. You gain a lot of flexibility with this approach.
Cash or Loan?
Question: Hi, I have to replace my roof (sooner then later). Should I pay cash from a money market savings account, or take out a loan? Thank you, please get back to me rather sooner then later :) Gabriele, St. Paul, MN.
Answer: This is really a money management question. The baseline answer is pay for the home improvement with cash from savings. This way, you don't take on any debt. Plus, the interest rate you're getting on your savings is probably a paltry sum anyway.
However, there may be some good financial reasons for you to hoard savings right now. If that's the case, then by all means take out a loan. The best loan is probably a home equity loan. It's ideal for a lump sum payment such as a new roof, and you're preserving the value of your home. The rate of interest is fixed, which makes it easy to plan. You could take out a home equity line of credit, but the interest rate is variable. It's a loan option best tapped for projects that are done in batches or over a long period of time.
How Much Is Enough?
Question: I've yet to find a book or article that can answer this question: How do you know if you're financially okay?
I'm 38. I make $80k a year. I have $250k divided between a Roth IRA, 401k, and a single account. I put 20% down on a condo and the mortgage is the only debt I have. I also have long-term care insurance. Can I stop worrying? C. Houston, TX
Answer: Why is it that dire jeremiads about getting old resonate with so many of us? Why is it that conversations about retirement at work and the neighborhood barbeque so often turn into a litany of woe and dark humor?
Certainly, some segments of society are extremely vulnerable in their old age, such as poorly educated, low skill workers. But for many others, from the worker on the factory floor to the professional with an office--to someone like you--the apprehension largely stems from the realization that there is no way of knowing how much is enough to fund a lifestyle--let alone medical bills.
Yet most people will find themselves in decent financial circumstances with room for maneuver late in life by following some basic savings strategies and taking a broad perspective on investment. And that includes you from what you've told us. Keep doing what you are doing.
As important, take the time to carefully thinking through "What really matters to me?" That way you'll continue to come up with devise sensible answers to the question "How much is enough?"
One book that I like for thinking about a question like yours is Ralph Warner's Get A Life: You Don't Need a Million to Retire Well. Another one is The Number by Lee Eisenberg.
06/10/08 by Chris FarrellGetting Started
Question: I am 22. I have no debt. I currently have 6500.00 in savings & add about 300 a month to this account. I want to make my savings "work for me". What steps should I take ?? I want to start practicing good money habits now...please help. Christina. Conway, MA.
Answer: You're already doing better than many (most?) people. You're saving, and you want to learn more. That's a terrific combination.
What I especially like is your phrase "practicing good money habits." It's so easy to get lost in the technical and financial complexities of managing money when what really counts as sound personal finance is developing a handful of good habits. That means save for retirement in a tax sheltered pension plan with a well-diversified portfolio. Build up with automatic withdrawals from your checking account a nest egg that can be used for everything from surviving a layoff to putting a down payment on a home. Own your own home. Don't take on credit card debt. Keep good financial records. Insure your loved ones. Keep it simple, always.
Of course, managing money easily gets much more intricate. For instance, does it make sense to open up a Roth-IRA (it usually does) to the advisability of purchasing a variable annuity contract (the answer is no for most people). Still, the essence of good money management is good habits.
To learn more, there are two books I've recommended before that offer plenty of insight and wisdom. They also have the virtue of being short. The Only Investment Guide You'll Ever Need, by Andrew Tobias. It came out decades ago--1978. But it has been revised many times since then. Tobias is an entertaining storyteller. I'm also a big fan of Burton Malkiel's The Random Walk Guide to Investing: Ten Rules for Financial Success.
Save for Retirement?
Question: Chris - How much should someone save for retirement if they do not plan on retiring? I love my job and I plan on working well into my 70s as long as I have no health issues. I'm 50 now and have a modest retirement portfolio. Dave, St. Paul, MN
Answer: Don't think "retirement." Think a "margin of safety" and "flexibility." What you're trying to do by saving is maintain your current standard of living throughout your lifetime. Savings gives you a margin of safety if your job vaporizes when your older and harder to employ or if your health deteriorates.
Maybe you don't want to retire, but perhaps you'd like to change careers, try something else. A financial cushion allows you to do that easily. Perhaps you'll decide when your older that what you really desire is travel the world for three years. Well, with savings you can.
What's the right number? Realistically, most people can set aside 10% to 15% of their income with good habits and by taking advantage of savings vehicles like 401(k)s. Depending on your wealth, health, and dreams you could be more or less aggressive than that. But it's a good benchmark to start with.
Are Credit Unions Insured?
Question: With uncertainties concerning the financial soundness of some banks there has been reassuring mention in news stories of FDIC protections. I have yet to hear mention of similar reassurance to members of credit unions that belong to the National Credit Union Association. Is it in fact known that National Credit Union Share Insurance is on a par with FDIC and that invested funds are equally safe?... Roy, South Burlington, VT.
Answer: The short answer is yes. The outline of the insurance coverage is the same as FDIC, with a standard $100,000 protection that jumps to $250,000 for certain retirement accounts, such as IRAs.
You can get more information at the National Credit Union website at www.ncua.gov.
Here are highlights from their discussion of deposit insurance:
The shares in your credit union are insured by the National Credit Union Share Insurance Fund (NCUSIF), an arm of NCUA. Established by Congress in 1970 to insure member share accounts at federally insured credit unions, the NCUSIF is managed by NCUA under the direction of the three-person NCUA Board. Your share insurance is similar to the deposit insurance protection offered by the Federal Deposit Insurance Corporation (FDIC)...
Credit unions that are insured by the NCUSIF must display in their offices the official NCUA insurance sign which appears on the cover of this brochure. All federal credit unions must be insured by NCUA...
Not one penny of insured savings has ever been lost by a member of a federally insured credit union. The federal insurance fund has several programs to help insured credit unions which may be experiencing problems. Liquidations or failures are a last resort. If a federally insured credit union does fail, however, the NCUSIF will make any necessary payouts to the credit union's members. These payouts are usually done within 3 days from the time the credit union closes its doors.....
07/18/08 by Chris FarrellOut of Debt. Now What?
Question: I just paid off the last of all my debts! After getting into some serious spending problems in my 20s, I've poured everything extra over the last three years to pay off nearly $25,000 in personal debt. I've been so focused on that goal that I haven't considered much else. So, my question for you is: What do I do now?
A few extra pieces of information: I'm 30 years old. I'm currently putting 8% of my pre-tax income to retirement, and my job as a public school teacher includes a pension. I'm not married, have no kids, and rent my apartment in New York City, though I'd like kids and a house at some point.
I'm building an emergency fund. (Right now, it's about one paycheck. I'm working for three months' salary.) After that, what else should I be doing now that the debt is gone? Thanks for your insight, Kara. Astoria, NY
Answer: Congratulations. In the current environment I think you should continue what you're doing: Build up your cash savings in a mix of FDIC insured savings accounts and conservatively run money market mutual funds. Your savings will hold its value, although it might lag inflation a bit.
This approach also gives you time to see how you manage your money now that your out of debt. I'm sure you have some delayed purchases--clothes, vacation, maybe a bike. I would slowly buy some stuff and see how you do. You might also use this time to research the real estate market, see what you like, how buying would affect your income, and whether it makes financial sense or not.
Last, I'm a big believer in investing in long-term savings in a taxable account. That could mean regularly putting some money into a broad-based equity index fund. The advantage of this approach is that money compounds over the long haul, but if you do need it you can sell some stock and pay capital taxes on it. But unlike money held in a tax-deferred retirement savings account, you won't pay the 10% penalty if you take the money out when you're under age 59 ½.
What now?
Question: I am notoriously bad with my finances, and for basically the past five years since I graduated college, I have ignored them. Of course that never works out well. I found myself in about $4000 of credit card debt on top of my student loan of $22,000 which I had deferred for as long as I was able to. About a couple of years ago, it all caught up with me and I enrolled in a debt management plan, consolidated my student loan, and have been making paying both regularly each month.
Now I have paid most of my credit card debt with less than $1000 left to go, and I have stopped the debt management program because I realized that I was simply paying them to write one check a month. I have a 401K plan with a couple of thousand and a couple of hundred in cash savings. I also listen to your show to try and understand my relationship with money.
Finally here's my question: I am young and live on my own in New York. Where should my next financial goals be placed? My expenses are still pretty high but luckily manageable. How do I keep moving forward financially? Thanks, Amelia, Brooklyn, NY
Answer: Congratulations for seizing control of your finances and paying down the credit card debt. That's terrific. I'm always distressed when I hear about debt management programs that essentially take money from people who can't afford it.
How you should move forward financially is a big question, and the answer will evolve over time. But here are some thoughts. I'd continue with whatever system you devised to pay down your credit card debt, but use it to build up savings from this point on.
I want to share this email I got the other day (in a different context). It's from John. He's 69 years old and lives in Ham Lake, Minnesota.
... Some advice I was given when I was 20 years old in 1959 was to save something out of every pay check, having it invested before I ever saw it. AKA, Stock purchase for one company, savings bonds with another and the 401K the last 20 or so years. It has put our children through college, help up purchase a home and gives us retirement income without losing the funds necessary to keep the $$ coming....
You want to save for retirement, which you're already doing. Keep building up that nest egg. By the way, are you putting away the maximum?
We live in a harsh economy. I would also focus on building up your "emergency" savings. This will give you a cushion in case you lose your job. It will also give you the freedom to take a risk and try another employer, to buy a home, or to seize some other investment opportunity that might present itself.
Emergency Stash?
Question: I'm a retired Police Officer. I have gotten a post retirement job. With my pension I don't need the money to pay bills and I have been putting in a savings account. I would like to know if there is a better place to put my extra money where I can still get it in case of emergencies and other unexpected expenses. Glen, Anita, IA
Answer: You should think about a money market mutual fund. For instance, I put part of my monthly savings automatically into a conservatively run money market mutual fund. You'll make a shade more interest than in a bank savings account. And when the Federal Reserve starts hiking its benchmark interest rate, you'll participate in that higher short-term yield. Typically, you can write several checks a year off the account, so it works for emergencies and large unexpected expenses.
Two cautions: First, invest in a large brand-name financial institution with the reputation and financial resources to support the money market fund if that becomes necessary during the ongoing credit crunch. Second, most firms offer different kinds of money market funds, with the most conservative option paying the lowest yield and the riskier flavors higher interest rates. Stay conservative. This isn't risk-money. You want it to be there when you need it. Don't reach for yield.
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.
Emergency savings
Question: This is a basic question, but with everything that is going on I am confused. I am starting a job and I want to begin setting aside an emergency fund of three to six months of living expenses. This money is only for emergencies, so my primary interest is having access to it. What are the types of accounts or institutions I should consider for this emergency money, and what can I expect in terms of fees and returns? John, Palo Alto
Answer: You're not the only one that's confused at this time, and we're all asking very basic questions about our money. They're usually the best questions. The legendary investor Benjamin Graham once wrote that when challenged "to distill the secret of sound investment into three words, we venture the motto, Margin of Safety." Very simple. Very basic. Very wise words for all seasons, but especially at an unsettled time like this.
Now, stuffing our money into a couch--however tempting--isn't a good idea. I'd do nothing more glamorous that putting the money--or at least most of it--into a bank savings account, a money market deposit account, a short-term certificate of deposit and the like in an FDIC insured institution. (Credit unions have a comparable federal insurer.) Your money is completely safe up to $250,000 even if the bank fails, and you have easy access to it if you need it.
As for fees, a number of banks are hiking fees and penalties in an attempt to shore up their crumbling finances. And I thought fees and charges were already to high. It pays to shop around, and I'd look into community banks and credit unions. Here's is an email we got over the weekend about credit unions from Dana in Federal Way, WA.
I just got finished listening to your segment on interest bearing bank accounts. Minimum balance of $3500? Nope! My account is completely free. My checking account is through a credit union.
As a general rule the trade-off for safety is a very low interest rate on savings. But so what? The money will be there if you need it.
11/17/08 by Chris FarrellStarting out savings
Question: I am a 23 year old college student who is starting to discover the wonders of public radio and paying attention to the news on a daily basis. In the face of such a grim economic situation, I would like to prepare myself for the future to the best of my ability. Currently, I am able to save 25% of each paycheck and I keep that 25% saved in an online savings account which earns 2.2% APY. I do not have the capital required to make the minimum investment in items such as stocks and the like. I am also concerned that my 2.2% APY on my savings account is not enough to keep up with the rate of inflation. My goals are to save and possibly invest my money for 10+ years, but still have access to it in the case of an emergency. What should I do to help my money grow? For now, is keeping my money in a savings account my only option? Dennis, Cherry Hill, NJ
Answer: Welcome to the world of public radio! Yes, the economic news is grim, and likely to get worse in the coming months. Right now, I'm impressed with how much you're setting aside out of every paycheck. Frankly, I like what you're doing with the money at the moment. You are keeping up with the rate of inflation at the moment (at least as measured by the producer price index and the consumer price index). And if inflation does start to climb the shift will be reflected in higher interest rates on your savings in the online account.
It' isn't your only option, but the savings account is a good one. The reason I like what you're doing is that you'll have savings to tap when you graduate. That money will buy you flexibility and time when it comes to getting a job. You won't feel the pressure to use a credit card, either. When you do get that job, participate in the retirement savings plan and make an automatic withdrawal from your checking account into savings every month, say, $25, $50, $100. Personal finance is basically establishing good money habits, and you're well on your way.
Other thoughts on saving for Dennis?
Stop making 401(k) contributions?
Question: Hi Chris - I'm 38 and there's a better than average chance that I won't make the next cut when my company has another layoff. I've always socked away 401k money since my 20's but think that now might be a good time to keep that money in cash to help provide even more cushion during a job search.
We currently have almost 3 months salary in the bank. My wife works part time and takes care of our 2 kids. Would it make sense for me to set aside the money that would normally go to the 401k, and then invest in a Roth IRA at the end of the year if I don't have to tap into it? We have no credit card debt - just a couple mortgages, a car loan and several monthly prescriptions. Thanks - Mike, Denver, CO
Answer: Your instincts are right. I would stop contributing to the 401(k) and stockpile more cash in an FDIC-insured account in anticipation of tough times. You don't want to take any risk with the savings for now. Another way to build up savings is to look at what debts can you eliminate. It reads as if you have a mortgage, second mortgage (either a home equity loan or line of credit) and a car loan. Can you get rid of the second mortgage? How about the car loan? Both?
The one caveat to this advice is if your company offers a match in the 401(k). Do you reduce your contributions to the match or just stop altogether? Normally, I would say cut to the match and that may still work for you. But if the odds are high that you'll be laid off soon I'd rather you focus on getting your household balance sheet in good shape to weather a job search. And, of course, it isn't an issue if the company doesn't match a portion of your retirement contributions..
Good luck.
How much in emergency savings?
Question: How many months of living expenses should I have in my emergency savings account, in our current economic situation? I have always heard "six months," but I suspect that applies to a "normal" economy, in which I could probably find a new job within six months. Thanks, Sheila, Belmont, CA
Answer: The size of the suggested emergency savings pot has evolved in recent years. For a long time, the rule of thumb was to set aside 3 to 6 months of easily accessible savings. That number now is 6 months to 1 year.
The reason for the increase is that the risk of a long spell of unemployment had gone up even before the recession and the odds had also gone up that the new job would pay less than the old one. Both of these risks are worse with a recession that shows no sign of ending anytime soon.
Of course, 6 months is a starting point. For many people, setting aside enough to cover living expenses from 3 months to 1 year is a goal, not a current reality. My attitude is that there's no real penalty for financial prudence. And, if it turns out that you end up saving more than is necessary, you can always re-label your "emergency fund" into your "opportunity fund." The lesson of past recessions--this one will be no different--is that anyone with savings will have ample opportunities to snap up bargains. Prudence pays off big in a downturn.
02/23/09 by Chris FarrellMom and savings
Question: My 76 year old working mother has most of her retirement savings in the stock market so it is just going down. She has been putting her social security money in a GE Interest Plus account because it has a higher interest rate. She has over 300K in that account which is not FDIC insured.
Since the GE account is the only really available money she has, can you help me convince her that it is better to move it to two separate FDIC insured banks even if she gets a lower rate of return? Thanks, I am true believer in your show. Allison, Sheffield, MA.
Answer: I agree with what you're trying to do. To be clear, General Electric is a good company despite its recent earnings travails. For some people putting a slice of their savings in its short-term debt is a reasonable risk.
But, like you, I am concerned about your mother taking on that risk for a modest increase in interest income. It isn't a good trade-off. I assume you've talked over the risks with her, and she hasn't been convinced. Still, we live in a financial era where the unthinkable is thinkable, a world where the government nationalizes Fannie Mae and Freddie Mac, quasi-nationalizes AIG, the world's largest insurance company, takes big ownership stakes in the nation's largest banks and, most likely, will soon nationalize them (although it may use some other word than the dreaded term, nationalization).
The good news is that your mother is still working, making an income. She works for that money, and I imagine she doesn't want any of her savings to go poof, not at age 76. So, how about proposing a compromise? See if she'll agree to put some of the money--a third? half? two thirds?--into FDIC insured products. One thought is to invest the money in a ladder of certificates of deposit, from 3 months to 2 years. She can also get a pretty decent yield on FDIC savings accounts offered by online banks. This way she has the full faith and protection of the federal government behind a large chunk of her savings. But she gets to earn a higher interest rate on the remainder.
Let us know what happens.
02/25/09 by Chris FarrellInheritance
Question: My boyfriend's father recently lost his 8-year battle with cancer. He received approximately $300k from his father's life insurance policy; a benefit that he feels was meant for him later in life, not at the age of 27. Though under unfortunate circumstances, the reality is that he now has this chunk of money.
What to do?
He has no intention to buy property at this time because, he just started going to school for paramedic firefighting and will not be looking for a job for two years (and may have to relocate for such job).
He is considering dividing the money in various investment/savings options, including CDs, a money market account, and a Roth IRA.
But, what about investing in stocks or mutual funds? Given the current state of financial affairs and his age, what advice could you give on investing a portion of his money now, for the long term? Rachel, Lauderdale-by-the-Sea, FL
Answer: I'm so sorry for your friend's loss. It's hard losing a parent. I have three main thoughts on what to do.
First, take the inheritance and put it into government backed products. He should preserve the value of the money while he figures out what to do with it. That means investing in FDIC-insured products such as certificates of deposit. Since the Federal Deposit Insurance Corporation backs up to $250,000 per account at a bank, I would divvy up money so that it's all insured. The FDIC's website at www.fdic.gov has a good pamphlet that clearly explains its coverage. (The same holds for federally insured credit unions.) He could also invest some or all of the money in U.S. Treasury bills. This way he won't lose any money to the vagaries of the bear market and recession that looks increasingly like a mini-depression.
Second, he should take his time deciding what to do with his inheritance. It might take a year or two or three to figure out the best course of action. That's fine. He should use the time to learn what investing and savings strategy will work for him over the long-haul, what risks is he is comfortable taking with the money, and what are his financial goals and ambitions. In addition, by taking his time he'll have launched his career as paramedic firefighter and have a better sense of his job and income prospects.
Third, he needs to trust himself and not the army of money advisors that will knock on his door. Sad to say, there are far too many smooth-talking sharks that prey on people with a financial windfall and not much knowledge of how to manage it. Of course, there terrific finance professionals, and an advantage of going slow and understanding his options is that he'll be better equipped to judge an honest financial planner versus a fee-hungry scalper.
Extra money
Question: My wife and I have transitioned to using cash to pay for daily expenses versus a credit card. As a result of this transition, we have are able to save more money. Now the question for us is where to put the extra savings? We are both in our early thirties, own a home with a mortgage, and have a car loan, a student loan, and a home improvement loan. We have 401K investments, which I have been contributing to since I was 22, but we do not have 6 months of expenses in liquid funds. Should we using our increased savings to increase our 401K contributions, we are not at the contribution limit today, increase emergency savings, or pay down debt? I appreciate any suggestions you can provide. Regards, Tim, Victor, NY.
Answer: Congratulations on getting your finances under control. It's nice to take a question, too, where all three of the money alternatives are good. You can't go wrong if you decide to hike contributions to your retirement savings plan, add to emergency savings, or pay down debt.
Still, I would recommend dividing the extra money into two small streams, one channeled toward extra debt payments and one siphoned off into savings. I'd accelerate debt payments on the car loan and the home improvement loan. I'd put the remaining extra money into an FDIC insured savings account or FDIC insured short-term certificate of deposit (or comparable products at a federally insured credit union). You won't make much money on the savings (okay, that's an understatement these days) but the money will be there if you need it.
One other thought to raise, this one concerning retirement savings. Just make sure you're taking full advantage of the company match if there is one. That's too good to pass up.
Credit unions
Question: My sister and I are having differences of opinion in investing our Father's money. He is in Assisted Living, age 93. Right now, the money is in U.S. Treasuries and earning very little interest. My sister wants to take most of the money ($150,000) and put it into CDs with SchoolsFirst Federal Credit Union which would earn 2.5%. I want his money to be safe and wonder about the financial footing of this credit union. Supposedly it is sound. Any suggestions? An avid listener of Marketplace Money on Saturday mornings. Linda, Tulsa, OK
Answer: I'm not sure I want to come between you and your sister, but we do get a lot of questions about the safety of credit unions. It's impossible for outsiders like you and me to judge the financial soundness of any bank or credit union. In the jargon of Wall Street, financial institutions are "black boxes." We can't figure out what's going on inside (and it turns out even the insiders couldn't figure it out).
What we can do is make sure the financial institution is backed by the FDIC or its credit union equivalent, the NCUSIF. That stands for the National Credit Union Share Insurance Fund. It's an arm of the National Credit Union Administration or NCUA.
Enough with the acronyms. I checked online, and SchoolsFirst is a federally insured credit union. The rules are the same as the bank FDIC limits: Deposits are insured up to $250,000. So, the money your father has would be fully covered.
You can rest easy if you put the money into a federally insured credit union. What if the credit union failed? (To be clear, I'm not saying it will or is even at risk of failing.) Your money is safe. The worst that could happen to it is that you can't get access to the money for a few hours or perhaps days (and I'm spinning out the worst case scenario here). The other risk is that the terms of the CD could be changed if the credit union was seized by the regulators and sold to another institution. The principal is completely safe, of course, but sometimes the interest rate on the CD is cut.
In a sense you can't go wrong so long as you stay short and stay safe. While I was writing this I wondered if a good solution was to decide on a mix, keeping some in short-term Treasuries, and adding some short-term CDs and savings account.
What to do with a tax refund?
Question: We are getting a hefty tax return this year (and yes, I had our tax accountant double check it three times!)-- due to capital gains losses, losses on rental properties we have and loss of income for my husband. It's a hefty 5 figure refund. I just don't know what to do with it. Invest it? But where? Slit that mattress of ours? Money market? Savings? Any suggestions? Nancy, Berwyn, PA
Answer: Please, not in the mattress! It's distressing enough that home safe sales are up during this financial crisis.
Seriously, if I were in your position I'd put the money right into an online savings account (FDIC insured), or some kind of comparable savings account backed by the full faith and credit of the federal government. This way you preserve the value of your unexpected "windfall" while you and your husband figure out the best use of the money. In light of all the economic uncertainty--and the losses you've suffered this past year--you may decide to keep it in a safe place in case you need it. On the other hand, you might want to pay down debt (always a good idea), invest in more education and skills for the job market, upgrade some aspect of your rental properties, or simply spend it in a way that adds to your life experiences.
But while you two talk it over, I would put it in a very safe place like a bank savings account or certificate of deposit--nothing fancy.
A safe place for money
Question: My Dad, 68, is dying of cancer and recently entered Hospice. He has a life insurance policy in the amount of $500,000. This is money my mom, 68, would be living on along with Social Security. Her house and car are paid for and she has very little debt. Her Insurance Agent, who sold her the policy, is suggesting she place the money in a 10-year annuity. That she doesn't want to do.
She would like to place it somewhere she can live off the interest and hopefully not draw down the principal. If need be, she could access some for special items...if she were to buy a new car in the future, etc. She also mentioned she would prefer to handle this herself, not going through a broker.
A few questions... Should she manage this herself or work with a broker? Where can she put the funds that will allow her to live off the interest? Any other issues we should consider or need to know when an insurance company pays out for life insurance? Thank you for your advice. Cheers, Shelly, Shelly, Cotton, MN
Answer: I'm sorry to hear about your father. There are no easy answers to your questions. That's why my main piece of advice is to be extremely conservative with the money in the near future. I would put some of it into an FDIC insured savings account, and the rest into short-term certificates of deposit, say, 6 months to 1 year. I would simply focus on making sure that all the money comes under the $250,000 FDIC limit. With this strategy your Mom can't lose any of the principal, although she won't make much in interest payments. The FDIC has on its website--www.fdic.gov--an easy explanation of how to accomplish this goal of principal preservation.
Then the two of you together need to figure out the best way to invest the money. You don't need a broker for this, although I'd talk to lots of people to dig for thoughts, information, and ideas. For instance, one common low-risk low-return strategy is to create a fixed income "ladder." She could invest the money in 3-month CDs, 6-month CDs, 1-year CDs, and 2-year CDs. The basic idea is if interest rates rise she can reinvest the short-term money at the higher interest rate and if interest rates fall she is still earning a decent yield on the longer term CDs. She could accomplish the same strategy by buying Treasury securities directly from the U.S. government at www.treasurydirect.gov. That's just one idea. Another common strategy is to take a slice of the proceeds and put it into an immediate annuity with a blue chip life insurance company. The immediate annuity would guarantee her an income for life.
Of course, much depends on what your Mom wants to do in the coming years. What does she want to spend her money on? Other issues to talk about include how will she handle the money as she gets older? What will be your role?
Investing the money very conservatively for now gives the two of you time to think through what's the best course of action.
TIPS
Question: Chris has recommended TIP (Treasury Inflation Protected somethings!) in the past. With the amount of money flowing into the economy from the various rescue plans I am concerned inflation is going to be a big factor in a few years, does he still recommend them? Thanks, Simon, Raleigh NC
Answer: Do I still like Treasury Inflation Protected Securities or TIPS? You betcha. The impact from high and rising inflation--the scenario you're worried about--is what TIPS are designed to protect you against. TIPS are default-free government-issued inflation-indexed bonds that come in 5, 10 and 20 year maturities. (The maturity date of a bond is when you get back the principal amount you invested and interest payments stop.) TIPS offer a fixed interest rate above inflation, as measured by the consumer price index. An additional advantage of TIPS is that they also offer a hedge against deflation--a decline in the overall price level of goods and services--by offering a "deflation floor" that protects principal value. TIPS are an investment for all seasons. They won't make you rich. But $1 saved today will be worth $1 in 5, 10 or 20 years--plus some interest.
TIPS have two drawbacks. The first is that Uncle Sam requires owners of TIPS in a taxable account to pay income taxes on any inflation-adjusted gains before you get any of your inflation-adjusted money at maturity. The easy way to invest in TIPS and avoid the tax problem is to own them in a tax-deferred retirement savings account, such as a 401(k) or IRA. The other issue is that you can't buy TIPS directly from the U.S. Treasury for your retirement savings account. You have to pay a broker to do it for you. The federal government seems to be more worried about lining Wall Street's pockets than making it easy and cheap for savers to own TIPS in their retirement accounts. Shame on Treasury.
Retirement vs. student loans
Question: Hi Chris, my question relates to two subjects: a student-loan for graduate studies and funding my retirement. I am 27 years-old and am planning to enroll in a graduate program (MBA) in the fall of 2010. The total cost of this education is in the vicinity of $100,000. By the fall of 2010, my savings should amount to at least $25,000. So, I will have to obtain financing for the majority of my education costs.
Since I will require a loan for such a large percentage of my educational costs, should I immediately cease contributing to my retirement accounts and, instead, add that money to my savings? Currently, I am contributing 5% of my pre-tax income to my 401k through my employer. Moreover, I am making regular contributions to a Roth IRA so as to achieve a total contribution of $5,000 by the end of the year. Please let me know what I should do. I worry about taking on such a large student loan. But also, I worry about the long-term consequences of not regularly contributing enough to my retirement.
Here's some information about me that you may find useful when crafting your reply. I am currently employed and am quite confident that my income ($70,000/year) will remain steady for the remainder of 2009. My savings currently amounts to $25,000 and my credit score is 770. I do not have any debt. Thanks Chris. I love the show and it's really helped me in so many ways. Cheers. Mark, Los Angeles, CA
Answer: Thanks for your note. You're making a big investment in your job and career by getting an MBA. You've done the research, and the rate of return on that investment measured in terms of job options, total compensation and career satisfaction will more than pay for the money you borrow. In a sense, your standard of living in retirement will largely be influenced by how much your investment in an MBA pays off over time.
Price matters, and the less you go into debt to get your MBA the more financial and job flexibility you'll enjoy at graduation. That's why I think your instinct to reduce contributions into retirement savings and, instead, put the money into a bank or credit union savings account, certificate of deposit, or some sort of very safe parking place for money is sound.
Here's another thought: Stop contributions into the 401(k), but continue to fund the Roth-IRA up to the $5,000 limit (and that's how much you are setting aside in total anyway). A Roth is a unique retirement savings vehicle. It's a retirement plan and a parking place for emergency savings. The reason is that by law you can withdraw contributions without any tax bite or early withdrawal penalty. You can't tap the earnings without taking a big hit, however. You leave the earnings alone.
You keep your financial options open by funding the Roth. If you decide the smart strategy is to borrow less you can withdraw your contributions from the Roth and just leave the earnings in the account. If it turns out you're borrowing less than you anticipate, well, you leave the Roth alone and let the money compound over time.
Since a Roth is funded with after-tax dollars will give up some income tax advantages with this tactic.
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.
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.
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.
Cut down on 401(K) contributions
Question: My husband and I are currently putting 9% of our income into our Roth 401K with a 4% match from his employer. We got a late start in contributing to that due to a late change of career which entailed years of schooling, so we currently only have about $40,000 in our 401K.
However, we have almost no savings outside of that. We have $5000 in the bank, some of which we need to use over the summer. I am wondering if we should decrease our 401K contribution and sock that money into savings instead until we have a few months' worth of cushion. Kathleen, Rexburg, ID
Answer: I think your financial instincts are right. It's important to have a decent cash cushion in normal times, let alone during the extraordinary period we're living through today. You'll still be saving money, just not as much in the retirement account (where you would pay a steep penalty if you tapped into that money.)
There are three keys to this strategy: First, continue to take full advantage of your employers match. The real investment kick in a retirement savings plan comes from the match. Second, shift the money into a very safe place backed by a government guarantee, such as an FDIC insured savings account. Third, remember to increase the sums going into the retirement plan when you've built up a large enough cash cushion.
I-bonds at 0%
Question: Every May and November I download the redemption values for my I Bonds. I use the program called "Savings Bond Wizard" that goes to the government website and automatically downloads the values of the bonds for the next period of time (in this case it would be May 2009 thru Nov 2009). Every time I have done this in the past, I can see how my bonds increase every month. This time, I did not see any increase at all in any of the months May June July Aug Sept Oct or Nov 2009. Do you know why this is? Could it be that my bonds will not grow any interest at all for all those months? Thanks for your help! Maxine, Danvers, MA
Answer: You read it right: The yield on I-bonds, the government's inflation protected savings bond, is almost zero. That's right, 0%. The I-bond joins a long list of very safe government backed securities that pay savers from nil to fractional yields.
Here's the deal: Treasury recently announced that inflation-linked bonds bought between May and October will earn 0% interest for the first 6 months. The same holds for current I-bond owners when their rates reset. Remember, I bonds come in two parts: a fixed rate and a rate that adjusts with changes in the Consumer Price Index. The fixed rate is at 0.10% for new issues. That fractional rate of interest will last for the 30 year life span of the bond. The 0% yield component comes from the link to the Consumer Price Index. Reflecting the worst financial crisis since the Great Depression, the CPI came in at a more than 5% annual rate during the prior 6 month period. However, the yield on I-bonds can't fall below zero % so that's what holders will get.
By the way, I still like I-bonds. It's an insurance policy, a good hedge against the risk of rising inflation once the recovery does set in. Plus, these 30-year bonds allow your money to compound tax-deferred until they're cashed in. (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.) There are no commission costs when buying or selling them.
A bond ladder
Question: I am 42 and have never ventured beyond CD's so obviously my tolerance for risk is very low; I don't like anything I don't understand - compound interest is something I do understand! I have a 90K CD that just matured at one of the national big banks on "shaky ground" and I plan on transferring it to a local bank for my own peace of mind. I will put 5K in the "rainy day" fund, and then have 85K left. The only way I can get a rate of 3% or higher is to go for a CD of 50 months or longer. Our circumstances right now are such that I need to use this money as a "monthly income generator;" I have the monthly interest transferred into a checking account and use it for expenses (so I don't ever get the full APY, just the interest rate). Our son has autism and I need to be home with him in order to take him to a special preschool and get him the therapies that he needs. If I was working, I would let the interest accrue. Are there any safe alternatives to CD's where I could get a monthly payment at 3 to 4% or higher on my 85K without committing to 4 or 5 years???.... Thanks in advance for your reply and I'm grateful for your advice! Cheryl, Akron, OH
Answer: First of all, you're right to steer clear of anything you don't understand. Secondly, you are risk averse and you have good reason to be cautious with the money. It's an axiom of finance that you can't get a higher yield without taking on more risk, and right now safe securities pay a paltry rate of interest. Third, I am worried about tying up money in a CD for four or more years. What if rates jump higher next year if the economy recovers, inflation rears its head--or both?
How about creating a laddered portfolio out of FDIC-insured CDs or U.S. Treasuries? It's both a savvy and safe way to invest. The basic idea behind a ladder is that you buy some 3-month, 6-month, 1-year, 2-year, 3-year and 5 year securities. If rates go up you reinvest your short-term securities when they mature at the higher rate. If rates stay where they are you still get the higher yield from the 4 to 5 year securities. You'll get the average yield of all securities you buy, and as long as you hold it until the CD or Treasuries mature, you can't use lose money.
By the way, it's the after-tax yield that matters. So, I would compare the after-tax yield on CDs to the after-tax yield on Treasuries (you don't pay state and local taxes on the latter). You can buy Treasuries without commission--in other words, for free--from the U.S. government at www.treasurydirect.gov. The website www.analyzenow.com has a web-based program for monitoring bond ladders. Just go to the free programs section and click on the "investment Manager" program. Smart Money has a nice article on bond ladders here.
Mortgage vs. CDs
Question: We have several CD's that are coming due. Interest rates are so low we are wondering if we should pay off our 6.875% home loan with the CD's and then pay our house payment to ourselves to resave. We only owe about $72K. The CD's are for our retirement; we are self employed. Gail, Arlington, WA
Answer: First of all, I don't see how you can go wrong by paying off the mortgage or reinvesting the money into CDs.
On the one hand, the advantage of eliminating your mortgage is that you'll earn a 6.875% return on investment--not bad in this market. I also believe that most homeowners should enter their retirement years without a mortgage.
On the other hand, if you keep the money in savings you have a personal financial safety net in case business slows down for one or both of you during the economic downturn. I also believe it's smart to own a well-diversified portfolio and not put too much of your savings into a single asset like a home.
So, my answer really comes down to evaluating how much risk you face. The more secure your income and the better diversified your overall household portfolio the more I would lean toward getting rid of the mortgage, and vice versa.
New or used?
Question: I wasn't sure whether to ask you or the Car Talk Car Guys about this - Maybe a joint consult? I just got half a book advance, and have $15,000 to do something with. My finances are secure - no credit card or other debt, own my home with an easy mortgage payment as well as a paid-off condo. I live off secure rental incomes and have $10,000 in regular savings account.
I've always invested in real estate and have no experience in, or much desire to get into stocks, even if they weren't so crazy these days. I'll get another $15,000 in September, but even $30,000 isn't much to work with in real estate these days. Meanwhile, I have a 1994 Honda Accord with 105,000 miles. It runs fine, but I'm thinking since I have the money and no real interest-earning investment ideas, perhaps I should buy a newer, lower-mileage, but still used Honda Accord.
Then a friend said for that price I could just buy a brand new Toyota or something. But I've always understood that the moment you drive a new car off the lot you loose 1/4 of its value. Is this still true? I'm not a new car person, just looking for another 15 year run of trouble-free driving and the best "investment" of my money. What should I do?
Thanks, Victoria, Washington, DC
Answer: When it comes to cars I'll defer to the Car Talk guys. But since you asked I'll throw in my two cents. Right now, there are good deals for both new and used cars.
It's disconcerting to think that when you buy a new car and drive it off the lot for the first time its value falls by some 20%. And that is after you've done comparison shopping, online research and final negotiations to get the best price possible. Still, it's an irrelevant fact if you buy new and own the car for a long time, driving it into the ground. How fast and how much it depreciates doesn't really matter.
Used car prices are cheap, and the used car business has become far more respectable over the past decade. Still, the one thing to remember when buying used is that you're inheriting someone else's problem with the car. I know nothing about cars. Engines are a mystery and repair shops are an alien. That's why I've always been a charter member of the buy new and then own for a long time school of car ownership. Some of my more car savvy friends would never purchase a new car, however. But they know what they are doing. I don't.
Here's my real question: Why spend the money? Why not just save it for now? Sure, you'll make a fractional rate of interest on the savings. But so what? Your car is fine. There's no need or rush to replace it. I would just put the money into your savings account, let it lie there safely and, when a good investment opportunity or a smart purchase comes along in the next couple of years, you'll have the money to tap.
By the way, what is the book on?
A college savings plan?
Question: We are in our 30's with three kids ages 7 and under. We live simply and have been able to get by on our income around $24,000 per year, plus our tax return which is usually several thousand. Though this seems like pennies compared to what others mention saving and investing, we have over the last 7 or so years managed to save over $10,000. We now find ourselves in a situation where we don't need to buy a house (which is what we originally thought we were saving for) but feel like that $10,000 should be put to use for us somehow. We like the idea of starting 529 plans for the kids' college funds. But we have nothing in the form of potential retirement. Should we invest it in some other way? Or, should we just keep it in our savings account, which is what we have done in the past. Often we have had to dip into several thousand a year between car trouble, and slim employment income. Kari, Eau Claire, WI
Answer: You're terrific savers. Congratulations. I understand your desire to set money aside for your children's college education. But I wouldn't if I were you. Several years ago I interviewed the head of admissions at the University of California, Berkeley. He made several points that have stuck with me. When you have a slim employment income and have to worry about keeping the car running you shouldn't set money aside for college. Instead, focus on making sure that your kids get a good education, one that prepares them for college. But with your income and three kids there will be plenty of money available from the federal government, state government and colleges to help defray the cost of college.
I'd rather you continued to save for a rainy day and for your retirement. You can accomplish both with a Roth IRA. I've written a lot about the Roth on this blog. In essence, a Roth is a retirement savings plan funded with after-tax dollars. When you withdraw the money during retirement it's free of taxes. That's right, Uncle Sam doesn't tax Roth savings. Here's the thing: You can take out your contributions at any time without paying a penalty or taxes. You just can't withdraw any gains (you would pay a penalty and income tax on the gain if you take it out early).
So, a Roth is both a pot of emergency savings and a retirement savings plan. This is a nice article from Kiplinger's that goes into more detail about a Roth.
Borrow to buy land?
Question: My husband is the primary income, and I work 12 to 15 hours per week from home while I take care of the kids. We have a 5 month emergency fund, and he is saving 10% from his pay for retirement. Our only debt is the mortgage. We would love to build a house one day. The question is ... should we take money from our emergency fund to buy the land? We are nervous about doing this. We also hate to add another debt payment. Additionally, we are not investing other than in his 401k fund. Should we do anything differently? It is very hard because the emergency fund was a long hard process to build. Litsa, Charlotte, NC
Answer: When I read your question my first thought was that you've already answered the question. You don't think now is a good time for you and your family to drain your savings and take on debt to buy land. I would agree. Even though the economic news is less bad these days the economy remains weak with the unemployment rate at 9.4% and home prices still trending lower.
That said, it's terrific that you've managed to set aside a 5-month emergency savings account. That isn't easy to do. I would focus on continuing to add to that savings. It's a strong financial foundation for your household.
You should also have your own retirement savings plan. A SEP-IRA is an easy retirement savings plan to set up for the self-employed. You could also open up a traditional IRA (funded with pretax dollars) or a Roth-IRA (the contributions are with after-tax dollars.) You can learn more about these retirement savings IRA options on the Getting Personal site.
Make minimum credit card payments
Question: I recently gave 2 weeks notice at my job which I recognize is slightly insane in this economy, but I'm confident that it was the right decision. I have enough savings and annual leave to not work at all for at least 6 months, but I'm not expecting that to be the case as I also have some freelance work lined up and on the horizon. Over the last year, I've made a significant dent in my credit card debt. My question is: while I'm unemployed, should I continue to pay over and above the minimum balance as I've been doing or should I pay only the minimum balance until I have a full time job again? I should say that my budget calculations for not working for 6 months were based on paying only the minimum and on not having any freelance work coming in. Thank you, Antoinette, Brooklyn, NY
Answer: No, you are not insane. Far from it. Despite the economic downturn and all the financial problems we're living through you still need to weigh the odds and, when it makes sense, take a risk. It seems to me you've thought through your job change well. You have a plan and you have savings. For now, I'm comfortable with you keeping financial flexibility by making minimum payments for a couple of months.
Here's a small trick I picked up from a new book by Gerri Detweiler, Nancy Castleman and Marc Eisenson, Reduce Debt, Reduce Stress: Real Solutions for Solving Your Credit Crisis. (I know you aren't anywhere near a credit crisis, but I like the tip. I'll write more about the book another time.) It might be a smart financial move for you. It's at least worth considering assuming you don't add to your credit card balance.
The basic idea: You pay the minimum required credit card payment this month. Your minimum payment should go down slightly next month. But you send in last month's required payment and you continue to do that for the next several months. The financial impact is very slight at first, barely noticeable. Yet applying just a little bit of extra money every month eventually gathers momentum. With this technique you won't strain your finances, but when you get your next job it will be that much easier to eliminate the credit card debt.
I hope you find the kind of work you're looking for.
06/09/09 by Chris FarrellInflation and an IRA
Question: I'm interested in finding a good investment for inflationary times. This would be about 7% of my retirement portfolio; around 10,000 in cash languishing in 2 different IRA accounts. I am 42, and will probably have to work until I croak. I am guessing I'll retire at 75 or so. I considered purchasing some I Bonds in an IRA account. I'd like to be able to sweep the proceeds of a dividend-yielding investment into the bonds once a year. I contacted my stock-trading account - no dice on holding I Bonds in my account there. I contacted Treasury Direct and they told me I needed to find a bank that would hold the bonds in an IRA and also contact the IRS. Do I need to call all the banks in town to see if anyone will do this? Is there a kind of bank that I should focus on? A directory that would help? Am I trying to do something completely wacko and ill-advised? Jill, Northfield, MN
Answer: I wouldn't say "wacko". But ill-advised? Yes. For a number of technical and legal reasons you can't get I-bonds into an IRA. More importantly, you wouldn't want to do that anyway. In a sense, an I-bond acts like an IRA. The money you put into an I-bond compounds tax deferred until you cash it in. At that point you owe ordinary income taxes on the gain. With an IRA, your investment grows tax deferred until you pull it out in retirement and pay ordinary incomes taxes on the withdrawal. You'd be wasting the tax shelter if you could invest it in an IRA.
That said, I like I-bonds. I would just buy them directly from the Treasury.
Inflation isn't much of a problem right now. The government reported this morning that the Consumer Price Index for the 12 months ending in May was down 1.3%, the biggest decline since 1950. I'm not very concerned that the Federal Reserve extraordinary actions to shore up the economy will end in a bout of hyperinflation, either. The formidable combination of an intensely competitive global economy and a competent central bank will keep inflation around its target level of 1% to 2%.
Of course, that forecast could be horribly wrong and a reprise of the inflationary '70s awaits us. Even if I am right low levels of inflation erode the value of a dollar over time. Long-term savers should worry about inflation a lot. That's why I like Treasury Inflation Protected Securities or TIPS. It's an ideal security for an IRA, although you'll have to buy them from a broker. I've written a fair amount about TIPS elsewhere on the Getting Personal site. The best overall source of information for investing in TIPS and similar securities for safety and security is Worry Free Investing by Zvi Bodie, finance professor at Boston University. You can check it out here.
06/17/09 by Chris FarrellSave more or attack student loans
Question: I am trying to balance saving enough money in case I lose my job and paying down my current (and increasing) student loan debt. I work full time and am a part-time law school student. I have pre-existing school loan debt from another graduate degree (about $45,000). Now, I'm accruing more by attending law school. The pre-existing loans are deferred, but I could still make payments since I'm working. I am not sure how to balance making sure I have enough savings and paying off the debt. Right now, I have a solid 10 months of expenses in savings (not counting any of my retirement savings). Should I stop worrying about the savings and start paying down the school loans again? Rebecca, Hoboken, NJ
Answer: As you well know, the cost of living in the New York City area is expensive. It's impressive that you've accumulated a solid 10 months in savings. It's a decent financial cushion for anyone. It's a judgment call, but a key for answering this question is this: Is your job is really at risk or are you just feeling the general unease we all have about our jobs during the economic downturn. Assuming that you are reasonably secure in your job I would start paying down the student loans again. And then you can get even more aggressive when you get a job as a lawyer.
06/22/09 by Chris FarrellPay off student loans
Question: My only debt after I sell my house will be a student loan. Here is the info on that loan:
Principal: $13,741.43
Rate: 1.65%
Monthly payment: $123.63
I don't think that there is an early pay off fee. I'll have enough $ from the sale of the house and cashing in other investments to pay it off. Should I? Or should I invest it in something that is uber secure with a higher interest rate? I like the idea of living debt free...aside from house payment. Just want to know my options. Would love your thoughts. Thanks, Austin, Louisville, KY
Answer: It's wonderful to live debt free. Even though the rate on your student loan is extremely low it's still better to be free of a monthly debt obligation. I certainly felt that when I paid off my car loan. It's much easier to build up savings every month when you aren't paying down a loan, too.
Why wouldn't you eliminate the debt? The main reason would be if you're nervous about losing your job. I would park the money into an ultra-safe government-insured savings account if a layoff is in your near future or even if there is a strong possibility that you might get handed a pink slip. Another reason to hesitate might be if you don't have any emergency savings set aside. In that case, you might want to some of the money into savings and the rest into paying a chunk of the loan.
Still, if you're reasonably secure I'd pay off the loan.
Starting a business and saving
Question: I was laid off and now I'm living off my savings. No income for the time being. I've been preparing to launch my own business and I'm fortunate because I've always been a good saver, so I don't even have to look for a loan at this point. My question is - where to keep the money I've saved? Most of it is in a savings account (got a good deal on interest, but only until 2010) and some is locked into my previous employer's 401K, earning basically nothing because I'm afraid to go into stocks or bonds. I have a self-employed 401K that's also inactive - same reason: I don't want to lose any of my funds... Love the show and the blog and everything! Thanks for any advice. Rina, Bronx, NY
Answer: For the moment, I think you're doing the right thing keeping your money in a savings account. After all, you're taking a big risk starting your own business. Good luck with it, too. I hope your idea succeeds. Business history suggests that the best time for entrepreneurs to open up a new business is during a downturn. The savings is an anchor offsetting the risk you're taking as an entrepreneur. And you need the money to live on.
Don't let the stock market paralyze you. There is nothing wring with being conservative. The counsel that equities should form the foundation of a long-term investment portfolio owes a huge debt to the finance insights of Paul Samuelson, the Nobel laureate. For many people I think equities should be part of their retirement portfolio. Yet in an interview I had with Samuelson about a decade ago, he said, "there are lots of reasons to have an equity share which is significant. But it all depends on your risk tolerance. For my late mother, her level of risk tolerance called for a very small equity share. You have to always sell down to the sleeping point."
You're a good saver. I'd continue to save for your retirement when your financial circumstances improve. But I'd do it in products that are safe and secure--and allow you to sleep.
What is emergency savings
Question: My husband and I got married recently and we're having a bit of a debate about what constitutes an emergency fund. I believe it is an account (money market, CD, savings) with 4-6 months of expenses stashed away. My husband feels that it doesn't have to be a particular account; in fact he would say that I could count my 401K and IRAs as emergency funds. I completely disagree as my retirement funds are for just that, retirement. In an extreme situation, I could tap into those, but it would have to be from dire need. We'd appreciate your wise counsel on the subject & enjoy listening to your show on Yellowstone Public Radio. Thank you, Rachelle, Bozeman, MT
Answer: I don't want to get between you and your husband, but I'm going to have to take your perspective on "emergency" savings. It's your safe and secure money that you have quick and easy access to without paying a penalty. Emergency savings includes savings accounts, money market mutual funds, short-term certificates of deposit, Treasury bills and the like. Of course, there are differences between these products. You can get immediate access to a savings account attached to your checking account. If you own a 3-month T-Bill that you purchased through treasurydirect.gov you'll have to wait until matures.
The problem with tapping into 401(k)s or a traditional IRA is that you could end up paying a 10% penalty or ordinary income rates on the withdrawal.
However, your husband is right to consider the retirement plans as part of your overall savings. There are ways to get at it, too. You might be able to withdraw some of the 401(k) money as a loan and pay yourself back over time (assuming your employer lets you borrow against your 401(k).) You can take money out of the IRA and, if you return it all within 60 days, there are no penalty or tax implications. You can only do it once a year. Still, both these strategies have significant financial drawbacks, which is why I don't recommend them.
There is an exception: The Roth-IRA. The contributions into a Roth are with after-tax dollars. In a pinch you can withdraw your Roth contributions without paying a penalty or taxes to Uncle Sam. Just leave the investment returns alone, since there is a levy on earning if you do take them out. A Roth is both a retirement savings plan and an emergency pot of money.
Buy or rent
Question: My husband and I can't decide whether or not to buy our first house. We will likely be in any house we buy for at least five years -- there is some possibility we would move after that. We have $50,000 available for down payment, but we also have a 13-year-old and a 10-year-old and are worried about college. We only want to buy a house if it is beneficial to us financially in the long run -- otherwise, we are happy renting. And we hate to say goodbye to that pot of cash that could buy our boys more choices for college (though we also worry about inflation destroying it, and losing this opportunity to buy in a neighborhood we like but usually can't afford to buy in). Should we become homeowners, or not? Laura, Milwaukee, WI
Answer: I really like the way you're asking the question. The answer comes from understanding the trade-offs you'll make to own, and whether it makes sense for you. Owning can make sense. Prices are attractive. The $8,000 first-time homebuyer tax credit is an added incentive if you quality. A home is a lifestyle, too. It's a place where you live with all the benefits that come decorating and landscaping it the way you want.
That said, you want to ignore the two biggest lies in the real estate business. The first is to "buy as much home as you can." It's a recipe for financial trouble. The second is renting is "throwing your money away." That's wrong.
Here are my principle guidelines to weighing the costs and benefits of homeownership:
*Compare the cost of owning vs. renting.
*Buy only if the deal is financially conservative
*Keep the mortgage and financing simple--no piggy-backs, 80/20s, and the like
*Smaller is both smart and socially sustainable
Number crunching will help keep emotions in check. Let's say you calculate that the monthly cost of ownership, taking tax benefits into consideration, is higher than the monthly price of renting for a comparable property. If you buy a home, you're making a big bet that home prices will rise to justify the purchase. But you have a financial cushion if the cost of ownership is less than renting. There are a number of good online calculators, but I tend to gravitate toward the websites www.dinkytown.net and www.hsh.com. Time is critical. Ownership doesn't make sense unless you're confident that your time horizon is at least 5 years. You're in the ballpark from a time perspective.
After you've gone through all this, I would then decide whether ownership is sensible for you. There's nothing wrong about deciding to rent and save.
Invest in BRICs?
Question: I am 56 years old. I got out of housing before the market fell. I sold my house. I stayed out of the stock market over the last 7 years, so I didn't make or lose money. I was content with small but safe money market accounts. But I don't know what to do now. I have in excess of 250,000 that I could invest. My banker thinks that I should get some money market linked CDs. There is 100% principle protection on FDIC Coverage to applicable limits, and "opportunity to participate in the leverage potential appreciation of equally-weighted BRIC foreign currencies. Is this a good idea? When I retire, I should receive between $2,200-$2,500 per month. I also have another $250,000 401 Ks and several stocks. I am looking at finding an investment that would be FDIC insured but still pay a reasonable investment-3-5%. I would consider something more aggressive if it still felt safe. Must be a lot of people in my age group with this problem. Any suggestions? Anne, Minneapolis, MN
Answer: Here's my basic problem. You've done a good job saving. You're conservative with your money. Why put some of your savings into one of the riskiest bets in the global capital markets, the BRICs? That's shorthand for the world's largest developing nations--Brazil, Russia, India, and China. There are powerful, compelling arguments that the future is bright for the BRICs over the long-haul. But they remain volatile markets and fragile economies. Investing in the BRICs isn't for the faint of heart. Investing in foreign currencies is "rank speculation," to quote from Jack Bogle, the legendary founder of Vanguard.
I know that your principal is safe with this kind of market-linked CD, but it just doesn't make sense to me. The way you've described what you are looking for in an investment tells me that sticking with shorter term Treasuries and CDs--and accepting the lower yield--is probably your best bet.
07/15/09 by Chris FarrellHow to protect against inflation
Question: I hate to see this happen to the Obama administration; however, if you combine the debt created by the Bush era and the deficit spending (a.k.a. Stimulus Package and Bail Out packages) that Washington is embarking on, how can we not repeat the sky high interest rates that folded the Carter administration where cash was king accompanied by nose bleed inflation rates--especially since manufacturing has all but left these shores for cheap overseas labor? Thank you. Stephen, Cape Neddick, ME
Answer: Many people in the markets are worried that the Fed's quantitative easing will end in a bout of high and rising inflation. Still, it seems to me the fear that inflation lies around the corner is exaggerated. The economy is still weak if not in recession and unemployment is rising. Now, it's likely that inflationary pressures will emerge when the economy finally regains its footing. It's a safe forecast that at some point down the road the Fed will confront a tricky monetary policy act. I'm sure we'll go through some inflation scares. But the Fed is well aware of the risks and, while the conduct of monetary policy is as much an art as a science, Chairman Ben Bernanke thoughtfully discussed the central bank's "exit strategy" in Congressional testimony earlier this week.
But high and rising inflation or hyperinflation? Personally, I don't see it. For instance, the U.S. government's Treasury Inflation Protected Securities or TIPS are forecasting that inflation will average less than 2% over the next decade. You would think investors would demand more of an inflation hedge if the threat of hyperinflation was real. The global competition for profits and markets is intense and that competition will aid central banks around the world in keeping inflation tame. I still think the long term trend is toward minimal inflation rates in an increasingly integrated world economy. Plus, central bankers have a pretty good intellectual tool kit when it comes to bringing inflation under control. What central bankers don't really understand, what they disagree on is how to handle bubbles, market booms and market busts.
That said, the risk of high and rising inflation exists over the next 5 years or so considering the extraordinary actions the Fed has taken to bail out the banking system and avoid a depression. Even small rates of inflation, say, in the 2% to 3% range, reduce the purchasing power of savings with time.
So, since we're dealing with personal finance questions here what's a good way to protect your savings from inflation? A portfolio made up of mostly Treasury bills does an excellent job of keeping pace with inflation. However, the price for that inflation hedge is no growth or no earnings premium over inflation. Most of us would like to make some money on our money. That's why the key investment product for long-term savers is TIPS. Everything can be built on top of a foundation of TIPS. For those who want to take greater risk in the search for higher rewards should allocate a larger portion of their portfolio to stocks. For those who are more risk adverse a larger investment in Treasury bills makes sense.
Safe savings
Question: I am a newly divorced mom who has just sold her home as part of a divorce settlement--at a big loss. I have 60K as my share. I was unable to negotiate a mortgage because I have not worked full time since my special needs child (now teen) was born. I am seeking full time work (bank says they need 12 months work history) and have rented a small house for 1 year. (My rent will be more than my mortgage would have been if I had been able to buy the house I just sold.) Where should I put my 60K until I can purchase a home? Preferably somewhere where I earn a return, without risking the principal. Would your answer be different if I decide not to buy a home for 2 or more years? Karin, Scarborough, ME
Answer: You right to want to park the money in a safe place. I would put the money into a FDIC insured bank or a federally insured credit union. You could put some of the money into a savings account and some into short-term CDs. The other alternative is to buy short-term Treasury bills from the U.S. government at www.treasurydirect.gov. In all these examples the money will be there when you need it.
My answer would be the same whether you buy a home in two years or not. Here's why: You're going through a lot of tumultuous changes. You've gotten divorced. You're looking for full-time work. And you're raising child with special needs. So, I would avoid making any dramatic investments--and that includes a home--until you have a better sense of your new work and home life. You'll figure it out, but it takes time. Meanwhile, keep your savings safe.
07/28/09 by Chris Farrell
CDs
Question: I am a 33 year old unemployed librarian (laid-off from part-time professional position end of March 2009) full-time doctoral student. I have about $12,000 in a CD that just came due. Rates are terrible of course, I shouldn't need the money anytime soon, and I'm trying to figure out the best, but not too risky, place to put this money, which is most of my savings. I'm leaning towards a 9-month Ally Bank CD with a 1.90% rate. Does it even matter at this point what I do with the money as long as it's safe and secure? I have a separate Roth Ira. Thanks so much. Miriam, Brooklyn, NY
Answer: Ally Bank is the old GMAC bank. The name was changed back in mid-May. I guess the GM name didn't exactly evoke warm feelings of financial security. The online bank is insured by the FDIC. You're right, the key is that your money is safe and secure. My only question is whether you want to keep some of the money easily accessible by parking it in the online savings account. This way you won't have to break the CD contract and absorb a penalty if you need some quick cash.
I-bonds
Question: Do you agree with the U.S. Dept. of Public Debt that the current inflation rate is MINUS 5.56%? I have 3-I bonds purchased August 2000 with a 3% fixed rate. When I saw a zero interest rate for my bonds I asked Public Debt what happened to my 3%? They added the new MINUS 5.56% to my 3%. Are they manipulating the word inflation? I think of it as being zero at it lowest. Valerie, San Francisco, CA
Answer: It's a hard number to believe with the everyday pressures on our budgets to pay for gas, food, insurance, and the like. But the green-eyeshade brigade at the Bureau of Labor Statistics isn't manipulating the data. The government statisticians there live for these numbers. They take it seriously. So, although the price index IS incomplete and has flaws, no one is trying to be the number-crunching version of a Bernie Madoff.
What the decline in the consumer price index reflects is the downward momentum of the global recession, the longest, most severe recession since the Great Depression. It isn't just in the U.S., either. Inflation rates in almost all economies have fallen sharply along with declines in commodity prices, the lack of consumer demand at the mall, and the steep drops in housing values.
Against this backdrop, any increase in the overall price level is a long way off. Right now, I think the fear of deflation or a decline in the price level is haunting central bankers worldwide. But at some point--hopefully soon!--the economy will revive and we'll get a good inflation scare. Most economists expect one considering all the money the Fed has pumped into the system to shore up the economy over the past three years. That's the risk an I-bonds is designed to protect you against and it's why I think there is value for the long-term saver in owning I-bonds.
08/07/09 by Chris FarrellMedium-term savings
Question: I am a 24 year old engineer who has been extremely fortunate in this economic downturn. My wife and I have no college or credit card debt and a combined income of 100k. Up to this point the majority of our savings has been in retirement accounts, such as 401(k)'s and our Roth IRAs. We also have begun to build an emergency fund in a money market account for short-term savings. The glaring weakness I see currently is medium-term savings, such as for our next house or car in 5-10 years. My hunch is that some low-cost index funds are the way to go right now. Is this the right overall investment strategy to be taking in the short, medium, and long-terms? Adam, Hamilton, OH
Answer: You're smart with your money and you have a good savings strategy. Here's a suggestion for your medium term savings. I like the idea of investing in a low-cost broad-based equity index fund in a taxable account. Your annual tax liability is fairly small, most reflecting dividends payments. The capital gains impact is minimal since index funds mostly don't sell their holdings unless it's to take into account changes in the underlying index. You'll face the capital gains tax hit when you sell shares, assuming the investment has appreciated in value over the years. I like the idea of setting up an automatic investment plan so that every month a small sum of money goes out of your checking account and into the index fund.
You can complement this risky slice of your savings portfolio with an investment in I-bonds. It's an inflation-protected savings bond. There are no commission costs to buy and sell I-bonds. You can buy $5,000 online in electronic I-bonds directly from the U.S. Treasury and another $5,000 in paper I-bonds from your bank or credit union. Your money compounds tax-deferred and you don't pay Uncle Sam at your ordinary income tax rate until you cash them in. If you sell the I-bonds before 5 years you'll lose three months interest as a redemption penalty. There is no penalty after 5 years. To be sure, I-bonds aren't in favor right now because the rate is zero. That's right, 0%. The rate reflects the steep decline in the consumer price index during the Great Recession. The reason it doesn't bother me is what if inflation surges in a year, three years, or five years from now? The dollars you put aside today will be protected against inflation, at least as it is measured by the consumer price index.
By the way, I look at this approach as a 5+ years strategy, especially with the index fund. If your time horizon is less than 5 years the stock market is simply too volatile a place for savings. .
A bond ladder
Question: Looking for safe place for investing which pays a higher yield than CD's. As a senior, in these uncertain times, I am a conservative investor. Miriam, San Diego, CA
Answer: Today's low yields are tough on savers, especially seniors looking to live off their savings. However, even though it appears that the recession is ending there is still a lot of risk in the economy and markets. So, I think the risk of reaching for yield is too high. I'd stick with government-backed savings, from Treasury bills to CDs.
One time-tested strategy is to create a "ladder" of CDs or U.S. Treasuries. The idea is to invest in securities with different maturities. For example, using the national CD rates published in today's Wall Street Journal you could buy a 6-month CD at 1.25%, a 9-month CD at 1.45%, a one-year CD at 1.61% and a three-year CD at 2.61%. Now, let's imagine in six months that interest rates are higher. You will have a short-term CD maturing at that time and you can reinvest the money at the higher rate. What if rates go even lower over the next six months? You're still earning a relatively better return on your longer-term higher-yielding CDs. You can also do this with Treasuries bought directly from the federal government at treasurydirect.com.
08/17/09 by Chris FarrellSaving for retirement
Question: I am a 55 year old divorced female who owns my own fledging consulting business. I have no retirement savings except Social Security. As part of my divorce many years ago I will be shortly be receiving my portion of my ex-husband's retirement fund as determined by a QDRO. [A Qualified Domestic Relations Order allows for the division of retirement plan assets in a divorce.CF]
I must roll it into a 401K to avoid any penalties of course but wonder what is best to do with it once it is in a fund. What is the best kind of 401K? Should I invest in some medium risk stocks as long as I can do something to guarantee the principal?
I am very much a novice at this and as you can probably understand by the fact that I have virtually no retirement savings -- have not been especially good about savings in the past. Lucy, Baltimore, MD
Answer: Congratulations on getting your consulting business off the ground. You're already taking on a lot of financial risk by being an entrepreneur. That fact alone suggests your savings should lean toward the secure and cautious. What's more, you say you're a novice at investing. That, too, suggests investing conservatively in a retirement savings plan. Last, you want to avoid the temptation of rolling the stock market dice to make up for lost time. Stocks are simply too risky for that kind of bet.
In thinking about your question maybe the best advice I can give is for you to pick up a copy of "Worry-Free Investing" by Zvi Bodie and Michael J. Clowes. Bodie is a leading finance professor at Boston University. Michael Clowes is editor at large at Pensions & Investments, a trade publication. The book was published back in 2003 in the wake of an earlier bear market in stocks and it remains a book for the times. Instead of asking, "How much money will I make?" they're wondering about the more fundamental financial question, "How much can I afford to lose?" Their basic message fits in with your question.
What's the answer? Their preferred investment for long-term retirement savings is U.S. government inflation protected securities. These securities preserve the purchasing power of a dollar against the ravages of inflation. Inflation is the enemy of long-term savers. Think about it: One hundred dollars loses half its value in 20 years with a 3.5% average annual rate of inflation. The same sum falls by about a third over two decades even at a modest 2% inflation rate. Of course, you'll take a lower payout on your savings in exchange for the inflation protection, but it's worth it. The authors deal with other conservative investments. They aren't stock-phobic, they'd just prefer that individuals roll the stock market dice only after looking after their baseline financial goals. I think a book like this might give you some needed guidance.
08/31/09 by Chris Farrell
What to do with an annuity
Question: I retired in 2007 from a university. My retirement funds are with TIAA-CREF, split roughly in half in 2 annuities. One is a fixed annuity and the other is a variable annuity, balanced 50/50 between bond and stock funds. I probably lost 20-25% on that fund in the crash last year. The 2 annuities together provide about 40% of my monthly retirement income.
I have resisted freezing the variable annuity and making it fixed because that would provide NO chance to recoup some of my loss. When I set these up in the first place, the fixed annuity was my hedge against the kind of crash we suffered in the past year. I'm not feeling the pinch although my income dropped a little this year but income tax adjustments offset the loss--and I do a little consulting for "egg money." I also have a savings account equal to 1/3 my annual income. I rent, so as not to have house expenses.
Am I crazy to hold firm? If I look at a 20 year time horizon, isn't it likely that my annuity will slowly come back over time (and maybe I could fix it then)? I would be interested in Chris Farrell's opinion about this. Thank you. Elaine, New Berlin, WI
Answer: One reason why I'm posting your question is that I admire your retirement strategy. We can all learn from how you have thought through your finances and what you have done. You set up a smart hedge against a bad market environment. You have savings. You still have some earnings coming in. Your expenses are under control. As far as I am concerned, you've really come up with a sensible strategy for all seasons.
As to your question, I still like the idea of you keeping the hedge with the floating annuity. It allows you to participate in the good times. But your other savings buffer you against the bad times when they come again.
One other thought: I would hold off freezing the variable annuity until you had an answer to this question: How much of your portfolio do you want exposed to stocks, if any? Right now, it seems to me that you're mostly fixed income between the savings, the fixed annuity, Social Security and the 50% of the variable annuity that is in bonds. So, one issue for you is how much of your portfolio would you like exposed to stocks? More? Less? The same?
What do other people think?
A more conservative portfolio
Question: After listening twice to your recent commentary about Wall Street and having recently read Robert Reich's blog titled 'The Continuing Disaster of Wall Street, One Year Later' I'm concerned about our stock investments and retirement timeline.
We're looking at retiring at the earliest in 2012. Our present investment portfolio is weighted to 'aggressive' mutual funds. Given our (hopefully) short retirement timeline another major downturn of the market would put us in a serious retirement hole to dig out of. It seems to me that we'd be better off shifting our stock to bond ratio to a safer mix. As always, we enjoy your advice and commentary. Joe, Hagerstown, MD
Answer: You're right to be concerned. We've had two recessions, two bear markets, and a credit crunch in 8 years. My basic assumption is that everyone needs to build a substantial financial buffer with their savings. Economic downturns are as much a part of a capitalist system as expansions and bull markets.
I like the approach of Jack Bogle, the founder of the Vanguard mutual fund behemoth and a regular guest on Marketplace Money. (By the way, any of Bogle's books on investing and money are worth reading.) His rule of thumb is that the fixed income portion of your portfolio should equal your age. So, if you are 30 years old, fixed income securities should be 30% of your portfolio; 55 years old, the fixed income portion is 55% of your portfolio. Bogle walks his investment talk, too. When I talked to him several months ago he was 80 years old and with that much of his portfolio in fixed income securities he didn't really even feel the sharp drop in stocks.
Of course, like all rules of thumb your age is just a starting point. You can decide to be more or less conservative, depending on your circumstances and household wealth. And with your fixed income investments I would stay conservative. For instance, Treasury Inflation Protected Securities, Treasury bills, Treasury notes are default free investments. So are I-bonds. Certificates of deposit and savings accounts that come under the FDIC insurance limits are good, too.
So, I'd play with the numbers and see if this approach works for you.
A stock market winner
Question: My wife and I are in our mid 30s and we decided to take a gamble back in Jan 09 when everyone said the world was coming to an end. We took $20,000 out of our savings and plunged it into an established travel company we used to work for that was trading below its all time low (lower than after 9-11). Well the world did not end, and 9 months later we're sitting on a handsome sum of money thanks to a 4x growth in stock price. My question is what should we do with the money? Popular ideas are to slowly work the money into a Roth IRA or other investments, or to pay off our $120,000 7.2% 30 year mortgage (25 years remaining), which would free up $1200 in expense monthly.
I appreciate your help and love the program. Jonathan, Miami, FL
Answer: I love your story. We all know that being a contrarian investor is smart, but it isn't easy. As John Maynard Keynes famously wrote eight decades ago, "Worldly wisdom teaches it is better for reputation to fail conventionally than to succeed unconventionally."
What would I suggest doing with the money? You could always refinance your 7.2% mortgage with fixed rates to 5% these days. And then you could use the money to build up a broadly diversified portfolio. But, assuming you like your home and neighborhood, I'd lean toward taking advantage of your windfall to live debt free. Imagine, you're both in your mid-30s and from here on out you could live well off your income from work, add to your savings, and avoid borrowing. Being debt free at your age will give you a lot of financial flexibility and personal freedom down the road.
09/24/09 by Chris FarrellGo on trip
Question: My wife (30 yrs old) and I (31) have been saving for multiple years to take a 6 month world trip and I am hoping you'd give me your opinion if it is too financially risky to take this trip. I can take a leave of absence from my work with the expectation that I'll still be employed when I return. My company is an FFRDC [Federally Funded research and Development Center] so it is relatively secure. My wife will have to quit her job and search upon return. However my job is 2/3 of our income and we could live off my job alone if needed. We rent so we should be able to cut most expenses while we're away. We have zero consumer debt, though we have $45,000 in federal student debt at 2% APR. We estimate the trip will cost $30,000 and have $40,000 so that we have a good buffer. This is not our only savings as we have been saving for retirement for multiple years and already have about $100,000 toward retirement in our tax advantaged plans. We also have several months (~4 mo) expenses saved up in the bank for a rainy day. However I am still a little worried. With the poor economy and losing 6 months of pay is this just foolish conspicuous consumption that will put my wife and I in financial peril or is this a small, calculated risk which, given we are young, can course correct even if the unexpected happens? Obviously I'd love to make this trip, but I like feeling financially secure as well. First Name: Nichols, Redondo Beach, CA
Answer: Okay, I'm jealous--really jealous. It sounds like a wonderful adventure. I guess I'm supposed to act like a sober-minded guardian reminding people not to take unnecessary risks when the economy is down. But I can't do it. I don't believe it. As the 15th century French poet Charles D'Orleans wisely wrote, "It's very well to be thrifty, but don't amass a hoard of regrets."
You can't get rid of the risk that when you return you face a rough time. It's in the nature of your adventure. But you've carefully thought through the risks and rewards of taking the trip, and you've done a lot to minimize the risk of hitting a tough patch when you return. You've prepared your employer for your leave. You've saved a lot, leaving yourself a decent margin-of-safety to fund your wife's job hunt when you get back to California. The global downturn also means that in many places you'll be able to take advantage of cut-rate prices. Bon voyage.
10/06/09 by Chris FarrellA whole life policy
Question: My wife and I are in our early 50s. We have been told that we should have a whole life policy in our investment portfolio as a conservative investment vehicle (we currently carry $150,000 term life policies on each of us). Our combined gross annual income is approx. $155,000, and we are saving for retirement in 401Ks at approx. 15% of our annual income. We also invest in Roth IRAs and have two homes that are nearly paid off. So, about the whole life for us, what do you think? Thanks very much! - Tim, Indianapolis, IN
Answer: I'm skeptical. Do you need more life insurance than you are currently carrying? If yes, why not simply hike the amount of term life insurance you have currently. Or do you face a future that calls for a whole life policy?
A whole life policy combines a death benefit with a tax-sheltered savings account. In essence, you pay a premium for the coverage, the insurance company deducts insurance and expense charges, and then it credits the rest of money into a tax-sheltered interest-bearing checking account. It can quickly gets a lot more complicated than that, by the way, but that's still the essential idea.
I like judging whole life from the perspective of does it meet your life insurance needs better than term insurance?
To be clear, whole life fills a need. But I'm skeptical that its a conservative investment alternative for many people. If you need a stronger hedge against bad times in your overall portfolio why not put the money into all kinds of conservative savings choices, from CDs to Treasury notes to I-bonds. The cost of owning investments like these are minimal. (And if you buy I-bonds, bills, notes and bonds directly from the Treasury there are no commission costs to buy.) You don't have to worry about default risk. Interest rates won't always be at such razor thin levels, either. You can be tax smart with these alternatives, too.
Clearly, you're good savers with plenty of assets and almost no debt. I think I would just continue what you're doing.
If you do go the whole life route, take your time, shop around, and ask lots of questions.
Military thrift plan
Question: Hi, I recently left active duty military service and am trying to decide what to do with my Thrift Savings Plan. I've got about $40k saved in it right now.
When I look at the options for withdrawing, it seems like I'll be paying either 10 or 20 percent penalty fee.
I was thinking about starting a ROTH IRA. Should I take the penalty and roll it over into a ROTH IRA? Or am I better off just letting the money sit in the TSP until I retire? Thanks, Spencer, Humble, TX
Answer: You have a number of good options to think through. And you shouldn't pay a penalty or taxes with them. The one exception on taxes is the Roth option. I'll explain in a moment.
First of all, the Thrift Savings Plan is a really good, low-fee plan. It's hard to beat. You might want to simply leave your retirement savings in the plan.
If you still want to move your savings out of the Thrift Savings Plan you can roll it over into another tax sheltered plan. For instance, if your current employer's savings plan allows it you could transfer the money into your new 401(k). Alternatively, you could roll it over into an IRA. In both cases you don't take the money out. You'll make an institution to institution transfer of the money, preserving its tax-sheltered status. No penalties will be imposed, either.
You could put the money into a Roth-IRA. Since the Thrift Savings Plan was funded with pre-tax dollars and a Roth is funded with after-tax dollars you'll owe taxes on the money your transfer into the Roth. However, when you pull the money out during retirement the gain is free of Uncle Sam's levy. By the way, in most cases it does not make sense to Roth if you have to use your retirement savings money to pay the tax levy. It reduces the amount that can grow, free of tax, in the Roth.
I'm not sure which branch of the military you served in. But the Navy offers a clear brief explanation of your choices.
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Chris Farrell Marketplace Money personal finance guru
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