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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.

12/19/07 by Chris Farrell

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Savings for a Stay-At-Home Mom

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

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

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

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

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

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

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

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

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

01/03/08 by Chris Farrell

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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.

02/06/08 by Chris Farrell

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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.

02/13/08 by Chris Farrell

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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

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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.

04/02/08 by Chris Farrell

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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.

04/04/08 by Chris Farrell

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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.

05/05/08 by Chris Farrell

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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 Farrell

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Getting 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.

06/18/08 by Chris Farrell

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