Getting Personal
Wall Street Woes Archives
Worried about financial safety
Question: My husband and I are 32 and 31. We have approximately 80K in retirement investments (SEP IRA, mutual funds) with Wells Fargo. We noticed recently that they have a disclaimer on their forms stating that investments are not FDIC insured. With the recent collapsing of investment firms and banks, and with the Lehmann Bros not being bailed out by the government, the uninsured FDIC investment makes me somewhat nervous. How do we know that our investment is "safe"? Should we consider doing something else with our money until we know Wells Fargo makes it through this time of turmoil? Renee, St. Paul, MN
Answer: I'm getting variations of your question from a number of folks. Checking, savings, money market deposit accounts, certificates of deposit, and other bank products are insured by the FDIC up to $100,000. (A CD in an IRA is insured up to $250,000.) You're absolutely right: There is no FDIC insurance when it comes to stocks, bonds, mutual funds, ETFs, commodities, and other market investments even if you bought them through a bank or a similar financial institution.
Still, there is a safety net. The biggest protection for your investments comes from the segregation of customer accounts from the finances of the bank or brokerage house. If a bank or brokerage house goes under, you still own the securities and your account will be sold or transferred to another institution. The Securities Investors Protection Corp. (SIPC) offers additional protection in case of fraud or malfeasance.
None of this investment safety net preserves the value of your money in the market. For example, if you own a stock mutual fund it's probably way down and odds are it's headed even lower. But you won't be wiped out if the financial institution you do business with fails.
That's only one aspect of financial safety. Another is taking a close look at the actual investments you're in. The key question is how well diversified are you? And, with all the turmoil in the market and no end in sight, do you feel that you have too much in stocks or some volatile asset. If the answer is yes, by all means trim back to a more conservative portfolio. .
Is my Roth safe? How about my SEP?
Question: I have my Roth IRA with Merrill Lynch, in what they call an MFA account. Also have my SEP there. Since the Bear Stearns debacle, I've been wondering what happens to individual investor's accounts, but have been afraid to ask. What I don't understand is what happens to people with accounts in a firm that goes under? I know Merrill Lynch is being taken over, but I don't know what happens to individual small fry accounts like mine. B., Ancram, NY
Answer: Your account is safe. You may be a "small fry" like most of us, but you're still a valuable customer with assets.
Like any merger, there will be a (difficult) knitting of back offices, maybe a name change, perhaps a different logo, and some new employees. These are the kinds of shifts in business that typically accompany a merger.
But you still own the mutual funds, stocks, bonds, or whatever securities you have in the MFA that makes up your Roth. The same holds with your SEP.
I would keep a close eye on several things. First, watch to make sure the information about your account stays accurate. Problems can emerge in the aftermath of a merger, and it's always easier to get the information fixed if the mistake is caught early. Pay attention to any fee changes or investment charges. Monitor customer service. All of these could improve or get worse in the coming months or year.
Too big to fail?
Question: Is Bank of America too big now to fail??? Do we have to few institutions? Jeff, Arlington, IN
Answer: Yes, Bank of America is too big to fail.
I expect with the benefit of hindsight that the deal struck by BofA to buy Merrill Lynch for about 40 cents on the dollar will turn out to be shrewd move. For one thing, the bank has snapped up one of the most famous brands in the country--let alone on Wall Street--at a bargain basement price. For another, BofA has made sure after this acquisition, the purchase of Lasalle Bank, and the takeover of Countrywide Financial, that in the eyes of regulators the financial services behemoth is too critical to the U.S. financial system to fail. Indeed, management has spent $100 billion over the past 5 years on acquisitions, according to the Wall Street Journal. The buying spree puts BofA at the top of the U.S. financial services industry
To your second question, the financial sector is reorganizing and shrinking. But it was probably too large to begin with, growing at a rapid pace over the three decades or so. It has grown to a much larger share of GDP than we've seen in the past. Consolidation is long past due.
That said, when it comes to our own banking I don't see any reason to do business with the biggest. The real key is the FDIC (or its credit union peer). So long as there is FDIC insurance, and your business with the bank is covered by the government's insurance safety net, then you should feel free to bank at a community bank, a regional bank, or your local credit union. The question remains whether a bank the size of BofA can deliver good service at a low cost to its customers. The good news is that there are plenty of competitors eager for your business if it doesn't.
Credit unions
Got this nice note this morning. It's an important reminder.
For Chris: I'm a regular listener and appreciate your work. Just a reminder that when folks are looking for safe deposits, equivalent to a bank with FDIC insurance would be a credit union with NCUA (National Credit Union Administration) insurance. It has the same full faith and credit backing of the federal government, $100,000 limit per account and multiple account structure as FDIC. Virtually all credit unions have this federal coverage. Depositors can look for the blue NCUA logo in the lobby or on a website. Thanks. Bill Hampel, Chief Economist, Credit Union National Association
09/19/08 by Chris FarrellMoney market mutual funds
Question: If the government is now going to insure money market funds, will the return go down as the risk does? Carolyn, Tallahassee, FL
Answer: Yes, the return should go down. It's an axiom of modern finance theory that the only way to create the potential for earnings a higher rate of return is by taking on greater risk. Money market mutual funds, which weren't covered by the FDIC, paid investors more than comparable FDIC insured deposits.
Now, the federal government has created the equivalent of the FMMMFIC--the Federal Money Market Mutual Fund Insurance Corporation. Of course, that really means the American taxpayer is backstopping the $3.5 trillion in money market mutual funds for the next year. (It also means that everyone--like me--who accepted a lower yield on their money market fund in return for parking emergency money in the most conservative option paid an unnecessary interest rate penalty. Those that reached for yield just got bailed out.)
The federal guarantee that money market mutual funds won't "break-a-buck" is for a year. But there is no way to put this financial genie back in the Wall Street bottle. Everyone knows the government will bail out the money fund business the next time trouble hit. What the year does is buy the authorties time to come up with a new regulatory scheme that takes into a account the federal government's explicit guarantee of our short-term savings.
For more information, check out Tess' conversation on money market funds with Marketplace' s Amy Scott on this week's Marketplace Money.
by Chris FarrellTax exempt money market mutual funds
Question: I have a municipal mm mutual fund with Fidelity. It is spread across all 50 states. The prospectus shows that for instance Lehman is the "liquidity facility" sometimes Bof A is mentioned or Morgan or JP Morgan Chase. What does that mean about the safety of this mm fund? Susan, Irvine, CA.
Answer: Right now, money market mutual funds are among the safest parking places for cash available. That's because the U.S. Treasury has decided that the American taxpayer backstops the business. The details are still being worked out, but the guarantee is that any publically traded money market mutual funds won't "break-a-buck," the financial pledge that at a minimum the dollar you've invested in a fund will be worth at least a dollar tomorrow. Funds will pay a fee to participate in the program, and the insurance plan has been funded with up to $50 billion. It only includes money invested before Sept. 19.
The Treasury has also clarified that the insurance pledge includes tax exempt money market funds. So, your very short-term fund has the protection of diversification (across all 50 states), the financial soundness of Fidelity and the Treasury's insurance guarantee.
The Federal Reserve has also adopted several rules to make sure that there is sufficient liquidity in the market. (More liquidity means it is easy to buy and sell assets at their fair market value, and less liquidity means it gets harder to buy and sell.)
Fund 401(k)?
Question: I am in my 30's and committed to a long term investment in my retirement. I have decided not to look at my 401k during this terrible financial time, since I am in it for the long haul. I have heard some commentators on the show mention that they are doing the same.
My question is - should I significantly decrease my contributions or stop contributing to my 401k all together until this crisis has passed?
I understand that could be awhile. My plan would be to put the money that I would have contributed to the 401k into a regular savings account. I know it won't grow but it probably won't disappear. Thanks for your help! I love the show. Nicole, Brooklyn, NY
Answer: You're far from alone in your confusion and nervousness. We're all feeling the financial strain of the past few weeks. My advice is to continue to put money into your 401(k). Last week, here's what Michael Mauboussin, chief investment strategist at Legg Mason's said to me last week: "With a longer time horizon, say 10 to 20 years, even the crash of 1987 looks like a blip."
However, you can always change where the money goes. The best strategy for most people your age, say, 20 to mid-40s, is to stick with the existing asset allocation. Assuming you have a well-diversified portfolio you'll do better staying put than selling in a panic. But you might have learned the hard way that your portfolio choices are too risky. You don't like this volatility. If that's the case, I would figure out how you'd like to adjust your portfolio to a more conservative position, and then do it over time. For instance, I would look at putting some money into a safe harbor like Treasury Inflation Protected Securities. Many 401(k) plans now offer a mutual fund option that invests in TIPS. If that isn't available, another conservative option is a fund made up of short-term Treasury bills.
The exception to this overall approach is if you're holding a risky, highly undiversified portfolio. In that case, I would bite the bullet and make major changes fast.
A final thought: While I would keep funding the retirement savings plan no matter what--especially up to the company match--it can make sense to reduce your contribution if you don't have emergency savings or if you can sense you're at risk of getting laid off.
Federal credit unions
Question: On last Friday's show it was stated something to the effect: "congress will never let the FDIC run out of funds". What about the NCUSIF? PLEASE WITHHOLD MY NAME, Scotia, NY
Answer: Technically, the FDIC could run out of money. But I don't believe the Treasury or Congress would let that happen. The same holds with the NCUSIF (National Credit Union Share Insurance Fund), the federal insurance guarantee for federal credit unions.
09/24/08 by Chris FarrellAre IRAs safe?
Question: "Is our IRA account in UBS Financial Services Inc. safe during this wall street crisis?"..." If not, would you recommend taking the money out and putting it into treasury bonds or treasury money markets with an FDIC approved bank?" Thank you for your assistance Lynette, Chico, CA
Answer: There are two answers to this question. First, your IRA account is safe. Even if UBS got into trouble, another financial services firm would take over the account. Second, the value of the account depends on what assets you're invested in. To take an extreme example (just for the sake of illustration) lets say all the money had been invested in Bear Stearns and Lehman Brothers. You'd be wiped out. In sharp contrast, if all the money were in T-bills, you'd be sitting (relatively) pretty.
Money market mutual funds
Question: I have been told that I should transfer my cash into treasury money market funds (MMF) to protect them during the current crisis. As of now MMF's are not insured or backed by the goverment. Should I assume that treasury MMF's are safe since they are invested U.S. treasury notes? George, Baltimore, MD
Answer: Right now, the savings parked in money market mutual funds before September 19th is extremely safe. In essence, to stop a modern run on the Wall Street bank--an investor flight from money market mutual funds--the Treasury decided to backstop the $3.5 trillion business with the full faith and credit of the American taxpayer. Call it the Federal Money Market Mutual Fund Insurance Corp.
The regulatory rules of the new insurance fund are still being drawn up, the government is determined the traditional industry pledge that net asset value on money funds won't "break a buck" will hold. The dollar you put into a taxable or tax exempt money market mutual fund before September 19 will be worth at last a buck when you withdraw money from the fund. I've long argued for savers to use the money market mutual funds that invest heavily in Treasuries. Why take a risk with your emergency savings money? You want it stashed in a safe haven.
Retirement savings and debt
Question: I have a SEP plan. I make quarterly contributions. I commit a % for the year. At the end of the year if I have extra I contribute more. My question is would I be better off putting the extra into paying off my car? Or just putting it in savings? I am sticking to my quarterly contributions but it is hard when by the next quarter it has "vanished". I am looking at retiring in 15 years. My spouse has a 401K, company pension and separate investments. Would it be better for him to not contribute at this time to the separate investments and work towards paying off the house? He is looking at retiring in about 11 years. Elizabeth, Indianapolis, IN
Answer: I'm glad that that you aren't just looking at your retirement portfolio. It's really easy to get caught up in the downward gyrations of the bear market in stocks and the abrupt shifts in market interest rates. (Imagine, the yield on the 3 month T-bill went briefly negative last wee. That's right, less than 0%.) It's good to keep funding it too.
When it comes to managing household finances, the main message of the past year has been get household finances in good shape by spending less and paying down debt. That's why I like your thought of taking that extra cash in this tumultuous environment and putting it toward eliminating the car loan.
However, I'd recommend that your spouse continue to save for retirement, too, as well as build up household savings rather than take dramatic steps to pay off the mortgage early.
Of course, in the heart of most (all?) homeowners burns an intense desire to say goodbye to the bank for the last time and own a home free and clear. There are advantages to accelerating mortgage payments. You can get a good return on your money, especially in this market. Let's say your mortgage rate is 6%. In that case, by paying down your mortgage early you'll earn the equivalent of a simple 6% rate of return on your money. If your rate is 5%, the return is 5%. (This simple example doesn't take into account taxes and other factors.) You'll save thousands and thousands of dollars in interest payments. And it's important for most people to be debt free when they enter their elder years--and that's what you want.
That said, here's why I'm cautious about getting too aggressive with mortgage payments. My basic problem is that most people end up putting too much of their financial eggs in one basket -- a home. That's another way of saying that your financial health is now increasingly dependent on how one asset performs and, as we are witnessing right now, home prices can go down as well as up. Diversification pays.
For me, the key is building up a well-diversified portfolio of cash, stocks, bonds, commercial real estate, commodities, and international equities--even in a market like this one. I especially like investing in Treasury Inflation Protected Securities (TIPS) and I-bonds. Both of these default-free securities sold by the federal government will protect you against the ravages of inflation. The value of your home shrinks as a percent of your net worth over time. Once you've built up a well diversified portfolio, then pay off the mortgage by all means.
A sensible way to shorten the life of your mortgage without taking drastic action is to make an extra monthly payment a year. By writing 13 monthly mortgage checks instead of 12 you'll pay off that loan faster. Just be sure to tell the bank in writing to put that extra payment toward principal.
Refinance mortgage?
Question: Yes, I'm one of those people with a sub-prime mortgage. When I got divorced and took over my mortgage, money was tight, so I got a 5 year ARM at 4.625. The lower rate expires in April of next year, and goes to LIBOR plus my margin of 2.25. Right now, that would mean a rate of about 5.5%, which would mean my monthly payment would go up about $100.00, which I'm not crazy about, but I could manage. My mortgage is about 40% of my take-home pay. However, who knows what the LIBOR is going to do, and my rate continues to adjust each year on the anniversary. If I refinanced right now to a fixed rate, I think I could get something like 6.6%, which would raise my current payment about $175 dollars, plus I would have to start over at 30 years.
Here's the kicker: my mortgage is held by WASHINGTON MUTUAL! Am I exposing myself to anything dangerous by not going with a different lender? What should I do? When should I do it? I feel paralyzed with indecision. Victoria, Los Angeles, CA
Answer: Ouch! From the subprime to WaMu, the largest bank failure in U.S. history. You've had quite a window into the making of recent financial history. On a more serious note, you may feel paralyzed with indecision, but you've already started the process of calculating how much your monthly mortgage payments would go up if you kept your adjustable rate mortgage at current rates. You're right to be wary of what rates will be in the future. You've also figured out what a fixed rate will cost you. That's a good start. To jump to my bottom line, I would refinance at a fixed rate at the new WaMu/Chase--or another bank. But it won't easy.
Now, for some elaboration on why I say that. Regulators seized and sold most of WaMu to J.P. Morgan Chase & Co. The transaction went remarkably well. The mismanaged Seattle thrift was going under as depositors withdrew money at an accelerating pace. (As an aside, the one agency that has performed admirably throughout the financial crisis has been the FDIC. Indeed, if Washington had listened earlier to Sheila Blair, head of the FDIC, and her prescient persistent calls for a comprehensive mortgage solution we wouldn't be in the current financial catastrophe contemplating a $700 billion bailout. The FDIC is no FEMA and Blair of the FDIC is no Brown, the incompetent former head of FEMA during hurricane Katrina.) WaMu customers were getting money from ATMs this morning.
You're now a customer of the JP Morgan Chase, the largest bank in the U.S. measured by deposits. There's no rush to refinance right now, not with the bailout negotiations continuing in Washington D.C. But I would go to your branch and talk to a loan officer. I would have him or her look at your mortgage and see what options will be available to you and at what cost. You should also check out what competing institutions will offer you, since the takeover gives them an opportunity to nab some new customers that want to say goodbye to Wamu--even in its latest incarnation--for the last time. Hopefully, Chase will want to keep you as a customer (they did spend several billion buying WaMu's customers, after all). So see what kind of fixed rate refinancing mortgage is available to you after taking into account your credit score, the value of your home, and market conditions.
What's more, to break the paralysis I would play a financial version of Pascal's wager. Pascal is famous for saying, "Is there a God, or is there not a God?" Of course, there is no real answer to the question. But Pascal argued that we can rationally decide to act as if there is a God or act as if there isn't.
Peter Bernstein, the dean of finance economists, has long argued that people should think through a financial version of Pascal's wager. First, he says, we can't piece the investment fog of the future. There's no certainty--it's in the nature of the beast. Instead, he recommends focusing on how serious will be the financial consequences if it turns out that your wrong in your bet? If the bet goes wrong, how bad could it be and how much will it matter to your finances.
You could gamble that LIBOR will stay low. And if it does, you'll be just fine. But what if LIBOR soars, how much will it impact your finances? My own feeling is that with 40% of your income already going toward housing the downside risk is big. I would focus on getting into a fixed rate mortgage. And its fine if it is with your current lender.
Stockholders and a failed bank
Question: I know WaMu depositors are insured, but what can WaMu stock holders do now? I’m relatively new to investing, and this is the first time I’ve seen my stock drop to $0.16! Andy, Ankeny, IA
Answer: The FDIC engineered takeover of Washington Mutual by JPMorgan Chase protects depositors, not shareholders. Shareholders are essentially wiped out. At this point, the real value of your WaMu stock could come on your tax bill, using the loss to shelter capital gains or ordinary income from Uncle Sam.
09/29/08 by Chris FarrellA SEP-IRA in troubled times
Question: This is the first year I have actually made a profit, after five years of self-employment in New York City. And I'd like to keep as much of it as possible, seeing as the future is rather uncertain! My accountant has been advising me to get a $10,000 SEP IRA in order to not give all my money away to the IRS. She insists that "the market is on sale" and that I am under no risk by investing my money this way.
She has suggested that I look up a few different companies that do SEP IRA's, so I know she isn't advising me to do this out of self-interest. Still, I can't help wondering, is it safe to invest in a SEP IRA at this moment in time when banks are failing and investment companies are in such trouble? How will I know who to get it with? And what, if anything, makes a SEP IRA safe or not safe?
I'm advised I must do this before tax year is over, so that I can avoid paying taxes on the income that I will be investing in the IRA. So, can you help? I'm sure I'm not the only one who needs this kind of advice! Thanks in advance! Carolita, NY, NY
Answer: Congratulations on making a profit. That must feel good.
A SEP-IRA is a low cost and simple retirement savings plan for the self-employed. Almost any financial institution, including banks, credit unions, mutual fund companies, discount brokers, to name just a few will be glad to open a SEP for you.
The contributions you make into a SEP are with pretax dollars, so your tax bill will be lower. The money compounds tax deferred until it's withdrawn in retirement. You'll pay ordinary income taxes on the money you withdraw during retirement.In most cases, you have until April 15 to make a contribution. For the self-employed in an unincorporated business, annual contributions to your SEP can range between 0 and 20% of your net adjusted self employment income. You can always skip making a SEP contribution in a bad year without any penalty.
Question is, where to put the money? These are confusing times and the list of unthinkables that have become reality is long and growing. Still, the most important thing is to make the contribution. You're young and time is on your side.
It's absolutely fine to park the retirement money into super-safe, low-yielding Treasury bills. (And I'm not kidding when I say low yield: Following the rejection of the $700 billion bailout by the House, rates on 3-month Treasury bills fell to 0.29%. We haven't seen rates like this since World War Two. According to the Bloomberg news wire, yields did reach 0.01% January 1940, four months after Adolf Hitler's invasion of Poland.) Other safe havens include bank certificates of deposit and Treasury Inflation Protected Securities.
Now, I assume the statement the "market is on sale" refers to the stock market. Problem is, we are in a bear market that could get worse, which is another way of saying that the "discount" could get even bigger. Even if true, it's important to know whether you're comfortable with the stock market? Will the volatility bother you? Can you sleep at night? Don't worry about it if you aren't knowledgeable about the stock market. You have plenty of time to learn. Keep the IRA money safe. But please spend the time learning more about stocks, bonds, retirement savings strategies, and diversification.
Although they have different messages you can't go wrong looking at two books: The Random Walk Guide To Investing: Ten Rules for Financial Success by Burton Malkiel and Worry-free Investing by Zvi Bodie and Michael J. Clowes. Both are in paperback.
CDs and the FDIC
Question: I understand that CD's are FDIC insured, but what about the interest on them?
Are you guaranteed just the principal amount or the principal plus interest, too? Mary, Waukesha, WI
Answer: The basic insurance amount is $100,000 per depositor, per insured bank, and that includes principal and accrued interest up to a total of $100,000.
When a bank fails, here's what the FDIC has to say in more detail about the effect on accrued interest.
The FDIC's insurance coverage includes principal and interest through the date of the bank failure up to applicable insurance limit for each deposit. The accrual of interest ceases on all accounts once the bank is closed. If an open bank acquires deposits from the failed bank, the acquiring bank becomes responsible for re-establishing interest rates and beginning the accrual of interest after the date of the failure of the bank. The acquiring bank may change the interest rate on the acquired deposits, but the depositor may withdraw their insured funds without penalty if they chose to do so. If no acquiring bank is found for the deposits and the FDIC pays the depositors directly for their insured amounts, interest does not accrue past the date of failure.
Investing during a Great Depression
Question: How do you *depression-proof* your assets. My husband says there's no way; that's what a depression means. My grandmother who survived the Depression said to just keep working and hang onto what ever real property you can; she never has believed in stocks, bonds, or anything "that I can't see". Nancy, Columbus, OH
Answer: I don't think we are going into another Great Depression. That said, it's a question I've been getting more and more. The bottom line is that if we were heading into another deflationary depression the best assets to own are default-free Treasury bills and Treasury bonds, with some other very high quality fixed income securities thrown into the mix.
In my book, "Deflation: What Happens When Prices Fall", I looked into what investments did well during the Great Depression. Here's what I found out:
Now, mention deflation and the markets, and most people will recall the stock market crash of 1929. Stocks had been lurching lower after reaching a peak in September, and on October 29th the Dow plunged by 30%. Volume reached a record 16.4 million shares, an infamous benchmark that held for 40 years. From its 1929 peak of 381.17, the Dow Jones industrial average plunged to 41.22 in July 1932. At the end of the decade the Dow stood around the 150 mark, and equity investors had earned a mere real 1.43% from 1929 to 1939. It wasn't until 1954 that the benchmark index passed the level it had reached before the 1929 Crash.
Like the 1990s, the stock market seemed everywhere during the go-go years of the 1920s. Yet despite colorful tales of cab drivers, bootblacks, clerks, housewives, doctors, lawyers, and other ordinary folk gambling their life savings in the stock market, historians now believe that no more than 8% of the population owned stocks, and most of those investors were well heeled. Wealthy or not, many investors lost fortunes. Comedian and singer Eddie Cantor supposedly lost a million dollars. Songwriter Irving Berlin didn't heed the advice of Charlie Chaplin to get out and lost a bundle. Irving Fisher, widely ranked among America's greatest economists, damaged his reputation by loftily predicting shortly before the 1929 crash that stock prices had reached "a permanently high plateau." Worse, a large part of his wealth disappeared in the crash.
Again, reminiscent of Enron, WorldCom, Global Crossing, and other current examples of corporate greed and malfeasance, the reputations of Wall Street's leading lights were also tattered. Richard Whitney, acting president of the New York Stock Exchange during the crash and a famous broker with the prestigious firm J.P. Morgan as his client, grandly lived well above his means. When insolvency loomed, he defrauded customers, his wife's trust fund, and the New York Yacht Club. He was caught, convicted, and sentenced to Sing-Sing prison. Charles Mitchell, known as "Sunshine Charley" and head of National City Bank, relentlessly pushed the salesmen in his financial supermarket with branches in more than 50 cities to peddle junk bonds and junk stocks on to an unsuspecting public. He was forced to resign in 1933, and indicted for income tax evasion the following year, although acquitted.
Obviously, stocks did horribly during the Great Depression. But bonds did well. Interest rates and bond prices are two ends of a seesaw. When bond yields are rising (usually from investors anticipating higher inflation), bond prices go down--and vice versa. Bond prices soared as bond yields came down sharply during the depression. For instance, the prime corporate bond yield average went from 4.59% in September 1929 to 3.99% in May of 1931. By June of 1938 the average corporate bond yield fell to a new low of 2.94%. Bonds returned 6.04% during the 1930s. Short-term fixed income securities or bills returned 3.39% over the same time period. But even fixed income investors are wary of deflation since unwary creditors absorbed huge losses during the 1930s as cash-strapped corporations and municipal governments defaulted on their debts.
Two Wall Street tycoons that ended up with "pockets full of money" after the Crash were Alfred Lee Loomis and his partner and brother-in-law Landon Thorne. The two had been leading financiers for the new electric power industry in the 1920s. Loomis was also a scientist, and he became a major supporter of some of the century's greatest scientific minds at his Tuxedo Park home. By early 1929, the two partners had liquidated all their stock holdings and put the gains into long-term Treasury bonds and cash. The reaction by their peers, so many of them forced out of business, seemed more like envy than admiration since "in the midst of so much despair, with the economic situation deteriorating day after day, Loomis and Thorne continued to profit handsomely," writes Jennet Conant, author of the Loomis Biography Tuxedo Park: A Wall Street tycoon and the Secret Palace That Changed the Course of World War ll.
Continue reading "Investing during a Great Depression" »
09/30/08 by Chris FarrellLow rates on savings
Question: If credit and money is so difficult to get right now, why are savings accounts still yielding only around 2%? Why can't we savers get a better deal? I remember routinely getting 6% at our credit union years ago, but that is long gone. Retirees and near-retirees want to know. Diane, Sinking Spring, PA
Answer: While Congress, the White House, the presidential candidates, powerbrokers, scholars and others struggle to come up with a way to contain the credit crunch, the immediate concern on Main Street is more prosaic and equally consequential: Will the money my family has set aside for everything from paying for car repairs to meeting a tuition bill to paying for high blood pressure pills be there when needed? Put somewhat differently, "what is the safe harbor," asks Zvi Bodie, finance professor at Boston University.
The answer is that there are several "safe harbors." Many are fleeing into a handful of options that are essentially risk-free parking places for money. The trade-off for a no-risk to low-risk safety net is a low interest rate and a low investment return. All the savings options involve relying on U.S. government backing rather than private sector promises.
Take short-term Treasury bills. Investors from around the world have decided to seek safety in T-bills. As I am writing this, investors are willing to get paid an interest rate of a mere 0.81% in return for owning a default-free investment, the 3-month T-bill.
You can do a little bit better with money market mutual funds that invest solely in short-term Treasuries, but not by much. For instance, the yield on the Vanguard Treasury only money market mutual fund is about 1.6%. And, of course, you mentioned your savings account. Well, assuming the deposits are insured by the FDIC, no one has lost a penny since the government's bank insurance fund was established in 1933 if the accounts had less than the insured limit. It looks like Washington is moving toward raising that limit even more, perhaps to $250,000. The $100,000 limit is something of a misnomer, however. It's relatively easy to park a multiple of that sum at the same bank and still get the total insured by the FDIC.
Again, because of concerns over safety--will my money be there when I need it--banks don't have to pay you much for your savings. The rates of certificates of deposit or CDs have gone up recently, but not that much.
One other point: Despite consumer inflation up over 5% so far this year, fears of inflation are receding. Higher inflation rates can drive up interest rates. But with the U.S. economy in recession, debt imploding, and the global economy slowing down it's hard to see the over all price level climbing higher anytime soon. (Nevertheless, I am a big fan of Treasury inflation protected securities, better known as TIPS. These default-free securities protect the investor from the ravages of inflation if it does ever pick up. TIPS offer a fixed interest rate above inflation as measured by the consumer price index (CPI). The bond's principal is adjusted as the CPI changes. That said, TIPS have one drawback for safety-minded individual investors: Taxes. In essence, Uncle Sam requires owners in taxable accounts to pay income taxes on inflation-adjusted gains before getting any of inflation-adjusted money at maturity. The trick to avoiding the tax hit is to own the bonds in a tax-deferred retirement savings account.)
Today's very low interest rates are painful for many savers, especially retirees. Still, my own feeling is that the trade-off is worth it.
Continue reading "Low rates on savings" »
10/01/08 by Chris FarrellFund a 529 plan now?
Question: My son is 4.5 and I am thinking of starting a 529 plan for his college tuition (I know I am late to this). My question to you (I know it sounds dumb but I want to get it right) - is this a good time to buy a 529 plan or should I wait for sometime and wait for the markets to stabilize? Krishnan, Tallahassee FL
Answer: No, you’re not late getting started on a college savings plan. You have plenty of time on your side since your son is less than 5 years old. And no, it isn’t a dumb question to ask. A lot of people share your concern considering the Wall Street credit crunch and the global financial crisis.
That said, the big advantage of funding a 529 plan now—despite all the turmoil—is that the money will compound tax free until you need it to pay for your son’s college sheepskin. What’s more, the money can be withdrawn tax free so long as its used for qualified expenses, such as tuition. I’d get the money to work.
Now, the option I like the most is the age-based investing option. The younger the student, the higher the percentage is invested in an equity index fund and as the student ages the percentage invested in equities automatically decreases and the percentage invested in fixed income securities automatically increases. Of course, the equity portion of the portfolio is getting hammered right now. If that’s too risky an option for you, most plans offer a money market fund as well as a conservative bond fund choice.
I’d open the plan and harness the power of tax free compounding over time.
10/02/08 by Chris FarrellLibor
Question: I hear that Libor’s rate have gone up a lot. Is this the same Libor rate that adjustable mortgages are pegged to? Dan, Baltimore MD
Answer: Yes, many U.S. adjustable rate mortgages are pegged to the Libor rate. Indeed, it’s estimated that about half of the ARMs written in recent years were linked to Libor.
Libor is short-hand for the “London interbank offered rate”. Libor is calculated for several currencies, including in dollars. The greenback rate is set everyday before noon by data collected from 16 banks by the British Bankers’ Association. You can learn more about Libor at the BBA’s website here.
The recent surge in Libor reflects the global credit crunch. The 3-month Libor rate was trading over 5% when the first bailout bill failed to pass but it has come down close to 4% with the second attempt succeeding. Still, banks are hoarding cash, unsure when they will need the money and increasingly fearful of lending it out.
The Libor rate is critical throughout the world. It influences everything from home loans to credit cards. According to Bloomberg, Libor determines prices for financial contracts valued at $393 trillion as of Dec. 31, 2007. Breaking it down, the story calculates that’s some $60,000 for every person on the planet.
10/03/08 by Chris FarrellThe money market mutual fund stabilization fund
Here is the press release put out by Treasury on its back-up plan for making sure that money market mutual fund money invested before September 19 doesn’t “break a buck”.
September 29, 2008 hp-1161
Treasury Announces Temporary Guarantee Program for Money Market Funds
Washington- The U.S. Treasury Department today opened its Temporary Guarantee Program for Money Market Funds. The U.S. Treasury will guarantee the share price of any publicly offered eligible money market mutual fund - both retail and institutional - that applies for and pays a fee to participate in the program.
All money market mutual funds that are regulated under Rule 2a-7 of the Investment Company Act of 1940, maintain a stable share price of $1, and are publicly offered and registered with the Securities and Exchange Commission will be eligible to participate in the program. Treasury first announced this program on Friday, September 19.
The temporary guarantee program provides coverage to shareholders for amounts that they held in participating money market funds as of the close of business on September 19, 2008. The guarantee will be triggered if a participating fund’s net asset value falls below $0.995, commonly referred to as breaking the buck.
The program is designed to address temporary dislocations in credit markets. The program will exist for an initial three month term, after which the Secretary of the Treasury will review the need and terms for extending the program. Following the initial three month term, the Secretary has the option to renew the program up to the close of business on September 18, 2009. The program will not automatically extend for the full year without the Secretary’s approval, and funds would have to renew their participation at the extension point to maintain coverage. If the Secretary chooses not to renew the program at the end of the initial three month period, the program will terminate.
To participate in the program, the Treasury Department will require money market funds with a net asset value per share greater than or equal to $0.9975 as of the close of business on September 19, 2008, to pay an upfront fee of 0.01 percent, 1 basis point, based on the number of shares outstanding on that date. Funds with net asset value per share of greater than or equal to $0.995 and below $0.9975 as of the close of business on September 19, 2008, will be required to pay an upfront fee of 0.015 percent, 1.5 basis points, based on the number of shares outstanding on that date. These fees will only cover the first three months of participation in the program.
Funds with a net asset value below $0.995 as of the close of business on September 19, 2008, may not participate in the program.
While the program protects the accounts of investors, each money market fund makes the decision to sign-up for the program. Investors cannot sign-up for the program individually. Funds should apply by October 8, 2008 for the program using the forms on the program webpage: http://www.treas.gov/offices/domestic-finance/key-initiatives/money-market-fund.shtml.
Eligible funds include both taxable and tax-exempt money market funds. The Treasury and the IRS issued guidance that confirmed that participation in the temporary guarantee program will not be treated as a federal guarantee that jeopardizes the tax-exempt treatment of payments by tax-exempt money market funds.
President George W. Bush approved the use of existing authorities by Secretary Henry M. Paulson, Jr. to make available as necessary the assets of the Exchange Stabilization Fund to guarantee the payment
The Exchange Stabilization Fund was established by the Gold Reserve Act of 1934, as amended, and has approximately $50 billion in assets. This Act authorizes the Secretary of the Treasury, with the approval of the President, “to deal in gold, foreign exchange, and other instruments of credit and securities” consistent with the obligations of the U.S. government in the International Monetary Fund to promote international financial stability. More information on the Exchange Stabilization Fund can be found at http://www.treas.gov/offices/international-affairs/esf/
And here is the FAQ: September 29, 2008 hp-1163
Frequently Asked Questions About Treasury’s Temporary Guarantee Program for Money Market Funds
How does an investor sign up to participate in the Treasury’s Temporary Guarantee Program for Money Market Funds?
While the program protects the shares of all money market fund investors as of September 19, 2008, each money market fund makes the decision to sign up for the program. Investors cannot sign up for the program individually.
How will investors know if their money market fund participates in the program?
Investors should contact their money market fund directly to determine if it is participating in the program.
What type of funds does the program cover?
All money market mutual funds that are regulated under Rule 2a-7 of the Investment Company Act of 1940, are publicly offered, are registered with the Securities and Exchange Commission and maintain a stable share price of $1 will be eligible to participate in the program. This includes both taxable and non-taxable funds.
Is an investor in a fund that is managed like a money market fund but that is not registered with the SEC covered?
No, the program only covers money market funds that are regulated under Rule 2a-7 of the Investment Company Act of 1940, are publicly offered, are registered with the Securities and Exchange Commission and maintain a stable share price of $1 will be eligible to participate in the program. This includes both taxable and non-taxable funds.
When will my fund be covered by the program?
Each fund must decide to participate in the program. If your fund participates in the program, your investment as of September 19, 2008 will be covered.
How much of an investor’s money market fund is insured? What happens if the number of shares held in an investor’s account increase above the level at the close of business on September 19, 2008? What happens if the number of shares held in an investor’s account decreases below the level at the close of business on September 19, 2008?
The program provides a guarantee based on the number of shares held at the close of business on September 19, 2008. Any increase in the number of shares held in an account after the close of business on September 19, 2008 will not be guaranteed. If the number of shares held in an account fluctuates over the period, investors will be covered for either the number of shares held as of the close of business on September 19, 2008 or the current amount, whichever is less.
Examples include:
If an investor owned 100 shares in a money market fund as of close of business September 19, 2008, but owns 50 shares on the day the guarantee payment is made, after the fund breaks the buck, then that investor will be guaranteed for 50 shares.
If an investor owned 100 shares in a money market fund as of close of business September 19, 2008, but owns 150 shares on the day the guarantee payment is made, after the fund breaks the buck, then that investor will be guaranteed for 100 shares. The fund, upon liquidation, will distribute proceeds to the shareholder for the additional 50 shares, at net asset value.
If an investor owned 100 shares in a fund as of close of business September 19, 2008, subsequently sold 50 shares and later bought 25 shares, the investor owns 75 shares on the day the guarantee payment is made and will be guaranteed for 75 shares.
If an investor owned no shares in a fund as of close of business September 19, 2008, but owns 100 shares on the day the guarantee payment is made, none of the investor’s shares are guaranteed by the program and the investor will receive the net asset value directly from the fund. What if another fund in an investor’s fund family breaks the buck before this program starts? Is the investor covered?
The program provides a guarantee on a fund-by-fund basis up to the amount of shares held as of the close of business on September 19, 2008. The performance of a different fund, even one in the same fund family of the investor’s fund, doesn’t affect the investor’s fund’s eligibility. Investors should contact their fund to determine if their fund participates in the program.
When does the program terminate?
The program is designed to address temporary dislocations in credit markets. The program will be in effect for an initial three month term, after which the Secretary of the Treasury will review the need and terms for the program and the costs to provide the coverage. The Secretary has the option to extend the program up to the close of business on September 18, 2009. In order to maintain coverage, funds would have to renew their participation in the program after each extension. If the Secretary chooses not to extend the program at the end of the initial three month period, the program will terminate.
Who provides this guarantee? Are investors able to get all of their money back whenever they want?
The U.S. Treasury Department, through the Exchange Stabilization Fund, is providing this guarantee. In the event that a participating fund breaks the buck and liquidates, a guarantee payment should be made to investors through their fund within approximately 30 days, subject to possible extensions at the discretion of the Treasury.
Is shareholder in a fund that broke the buck before September 19, 2008 covered?
No. This does not meet the program’s eligibility criteria noted above.
What should shareholders in a participating fund that breaks the buck do? Who should they call?
If your fund enrolled in the program you will be covered and do not need to take any action. Shareholders should contact their fund directly.
Who should a fund contact if it has further questions about this program?
Please e-mail the Treasury Department at moneymarketfundsguaranteeprogram@do.treas.gov.
10/04/08 by Chris FarrellTax exempt bond funds
Question: Almost all of my fixed income holdings are in municipal bond funds, since my wife and I are in the 28% tax bracket. I’m wondering about the safety of municipal bonds at this time, given the current economic environment, and whether we would be better off diversifying into government short or intermediate term bond funds. Any thoughts you have about this matter would be greatly appreciated. Larry. Hurleyville, NY
Answer: The 13-month old credit crunch has taken its toll on tax exempt bond funds. The state of California is facing a cash crunch, and may need a $7 billion federal bailout. (Isn’t it amazing how we’re just tossing around the term “billions”?) New York City plans to cut its budget. States and localities across the country are dealing with declining revenues, and the fiscal situation will only worsen as the economy sinks into recession. Many economists are changing their forecasts for the economy. They’re predicting a higher unemployment rate and a lower GDP number than before. Investors are fleeing even high quality munis for the safety of U.S. Treasury securities. According to the mutual fund rating service Morningstar, muni bond funds are in the red, with the typical fund down 5.6%. Much of that decline has happened over the past year.
There is another factor haunting the market: The unthinkable is increasingly thinkable. Default rates have been low in recent decades in the state and local government tax exempt market. Yet this credit crunch has overturned many historically based rules-of-thumb. The combination of a recession and credit crunch could drive the muni default rate higher. Are muni’s less safe than recent experience would suggest?
Troubling questions like this and the worsening fiscal situation are behind some crazy moves in the market. For example, investors are pocketing a higher yield from tax-exempt money-market mutual funds than from their taxable counterparts. Normally, tax-exempt yields are lower than taxable yields, since the tax hit is so much less. Money market funds that invest only in short-term U.S. Treasuries yield about 1.5% compared to a yield of about 5% or more on tax-exempt money market funds. So an investor in the 35% federal tax bracket filing jointly and paying what the Tax Foundation calculates is an average 9.7% state and local tax burden (since the securities come from municipalities around the country) earns somewhere around a 5% yield on the tax-exempt fund compared with around 1% on the taxable money market Treasury fund. In the 28% tax bracket the taxable yield jumps to 1.08%.
What to do? I know a number of smart people who are putting some of their risk money into high-quality tax exempts, especially into tax exempt money market mutual funds (and the tax exempt money market mutual fund money that was invested before September 19 comes under the Treasury’s new stabilization fund program). These investors believe the risk is worth the reward. They are comfortable with the risk..
Your investment issue isn’t a case where I can easily tell you to “do this, but don’t do that”. Instead, here’s my advice for a portfolio issue like yours: Make sure that you’re in the conservative portion of the tax exempt universe.
It pays to stay with high quality in the municipal bond market (as well as the corporate bond market), even though yields are lower. Safety matters. That’s why diversification also pays. I like tax exempt funds that invest around the country rather than in one locality—even though that means you give up some tax advantage. The added protection is well worth the small tax hit you’ll pay.
Larry, I am a strong believer in diversifying down to the sleeping point. If you’re comfortable with your fixed income portfolio after thinking it through, fine. If you are still worried, then diversify into Treasuries—enough so that you can relax
10/06/08 by Chris FarrellIRA vs, student loans
Question: I currently have approx. $60,000 saved for retirement, combined between a Roth IRA (Vanguard and Raymond James) and a SIMPLE IRA (Fidelity) offered through my employer. All the money is in mutual funds like Vanguard’s Total Stock Market Index fund, energy funds, materials funds, emerging markets, small- cap, etc. My entire portfolio is down by approx 25-30% from one year ago.
Also, I have approx. $28,000 in student loan debt from my Master’s Degree. I am paying approx. 5.5% on those loans. My question is this:
Does it make sense to cease contributing to my IRAs (with negative returns) and shift that money to paying off my student loans?
or Does it make sense to keep contributing to the IRAs - with the assumption I’m buying these mutual funds “on sale”. Any advice would be greatly appreciated! Heidi. Tucson, AZ
Answer: Sorry I have taken so long to post this Q and A. I got caught up in the latest presidential debate.
Anyway, the financial environment we’re in rewards savings and penalize debt. I believe that dynamic will hold even after the global credit logjam is eased and the economy emerges from recession. The advantage of accelerating your student loan payments is that you lock in a 5.5% or so rate of return with every payment.
That said, it’s important to keep funding your SIMPLE IRA at work, especially if your employer matches your contributions (up to a limit of 3% with a SIMPLE). The real investment return kick on any employer-sponsored retirement savings plan comes from the match. At the stage of life when you are savings for retirement you want to build up tax sheltered savings in a well-diversified portfolio. And you can put up to $10,500 in a SIMPLE this year ($13,000 if you’re over 50).
We’ve all gotten a lesson in how diversification doesn’t shelter a portfolio much during a global economic meltdown—unless the portfolio is heavily invested in Treasury bills, Treasury Inflation Protected Securities, or a similar safe haven. But that doesn’t mean diversification, compounding over time and dollar cost averaging (putting money into the market on a regular basis) isn’t a good strategy. The advantages of diversification will reemerge, typically within is three to six months, estimates Ross Levin, a certified financial planner and head of Accredited Investors Inc. in Edina, MN. “During times like this, don’t extrapolate what is happening today to fifteen years down the road,” he adds.
The current stock market “bargain” could become more of a bargain down the road. I’m not a market timer. Still, I like stocks. I am confident that the U.S. economy will rebound and that owning the total stock market index will pay off over time. So, I would continue to fund a retirement savings plan, and I would stick to a well-diversified portfolio. Time remains your friend.
However, assuming you continue to put savings into a retirement savings, then by all means take some of your discretionary income and it to work toward paying down your student loans.
10/07/08 by Chris FarrellRebalance portfolio?
Question: I’ve generally tried to rebalance my portfolio at the end of each quarter. However, with the stock market volatile and descending, I’m reluctant to rebalance toward stocks until I see some stability in the market. What’s your recommendation regarding asset allocation and portfolio rebalancing in these troubled times? Mike, Woodbury MN
Answer: Whew, it’s hard to sell a good performing asset and buy a poorly performing one under normal circumstances, let alone during a bear market. From your email, it sounds as if you’re pleased with how you’ve allocated your money between various investments, such as stocks, bonds, and international equities. It’s the timing of getting back to the percentages you choose that’s troubling you. “Rebalancing is critical during these periods,” wrote Ross Levin, a certified financial planner and head of Accredited Investors Inc. in Edina, Mn. in a recent letter to clients. “By systematically rebalancing, you are forcing yourself to buy low. It has worked for us time and time again in my twenty-six years in this business.”
The list of unthinkables that has happened recently is long and growing. But I still think that Ross Levin is right. Rebalancing will pay off. And there’s no question that doing nothing will impact your asset allocation. For example, suppose you divided your portfolio into 60% stocks and 40% bonds. But after that you didn’t touch it. According to recent calculations by money managers Mark Kritzman, Simon Myrgren and Sebastien Page stocks would have varied from a low of 33% to a high of 99% during the past eight decades. Moreover, they add, the portfolio would have been more than 10% over-weighted in stocks nearly 75% of the time.
You can rebalance your portfolio either by redirecting future purchases or by shifting money among current holdings.
10/08/08 by Chris FarrellA money market mutual fund clarification
A clarification: There has been some confusion about an answer I gave last week about money market mutual funds. The Treasury stabilization fund only backs money that was in a money market mutual fund as of September 19. Plus, the money market fund has to decide to participate in the Treasury program. If you transfer money from a money market mutual fund that isn't participating in the program into one that is you won't get the Treasury backing since the funds had to be deposited before September 19.
However, I do think that the odds of a run on a money market mutual fund that is part of the program dramatically shrinks. There is an extra layer of safety even for money deposited after September 19.
10/09/08 by Chris FarrellTime to buy a condo?
Question: Thanks for being a voice of reason, especially these past few weeks.
I am a 56 yr old, single woman. I owned my own business for 16 years and consequently am only now beginning to put away money for my retirement. I have about $35,000 inheritance from my father. I am employed at a non-profit research institute, which relies largely on grant funding, but which has been decently funded for 50 yrs.
Here's my question: as I am looking to plan a retirement, I am considering buying a condo now in the $200 - 235,000 price range (housing here is such that anything less than that is nothing I'd really want to live in). If I use the inheritance money for a downpayment, I should be able to get a mortgage that I can comfortably afford - and still be able to put money in my 403B(10% of my salary + 3% from company and HSA ($3800. per annum). So, is this a brilliant time for ME to buy? Or is it foolish?
I keep my money in a local FCU, and although I haven't looked recently, I believe they are still making mortgage loans. I look forward to your thoughts. Mary Ellen, St. Paul MN
Answer: It's intriguing that we're starting to get more questions like yours. Home prices may be hitting a level that interest more buyers.
I think now is a great time to look for a house, to research a home, to visit lots of homes and condos, investigate neighborhoods, and really figure out what you like in your price range. I don't think you are being foolish at all.
That said, there's no rush to buy. It's a safe bet that home prices are still heading lower, especially with the economic downturn gathering momentum. I believe the credit crunch or credit crisis will come to an end. Clearly, it won't be easy, but governments and central bankers everywhere are making a concerted effort to break the credit logjam. Yet the damage to the real economy of goods and services, jobs and incomes will haunt us for a long time even after the financial institutions start borrowing and lending again.
Of course, none of us can really time bottom. But if you spend the time now finding what you want you can then evaluate whether it's a good buy for you. And at some point prices will bottom out and the market rebound.
When you're looking, also think about retirement. For when it comes to finding a retirement home, the best answer for many people is current home. I have a feeling that you'll want to stay in this place, so look into how feasible the condo is from a long term care point of view. Staying at home doesn't just mean judging whether its an easy place to live in as you age, but it also means evaluating the infrastructure of your neighborhood. Among the key question to ask: Is there convenient public transportation or are family and friends willing to drive you around? What medical and home health care services are available?
Buy gold for IRA?
Question: Hi Chris, I am seeking advice as to what I should do with my IRA fund. I have a portfolio of various mutual funds that used to be worth $ 17,000 now is about $ 13,000. I have lost plenty from the latest stock market crashes. Since it might be a long while till the bull market reappears, do you think I should keep things as they are or should I cash out or are there other options?
I realize I will take quite a hit if I cash out so what other alternatives do I have that could spare further losses in the market. I have been thinking of buying gold certificates with some of the money I have in my IRA, would this be a wise move? Theresa, Manchester
Answer: Last night at NET in Nebraska I participated in a statewide public radio and public television call-in show. In essence, the topic was the global financial crisis and you. The questions were terrific and it was a good show. You can listen to it at NET Nebraska.
Gold came up several times during the conversation in Nebraska. It's a traditional safe haven, and the price of gold has jumped to over $900 an ounce in the commodity futures market. Is gold a place to seek shelter from the financial storm?
I'm a skeptic. The precious metal has been doing well during the financial crisis. It could do a lot better, too. My problem with buying gold now is that it's a pure speculation on price appreciation--a bet that you will be able to sell it at some point in the future at a higher price than you bought it. But the metal is volatile. Again, it's a speculation. Put it this way: Gold doesn't pay dividends. It doesn't create cash flow. It fluctuates on speculation. It isn't a good investment for an IRA.
If you want to own gold I would do so outside the IRA. The are some exchange traded funds (ETFs) that offer a cost-effective option for the individual investor. There are also some mutual fund options.
The counterpoint to my perspective on gold comes from mutual fund maestro Jean-Marie Eveillard. He had a terrific long-term record running the First Eagle Global Fund for more than a quarter century. Like many wealthy Europeans, he always had a small percentage of the mutual fund equity portfolio invested in gold. He treated it as an insurance policy. When the equity markets went down, the price of gold would go up, cushioning the impact on the portfolios value.
Still, I prefer Treasury bills and Treasury Inflation Protected Securities. These are investments that preserve capital and make you some money. No one will get rich with these securities, but the value of a dollar will be preserved. TIPS are a more cost effective insurance policy.
The FDIC, a bank merger, and deposits
Question: Hey - Imagine that last week I had $250,000 in deposits in Wachovia and another $250,000 in Wells Fargo, all FDIC insured, all okay. Now that they are the same company, would I still be fully insured? Bill, Louisville KY
Answer: I don't think I'd go to Las Vegas with you, but as far as your insured deposits go you would be just fine. According to the Federal Deposit Insurance Corp. when two banks merge--whether it's a shotgun marriage or a voluntary union--the FDIC provides a "grace period" that protects depositors with funds at the two banks. As a general rule, the accounts would continue to be separately insured for 6 months after the merger. The idea is that 6 months gives you enough time to make any needed adjustments to your accounts to stay insured going forward.
By the way, the grace period can be longer for certificates of deposit (CD). When a CD is taken over by another bank thanks to a merger, it continues to be separately insured until the earliest maturity date after the end of the six-month period.
10/13/08 by Chris Farrell
Gold, again
Question: If very high inflation is in our future due to the Great Bailout, would your same advice re gold in a IRA still hold? Ned, Melbourne FL
Answer: Gold will do well if the massive government bailout does lead to a high and rising increase in the overall price level or inflation rate. Gold is a traditional hedge against the debasing of the currency, and gold did spectacularly well during the Great Inflation of the 1970s. The price of gold soared in recent years along with skyrocketing prices for food and energy.
When investors get truly nervous about the U.S. economy many seek refuge in gold. Considering how scared so many people are today even after the Treasury announced the semi-nationalization of 9 major U.S. banks it's no surprise that gold is trading at $842 an ounce. That's down from a peak of more than $900 an ounce, but still high.
By the way, gold's previous peak was $850 in 1980. Adjusted for inflation, gold would have to reach over $2224 an ounce to best that price.
That said, I don't think we're going to have another Great Depression because the actions being taken by the monetary and fiscal authorities will succeed at restoring trust in the credit markets. I do believe the recession in the U.S. will be long and severe. I am more worried about the prospect of deflation or a decline in the overall price level than I am over inflation. Asset prices are sharply lower. The banking system is damaged. The competition for markets and profits will heat up in the global economy with growth slowing worldwide. Taken altogether, it seems like a recipe for falling prices. Even the International Monetary Fund has also weighed in on the topic, arguing that deflation is a real risk in a decelerating global economy.
But you could be right. Forecasting is a hazardous business. I still consider putting money into commodities a speculation and not an investment, especially in a retirement savings account. It's a gamble that you'll be able to sell the metal at a higher price in the future.
The traditional European idea of keeping a small percentage of an overall portfolio in gold as a hedge against political and economic crisis doesn't bother me. But I still prefer investing my "insurance money" in Treasury Inflation Protected Securities or TIPS. It's a default free security. You'll earn a rate of interest. You'll preserve the value of your capital with the inflation adjustment (based on changes in the CPI.) TIPS are also designed to act as a hedge against deflation, too. (While some commentators believe the Consumer Price Index is manipulated by the government I've never found the argument particularly convincing.)
The bottom line: I'm not a speculator with my retirement money. I prefer investing in my IRA. If you want to bet on the future price of gold I'd recommend doing it outside a retirement account.
10/14/08 by Chris FarrellTax exempt bonds
Question: Can you explain why an ETF that invests in 100% government insured revenue and general obligation municipal bonds would be sliding so precipitously on good days and bad ones? Thank you. Marysa. Delray Beach, FL
Answer: The tax exempt market still has a stodgy image of a market that barely moves with wealthy investors complacently clipping their coupons. The market hasn't been that way for a long time and lately it has been on a wild ride. The slide in value in your exchange traded fund or ETF reflects investor nervousness over credit quality, state and local government finances and the recession.
First, a brief definition: Tax exempt or municipal bonds are sold by state and local governments to fund roads, sewers, schools, stadiums and the like. General obligation bonds (GOs) are backed by the full taxing power of the state. It's the safest sector of the tax exempt market. Revenue bonds are typically backed by a stream of income, say, from a toll road. The income backing a revenue bond can be fairly assured or very risky.
In recent decades, state and local governments boosted the rating--and lowered the yield--mostly of their revenue bonds by buying private insurance that protected investors in case of default. It was a great business for the private insurance companies since default rates in the muni market have been traditionally low in recent decades. (I always thought the business was a scam but that's a story for another day.) In recent years, the insurance companies decided to make even more money by getting into riskier businesses where they could charge higher fees--including exposing their balance sheets to subprime loans. The move backfired badly with the housing market implosion and the credit crunch. The insurance company debacle has roiled the market.
What's more, state and local government revenues are crimped by the downturn in the economy. The consensus is that the tax revenue situation will only get worse since we are either in a recession that is spiraling downward fast (as I think) or the country is about to enter a recession that could get severe (the opinion of many economists). The expectation is that the tax exempt market default rates will be higher than recent experience, too. The last time the there were a lot of state and local government defaults was during the Great Depression.
Taken altogether, the uncertainty has driven bond prices down and bond yields up. The nervousness in the market is so great that muni bond yields are now higher than comparable U.S. Treasuries. That's amazing considering that muni bond yields are exempt from federal taxes. (Many muni bonds sold within a state are also exempt from state and local taxes. But since many muni bond mutual funds and ETFs buy bonds issued across the country you'll pay state income taxes on that kind of investment.)
Let's assume you're in the 35% federal income tax bracket. You also pay a 10% state and local tax rate (the national average). Today, the 3-year Treasury note yields about 3%. The highest quality muni bond with a comparable maturity yields some 3.6%. The muni bond yield is the equivalent of a 5.5% taxable yield. If you're in the 28% tax bracket the muni bond is still paying the equivalent of a 5.1% taxable yield.
Munis are offering their investors attractive yields, but the higher yield reflects greater risk.
Where are the stock market "circuit breakers"?
Question: why did the market not shut down during the freefalls in the past weeks?
i remember that it would shut down as did russia's in a free fall before this administration. Kate. Los Angeles, CA
Answer: I wondered the same thing. It turns out the market didn't fall enough.
The New York Stock Exchange established "circuit breakers" following the market crash of October 1987 and the plunge in the stock market in October 1989. (What is it about October and plunging stock prices?) The triggers for the circuit breakers are set at 10%, 20% and 30% of the Dow Jones Industrial average from a level calculated at the beginning of a quarter. Here are the figures for the fourth quarter of 2008.
According to the New York Stock Exchange, in the event of a 3350-point plunge in the Dow (30%) the market would close.
If the Dow dropped by 2200 points (20%), there would be a two hour stop in trading if it happened before 1 PM. (Between 1 and 2 the market would close for an hour and after 2 trading would halt.).
If the Dow falls by 1100 points (10%) before 2 PM trading would stop for an hour. (Between 2 and 2:30 there would be a half-hour stop and after 2:30 the market would stay open.)
Let's hope we don't see the kind of one-day drop in the Dow that would trigger the circuit breakers.
Moving soon and savings
Question; My husband and I are both in our early 30s and now that we are both finished with graduate school we are finally in a position for the first time in our lives to have money to invest. The money that we had saved prior to grad school had gone to purchasing our condo. We are both putting some money away for retirement through our jobs and we don't have any debt except for our mortgage and what is left on our student loans. I was planning on contacting a finical adviser however now that so many investments are loosing money (including the ones that our retirement funds are in) I am considering putting our money in some short term CDs and investing it in 6 months or so. Is this a bad idea? We were hoping to use at least some of the money to by a house in a little over a year when my husband finishes his post doc and we have to move. I have read through some of your other advise and have seen that you mention money market mutual funds often. Would this still be a good idea right now? Elizabeth, Bozeman MT
Answer: My advice for you would be the same in good times (remember those days?) and bad times (like now): Stash your short-term savings in a very safe place. The price for safety will be a low yield, but that's okay. The savings will be there when you need it.
After all, the savings will be tapped in a relatively short period of time, perhaps a year or so from now. You'll be moving and that's always expensive. You may buy a house and you'll probably want to sell you current condo. A certificate of deposit (CD) at a federally insured bank or credit union is a safe parking place for savings. If you do decide to go the money market mutual fund route, remember my two maxims for safety. First, go with a blue chip, nationally and internationally known financial institution and, second, stick with the U.S. Treasury security-only option (or the money fund that is primarily comprised of short-term Treasury securities.)
What's more, I'd put the money in a money market mutual fund that has decided to participate in the U.S. Treasury's new stabilization program. The money market fund has to sign up. To be sure, the government fund only backstops money invested in a participating money market fund before September 19th. Still, it does offer reassurance to those investors and is a source of stability to the overall fund.
For your longer term investments, including retirement, I would build up a well-diversified portfolio. I agree with an Op-Ed piece Burton Malkiel wrote in yesterday's Wall Street Journal. He's a finance professor at Princeton University and author of one of the best selling investment guides of all time, "A Random Walk Down Wall Street:"
But just because stock markets have panicked, investors should not. The best position for investors today is not "fetal and 100% in cash." We are not going to have a depression, and we have survived financial crises before. A century of investing experience, as well as insights from the field of behavioral finance, suggest that investors who bail out of equities during times like these are almost always making the wrong decision.
It is very tempting to try to time the market. We all have 20/20 hindsight. It is clear that selling stocks a year ago would have been an excellent strategy. But neither individuals nor investment professionals can consistently time the market. The herd instinct is extraordinarily powerful. When the economy and the stock market were booming in early 2000, investors could easily convince themselves that prosperity would continue without interruption and that stocks catering to the "New Economy" were surefire tickets to wealth..... The herd instinct works exactly the same way in bear markets. Nervous investors convince themselves that every "light at the end of the tunnel" is a train coming in the opposite direction. Panic is just as infectious as blind optimism.
Before you hire a financial advisor, I'd get a copy of Burton Malkiel's "The Random Walk Guide To Investing: Ten Rules for Financial Success". It's in paperback (so it's a lot cheaper than hiring a financial advisor) and the short book contains the kind of information most of us need to do well investing over a lifetime.
Online Savings and CDs
Question: I hear a lot about money market accounts, and Roth IRA's as safe haven's for investing. I've been putting money away in a ING savings account (was earning 4% at one time, now 2.75%). How come I have not been hearing of this as a viable option as a secure place to keep money? Is there an advantage of a money market account vs the ING account? Scott, Tallahassee, FL
Answer: Online bank savings accounts backed by the FDIC are a great place to save. You're not only earning a higher rate than you do on the safest money market mutual funds, but the savings are insured by the FDIC. We've been listing this kind of savings account on our menu of safe options for savings we've discussed during the credit crunch and financial crisis.
Speaking of the financial crisis, it continues to reverberate throughout Europe. Most recently, the government of the Netherlands is putting more than $13 billion into ING Groep NV, the banking and insurance giant. The financial behemoth says its oldest legal predecessor is the Kooger Doodenbos from Koog, Noord Holland, founded in 1743. ING is now one of the world's largest deposit-gathering financial institutions. It remains high on anyone's list of strong financial institutions, but investors are so nervous that the bank and the Netherlands' government decided to make a prudent injection of money before confidence started eroding. The ING parent company owns ING Direct, the online bank that operates in the U.S. and elsewhere. The key for you and others is that deposits in the U.S. branch of ING Direct are backed by the FDIC--assuming the sums saved come under the $250,000 insurance limits.
Investors are pouring more money into certificates of deposit, too. Still, considering the flight to safety and the current nervous environment, rates aren't bad. The national average for a 1 year CD is 3.6%, according to bankrate.com. (The website is a good source of information on CDs, savings rates, mortgages, etc.) Still, you can do better than that. For instance, my online bank is offering a two-year CD at 4.15%. That's well above the 1.7% yield on a two-year Treasury note. yet the risk of owning the CD is the same as owning a T-bill if the account is backstopped by the FDIC. .
Fannie and Freddie?
Question: Many of us know about the woes being felt by Fannie Mae and Freddie Mac, and their stock performance tells it well. But is now the time to buy them? I mean, with a history of a 40-60 point value, a low current value, and (seemingly) a government assurance of not failing, it seems pretty attractive to this novice investor. Thanks! Mark, Charlotte, NC
Answer: You're right that the stock of Fannie Mae and Freddie Mac are still trading. But "low" seems too mild a word. As I'm writing this, Fannie Mae is trading at.880 a share--down 97.7% year-to-date. The comparable market figures for Freddie Mac are .940 and -97.1%, respectively. That's a disaster for shareholders.
Here's what the market service Morningstar said about Fannie Mae last month:
"The magnitude and duration of the housing bust and job losses will largely determine Fannie Mae's fate. If the spiral of downward home prices, negative equity, foreclosures, and lack of financing alternatives continues, Fannie Mae might need substantial additional equity capital in order to operate. Not only are higher minimum capital standards and additional dilution a risk, the firm appears to be losing control over pricing, growth, and underwriting decisions to its conservator. The firm could also be nationalized outright based on future political decisions."
The same holds for Freddie Mac.
I'm not a stock picker. I don't think novice investors should be speculating. I guess if you have some entertainment money that might go toward an evening out, the slots at Las Vegas, or the stock of Freddie Mac and Fannie Mae, then by all means take a flyer. But its not an investment. It's a speculation.
Microfinance and the financial crisis?
Question: With all this talk of the credit crisis, I'm wondering what's become of microlending and those microlending companies you've covered in the past. Maybe you could do a follow-up on some of them? Thanks, Spencer, Andover, MA
Answer: My suspicion is that microfinance will do well--and maybe even expand--during the financial crisis. Certainly that's the point of view of Muhammad Yunus, the founding father of microfinance. The modern microfinance business began when Yunus established the Grameen Bank in 1983. It offered very small loans to impoverished people, mostly women, to finance small business ventures. The Grameen Bank, which won the Nobel Peace Prize jointly with Yunus in 2006, now has a far more solid loan portfolio than many global commercial banks. In a recent interview with Business Week. Yunus said, "Our system is based on trust, not collateral or guarantees, and still the people pay back."
Swaminathan S. Anklesaria Aiyar agrees. A leading Indian journalist and consulting editor to the Economic Times recently wrote: "This is extraordinary. Big financiers lend against collateral, a back-up if their borrower defaults. But MFIs [microfinance institutions] lend with no collateral at all. Big financiers lend to the most creditworthy corporations. MFIs lend to poor women whom nobody in history considered creditworthy before. Yet, the secured loans to big corporations are bombing, while unsecured loans to poor women are being repaid in full."
The track record is good. The need is there. The microfinance world is one where very small sums can make a big difference. And for many people the lure remains: Even though most microfinance institutions are started with public or philanthropic money, or money from other sources, many eventually become self-sustaining, profit-making enterprises.
It's a story well worth following. Thanks.
A margin of safety
Comment: My husband and I are respectively 81 and 76. Luckily my husband is very conservative and has invested largely in CD's, bonds and TIPS. About 6 % of our networth is in stocks. We live frugally, having sold our house in Connecticut in 2005, and leased a rental apartment in Milwaukee. So we are not likely to be greatly affected by the downturn. Regina, Fox Point, WI
Answer: I know there is no question here. But I've posted Regina's comment because it shows the payoff from managing finances conservatively. Their situation echoes remarks by Jack Bogle, the octogenarian founder of the mutual fund giant Vanguard, in a recent conversation I had with him: "I am a believer in diversification. You buy index funds for stocks, and your bond portion should equal your age. This is how I invest, so I know how little it's hurt me to have a substantial position in U.S. bonds."
Whether young or old, everyone needs to build in a margin of safety. After all, you can't get rid of the uncertainty. As Don Quixote de la Mancha said: "Tis the part of a wise man to keep himself today for tomorrow, and not venture all his eggs in one basket."
TIPS
Question: On a recent show, you suggested that investors should hold a significant amount of TIPS in their IRAs. I think this is a reasonable idea so I started looking into doing this. I believe that the best way to purchase and own TIPS is to own the bonds directly, since then you are locking in the maturity date. The best way I found to buy TIPS in this way is through TreasuryDirect. However, I could find no way to be able to purchase through TreasuryDirect from an IRA. So my question is: Is there a way to buy TIPS from an IRA using TreasuryDirect? Robert, Shoreview, MN.
The alternatives are
1)Buying TIPS on the secondary market from a brokerage account in an IRA. This is inferior for three reasons : you pay a commission, you will get hit with a heavy spread, it is difficult to calculate the actual "base" interest rate you will be getting.
2) Buying a TIPS mutual fund in your IRA. This is inferior because TIPS funds actually act much like bond funds, and fluctuate based on current interest rates. Also, there's the added complexity that they also will fluctuate based on inflation expectations. And there is no fixed maturity.
Answer: You're absolutely right, and it's a disgrace. I know a number of finance academics like Zvi Bodie of Boston University have lobbied for the Treasury to let individuals buy from Treasury Direct in their IRAs. But it looks like Treasury is more concerned about Wall Street commissions than the retirement security of the individual saver. The same goes for their decision to limit the amount of tax sheltered I-bonds that an individual could buy in any one year. (The limit is $5,000 electronically and $5,000 in paper bonds.)
I still like TIPS. I prefer buying on the secondary market because then you know what you have and when it will mature. But a lot of people are uncomfortable with that. In that case, I would go the mutual fund route.
Nationalizing 401k assets?
Question: Will you be writing of alternatives to 401ks in light of articles intimating the House is interested in the idea of nationalizing 401k assets? Bill, Golden Valley, MN
Answer: I've seen the phrase "nationalizing" retirement money in a number of different contexts. Still, this rumor seems to be getting some play for a number of reasons. For one thing, the list of "unthinkables" that have actually happened is long and growing. A conservative, Republican Administration engineering a more than $1 trillion bailout -so far--of the financial system. The government seizing control of mortgage giants Fannie Mae and Freddie Mac, and the global insurance giant AIG. The failures of investment banks Bear Stearns and Lehman Brothers. The quasi-nationalization of the banking system. The American taxpayer backstopping the $3.5 trillion money market mutual fund business. The possibility of another Great Depression.
For another, Argentina's government is out to nationalize some $30 billion in private pension funds. The stated reason is to protect retirees from falling stock and bond prices. But the real reason, it appears, is a desperate move by the government to shore up its deteriorating finances.
Last, charges are flying that Sen. Barak Obama will pursue a socialist agenda if he wins the race for the White House, as appears likely.
While all of us have to be careful when we say something will never happen, 401(k) assets and the like won't be seized by the government. No way. No how. Period.
To be sure, if the financial crisis continues the government may takeover or invest in more financial institutions that manage retirement assets--from insurance companies to banks-- but the U.S. government isn't the same as the Argentinean government. Congress and the White House aren't going to seize our retirement money. Barak Obama isn't a socialist and he has no socialist agenda.
That said, there are good reasons for wondering whether Wall Street should manage any of our long-term retirement savings funds. Put somewhat differently: Is the 401(k) plan, which has become the main retirement savings vehicle for the American worker over the past three decades, a mistake?
I think the case for rethinking the 401(k) as a pillar of retirement savings is compelling.
To be clear, the democratization of stock ownership is a welcome and powerful trend. Two hundred years after 24 New York brokers and merchants met on Wall Street to sign the "Buttonwood Agreement," a pact that established standard commissions for trading securities, investing now has all the characteristics of a mass social movement. People's Capitalism has helped fuel entrepreneurship and risk-taking. Despite abuses, stocks options, restricted stock, profit sharing plans, and similar equity-based compensation schemes are critical building blocks to innovation, the driving force behind economic growth. Thanks to the Internet and advanced telecommunications networks, it's cheaper than ever for individual investors to buy securities.
No, the question is focused on retirement savings, the money employees set aside during their working years to smooth out their standard of living in retirement. Employees bear all the responsibility if the worker make mistakes, and time to make up for investment mishaps shrinks as stomachs go slack and hair turns gray. It's an axiom of modern finance that the only way to create the possibility of higher returns is to take on greater risk. But the risks employees are absorbing today seem disproportionate to the potential rewards.
What's more, our retirement savings system is far too balkanized. There's 401(k)s for the private sector; 403(b)s for non-profits; 457s for state and local government employees; and SEP-IRAs for the self-employed. Then there are IRAs and Roth-IRAs. All have different rules, income limits, and restrictions. For example, you can put a maximum of $15,500 into a 401(k) while the contribution limit to an IRA is $5,000. The maximum into a SIMPLE IRA is $10,500. It makes no sense.
There is plenty of room for improvement. There have been hearings on Capital Hill recently, looking into retirement security. There should be more.
Pension experts are working on ideas that may make it easier for workers to save for the last stage of their lives. For example, a number of academic quant jocks are exploring creating annuity-like products that would guarantee workers a steady, inflation-protected income during their golden years but would be less expensive for companies to offer their employees than the traditional defined-benefit pension fund. The demand then would be on workers to take the responsibility of saving but they would avoid the burden of investing.
These ideas are worth exploring.
But as for seizing pension assets? Not a chance.
Borrow to buy?
Question: The stock market meltdown that we're facing today looks like one of the best stock buying opportunities that I am likely to face in my lifetime. I don't have a lot of spare cash, so I'm considering borrowing some money to buy some mutual funds. I'm 34, have a stable job in a good company. I have a 30-year fixed mortgage and a HELOC that currently offers an interest rate of 5.25%. I don't have much debt other than a car loan that I'm paying down. I am going to school part time on a student loan. I'm thinking about taking $4,000 or $5,000 out of the HELOC and buying an index fund or a financial sector fund. What do you think? Patrick, Atlanta GA
Answer: Big mistake. Yes, stocks may offer a high potential return, but only by taking on a considerable amount of risk. Remember, stock market returns are not guaranteed, but you will have to meet the interest payments on your loan no matter what--or put your house at risk. Borrowing on your home to invest in the stock market is always a bad bet. And in the current environment people need to be paying down debt, not adding to it.
That said, you could be right about the stock market. I don't know when or where the stock market will hit bottom, but there is value in the market. And there was a spectacular raly today of some 11%.
Warren Buffet, the famous stock picker, is buying. So is Marty Whitman, another well-known value investor of Third Avenue Management. Jeremy Grantham, the legendary investor at Boston-based GMO told Business Week that stocks are now cheaper than they've been since 1987. "You are looking at the best prices in 20 years, and you should be making 7% to 8% to 9% real [inflation-adjusted] returns," he said. "The last time I was this optimistic was in the summer of 1982."
These three long-time investors have built sterling money making reputations over a long period of time. Here's what Jack Bogle, the octogenarian founder of the mutual fund giant Vanguard, told me in a recent interview: "We can, however, look ahead and make reasonable predictions. In the bond market, we know with 90% probability that return in the next 10 years will be 4.5% to 5%. That's the historical number. If we have huge inflation and a Great Depression, and lots of bonds default--this is why I like Treasuries--then that's something else again. In stocks, we know the sources of stock returns. Dividend yield is almost 2.5%, and earnings growth from these levels ought to be 6% over the next decade. That's an 8.5% return."
Grantham notes that when bubbles burst markets historically overcorrect by a lot. Your idea is a reasonable bet. But don't borrow the money. Use cash.
10/28/08 by Chris FarrellHarvesting capital losses
Question: My portfolio contains some stocks that have cratered -- and I don't expect them to turn around soon in this economy. Might it be beneficial to take a long-term loss on them this year, with an eye toward lowering current taxes and trimming some dead wood? Thanks, Dave, Reston, VA.
Answer: The answer is "yes" to both questions. You will have a lot of company taking capital losses this year, especially with the stock market down about 35% year-to-date. It's also a good time to harvest some dead wood. However, when evaluating investments remember that the underlying fundamentals trump tax strategies.
That said, the capital gain section of the tax code is a fertile area for tax-savvy financial planning. You need to sell in order to get the capital loss or losses, defined as selling an investment at less than the price you bought it for or its adjusted basis. (The expenses you incur selling the investment are deducted from the proceeds and added to the loss.) And, of course, we're looking at stocks, bonds, or other investment in a taxable account. For instance, you can't deduct losses in a tax-deferred retirement savings account, such as a 401(k).
Of course, since we're dealing with taxes the calculation isn't simple. You'll want to familiarize yourself with Schedule D, as well as the differences between short-term and long-term losses and gains. Computer-based programs like Turbotax are helpful or you can hire an accountant to do it for you. If you have a capital loss remaining after offsetting any capital gains you've realized, you can still deduct $3,000 from your income taxes. If the loss is greater than $3,000 you can carry the leftover portion to the following year, and the year after that, and so on.
Where is the money going?
Question: If everyone is withdrawing money from stocks, mutual funds, hedge funds and every place where they have money, what are they putting it into? I can't believe that all the money that has been withdrawn is just lying idlely around. Nobody does that. It has to be invested in something. Jerome, Boiling Springs, PA
Answer: You're right that money is fleeing out of risky assets like U.S. stocks, emerging market equities, and junk bonds. To give you just one example, investors have pulled some $124 billion out of stock mutual funds year-to date (the data goes through September), according to the Investment Company Institute, the Washington D.C. based trade group for the mutual fund industry. Of course, there are still lots of buyers in the stock market looking for bargains.
Still, many savers are looking for a "safe harbor" for their money. The most popular safe harbors rely on U.S. government backing rather than private sector promises.
Therefore, investment money at home and abroad is pouring into default-free U.S. Treasury securities. Investors are so eager to preserve the value of their money that they're willing to accept a mere 0.44% yield on a 3-month Treasury bill and only a 3.9% yield on a 10 year Treasury bond. Savers are also seeking safety in banks backed by the FDIC and the comparable federal backstop for credit unions. Savers are putting their money into certificates of deposits, savings accounts, and the like. The money is safe at the federally insured bank or credit union so long as it's under the $250,000 FDIC limit. (There are a number of ways to increase coverage limits even at the same bank. The FDIC has a clear explanation of its insurance fund at www.fdic.gov. )
One reason the Fed cut its benchmark interest rate to 1% is to encourage both savers and lenders to take on a bit more risk. For savers, the lure of high returns in a low interest rate environment could entice them to snap up quality corporate bonds, good tax exempt bonds and blue chip stocks. For lenders, it boosts confidence that the financial world is not coming to an end and that could lead them to make more loan money available to the average worker.
The end of indexing?
Question: Chris, My wife and I have been following your advice (and the advice of many others) for retirement investing for years. We have about 15 years until we hope to retire (of course, hope is the operative word there, since the gallows humor going around these days is that "80 is the new 65"). Basically, we buy broadly diversified index funds on a monthly, dollar-cost averaged basis, and we hold (about 65% equities and 35% bonds). I'm watching the beginning of yet another bloodbath day for the stock market this morning (October 24) and I've recently started to question this buy and hold strategy. It really hasn't work for the S & P over the last decade or so. With pundits throwing around opinions like "there won't be another secular bull market for a long time, but there will be cyclical bull markets in the coming years," isn't an active buy and sell approach a better one, and, if so, how does the average investor participate in that approach? Richard, Bozeman, MT
Answer: Another gallows joke I've heard is that a "walker" is the new corporate benefit.
On to your question: One personal finance lesson not to take away from recent experience is that indexing is a mistake. Yes, I imagine you're hearing talk about how professional money managers can avoid the investment carnage by trading adroitly. That's reminiscent, at least to me, of comedian Will Rogers famous quip, "Buy stocks that are going up. After they have done that, sell them. If they ain't going to go up, don't have bought them." Or, as Rex Sinquefield, chairman and chief investment officer at Dimensional Fund Advisors, once said: "There are three classes of people who do not believe that markets work: the Cubans, the North Koreans, and active managers."
There's no reason to believe that actively managed mutual funds will systematically do better after fees in this market--or any other market for that matter. (And a lot of hedge funds--managed by the best and brightest--are getting wiped out these days. It's one reason the stock market is so volatile.) In a sense, Wall Street takes its cut everytime an actively traded mutual fund or managed account makes a bet, and their take slices into returns. "Meanwhile, Wall Street's Pied Pipers of Performance will have encouraged the futile hopes of the family. ... will be assured that they all can achieve above-average investment performance - but only by paying ever-higher fees. Call this promise the adult version of Lake Woebegon."
Who wrote that? Ralph Nader? No, it was Warren Buffett, the greatest stock picker in modern times. He's spot on.
The expense ratios on index funds are razor thin--ranging between, say, 0.10% and 0.20% for a broad-based equity index fund vs. 1.0% to 1.5% for a comparable actively managed funds. Over the years, that fee advantage adds up. Then there is the cost of time. You have to ferret out good mutual fund money managers, or pick out stocks on your own, and then monitor them closely. That's tough to do. In a letter to shareholders Buffett made a strong case for the kind of value oriented stock picking approach that he practices--which is knowledgeably poring over balance sheets and studying management. But if truly understanding a company isn't your passion, then use index funds, he advised. "By periodically investing in an index fund, for example, the know-nothing investor can actually out-perform most investment professionals," Buffett wrote. "Paradoxically, when 'dumb' money acknowledges its limitations, it ceases to be dumb."
Traditional pension and bonds (and stocks)
Question: I am hoping to retire in 5 years at age 62. I've got a three-part retirement plan: a government pension, social security and a 457k. Rather than following John Bogle's advice to invest in bonds at a percentage = to your age, I invest my 457k mostly in stock funds, reasoning that the pension is kind of the equivalent of the more secure bond funds. Also, I expect to be drawing from the 457k for maybe 30 years, which seems like another good idea to keep it in stocks for awhile. What do you think? I've never seen this question addressed before. (I wish I had asked this question before the current financial crisis - I don't mean to gloat over having an actual pension.) Connie, Portland, OR
Answer: Your question illuminates the value of a traditional defined benefit pension plan, the kind that pays out a monthly income to a retiree based on a salary and years of service formula. But fewer and fewer workers are covered by that kind of pension plan. Take this paragraph from a recent research paper by David F. Babbel, finance and insurance professor at the Wharton School and Craig B. Merrill, professor of finance and insurance at the Marriott School of Management.
The economic implications for the average individual are significant. Under a traditional pension program, the retiree receives a set monthly income for as long as he or she lives. Under a defined contribution program, such as a 401(k) or 403(b) program, the amount of income you collect after retirement and how long you continue to receive it is anyone's guess. There are no guarantees. In effect, the risk of retirement has been shifted away from the employer and the PBGC that insures the pension benefits, and placed upon the shoulders of the employee. Put another way, the financial risk of retirement has been transferred from those best able to bear it to those less knowledgeable and least able to bear it.
I think it's a good idea to treat the pension plan as the equivalent of fixed income. Those regular payments make it a bond-like portion of your portfolio. "Too many investors forget that Social Security and pension benefits are fixed-income assets," says Jack Bogle, the legendary founder of the Vanguard mutual fund.
In other words, your overall insight is sound and you can hike the equity portion of your 457 defined contribution pension plan. As an aside, I agree with you that you have time on your side with your equity investments. Brad DeLong, economist at the University of California, Berkeley and former assistant U.S. Treasury secretary during the Clinton Administration, recently made a compelling case for equities. He notes that stocks have been a terrible investment over the past decade, and that the recent 40% or so decline may not be the end of the bad news.
Still, with a time horizon of one to two decades, he argues the math favors stocks. "At the moment, the yield-to-maturity of the 10-year US Treasury bond is 3.76 percent. Subtract 2.5 percent for inflation, and you get a benchmark expected real return of 1.26 percent. Meanwhile, the earnings yield on the stocks that make up the S&P composite is fluctuating around 6 percent: that is how much money the corporations that underpin the stocks are making for their shareholders.... Thus, the expected fundamental real return on diversified US stock portfolios right now is in the range of 6 percent to 7 percent.
The whole article is well worth reading.
As for your traditional pension, a few risks to keep in mind. The insight that it's a bond like part of your portfolio doesn't tell you how much to have in stocks and bonds. For another, inflation can erode the value of that pension. While many government defined benefit plans do increase the payout along with increases in inflation, not all do. Almost all private sector traditional pensions don't take inflation into account. Check out how your pension deals with inflation. I would consider adding Treasury Inflation Protected securities or TIPs to an overall portfolio.
In addition, I wonder if the pension plan should be treated as the equivalent of a corporate bond. After all, many public and private sector pensions are under financial strain and there is always the risk that benefits could be cut into the future.
TIPS
Question: With our 401(k) and 403(b) accounts having seriously tanked during October, we're becoming more intrigued with TIPS. But we don't really know how to go about investing in this vehicle -- or if we should even consider this as an option. Can you recommend a good resource to learn more about this and how one can get started? Fred and Dana, Omaha, NE
Answer: As you know, I'm a big fan of investors putting their safe, long-term money into Treasury Inflation Protected Securities or TIPS. I have just the recommendation for you, too. It's "Worry-Free Investing " by Zvi Bodie, a leading finance professor at Boston University and Michael J. Clowes, a long-time journalist and editor.
Several years ago I wrote a book review of Worry-Free Investing. The review came out around the time that the stock market was finally doing better following the false rallies in the fourth quarter of 2001 and 2002. Here's an excerpt:
...Bodie and Clowes' investment advice resonates with the harsh lessons of a three year long bear market. Instead of asking, "How much money will I make?" their fundamental financial question is "How much can I afford to lose?" Stocks, they believe, are too risky for many people to achieve financial security even when held for long periods of time. Instead, their idea is to lock in a long-term standard of living while taking as little risk as possible. Their preferred investment is U.S. government inflation protected securities that preserve the purchasing power of a dollar against the ravages of inflation. Other investments they highlight include the value of Social Security, annuities, and a home. "Worry-Free Investing" is simply written, and well illustrated with examples. The authors walk you through the mathematics of their computations so you can do them on your own with a simple calculator.
Still, their basic message is timeless. The economic idea underpinning the book is that most people don't want to get rich, or perhaps more accurately, aren't willing to make the gambles that could just as well lead to bankruptcy as a flush bank account. No, most people want to sustain their standard of living throughout their life. The way to accomplish that goal is to limit downside risk and preserve the value of money set aside today that will be tapped in your golden years. "If you want to sleep nights secure in the knowledge that you will achieve your savings goals, you must invest in a way that eliminates the possibility that inflation will undercut your efforts," say Bodie and Clowes. "If you try to do it by saving less and expecting the stock market to do the heavy lifting, you may not get there at all."
The authors don't dislike stocks. They just think stocks are much riskier than conventional wisdom holds and that it's only sensible to roll the stock market dice after locking in your baseline financial goals...
Check it out. I think you'll find solid financial insight along with plenty of details on how TIPS might work for you.
Green investing
Question: Can you suggest some places to search for good environmental/green energy mutual funds? My REIT (PLD) has plummeted to an unbelievable low and I was thinking of riding it back up, but also wonder if a change to renewable energy fund or some other environmental fund would be a better choice. I listen to the show most every week. Thanks Chris, Kathleen, Carmel CA
Answer: Investor interest in putting money into green mutual funds has been growing in recent years. However, the sector has been hit hard along with the rest of the stock market so far this year. What's more, the sharp drop in oil prices has put additional downward pressure on the alternative energy and green universe.
For instance, I just looked up some return figures on a handful of the better known green mutual funds and companies. The total return to investors on the Winslow Green Growth fund is -56%, year-to-date. The comparable figure over the same time period for the Calvert Global Alternative Energy Fund is -54%, the Guinness Atkinson Funds -57% and the New Alternative Funds -45%. A number of small alternative energy companies have cratered recently, especially after Verasun Energy, the large ethanol producer, recently filed for Chapter 11 bankruptcy protection. For example, AE Biofuels is down 52% and Clean Energy by -50%, year to date.
Still, it's an intriguing investment play. I can't imagine that the enthusiasm for green companies and alternative energy will wane over the long haul, especially once global growth picks up and worries about climate change move back to the fore. Indeed, President-elect Barack Obama said his Administration would "invest $15 billion a year over the next decade in renewable energy" in a recent Wall Street Journal Op-Ed piece. .
As an aside, the biggest rap against socially responsible investing is the belief that marrying personal values to an investment portfolio cuts into returns. In other words, doing good and making money don't mix. I don't agree. A number of academic studies suggest there's little difference between pooling money to make money and pooling money to make money and express values. This came home to me in a series of papers by Meir Statman, a finance economist at Santa Clara University. Among his conclusions, the risk-adjusted return on socially conscious index funds (yes, I still favor index funds) is roughly comparable to the Standard & Poor's 500 index. The performance of actively managed socially responsible mutual funds is about equal to their conventional actively managed mutual fund peers.
One note of caution: Socially responsible funds tend to have high fees that cut into returns. For instance, the mutual fund rating service Morningstar says the levy on green mutual funds range from 1.25% to 1.98%. "We're generally wary of pricey funds because high fees are one of the most powerful predictors of future underperformance," writes Michael Herbst, mutual fund analyst with Morningstar.
Two good places for additional research are socialinvest.org and socialfunds.com.
Municipal bonds
Question: Would you suggest waiting until the "dust" settles before starting to invest in muni bond funds, as opposed to CDs at this point? We would like to have some more tax exempt investments. I worry that some local govts still have trouble renegotiating insurance on their bonds. We are almost at retirement age, and have our money at this point, in Treasuries and CDs. Beth, Indianapolis, IN
Answer: Tax exempt bond yields are still very attractive relative to taxable fixed income securities like U.S. Treasuries and certificates of deposit. But that higher yield reflects greater risks. State and local government revenues are falling with the economy in recession. There are concerns that the muni bond default rate could be unusually high during the latest downturn. The insurance on tax exempts is essentially worthless. For example, on November 4, Vanguard announced plans to merge its $3.2 billion Insured Long-Term Tax-Exempt Fund into its $2.8 billion Long-Term Tax-Exempt Fund. "The municipal bond market has changed to a point where insured bonds provide little, if any, additional benefit over high-quality uninsured credits. We concluded that a fund focused solely on insured bonds no longer provides tangible benefits," said Gus Sauter, Vanguard's Chief Investment Officer. "Shareholders will be better served by merging the two portfolios to create a single, well-diversified, high-quality fund."
So, part of the answer is whether you want to move your money out of default free securities--U.S. Treasuries and CDs if under the $250,000 FDIC limit--into a slightly riskier investment. My bias is toward conservatism. If you think the extra yield is worth the risk with at least some of your money I would stick to a high-quality broadly diversified tax exempt mutual fund portfolio. Don't reach for even higher yields by investing in the riskier sectors of the muni market.
Shut down the stock market?
Question: Dear Marketplace, I have been thinking about this for some time, but could never find an answer on my own, so I am hoping you can help me out. Every weekend and on several holidays, the US Stock Market (and every stock market it seems) closes. During that time, the market doesn't go up or down, and thus while people are not making money they are also not losing money.
I remember a few months ago that one of the world's stock exchanges was closed, and looking at the history from the NYSE website, it has closed or had part-days hundreds of times in the past for various reasons.
Can the government force the closure of the stock exchange if the stock prices fell too low or too quickly? Is it economically viable, or wise, to keep the exchange closed for more than a day in order to stop the decrease in values of people's mutual funds, stocks, IRA's etc? Would such a period cause stock brokers to want to sell more and faster when the exchange would be re-opened, or would such a closing allow people to "cool down"? (Though the last question is more of a social/psychological question) Thank you for your time. Douglas, New York, NY
Answer: I recently pulled a wonderful book of financial history off my book shelf at work. It's "When Washington Shut Down Wall Street," by William Silber. He's a finance economist at New York University's Stern School of Business. I've only just started it but it's a tale of U.S. Treasury Secretary William Gibbs McAdoo taking dramatic action in the summer of 1914--before the Federal Reserve opened for business. The outbreak of World War I threatened the U. S. with financial disaster. The dollar was falling, and investors feared that the U.S. would go off the gold standard. Gold was flowing out of the country. McAdoo closed the New York Stock Exchange for more than four months "to prevent Europeans from selling their American securities and demanding gold in return. He smothered the country with emergency currency to prevent a replay of the bank runs that swept America in 1907. And he launched the United States as a world monetary power by honoring America's commitment to the gold standard," according to the book's blurb.
The New York Stock Exchange has been periodically shut down, the last time following the tragedy of 9/11. Another notable moment was during the Bank Holiday of 1933. Today, there are also procedures in place to stop trading if the market plunges too far too fast. (See my earlier post on the daily trading downward limits, "Where are the stock market "circuit breakers"?")
Indeed, New York University economist Nouriel Roubini on October 23rd predicted that policy makers might be forced to close financial markets as the panic selling accelerated. They didn't, but the next day the U.S. stock futures market stopped trading. Declines of more than 6% tripped the circuit breakers at the opening. Still, the stock markets circuit breakers are only designed to stem a panic, and at most are imposed for a day.
The President can close the stock markets. Nevertheless, while most economists recognize that stock markets can or should be closed at extraordinary moments, most would argue for keeping the practice a rarity rather than an acceptable tactic. The reason is that it's almost always far better to let buyers and sellers try and figure out where the market is going, and then let the traditional evening close stop trading. (Of course, in a high-tech global capital market the reality is that trading continues in other markets and in different time zones.) The real risk is that a government-mandated shut down for any period of time can make the panic worse. About a decade ago, the late Nobel Laureate Merton Miller told Business Week that ``You want the price to fall, because that will bring buyers out of the woodwork.''
Capital losses on home sale
Question: My wife and I were fortunate enough to sell our home in North Minneapolis last May, but we did end up bringing our checkbook to closing. We sold our house for a bit less than we owed. We were told at the time by a couple of professionals (a CPA and an investor) that we cannot write those losses off when we do our 2008 taxes. I was wondering if any of the bailout plan signed by congress and the president changed any of this to favor us, or if you see any chance that someday we could get a kick back for our loss? Thanks! Andy
Answer: The information you got from the CPA and an investor is right: Any loss from the sale of your main residence can't be deducted on your tax form come April 15.
Of course, tax cutting is high on the legislative agenda with a new President and a new Congress confronting a recession that's getting worse by the month. A hodgepodge of ideas is in circulation. The more popular proposals include suspending mandatory distributions from 401(k) plans and the like for those 70½ and older, allowing taxpayers to take out as much as $10,000 penalty- free from their retirement accounts (you'd still pay taxes on the withdrawal), getting rid of income taxes for seniors making less than $50,000 a year and allowing a 10% mortgage tax credit for any homeowner that doesn't itemize.
The notion of allowing homeowners to take into account capital losses on sales usually gets short shrift. It's a concept that gets a hearing every time there's a downturn in the residential real estate market. But homeownership is already such a tax favored investment that even the housing-and mortgage-friendly Congress has rejected this tax initiative in the past.
I can't handicap the odds, but the traditional avoidance of capital losses on home sales could weaken. For one thing, the idea of allowing homeowners to take capital losses has been making the rounds in the blogosphere. For another, there is a growing sense that the federal government needs to direct more aid to homeowners and less to financial institutions. For example, reading the Washington Post this morning I learned that Treasury Secretary Henry Paulson had--with little comment--changed the tax law to eliminate strict limits on the losses banks that take over other banks can deduct from their taxes later on. The restriction had been on the books for more than two decades. It was intended to put an end to an increasingly commonplace tax shelter abuse. Although not directly comparable, I can't help but think: If it's good enough for financial institutions why not for the homeowner?
However, in terms of personal financial planning, I wouldn't bank on the capital gains tax law changing when it comes to housing.
Co-sign a loan?
Question: My daughter and son-in-law have an empty "underwater" condo. We all shudder at the thought of renting it out! It's hurting them to be paying a mortgage and other expenses while not living there, so they hope to sell it in 2009. They will owe around $25,000 more at closing than they will receive. I am considering either loaning them the money at a rate about what I can earn on a CD or other savings, OR co-signing a loan from their bank or credit union. I trust them to make payments either way. What are the advantages and disadvantages of either of these plans - for them AND for me? Carol, St. Cloud, MN
Answer: I am not a fan of anyone co-signing a loan from a bank or credit union no matter how much you trust the person. You know them, and you know that they are trustworthy people. But sometimes even very good people can't pay a loan because of a lost job or big medical bills. And then you are on the hook to make the loan payments if you co-signed the loan.
I have been getting more questions lately about co-signing. It's a reflection of tough economic times. Although the circumstances are very different from yours, I want to highlight another email I recently received from a listener. It's from Gregory in Irvine, CA, and it offers a grim reminder of the risks of co-signing:
I co-signed a car loan for a friend and right now there is about 4,000 owed to it. This was a mistake that I regret a great deal because it turns out my friend is not responsible with money and I have just learned he lost his job a few weeks back. I no longer talk to this friend of mine and I do not want any communication. Last week Wachovia, the loaning business, called me and told me that this last months car payment is 15 days over due and they will report the late payment in another 15 days. Please help. I do not want to bail out my former friend for a car he never should have bought in the first place, yet I do not want my credit to be destroyed. Can I refinance the car in his name alone? If the car gets repossessed will it really upset my credit that much? What should I do? What would you do?
Greg is legally obliged to pay up. The only solution I can see is Greg needs to swallow his distaste and approach his former friend and see if they can negotiate some kind of solution.
Since family relations are strong in your case, and everyone wants to avoid the renting option, I would lend the money with an interest rate to your daughter and son-in-law. Then if they fall on hard times the three of you can renegotiate the loan without the involvement of credit reporting bureaus, credit scores, or an impersonal financial institution.
From India: what to do?
Question: We are currently relocated for a year in Bangalore, India with a July 2009 date to come home. My husband is an IT consultant who has a retailer for a client so in naturally worried about a job when we return to America. The company gave no raises this year but we did receive a $7-8,000 bonus. My husband and I have started to discuss what to do with it--pay down the mortgage or invest in non-ira stocks to have some cash savings?
We have no other debt except a home mortgage and a vacation home mortgage and we have solid retirement investments (although these economic times are hard on the mutual funds and blood pressure!) plus a non-retirement money market account. We will save money by being an expat as many of our costs in India are picked up by the company. We have three children, the oldest is 13 and youngest is 9 so there will be some college costs coming up in the next 5 years.
We have discussed other forms of investment--do you invest in a business, or buy more property? Is there a more creative way to invest the money or is it better to "keep it simple stupid" approach? We have always valued you advice and was wondering what your thoughts are. Thank you, Monica, Bangalore, India
Answer: It must be a fascinating to live in India at this time. The economies of the U.S. and India are closely intertwined, and American companies have spent billions in investment dollars expanding in India since 2000, transforming urban centers. More recently, a number of Indian companies went on a global corporate buying spree. But now the global economic crisis is hitting the Asian giant hard.
Anyway, on to your personal finance question. Yes, as you know, I am a big believer in the KISS approach--keep it simple, stupid. I also believe in seizing an opportunity when it comes along. Right now, as you say, you have a unique opportunity to truly build up savings because you're living the ex-pat life. Take advantage of it. If it were me, I would stash away as much money as possible into safe investments that would preserve the value of your capital while making you a bit of money. Of course, none of these investments, such as Treasury bills and FDIC insured CDs, are very exciting.
Your new-found savings stash can do double duty when you come back. First, it's your safety money in case it is hard to find a job. It buys you or your husband or both of you time to look for a good job. But, let's say that you come back with jobs waiting for you. Then the savings is your opportunity fund. It's a safe bet that over the next several years those households with cash will have the ability to snap up bargains. You can also use the money to help out with college if that turns out to be the best use of the savings.
That's why I would recommend primarily focusing on increasing your cash savings. I think you are in a wonderful position. If you want to have some fun, put a slice of money into an equity index fund on the theory that the stock market will rebound at some point. Or you could take that slice of money and put it into a 529 college savings plan.
If a mutual fund company fails?
Question: If you own mutual funds through a company such as Vanguard or Fidelity, what happens if the company goes bankrupt. Do you still own the underlying equities or is your investment lost? If it varies by fund or institution, how do you distinguish between them? Stephen, Berkeley CA
Answer: What a long way we've come over the past year, and not for the better. Questions like this used to be highly abstract, but now we need to take them seriously.
In essence, mutual fund investors don't have to worry. Your investment isn't lost.
The money you've invested in the mutual fund is safe even if the fund company goes belly-up (like Lehman) or needs a federal bailout (like AIG). There are several lines of safety. For one thing, you're a shareholder in a mutual fund. Your money isn't an asset of the fund company itself. For another, you and all the other shareholders in the fund actually own the securities, not the mutual fund company.
What's more, the securities--stocks, bond, and the like--are held in a segregated custodial account, which is typically managed by a bank or trust. Mutual fund companies carry mandatory insurance. If it has a brokerage business, any accounts there will be covered by the SIPC. Another financial institution would likely swoop in and manage the mutual funds, too.
Of course, these layers of protection that ensure the money is yours do not affect the value of that money. And for most of us that means portfolios are off anywhere from 20% to 40%.
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 FarrellBuy a home?
Question: My fiancé and I are trying to decide whether or not it is a good time for us to buy a house. I am a PhD candidate earning a stipend and have savings for a down payment. He has a full time job as an analyst with a large aerospace manufacturer. We will definitely be in the Seattle area for another 2 years but aren't certain where we will go after that (once I graduate). We have heard mixed things about how long you have to live in an area for buying a house to be worth it and whether or not now is a good time to buy a house. Do you have any advice? Amanda, Seattle State: WA
Answer: Many people are wondering when it makes sense to get into the housing market again. After all, there have been double-digit price declines in most major markets. For instance, over the past year ending in August home prices are down 31% in Las Vegas and 27% in Los Angeles, according to figures compiled by the S&P/Case-Shiller Home Price Index. In comparison, Seattle has held up relatively well with a mere 8.8% decline over the same time period.
That said, I think there are more price declines to come. We're in a recession, and it took a turn for the worse in October. As far as I can see the economy in November is certainly no better than last month and probably worse. I can't imagine many people will extend their finances to buy homes until the scale and scope of the recession is clearer.
What's more, as a recent post on the Business Week Hot Property blog points out, by two common measures the housing market is still overvalued. Comparing the median cost of a new home to median income suggests that home prices nationwide could drop another 15% to 20%. The home prices to average rent ratio is predicting a 20% to 25% decline.
But here's the main reason I wouldn't buy a home right now: You say you might move out of town in two years. I wouldn't buy unless I knew I was going to live somewhere for at least 3 years and preferably 5 years. Even with prices down, a home is an expensive investment. The down payment will absorb savings. Then there are all the closing costs associated with taking out a mortgage. Closing costs can include points, taxes, appraisals, credit reports, title insurance, survey's underwriting fees, and document preparation. The price-tag for all this stuff can range somewhere between 3% and 6% of the mortgage amount. What's more, anyone who has bought a home could tell you that the money spigot doesn't end with ownership. I would save my money and wait to buy a home. That is, until you know where you'll be putting down roots.
Credit problems
Question: I have been working to eliminate my personal revolving debt for more than five years by paying the minimum monthly or more. It is evident that I'm not really making any headway and may be going in the opposite direction with creditors raising my interest rates to well above 25%. As you know, creditors check credit scores regularly and arbitrarily raise their rates and charges.
Now that my income has unfortunately dropped, I'm wondering if under the new bankruptcy law I'm better off negotiating a settlement with each credit card creditor. I'm not looking for a write-off, but a negotiated settlement with payment terms.
My question is should I take this course, suffer the consequences on my credit score, and rebound down the road? Ron, Escondido CA
Answer: It's outrageous that banks are hiking credit card interest rates when the economy is in recession, job losses are mounting and taxpayers are bailing out the financial system with at least $1 trillion dollars. It seems to me that raising credit card rates now is bad for households and the economy. (Longer term tighter credit terms might be good, but in the short-run it looks bad.)
For instance, both American Express and Citigroup have said they're raising rates by 2 to 3 percentage points on some customers. I expect we will also see many people get hit by "universal default" and the default rate of around 30%. About half of all credit card issuers have a universal default policy hidden in the fine print of a credit card agreement. Late on any payment to any creditor, and the rate on the card could automatically jump to the default rate--even though you're up to date on the credit card payments. I don't see how anyone ever gets out of debt at a 25% to 30% interest rate. That's loan sharking.
Here are three practical suggestions. First, get a copy of Gerri Detweiler's "The Ultimate Credit Handbook: How to Cut Your Debt and Have a Lifetime of Great Credit." It's in its third edition, and is very helpful. However, my guess is that your way past the kind of advice she gives since you've been working on paying down your debts for 5 years. (But it's worth a look for anyone worried that they're carrying too much debt and trying to pay it down.) I am also a fan of the credit advice at the non-profit organization Nolo.com. Its web address is www.nolo.com.
Second, contact the National Foundation for Credit Counseling (NFCC). It's the largest and oldest national nonprofit credit counseling service. You can find a branch near you at www.nfcc.org. I'd set up a meeting with a debt counselor, and see what can be done with their help and guidance.
Third, consult with a bankruptcy lawyer to what are your options for wiping the debt slate clean.
You'll then be able to make a reasoned decision.
I wouldn't worry about your credit score right now. The key is to figure out the best, most practical way to eliminate your financial burden and, at the same time, to make sure you won't end up in the same place 5 years from now.
Stay the course?
Question: Hi, Chris. Like everyone else, my company retirement savings plan is way way down--56% off, to be exact. I'm 38 so I don't need the money right now, but it is incredibly painful to keep shoveling money into this hole. Through a generous company match, I'm investing almost 30% of my income into an target date (and therefore aggressive) mutual fund. I've heard you say that we should all just keep investing through the ups and downs but is that still true in this prolonged crisis? Won't it take these funds years and years to recover from losing half of their value? I'm not going to sell anything--that would be locking in the losses--but I'd sleep a lot better at night if a much bigger chunk of my future retirement savings was going into bonds or a money-market. What do you say? Thanks for all your help in this crisis. Erin New York, NY
Answer: Uncertainty is the overarching concept that rules our lives. We may have hunches and even mathematical probabilities, but we never know for sure what the future holds. Peter Bernstein.
Your portfolio is down even more after today's carnage, with the Dow Jones Industrial average plummeting by 445 points, or 5.6%. Citigroup shares lost 26% and J.P. Morgan Chase fell by 19%. Month after month, week after week, day after day it seems that the stock market falls ever lower. We keep hearing that this is the worst financial crisis since the Great Depression. Does that mean an 89% decline is in our future, which is what happened to the blue chip index in the early 1930s? Or, even though the timing is uncertain, is this a once-in-a-lifetime buying opportunity?
Like soothsayers of old, working people of all ages are struggling to peer into the future. That's because, over the past three decades, the 401(k) has become the mainstay retirement savings plan for private sector workers. Their nonprofit peers save in 403(b)s and government workers in 457 plans. Whatever the label, workers throughout the economy are confronting difficult investment choices. And the answers matter since investment decisions made today will influence whether a worker enjoys caviar or roe two-to-three decades from now.
This is no way to run a retirement system. But it's the one we got and it's the one you're invested in. My judgment is that you have time on your side so I would stay the course. I essentially agree with what Zvi Bodie, finance professor at Boston University, recently told me: "I would characterize my approach to investing as cautious optimism with the emphasis on cautious and the optimism faith in the progress of the U.S. economy," he said. "Another way of saying this, we have to be careful of wishful thinking, the belief that we can get high returns without higher risks, and on the other hand catastrophyzing, if that's a word."
In a recent article for the Wall Street Journal, University of Chicago finance professor John Cochrane made a compelling case for taking a more positive slant on the stock market's future, without going overboard. It's a cautious, well-grounded argument. (You can read it at his website. It's a good website for learning and researching finance, too.) Here's the kernel of Cochrane's position:
In a recession, or following losses, many investors become more averse to holding risks. They want to sell. But we can't all sell -- a fact routinely ignored in much financial advice and commentary. Instead, prices must fall and prospective returns rise until some investors are willing to buy. Unsurprisingly, upward spikes in the dividend yield came in bad economic times.
History is not a guarantee -- this time could be different. Rather than a higher return going forward, this price decline could reflect a consensus opinion that a massive depression is coming -- a 34% permanent decline in earnings and dividends and a massive wave of bankruptcies.
But as I read the news, the "risk aversion" story seems more plausible. We are in, or headed for, a recession. Anyone whose job or business will be impacted can't take stock-market risks, and should be selling despite low prices. We are seeing lots of "deleveraging," "disintermediation" and "forced selling." As losses mount, investors or institutions that have borrowed money must sell to avoid bankruptcy. Others, such as some university endowments or defined-benefit pension funds, have backstop commitments that must be honored, and they too must "capitulate" at some point. Still others may just be less willing to take risks after suffering a huge loss, a sensible "once burned, twice shy" mentality.
All of these actors become more averse to holding risks as the market declines, so they sell. This increasing risk aversion amplifies an initial price decline -- coming from bad earnings news or the huge rise in credit spreads -- into a rout.
If this is indeed what's going on, it also means that unleveraged, long-term investors should be buying, since prospective returns are better. They must be able to suffer through further mark-to-market losses, and not have recession-sensitive jobs or businesses. They must still have some money left to invest, so they can exchange some of their valuable Treasurys for assets that the suddenly risk-averse are trying to unload. The more these investors can understand and digest slightly exotic securities being dumped by leveraged intermediaries, the better. Warren Buffett is in the news, and he should be.
That said, you are putting a lot of money into the fund. If it were me, I'd be okay with it. (But I haven't changed my retirement asset allocation at all during this time; all the shifts have come outside the tax-sheltered retirement accounts.) You clearly want to take full advantage of your company's match. But you also said you aren't at the sleeping point. Why not direct future contributions into the high quality bonds and money market fund? This way you don't lock in any losses in the Target fund, but you build up a more conservative overall portfolio. Rather than selling down to the sleeping point, its more like redirecting your savings to the sleeping point.
Bank trouble and a credit card
Question: I have a Citi Bank credit card as my primary credit card. The account is in good standing with no debt, but what happens if Citi Bank collapses, files for bankruptcy, or merges with another company? Also, what about my interest rate, credit card benefits (such as cash back, airline mileage, etc.), and terms of use if something happens to Citi Bank? Sincerely, Andrew, PA
Answer: Citigroup's stock is getting pounded again today. Like GM, investors are losing faith in another icon of Corporate America. The mammoth banking conglomerate has lost 60% of its market value since last Friday and now trades at a 15 year low. Citi hasn't posted a profit in four quarters--unlike several of its major rivals--and the outlook is steadily worsening with the sinking economy and deteriorating credit.
I suspect central bankers and finance ministers worldwide will hold non-stop transatlantic meetings over the weekend about how to deal with the recent precipitous decline in Citi and other financial services stocks. After all, Goldman Sachs is now trading below its initial public offering price. Goldman is no longer the financial services industry's gold standard but a tarnished benchmark.
Citi is one of the biggest issuers of credit cards in the country with some 54 million cardholders. Although the bank has announced it's raising credit card rates on substantial portion of its credit card accounts by 2 to 3 percentage points--supposedly less than 20% of the total--the credit card portfolio is still one of its most valuable franchises.
How will you fare if yet one more unthinkable happens, that Citi sells off assets, gets acquired or the government buys an even bigger stake in the financial services institution? My bottom line: You're fine. Put it this way: If Citi really got into trouble your credit card account would be considered an asset worth owning. And if the past is any guide your credit card will work and you won't be left stranded.
However, a couple of cautions or safeguards. If Citi does get deeper into trouble, read your credit card mail carefully. The new owner might have information for you. For instance, a new owner may change the size of your line of credit. But the typical experience is for a new owner to honor most of the terms of your existing deal. Over time it may bring about changes so that there is only one interest rate, fee, penalty and other policies for all its credit cards.
Most importantly, continue to pay your bill on time.
A lay-off and the 401(k)
Question: I am getting laid off at the end of this year. I have been at the company for 12 years and have a decent nest egg in my 401k. What is the best way to preserve the value of my retirement savings as I make the transition from 401k to IRA? Max, Dalton, MA
Answer: Sad to say, your story is far from unique and it will become increasingly common in the months ahead. It's a tough situation. The first thing anyone in your position needs to do is contact human resources and see if you can keep the 401(k) intact at the company while you look for a new job. So long as you have $5,000 or more in the plan--and it sounds as if you have much more than that--federal law says in most cases fired and laid off workers can keep the money in place. That will defer the day of retirement savings reckoning for you in light of today's volatile market. When you do get a new job, you can either have the money rolled over into your new 401(k) plan or into a rollover IRA. (Make sure it's an institution-to-institution transfer so that there are no implications with the shift.)
Two words of caution: First, don't touch the money. Leave it alone. Second, be wary of any so-called financial advisors that might solicit your business when you lose your job. It seems that a number of financial services companies with high fees and poor products troll for victims among laid-off workers with an eye toward tapping into their retirement money.
Good luck finding a new job.
Closed credit card account
Question: I just received a letter from Chase informing me that they had closed one of my credit card accounts (I have two Chase cards) due to lack of use. I had this account for almost six years (in fact, the first credit card I ever had) and I have not used it for quite some time. The only reason I didn't ask for it to be closed sooner was my understanding that keeping it open was more beneficial to my credit rating than closing it. Taking that into account, doesn't this amount to Chase damaging my credit rating with no cause? Solon, Albany, NY.
Answer: It's remarkable how fast we've gone from a credit card world defined by billions in solicitations and offers of 0% financing to one defined by slashed credit limits and closed accounts. Yes, your credit score has been dinged somewhat. It doesn't really matter if you close an account or it's closed by your creditor. The main impact typically comes if closing the account affects your ratio of total credit balances to total credit limits. Closing an account lowers your overall credit limit and raises the ratio. But with good credit card habits--such as paying off the balance every month--your credit score will bounce back. It reads that you manage your money well.
I believe that consumers should control their own credit habits and not follow the formulas of Fair Isaac, the main credit scoring company. I know that's a bit naive, but in an era of identity theft and too-easy-credit it's better for most people to close unused accounts than keep them open. (I realize in your case it wasn't a choice. This is as a general approach.) The big exception is if a major purchase, such as a home or car, lies in your immediate future. In that case, it pays to wait to close the accounts until after the deal is done. But I would still close them.
Student loans
Question: No one has yet commented on how the credit crisis is going to affect the availability of college loans. Likely, since it's still early in the educational year, no problems have been noticed...but what about later? Drew, Carlisle PA
Answer: The credit crunch is having a dramatic impact on the student loan market, although it does appear that most students are getting the money they need at the moment. Companies that lent to students relied heavily on securitizing those loans and selling them into the global capital markets. That business is largely shut down with the credit crunch. Sallie Mae and other student loan companies are struggling. Many financial institutions have stopped making private student loans or consolidating student loans. Compounding the financial pressures on lenders is a recent law that limits federal subsidies to them. Parents are also feeling the pressure since it's estimated that about a quarter of tuition costs were paid with home equity loans, and that market is drying up too.
I think the Department of Education has been a government backwater during the credit crisis. Still, it has enacted several initiatives to bolster the market. Most recently, it said it will support the market by buying up to $6.5 billion in federally guaranteed loans from the 2007-2008 academic year. The Dept. of Ed. is focusing on shoring up the Federal Family Education Loan Program, which accounts for most of the loans banks and other financial institutions make to students. The government also makes loans directly to students. (I expect that this latter program will expand under the new Administration.) A number of universities are dipping into their funds to make loans available.
So far, it looks as if the stopgap measures are mostly working. But there are genuine concerns going forward. The Dept. of Ed is working on a bigger program announced Nov. 8 to buy up more loans, but it will be awhile before it is up and running. It may not be enough, either.
More fundamentally, I think that the student loan boom has gone bust. Government policy, as well as colleges and universities, have come to rely too much on student loans. It's anecdotal, but I find it fascinating that - judging from the emails we get at Marketplace Money - student loans have replaced credit cards as the main debt worry of young adults. It's also sinking in that the student loan default rate is much higher than the 4% to 5% level the Department of Education has officially announced for years. For example, reaching back into the 1990s and following student experience over the subsequent years, students with loans totaling $15,000 or more had nearly triple the default rate of those with loans of $5,000 or less--19% versus 7%, according to researcher Erin Dillon of Education Sector, an independent think tank based in Washington D.C.
Finally, if you look at the wages of college graduates in the 2000s they're either flat or down, after adjusting for inflation, while the real cost of student borrowing has gone up. The college market needs to change: Too much debt, a high default rate, and low wages at graduation don't add up.
TIPS and deflation
Question: I called my broker to buy some TIPS. He told me to be very careful because they could lose value in a deflationary environment. Is this true? Steve, Minneapolis, MN
Answer: Not really. To be fair, some people use the term "deflation" to mean a trend toward a lower rate of inflation. And in that environment regular Treasury bonds will likely outperform their TIPS peers. But the trend toward lower inflation is what economists and Wall Street financiers call "disinflation."
Deflation is another matter altogether. It is the mirror image of inflation. Deflation is a fall in the overall price level. Inflation is an increase in the overall price level.
U.S. Treasury inflation protected securities (better known as TIPS) are default-free securities that protect the investor from the ravages of inflation. The inflation-indexed bonds come in 5, 10 and 20 year maturities. All offer a fixed interest rate above inflation as measured by the consumer price index (CPI). The bond's principal is adjusted as the CPI changes. I'm a big fan of TIPS since they offer a safe haven in times of trouble and they make sure that the value of a dollar saved today is worth a dollar--plus some interest--5, 10, and 20 years from now.
But here's an additional advantage of TIPS: They also offer owners protection against deflation. TIPS come with a "deflation floor" that protects the holder's principal value if the depression scare turns into a deflationary episode. In other words, if the Consumer Price Index is falling the floor guarantees the TIPS owner either the inflation-adjusted principal or the par value at maturity--whichever is greater. TIPS do not lose their value during deflation.
Penny stocks
Question: Thank you for your insightful financial advice on Marketplace. I enjoy your commentaries.
I had WM in an individual stock portfolio. Embarrassed - yes...
I was wondering if it would be better to: A. Sell all that stock and take the tax savings this year?, or B. Hang on to the new WAMUQ penny shares and hope that they will eventually make it back to around $12.00 a share? I'm thinking answer A because I don't anticipate those shares reaching those levels again for a long, long, long time. What's your two cents? Eric
Answer: Look at it this way: you have plenty of company owning Washington Mutual. You can also tell people that you owned one of the worst investments of 2008.
But then again, I don't understand the lure of penny stocks. I can't figure out why anyone would playing the penny stock market, especially in the case of a company like WaMu since there isn't any real remaining stock market value to it. There are plenty of good blue chip stocks to invest in. The value of WaMu is now with its new owner--JPMorgan Chase--that took over the company in a deal engineered by the Fderal Despoit Insurance Corp.
So, as far as I am concerned, I see the real value of the these shares for you is taking it as a tax loss.
12/02/08 by Chris FarrellFrontload 401(k) contributions?
Question: I am a married 31-year old. I am a corporate lawyer and my husband is an entrepreneur. I'm in the process of setting my 401(k) contributions for 2009. In the past, I've always contributed up to the annual limit (my employer does not match, but it does invest profit-sharing in my 401(k) account) spread out over the course of the year. This year, I'm considering front-loading my contributions so that my annual contribution of $16,500 is taken out of the first 8 or so paychecks of the year.
I'm considering this because (1) I'd like to take advantage of the market's current low prices; (2) we have enough in liquid assets that I can afford to take home a smaller paycheck for the first three or four months of the year; (3) I'd prefer to make the contribution while my job and income are stable -- who knows what could happen as the year progresses?
In addition, about half of my annual contribution will be in the form of a Roth 401(k), rather than a traditional pre-tax 401(k).
Are there any risks with this plan? Should I avoid frontloading my contributions? Emily, San Francisco, CA
Answer: I can't see anything wrong with what you want to do, but there is a trade-off. If you keep making the same contribution throughout the year, you're dollar cost averaging. That means you're putting the same amount of money into your 401(k) on a regular basis. The true advantage of dollar cost averaging isn't financial, bit psychological. Dollar cost averaging takes emotion --fear, greed, and panic--out of investing.
What you want to do is make a small bet by frontloading your contributions that the market is currently undervalued, and that you'll come out ahead compared to regular dollar cost averaging. I'm sympathetic to your point of view. If you're right, and the market does rebound over the course of next year, you'll come out ahead. If you're wrong, you'll be slightly worse off. That's the risk or trade-off.
There is a wonderful passage in Reminiscences of a Stock Operator written in 1923 by Edwin Lefevre. (It's a fictionalized biography of Jesse Livermore, the famed 19th century speculator.) Lefevre tells this story: Somebody asked Baron Rothschild, the great merchant banker, wasn't it difficult to make money on the Bourse (the French stock market)? The Baron replied that, "on the contrary, he thought it was very easy." "That is because you are so rich," objected the interviewer. "Not at all," said the Baron. "I have found an easy way and I stick to it. I simply cannot help making money. I will tell you my secret if you wish. It is this: I never buy at the bottom and I always sell too soon."
In a sense, whether you frontload your contributions or stick with the normal payment schedule, you're following Baron Rothschild dictum. Good luck.
Investing a windfall
Question: I am 63 and have enough to live on from Social Security, some bonds, the rental of a small cottage and the annuity I purchased when I bailed out of the stock market in March. (My intuition about things to come was causing pretty high anxiety when I'd wake up in the middle of the night, because I had half of all I possess in mutual funds.)
Last year my brother and I inherited 2/3 share of a house from our cousin. It's now worth approximately $270,000 but for many reasons probably won't be sold any time soon.
I asked my brother, who is a wonderful and generous person, if he would buy me out so I could use the money for investment, charitable giving and travel. (One further note about my situation: I don't own a home but live in a rent-controlled apartment I love in the busy, interesting downtown area of my small city.)
Long story short, soon I will have some $45,000 to invest! I feel happy and grateful and sometimes even giddy.
Chris, I really admire your knowledge, insight and wisdom. If you were in my place, what would you do with the money in this economic climate. I've thought about putting $5,000 into gold just in case things get much worse. Thanks SO much for any help you can give. Sarah, Berkeley, CA
Answer: I'm going to give you a very conservative answer (no surprise there, I guess!). First, however, I would strongly recommend taking some of the money and start planning for and then going on a trip that you've dreamed about for years. Enjoy a portion of this windfall.
Then I would take all or most of the remaining money and put it into a certificate of deposit at an FDIC insured bank (or a federally insured credit union), an online savings account with a good yield (again, backed by federal deposit insurance), or a mix of short-term Treasury bills. All of these options will preserve the value of your principal, and earn you a slender amount in interest payments. I would then use the year to figure out how you want to invest this money, what might be the right trade-offs between risk/growth investments and safety/income investments. What about owning some blue chip dividend paying stocks? How about Treasury inflation protected securities? Another annuity? Or keep it in easily accessible, safe investments? There's no rush to decide, and at the end of the year (or some period of time) you'll figure out what's the smart financial decision for yourself.
Last, you mentioned putting a sliver of the money into gold. Here's my two cents: I'm not a fan of speculating in gold. Eyeballing a one year chart, the price of the precious metal is down from its March peak of around $1,000 an ounce to about $777 as I'm writing this. To be sure, the price of gold has risen dramatically in recent years. But if you want to speculate on future prices, I'd prefer that you make a comparable bet on a blue chip stock market index. Yes, the index may go lower--a lot lower as the economic gets worse--but the index will reflect real earnings, employees, profits and markets in the underlying companies. Investors will eventually decide prices have been beaten down too far, that there is value in the market, and start investing more aggressively.
To me, buying gold is simply a bet that you'll be able to sell the precious metal at a higher price in the future than what you paid for it. You might win. You might lose. Other people are more comfortable with that kind of bet than me.
What do listeners and readers suggest she do with the money? (To send us your ideas, just scroll up to the top of the page and click on "Contact")
Charitable giving
Question: If I only have XX dollars in discretionary funds this year, what's the best way to spend them? Local food banks? International aid? Just a favorite charity, for a favorite cause? Split the dollars among all of these? I have some funds earmarked for charitable giving, and I know other donors (like corporations) are reducing their gifts, so I want to know how to make my giving really count. Joan, Moscow, ID
Answer: This is a really important question with the economy in a recession that is getting worse by the month. Employers slashed 533,000 jobs in November, and the unemployment rate has jumped to 6.7%. The broadest measure of unemployment, a figure that includes marginally attached workers and employees laboring part-time, stands at a dismaying 12.5% or 19.3 million workers, up from 8.4% a year ago, or 12.9 million employees. These numbers are dry reflections of hard times, from a family losing its home to foreclosure, a 50 year old worker getting a pink slip after a quarter century on the job, a recent college graduate working at temp jobs all over town, a single mother facing a sharp cutback in the number of hours at work, and so on.
It's also December, a traditional time for giving, partly because of the holidays but also for tax reasons. Uncle Sam gives you a tax benefit for charitable giving, but it has to be done before the end of the year to claim the deduction on your 2008 tax returns.
Of course, Americans get together all the time to share their concerns and passions, especially when it comes to improving their communities and society. We give money and time to support the arts, contribute to schools, build affordable housing, and tackle all kinds of social problems. We do all this activity through all kinds of charities, nonprofit organizations, and religious institutions that range in size from small groups of volunteers working out of a basement office to national fraternal organizations with several hundred thousand members to multi-billion dollar enterprises with skyscraper headquarters and global ambitions.
To me, what to give to at this time of need is a very personal decision. Hunger is a real problem. So is homelessness. But many community arts organizations also are facing financial pressures. What you want to give to may change over the course of the year. The problem most of us will face is having too little money to give. I know I'm not giving any specific guidance, but I think there are many worthy causes at a time like this. I do tend to like concentrating my charitable giving, but again, I don't think there's a right or wrong here.
Before giving, though, I would check on the of the watchdog groups that are available once you've focused in on an area. For instance, the Better Business Bureau has long kept a close eye on nonprofit organizations. The American Institute of Philanthropy promotes informed giving. These organizations prize financial openness. They frown on charities that operate with steep administrative costs or cozy insider dealings.
But this is a good question to open up to listeners and readers. Any thoughts on where to give during the recession?
No income and an IRA
Question: I have a Roth IRA and traditional IRA, both with Vanguard. I am not employed at this time but I would like to contribute to an IRA or somehow take advantage of the down market with indexed mutual funds. Can I do this without having earned income? Lynn, Mooresville, NC
Answer: You need to have earned income in 2008 to contribute to an IRA of any kind. (If you were employed earlier in the year, however, you got a wage or salary and you can then contribute to an IRA even though you aren't employed at the moment.) The important exception to this general rule is the so-called spousal IRA. A stay-at-home Mom or a stay-at-home Dad can put money into an IRA even if they haven't earned an income during the tax year. (They've certainly worked, however!)
By the way, even if you don't qualify for an IRA and you want to put some money into index funds to take advantage of a down market, why not do it in a taxable account? The annual tax bite of a broad-based equity index mutual fund like the S&P 500, the Russell 3000, and comparable indexes (assuming that's what you are interested in) is relatively small since there isn't a lot of churn with the portfolio by design. You can always tap the money when you need it without paying the 10% penalty that comes with a premature withdrawal of money from a retirement account.
No more 401(k) match
Question: Can a company that has been contributing matching funds on a 401K plan created by the company, suddenly stop contributing claiming economic conditions? Bert, Chatsworth, CA
Answer: Yes, a company can cancel its match. There's no legal requirement that companies offer a match, and firms are free to reduce it, suspend it or even eliminate it at any time. For instance, at the beginning of November the troubled automaker General Motors suspended its match into the company's 401(k). Other companies have followed suit. Right now, many people are getting hit by a double whammy with their retirement savings plan. First, their portfolios are in the tank thanks to the 40% decline in the stock market from last year's peak, and now they're losing the match, which is the real financial benefit of a 401(k), 403(b), and other so-called defined contribution savings plans.
That said, very few companies have eliminated the match. What's more, looking at the list of companies that cut down or suspended their match during the 2000-2001 recession nearly all of them resumed payments once economic conditions improved.
You should still continue saving for retirement in your 401(k) plan even if your company does stop contributing to it. A 401(k) plan is still an easy way to save for the long haul and it's a tax advantaged way to salt away money for later in life.
Invest and borrow?
Question: Hello, I love the show. I'm a bit of a personal finance geek and I look forward to it every week. I'm 25 years old and I'm returning to school in May for a year long program. Since I left college I've been making maximum contributions to a ROTH IRA (biweekly). I'd like to stockpile some additional money to help minimize the loans I need to help pay for school, so I'm thinking maybe I should stop my IRA contributions. However, I hate the idea of stopping contributions right now, when all the stock prices are so low and right after I've just lost quite a bit of money in the downturn.
So my question is: how do I prioritize this? Is it more important to minimize debt, or to continue to contribute to the IRA until I stop working to maximize my retirement money? Also, if it makes a difference I'll be entering the health-care field so I don't anticipate any problems finding employment after graduation. I'd appreciate any input on this dilemma. Thanks for your time, Peter, Buffalo, NY
Answer: We've been getting variations of this question from people wondering about how to think through the trade-off between debt and saving. For many people, the answer is don't take on debt--especially in light of the terrible economy. It's the right starting point for maintaining your financial freedom and flexibility when you graduate. Still, here's a way to think through more carefully the trade-off you're facing.
First, come up with some realistic numbers. What will be the full cost of school and how much would you have to borrow if you fund the Roth IRA? What will be your budget while in school? What will be your monthly debt burden when you graduate--and for how long? How much can you expect to earn when you graduate, and what kind of pay hikes or raises are common in your chosen career? I realize that the job market is tough right now, but you'll still need to research this part of the equation. (The health care market has held up well during the recession, but there's always a risk that jobs will be less plentiful when you graduate.)
Of course, you could make this even more complicated by making some assumptions about rates of return on investment. For instance, a recent paper by Christopher Carroll, professor of economics at Johns Hopkins University delves into the work of the legendary investor Benjamin Graham, as well as more current work by economists John Campbell and Robert Shiller, to judge stock market values over the next 12 years. He make a good case for assuming a 6% average annual rate of return on equities (net of inflation).
But you can't control return. What you can control is the amount of risk you take. That's why I would stay in the world of budgets, salary, and borrowing.
With these figures you can start playing with different scenarios. For instance, let's say starting salaries are low and your debt burden will be high. (That would raise a question in my mind whether the degree is worth it, by the way.) In that case, I wouldn't fund the Roth but focus on limiting your borrowing. However, if starting salaries are good, and the debt after graduation won't eat up much of your income (perhaps you'll be able to pay way more than the standard repayment schedule) then the case for funding the Roth is more persuasive.
Of course, the answer could lie somewhere in between the extremes--fund the Roth, but less than the maximum, and borrow less to pay for school.
The bottom line: Manage and limit your risk. Reduce the downside and weigh the odds. And then decide which trade-off you're more comfortable living with. . .
Debt and borrowing
Question: Is it better to pay down debt (ie. mortgage or car loan) during periods of inflation or deflation? I understand that it's a good idea to invest during deflation (because the interest rate is added to the deflation rate) and take on debt during inflation, but if an individual took on a mortgage in 2005, is it more financially advantageous to make extra mortgage payments during a period of deflation or inflation? Rebecca, St. Cloud, MN
Answer: First, let's look at the impact of inflation and deflation on borrowing. It only becomes significant at the extremes. When inflation is raging at double digit levels, such as in the late 1970s and early 1980s it does make sense to borrow since you're paying back the lender with depreciating (less valuable) dollars. When the fall in the overall price level is steep--like the Great Depression--the real cost of those debt payments is surging. You don't want debt during a severe deflation.
But during periods of low inflation (such as what we had for much of the past three decades) or mild deflation (which was the case for much of U.S. history before World War II) the message is the same: It's equally advantageous to make extra mortgage payments. You lower your debt burden and reduce the amount of interest you pay to own your home. The main reason not to accelerate payments has nothing to do with the direction of the overall price level. Instead, the concern is putting too much of your money into one asset--a home. Before making those additional payments my standard recommendation is to make sure you have set aside enough in emergency savings and a well diversified portfolio for retirement.
How about investing in a deflationary environment? Let's look at fixed income securities. Interest rates and bond prices are two ends of a seesaw. When bond yields are rising (usually from investors anticipating higher inflation), bond prices go down--and vice versa. Bond prices soared as bond yields came down sharply during the Great Depression. For instance, the prime corporate bond yield average went from 4.59% in September 1929 to 3.99% in May of 1931. By June of 1938 the average corporate bond yield fell to a new low of 2.94%. Government bonds returned about 6% during the 1930s, and short-term bills returned almost 3% over the same time period. Stocks did poorly for the decade.
Still, even fixed income investors are wary of deflation since unwary creditors absorbed huge losses during the 1930s as cash-strapped corporations and municipalities defaulted on their debts. That's why we are seeing a rush into default-free U.S. Treasuries.
Again, the kind of deflation matters. Prices fell at a frightening pace during the Great Depression. The investment record is different when deflation is mild. In many cases deflation and hefty investment returns in both stocks and bonds have co-existed. For instance, from 1802 to 1870 consumer price inflation averaged 0.1% a year. Stocks returned 7% during this period, according to Jeremy Siegel, finance professor at the Wharton School. Short-term government bills returned 5.1% and long-term governments bonds returned 4.8%. No matter how you slice the data the message remains the same, says James W. Paulson, chief investment officer at Norwest Investment Management. "Stock and bond returns run neck-and-neck when inflation is not a worry."
Trading in Lehman
Question: So, I'm confused as to why people are still buying and selling Lehman Brothers stock. They're bankrupt, why are people trading it, the stock reached as high as 30 cents after filing for chapter 11 protection. Why do their quotes online indicate a dividend (of nearly ten times the share price), why, why, why? I'll gladly buy you guys a round lot of Lehman brothers for an answer. Corwin, Cleveland, OH
Answer: Gee, thanks, Lehman Brothers wallpaper. I think not.
The stock closed at $0.04 today, and year-to-date its performance is -99.9%. It fell from a high of over $84 a share in January 2007 to pennies today. Take a look at this chart, courtesy of Marketwatch:
The Lehman bankruptcy in September--the largest in U.S. history--shook the global capital markets this year. According to news stories at the time, it had $639 billion in assets and $613 billion in liabilities. It's a complicated bankruptcy, and the firm is being dismembered in pieces.
The dividend information you see refkects the last dividend payment by Lehman for the third quarter of 2008, and paid toward the end of August.
By the way, thanks to Emily Brandon's blog at U.S. News & World Report, I see that the Pension Benefit Guarantee Corp. the government agency that insures private-sector pensions, filed today to take over Lehman's pension plan. The pension covers more than 26,500 employees and retirees, and it's 95% funded. If there is a shortfall the PBGC will make good on it. In its statement the PBGC said:
The pension insurer's move comes ahead of a Dec. 22 bankruptcy court hearing on the sale of Lehman subsidiaries that make up the firm's investment management business. The agency acted to end Lehman's pension plan prior to the sale so that the subsidiaries being sold remain liable for the pension plan's unfunded benefit liabilities.... The PBGC acted to end Lehman's plan because it stands to be abandoned following the liquidation of substantially all the firm's assets, and the increased financial risk to the PBGC if the subsidiaries involved in the current sale exit the controlled group and escape liability for the pension plan....
You're right. Shareholders have been wiped out. There's no value left in the equity. The company's stock no longer trades on the New York Stock Exchange. The PBGC is taking over the pension.
But we've seen this trading in bankrupt companies over and over again. Shareholders are out of luck, yet the stock trades as a "penny stock." A penny stock is essentially funny money for speculators and unwary investors. Buying penny stocks is not an investment. It isn't a sensible speculation. It's a mystery to me why anyone would buy a penny stock.
Bail on 401(k)?
Question: I'm 54 years old with a 401k plan that is pretty much all my savings. I'm married and together we make approx. $80.000/year. We just recently put our two girls through college. In the last year my 401k has lost a third ($90,000)in a conservative very diversified fund. My question; do I cash out my 401k, pay the 10% penalty and put the money in my checking account that gets 5.00% interest? Thanks for your help. Jim, Clarksburg, MA
Answer: No one likes to see their hard-earned money fall sharply in value. It's tough to watch. But I'd leave your retirement savings alone. I certainly wouldn't pay the 10% penalty to get at the money unless I was standing on the financial precipice and it was the only way to prevent my family from falling. After all, you're still young and time remains on your side. You have a long time before it's time for you to consider retiring, let alone start making withdrawals.
A couple of thoughts: First, you could put new contributions into conservative fixed income investments. Second, you could stop funding the plan for a bit if you need to build up emergency savings. Again, it would be preferable if you did continue to save for your retirement. Hopefully, with your two children out of college you have some extra cash around to save outside of your 401(k). Third, I would take advantage of this experience to decide what you want to invest in with your retirement savings once the economy rebounds and the market turns up. (Yes, I am an optimist.) Last, it would still be better if you went even more conservative with the money in the fund--but still not take it out.
In the future, it seems to me that you might want to allocate more of your money into conservative options--such as Treasury Inflation Protected Securities--that preserve the value of your savings.
I think any of these options would be better than taking the money out of the 401(k) and putting it into a checking account.
Avoiding a "Madoff"
Question: I have Roth IRA accounts with Vanguard and T. Rowe Price. I get transaction confirmations and quarterly statements from each. From what I understand, the people who invested their money with Madoff got the same thing, plus checks that cleared the bank. My question is: How do I know I can trust Vanguard and T. Rowe Price? What prevents those companies from doing what Madoff did? Thanks for your time. Callie, Miami, FL
Answer: It's a chilling thought, isn't it? Scam artists thrive during boom times when caution is tossed aside. For instance, in the 1920s the stock market boomed, and the bust caught many wealthy investors by surprise. Comedian and singer Eddie Cantor supposedly lost a million dollars. Songwriter Irving Berlin didn't heed the advice of Charlie Chaplin to get out and lost a bundle. Irving Fisher, widely ranked among America's greatest economists, damaged his reputation by loftily predicting shortly before the 1929 crash that stock prices had reached "a permanently high plateau." Worse, a large part of his wealth disappeared in the crash.
The reputations of Wall Street's leading lights were also tattered in the aftermath of the crash. For instance, Richard Whitney, acting president of the New York Stock Exchange during the crash and a famous broker with the prestigious firm J.P. Morgan as his client, grandly lived well above his means. When insolvency loomed, he defrauded customers, his wife's trust fund, and the New York Yacht Club. He was caught, convicted, and sentenced to Sing-Sing prison. Charles Mitchell, known as "Sunshine Charley" and head of National City Bank, relentlessly pushed the salesmen in his financial supermarket with branches in more than 50 cities to peddle junk bonds and junk stocks on to an unsuspecting public. He was forced to resign in 1933, and indicted for income tax evasion the following year, although acquitted.
Now, most money managers run legal operations and, largely thanks to the scandals of the '30s, there are checks and balances to the system that work most of the time. The most important is that the money managed by broker-dealers and mutual fund companies is kept in separate accounts, custodial accounts, monitored by the Financial Industry Regulatory Authority or FINRA. These account offer fraud and malfeasance protection up to $500,000 through the Securities Investors Protection Corp. In other words, if you've invested your money in mutual funds managed by Vanguard or T. Rowe Price (to use your examples) or if you trade securities through their broker-dealer operations, you're safe from the kind of Ponzi scheme run by Madoff.
In today's Wall Street Journal a story on how to avoid doing business with future Madoff's highlights the red flag this way: "The key one: Look out for an investment manager who wants complete control of your money, and asks for checks to be made out to him or a company he controls." If someone did that to you, run--don't walk.
Another well known red flag that gets revealed over time: If returns are too smooth and good to be true year in and year out--well, something fishy is going on.
So, all of us need to get familiar with the protections and information offered through the Financial Industry Regulatory Authority at www. Finra.org. The Securities & Exchange Commission offers some good consumer protection information at its website, www.sec.gov. But that agency hasn't distinguished itself at all since this financial crisis began, well over a year ago.
Buy a home now?
Question: Is now a good time to purchase my first home in Santa Cruz, California? Buying in this area has never been an option until now. I have watched closely as house prices drop. Some properties, not particularly nice ones, have dropped to just about where my husband and I can afford to buy. My husband and I are worried that house prices in general will continue to fall, thus causing the fixer-upper we can buy now, which is already a financial stretch, to lose much of its value in the future. Lindsay, Santa Cruz, CA
Answer: More and more people are asking themselves: Is this the time to buy? Home prices are down sharply over the last two years, and mortgage rates have recently trended lower, too.
Take California. The Golden State's housing boom earlier in the decade was phenomenal, and the subsequent bust has been scary. Over the past year, according to the Shiller-Case index, prices in Los Angeles have dropped by 28% and in San Francisco by 30%. A recent article in the Santa Cruz Sentinel says the median home price in Santa Cruz County fell to $433,000 in November. That's down 41% from a year ago.
The price of a median home is still high, however. I don't know where the residential real estate market's bottom lies--let alone when the housing market will stabilize. My best guess--and it's a guess--is that there are additional price declines in our future.
A home is a good purchase for many people. The key is that your finances shouldn't be stretched. If that's the case, a home is a low return long-term investment with some tax benefits and, most importantly, a lifestyle--a neighborhood and a nesting place.
Price matters. What concerns me is that you'd have to make a "financial stretch" to buy a home. That's how people get into money trouble. I'm less concerned that prices might go lower than I am about what owning a home might do to your financial health.
It isn't just the cost of paying the mortgage principal and interest payments, real estate taxes, and homeowners insurance. A home is expensive to run. You may love tending to your garden and taking care of the lawn, fixing the roof and maintaining the garage, but that pleasure costs money. A good rule of thumb for the average homebuyer is that annual maintenance costs range from 1.5 to 4 percent of the home's original cost. It sounds as if you and your husband are handy since you're looking at fixer-uppers. Sweat equity is a good way to build value, but there is still a cost to repair and improvements.
It's no fun being house poor. That's why I lean on the conservative side when it comes to home ownership. Run the numbers carefully. Be comfortable with the fact that a home typically only pays off over the long haul. Make sure that owning doesn't prevent you from meeting other important financial goals, such as saving for retirement. If your okay by these measures, then buy by all means. If not, I'd be wary.
Refinance, or not?
Question: In 2006 we bought a house in a pretty strong real estate market with a 30 yr fixed rate that wasn't stellar, (6.75%). We have no problem making the payments and putting away ~10-11% into retirement funds. We have student loan debt (<30k, @2.45%) and are paying those down on a 10 yr plan with no problem as well. My question is with the recent fed rate cuts, and our mortgage being our biggest debt, shouldn't we consider refinancing, and should we be sinking more money into our retirement funds, or into the principal? I've been quoted 30yr rates as low as 4.75% for our situation with closing costs of ~$3.5k, so the savings on the interest rates seems substantial. If its relevant, we plan on keeping the house for at least 5 more years, no matter what, after that it is total unclear. Luke, Baltimore, MD.
Answer: The Federal Reserve Board made history this week by cutting its benchmark interest rate between 0% and 0.25%. Since Thanksgiving weekend the impact of the Fed's campaign has been noticeable with mortgage rates--and a pick up in mortgage refinancings. The gap has widened enough that for many homeowners it makes financial sense to refinance. However, the pool of qualified applicants is relatively small compared to previous refinancing booms because lenders are limiting their interest to those with a good credit score and equity in the home.
First of all, I would run some numbers. There are a number of good calculators. Check out the ones at www.dinkytown.net.
While there is nothing wrong with accelerating mortgage payments, here's why I am cautious about the strategy: You end up putting too much of your financial nest egg in one basket--a home. That's why I still prefer building up a well-diversified portfolio, even in a market like this one. I would still save for the long run in a diversified retirement savings plan.
For many people a reasonable way to shorten the life of the mortgage without cutting back on retirement savings is to make an extra monthly payment a year. I've recommended this before. By writing 13 monthly mortgage checks instead of 12 you'll pay off that loan faster. Just be sure to tell the bank in writing to put that extra payment toward principal.
First time homebuyer
Question: What is your suggestion for finding up to date information on all I would need to know about mortgages for the first time buyer. I would assume that most books on the subject are now out of date with the current market. Paul, Valley Cottage, NY
Answer: One of the resources I like is www.hsh.com. It offers up to date information and thoughtful articles on the basics of buying a home, refinancing and the like. Another good source for information is www.bankrate.com.
Join retirement savings plan?
Question: Hi Chris. I have the option to enroll in a retirement plan at the company I work for. In light of the current stock market turmoil, I am a bit weary to enroll and wonder, is it worth it? I do have options of safe, moderate or risky investments, but they all seem a bit risky now. I am a 29 year old, earning about 41000 a year and the only debt I have is student loans, lots of student loans. Thank you for your insight. Janet, Minneapolis, MN
Answer: It's definitely worth it to participate in the retirement savings plan at work--especially if your company matches at least part of your contribution. I think even those financial planners and market forecasters that expect years of low returns and bad markets ahead of us would agree with that. The "match" is where much of the return comes from in a retirement savings plan.
Still, even if your company doesn't match your contribution, I would join the plan. For one thing, it's pretax dollars that goes into the retirement account. For another, the automatic withdrawal from your paycheck makes it remarkably easy to save, something most of us find difficult to do even with the best intentions.
I feel less strongly about which investment option you choose, although I want to stress the importance of building up a well-diversified portfolio. It's impossible to know if the market is hitting bottom now--or might do so in a year or even two. That's why the old proverbs that preach diversification and dollar-cost averaging remain wise counsel to anyone investing for the long haul. Diversification isn't a hedge against any financial crisis over a short period of time, but it's a smart strategy over any length of time. By mixing stocks, bonds, and other assets you can earn the highest potential return for the amount of risk you're willing to accept.
The benefits of diversification in reducing risk have long been recognized. A passage from the Talmud says, "A man should always keep his wealth in three forms; one third in real estate, another in merchandise, and the rest in liquid assets." Antonio in the Merchant of Venice slept soundly because, "My ventures are not in one bottom trusted, nor to one place; nor is my whole estate upon the fortune of this present year." Ideally, some of the assets in your portfolio will zig when others zag. Since no one really knows which markets will soar or sink, investing in all the major asset classes creates an opportunity to limit the damage from a downturn and to be in a position to catch the next big market upturn.
However, if for now your not sure what to do, join the plan, put the money into very safe assets, and then figure out over time how you'd like to create a diversified portfolio.
Ginnie Mae
Question: We've heard so much about the problems with Freddie Mac and Fannie May, how are they difference from GNMA's. Our investment in them seems to be holding its value when all else has declined. Why? Robert, Clinton Township, MI
Answer: Fannie Mae and Freddie Mac were hybrid companies, part private and part public. They were "profit-driven corporations, owned by shareholders and, in theory, beholden only to them," wrote James Surowiecki in a New Yorker column. "But they're also so-called 'government-sponsored enterprises,' set up by the state with the explicit mission of fostering homeownership, by buying and selling home mortgages." Fannie Mae and Freddie Mac had the implicit, but not explicit backing of the federal government. However, that implicit guarantee allowed the companies to raise money cheaply on the capital markets. The corporations were also exempt from most state and local taxes, as well as free of many Securities & Exchange Commission requirements. In the end, the hybrid structure allowed for management to fund too rapid growth with cheap money and gargantuan private sector pay and bonuses. Of course, as we all know the house of cards fell apart this year. The federal government had to make its implicit guarantee explicit by bailing out the two mortgage giants over the summer, and then, in essence, nationalizing them.
The Government National Mortgage Association--better known as Ginnie Mae--was established by Congress in 1968. It is a government-owned corporation within the Department of Housing and Urban Development (HUD). It was never partially privatized. It was never a hybrid private/public corporation (or what Surowiecki aptly called "the duck-billed platypuses of the financial world.") As a government agency the full faith and credit of the U.S. taxpayer has always been on the hook with Ginnie Mae. The federal guarantee was explicit all along. That meant it was conservatively run and managed with the risks it absorbed under control. Indeed, the agency's business model is conservative. It guarantees the timely payment of principal and interest on mortgage backed securities and the underlying loans are insured or guaranteed by other agencies--the Federal Housing Administration, the Department of Veterans Affairs, the Department of Agriculture's Rural Housing Service, and HUD's Office of Public and Indian Housing. By the way, Ginnie Mae's traditional edge on its better known rivals was erased after the federal government took over Fannie Mae and Freddie Mac.
Still, considering the simplicity of the Ginnie Mae business model it's hardly surprising it has largely stayed out of the news. That's not the same thing as saying there isn't any risk asscociated with its mortgage-backed debt. For one thing, like all bonds the value of its securities fluctuates with changes in the interest rate environment. For another, as with all mortgage-backed securities, when interest rates fall the owners of Ginnie Mae securities will probably get their investment money back earlier than expected. That's because the securities are made up of lots of mortgages. When rates fall, homeowners refinance, and the mortgage is paid off. Investors get their money back early forcing them to reinvest that money at a lower rate.
Nevertheless, these risks are relatively small compared to the safety of the security--something everyone worries about these days.
Wachovia
Question: We have inherited a substantial amount of stock's from Wachovia, (value around $50,000). Our question is should we keep these stocks knowing how unstable the market is, or, should we liquidate the stocks and pay off our credit card debt. Our current balance is approximately $25,000. So far we have spent around $35,000 of this inheritance from other sources. Thanks, Bev & Mike, Augusta, KS
Answer: I can't say if it makes more sense for you to hold or sell the stock. There are a lot of factors that go into a decision like that, from how patient you can be with the stock to how pressing is the financial needs you currently face. However, in the current environment (actually in any economic scenario) getting rid of credit card debt and staying out of credit card debt is a good thing.
That said, I want to highlight a critical aspect of the answer: Do you want to be a shareholder in Wells Fargo over the long haul? That's what you shortly will be since on Dec. 23rd the shareholders of Wells and Wachovia gave the thumbs up to a previously negotiated merger agreement.
The merger creates one of the country's largest banks with over $1.42 trillion in assets and some $800 million in deposits. The merger is part of a wave of consolidation sweeping the banking industry in response to the ongoing financial crisis. Vulnerable and weak institutions (like Wachovia) are seeking shelter by hooking up with sound and strong banks (such as Wells Fargo). San Francisco-based Wells struck the government brokered deal for Charlotte-based Wachovia back in October after a brief but bitter battle for control with Citigroup.
It's not surprising that the value of the merger has fallen since last October. It was originally estimated as a $15-plus billion deal, or around $7 a share. (Wachovia shareholders will receive 0.1991 shares of Wells Fargo common stock for each share of Wachovia they hold. ) But as I am writing this, Wachovia's stock is down to $5.43 a share, putting the value of the merger at a bit under $12 billion.
Again, if you hold on to the stock your making a bet on the long-term future of Wells Fargo, and that it will succeed over the next several years in integrating the operations of the two companies. The other factor is that you're betting you will earn a higher return on the equity than the "return" you would get on your money by paying off the credit card debt.
Negotiating credit card rates?
Question: do you think paying for a service to lower interest rates on credit cards can work? AFL Financial Services charged 990.00 to negotiate with my credit card companies, to lower interest rates. I have personally been able to negotiate with the companies in the past but now they aren't working with me. thank you karen, Seneca Falls, NY
Answer: More and more people are falling behind on their debts, thanks to the twin pincers of a financial crisis and a deep recession. That said, I'm not a fan of paying big fees to any outfit to renegotiate consumer credit card charges.
Here's a checklist for anyone carrying too much debt and looking for help. (My assumption with this list is that the debt burden has created a financially precarious situation calling for strong remedial action.):
First, check out a branch of the National Foundation for Credit Counseling (NFCC). It was founded in 1951, and it's the biggest and oldest national nonprofit credit counseling service. The website is www.nfcc.org and the toll free number is 1-800-388-2227. For example, I looked at the branch nearest you, which is in Syracuse. It offers Internet, phone and in-person counseling and the fees range from zero to $30. Low fees matter. You're already cash-strapped.
Second, for anyone that can't see their way out of debt (and it seems to me from your email that isn't you) consult with a bankruptcy attorney. Sometimes bankruptcy is the best path toward getting a fresh financial start. Sometimes it isn't. But you should be able to make an informed decision. A good source of unbiased information on bankruptcy and other avenues for getting out of debt is www.nolo.com.
Third, don't give up yet on renegotiating rates with lenders. Right now, it appears that your experience is fairly typical. But there is growing pressure on financial institutions benefitting from a taxpayer bailout to work with customers rather than take a tough stance. I'd get back in touch with your creditors in the New Year.
Last, whatever you do to get out from under your debts, congratulations. But the real trick is to make sure you stay out of debt. Create a plan--and stick to it..
Mortgage rates
Question: According to the Market Gauges in today's New York Times, the federal funds interest rate has dropped from 4.25% to 0.25% in the past year. Yet the rate charged homeowners for a 15 year fixed mortgage has dropped only from 5.33% to 5.05% in the same period of time. I wonder whether such discrepancies are historically typical, and what might be the typical time lapse before the mortgage rate drops proportionately to a reduction in the rate that banks charge each other to borrow money. Alternatively, does the discrepancy reflect the reluctance of banks to loan despite their receiving the TARP funds? This is of practical interest because I am contemplating refinancing my home mortgage and wonder how advisable it is to wait, assuming mortgage rates are likely to drop further as the effects of reduction in the prime rate will eventually trickle down to benefit consumers. Eric, Amherst, MA
Answer: If history is any guide, mortgage rates should drop farther, even though they are already at their lowest level since Freddie Mac started publishing the data back in the early 1970s. For instance, as I am writing this the yield difference between a 30-year fixed rate mortgage and the 10-year Treasury bond is 3.11 percentage points. (The 10 year Treasury bond is the benchmark interest rate for pricing mortgages.) The quick rule of thumb is that gap is normally about 1.5 percentage points, suggesting that the yield on the 30-year should be 3.61%. That's way below the current rate of 5.27% on the 30 year fixed rate. The interest rate on the 15 year mortgage would be even lower, closer to 3% instead of its current 4.83%. (Rates have come down slightly since you emailed your question which accounts for the different interest rate figures.)
History is one reason to suspect mortgage rates could go lower. Emerging signs of deflation or falling prices is another. And the government appears eager for mortgage rates to head lower. It's a good way to support the housing market since lower rates encourage refinancing and new home buying.
That said, we're living through a period where common rules of thumb are suspect. What's more, the government's ability to manipulate long-term bond yields is limited. Investor wariness about securitized mortgages is hampering the market's recovery. Lenders are wary of anyone with less than a stellar credit score. The housing market continues to deteriorate. All these factors are keeping mortgage rates historically high relative to Treasury yields. There's also the risk that at some point all the money the government is pumping into the system will ignite inflation fears.
What's the homeowner to do? Think through the downside. What if you wait for lower rates, and mortgage yields go up instead? How much of a difference will that make to your household finances? In other words, does it pay for you to bet on lower rates because it doesn't matter much to your overall finances if rates stay where they are or go higher and you can't refinance? Or is there a wide enough gap between your existing mortgage and current mortgage rates to make a refinancing financially sensible? if that's the case, why not refinance even if you do miss bottom? These are the kinds of questions and scenarios I would run through, always with an eye toward protecting yourself agaisnt the downside.
12/31/08 by Chris Farrell
Seeking yield offshore
Question: Millenium Bank, an offshore institution, is offering CD's at 5%. Is IFSA coverage comparable with FDIC? John, Los Gatos, CA
Answer: We've been getting more questions about Caribbean-based Millennium Bank and its ilk. The bank offers high interest rates on its certificates of deposit. For instance, it advertises a 6% interest rate for a 1 year CD with a $25,000 investment. Savers are hungry for yield in today's low interest rate environment. But there's nothing wrong with a low yield if your money is safe.
To be absolutely clear, I would not put any money into any offshore bank. Period.
I would not put any money into a bank that is not insured by the Federal Deposit Insurance Corporation (or its credit union equivalent.) Period.
The Millennium Bank is both offshore and its not insured by the FDIC. It's located in the tiny Caribbean country of St. Vincent and the Grenadines (SVG), with a population of 118,432 (July 2008 estimate), according to the CIA World Factbook. To be sure, the government has brought international regulatory standards to its small offshore finance sector, but the International Financial Services Authority (IFSA) isn't an FDIC or anything like it.
The bottom line: Caveat Emptor. Stick with the FDIC label.
Online savings
Question: I recently received a $25 check from ING DIRECT which I can deposit with them if I open an account in the "Orange Savings account." They claim to be members of the FDIC and they pay an interest rate of 2.75%. Re: deposits and withdrawals they say "you can move money automatically from your Orange Savings Account to your linked checking account and back." I'm nervous about doing this if this is not a legitimate company. I am 78 years old and cannot afford to make unwise financial decisions. Thanks for your help. Lois, Benzonia, MI
Answer: You're right to be cautious. Everybody should be with all the scams making the rounds.
But ING Direct is a legitimate company. (As I am writing this, the yield on the Orange Savings Account is down to 2.50% reflecting the overall decline in rates.) It's an FDIC insured online bank. ING and other online banks often offer slightly higher interest rates than their brick-and-mortar banking peers because they have less overhead. It's also a competitive strategy when many people are reluctant to do all their banking online. ING Direct is a subsidiary of ING, the Dutch multinational behemoth that is the world's 9th largest financial institution. You can learn more about the U.S. branch and its offering at its website, home.ingdirect.com.
You want to stay safe with your money, and take full advantage of the FDIC backing. . By the way, in today's low yield environment you can compare rates on other FDIC insured certificates of deposit and savings accounts (and the credit union equivalent) at a number of different places, such as www.bankrate.com.
01/06/09 by Chris FarrellWhen to pay off mortgage
Question: Given today's low returns on money market accounts and CDs, is now a good time to pay off one's mortgage? I am about 1/2 way through my 15-year, 4.875%, fixed-rate mortgage and plan to keep the house. The mortgage balance is $110,000. I have been "maxing out" my 401K for the last 18 years and am fortunate enough to work for a company that will provide a defined benefit pension. I have low expenses, no debt other than this mortgage and an income that allows me to save several thousand after-tax dollars each month. I have $250,000, after tax, in a money market account -- more than enough for emergencies.
I am thinking of using $110,000 of my after-tax cash to pay off my mortgage. Given the low returns on money market accounts and CDs, the argument for using extra cash to pay off debt, including mortgage debt, seems to warrant greater merit, right? Thank you very much, Carl (Currently working in Singapore), Alameda, CA
Answer: We've been getting a lot of questions about paying off the mortgage early and, while it isn't a financial mistake, I'm usually wary of the strategy. You'll see why in several previous postings. But I'm including your question as an example of when the strategy just might work.
You have a good-sized emergency fund, and after-tax savings. You're fully funding your retirement savings plan. You have a company pension to boot.You have no debt other than the mortgage. You are well-diversified with a great balance sheet. Wow.
I think there are only two issues to consider. First, are you going to stay in the home? Is this where you plan on living? It sounds like it, but if you were going to move shortly or desired a different house I'd probably just stick to the current mortgage payment schedule. Second, could you do better than 4.8% investing in the money in the market rather than paying off the mortgage? Of course, you don't know, but you might be able to. Still, in light of all the uncertainty in the economy and financial markets a 4.8% return on investment by getting rid of the mortgage and being debt-free seems really good to me.
Break the 401(k) piggy bank
Question: With the incredible deals in Michigan Real Estate and the loss that I've already taken in my 401K, what do you think about buying our dream home with the money left in our 401K? Patrick, Livonia, MI
Answer: Forecasting is a hazardous business. But for now it seems that the beleaguered Michigan economy will stay under downward economic pressure.
I think you're right that it's becoming increasingly affordable for many people to own their "dream home" with the sharp decline in home prices and the fall in mortgage interest rates. But I don't like the idea of raiding your 401(k) to buy that home.
You're far from alone with "paper losses" in your retirement savings account. Nevertheless, the money in this account is a pool of savings that will gain in value over the years. It's also a smart way to diversify savings outside the Michigan economy where you live and work. If you take the money out you will both lock in your losses and pay income taxes on the withdrawal and a 10% penalty. Taken altogether, it's a bad financial deal.
I want you to own your dream house. I don't see any reason to rush, however. The economy isn't going to turn around anytime soon, and even if you miss the bottom in home prices it's a good bet that prices will stay low for several years--at least. More important, one of the lessons of the past several years is to make sure you stay financially conservative when buying and owning a house. Another lesson is that a home is a long-term investment.
That's why I would start shopping for your dream house. Run the numbers, and figure out what you can afford while leaving the retirement savings plan alone (and continuing to save for retirement.). Add to and build up your savings so you can put down a good-sized down-payment. Make sure your credit score is high so you qualify for the best mortgage interest rate. You'll get that home, but with a healthier balance sheet than if you close out the 401(k). .
Convert an IRA?
Question: I am considering converting a Traditional IRA to a Roth IRA. My reasoning for this is: 1.The markets are depressed right now. If I convert now, the tax hit on conversion will be smaller, since my IRA has lost 25% of it's value. I have money outside the IRA which I will use to pay the taxes. Furthermore, I am expecting the market to rebound long term, and when it does, I will eventually get to withdraw the appreciation tax free.
2. I am self-employed, and so my income varies. This year my income is low, so I am in a low tax bracket, so I feel it would be advantage to convert at this time.
Is there any reason to not do this? Any other information I should be aware of?
At one point, McCain was talking about allowing people to withdraw from Traditional IRA's tax free. This would annul the main benefit of a Roth IRA. Do you think this could actually happen? Andy, San Francisco, CA
Answer: For many people, converting a traditional IRA into a Roth-IRA is a smart way to take advantage of the bear market. The gain is that the upfront tax hit on conversion is relatively small and should be dwarfed by the benefit of tax free withdrawals in retirement. Remember, a traditional IRA is funded with pre-tax dollars; you pay your federal income tax rate on withdrawals during retirement. The Roth is funded with after-tax dollars, but when you take the money out you don't owe Uncle Sam anything.
I think you've thought this through well. You're right, you will have to pay taxes on the conversion, but the tax hit will be minimal with the sharp drop in market values and your low income. The finances of a conversion get better if you have savings to tap outside the IRA money to pay the tax bill.
Your modified gross income has to be less than $100,000 to make the conversion, but that doesn't seem a problem in your case. (That rule will be scrapped starting in the 2010 tax year.) And added benefit of the conversion is that unlike the traditional IRA there is no mandatory withdrawal schedule beginning at age 70 ½ with the Roth.
Speaking of withdrawals, the two main law changes that I am aware of involving IRAs is first, allowing retirees to skip their mandatory withdrawals in 2009 and, second, extending the rule allowing each spouse to make a charitable distribution from his or her IRA account of up to $100,000.
To be sure, there are many tax cut proposals floating around fiscal-stimulus Washington at the moment. But it seems unlikely that Congress would let people withdraw money from Ira's tax free--at least not for any lengthy period of time.
Its not fair, right?
Question: Fortunately, our personal and self-employed business credit rating is very good, no late payments, etc. It would almost seem that with all the proposed "bailouts", people are being rewarded for mis-managing their finances and credit. What about us? What do we get for being financially responsible? What's in it for me? Bob, Deltona, FL
Answer: Congratulations on managing your money well. You're far from alone in feeling that the bailout isn't fair, that it isn't right that folks who didn't get caught up in the real estate frenzy and borrowing boom of the 2000s are now paying for the financial mistakes of those that did. Like you, they were prudent with their money. Now they're on the hook for bailing out Wall Street, bankers, and irresponsible borrowers. That's not fair, is it?
No, it isn't.
That said, none of this means the current bailout is a mistake. Would it be fair to put the economy into a deep recession or depression? I don't think so.
Here's the rub. If the monetary and fiscal authorities are right in their judgment that the risk of an economic plunge of frightening proportions is real--and I think they are--then the Herculean actions they're taking are fair to all of us. And it's striking how a majority of economists looking at what is going on in the financial markets, watching the ongoing national plunge in housing prices and accelerating unemployment take the risk of a depression seriously.
For instance, at the recent American Economics Association annual meeting there was a general agreement that the economy needed massive fiscal stimulus. As Michael Mandel, chief economist at Business Week reported from the convention, the highly respected Harvard University economist Kenneth Rogoff set the tome for the three day meeting: "His message was a gloomy one. We've got a lot further down to go," says Mandel. "He compared the U.S. crisis to other big financial cataclysms, among them the Nordic banking crises of the early 1990s and the Asian crisis of 1997-98, and suggested we are following much the same path. In each of these, the devastation was enormous, with home prices, adjusted for inflation, dropping by an average of 35% over the stretch of the downturn, and the unemployment rate rising by an average of 7 percentage points over the period."
The good news for you is that there is potentially a huge reward for your personal fiscal prudence. History shows that for anyone with money, downturns offer lots of opportunities to find terrific bargains. You get to buy good assets at a cheap price. Want to purchase a home at a substantial discount? You can. Good companies are selling at a discount in the market, too. I'd keep my eye open for bargains. After all, those that are strapped can't tale advantage of them.
That's fair, no?
01/12/09 by Chris FarrellAn "enhanced yield"?--not
Question: Hi Chris - My husband was given a brochure regarding something called the Capital Protected Fixed Yield Enhancement. Apparently this type of investment was only available to large institutions in the past, but due to "technological advances" is now available to individual investors. I understand the basic principle but there are a lot of words in the brochure that concern me, like "hedged with offsetting positions", "no risk or market exposure" and "fixed swap rate arbitrage". I have never heard of this type of investment before and am wondering, if it is such a great thing why isn't everyone talking about it, including my financial advisor? What are your thoughts Chris? In what type of scenario might an individual investor consider this type of investment? Thanks, Leslie, North Branch, MN
Answer: I can't imagine any scenario where the average family would consider this kind of investment for their savings. The reason why many financial advisors aren't talking about it is they are wary--with good reason. These are "black box" investments with lots of moving parts that don't pass the "easy to understand" test. What's more, lots of supposedly "safe" hedging strategies involving derivatives have blown up over the past two years. They tend to be high fee products.
Briefly, there are a number of capital-preservation enhanced-yield type products on the market. Typically, it involves investing money in a fixed income security at home or abroad. You get your principal back at the end of the investment from the income generated by that fixed income investment. The interest income allows the financier to take a sliver of your money upfront and place it in a basket of equities, foreign exchange rates, commodities, or some other investment. The game is to goose your yield by using derivatives, such as options, futures, swaps, swaptions and the like to create the opportunity of earning a higher return. Confused? Wary? Good.
I'm concerned about a proliferation of savings vehicles with bells and whistles designed to take advantage of our desire to save and yet earn a better yield than we can in Treasury bills, FDIC insured savings accounts and certificates of deposit, Treasury Inflation Protected Securities, I-bonds, and other investments backed by the full faith and credit of the federal government. Well, I like the government's handshake. I like the simplicity of the investments. The trade-off of a lower return is just fine with me.
The bottom line: Let the institutuions play with investment startegies like this. But for those of us working hard with for our money and trying to save against a rainy day, I'd steer clear of all enhanced- products unless you have a clear understanding of how they work, the risks you're taking, the reason you're taking on that risk, and a good understanding of how it will affect you if the deal goes bad. Think I'm kidding? Just talk to someone who put their savings into supposedly super-safe auction rate preferred several years ago. With the credit crunch, many of those investors still don't have access to their money.
Savings vs debt repayment
Question: So my wife just graduated with a masters and started working, and i just got a 25,000 promotion. Combined we are making about 3-4 times as much as we were last year. Our expenses have grown cause we were living in upstate NY, but now live in the bay area. But my question is should we try and pay off some of the college loans sooner, or should we try and save all the excess money for a down payment for a house? In reality it could take us a few years to save the 20% we would need for a down payment because of the outrageous cost of housing here. howard, los gatos, CA
Answer: You aren't kidding when you say home prices in the Bay Area are outrageous. Home values are down sharply, but the median home price is still about $350,000. That means if you bought the median home you'd have to save $70,000 for a 20% down payment. (And really you'd need more than that considering closing costs, moving costs, and the annual costs of homeownership. You don't want to be house poor.)
It's wonderful you have the money and discipline to save. How about this for an approach? First, let's put the bulk of the extra money toward savings. The money may go toward a home in the future. But the savings will work double duty in the meantime. The amount of money available will grow in case of a financial setback, such as a layoff. Plus, an emergency savings fund is also an "opportunity fund." Savers eventually get to take advantage of good bargains during downturns. You build a strong financial safety net, have money to take advantage of deals and, create a nest egg for a home.
Second, I would then take some of the extra cash and accelerate your student loan payments.
The thought is not to treat this as an "either/or" question, something all too common in the world of personal finance. Instead, play with the percentages and decide how to divide the money pie. Because of the recession, I would lean toward putting more of the money into safe savings and only slightly accelerate the student loan payments. But you and your wife may be more comfortable dividing the money in half--half into savings and half into extra student loan payments. Or the two of you may decide to put the bulk of the savings toward student loans because you can't stand living with a loan. There is no right or wrong course. You're saving--and that is what's critical in good times and bad.
Gold and catastrophe
Question: My husband is a huge conspiracy theory fanatic. He is certain that the new presidential administration will enact martial law and believes that our financial markets will crash and the dollar will be worth nothing. He wants to put his IRA into a gold ira where there is the actual metal in it. He is certain this will keep our money safe and if gold goes up more we'll make some money. I am very scared to do this. I am torn because I work for an investment advisor and a firm that believes that the market will turn around and to keep our current conservative mutual funds. Can you give us some detailed advice on if it is a wise move to sell our mutual funds and move this money into gold? We have already lost about how much the market is down. What gold investment company might be safe to look at? I hope you can help me. I don't know where to turn. Thanks. Marita, spring hill, KS
Answer: We are living in an era when many "once-unthinkables" have actually happened. The end of the Wall Street investment bank. The U.S. government buying investment stakes in banks. The taxpayer bailout of GM and Chrysler. And that's just a partial list.
The risk that the current recession turns into a depression is real. That's why the Federal Reserve is taking extraordinary actions to shore up the financial system and the new Administration is planning a more than $800 billion stimulus package to resuscitate the economy. I think the government actions will prevent a depression. My best bet is that all this activity will stave off collapse, and that the economy will revive.
I don't know if your husband likes to read, but An Empire of Wealth by historian John Steele Gordon is a well told tale about the hair-raising economic and political crisis the nation has faced before--and how we weathered those trials.
It's no surprise, but I'd stick a well diversified portfolio. Here's one approach: If your husband wants to go more into gold maybe you should keep your retirement funds in stocks, bonds, and similar investments. That way, as a family you will own a very "European" portfolio with gold as a hedge against bad times, yet still exposed to stocks and bonds for good times.
As for owning gold, the most efficient way to do it through an exchange traded fund or a mutual fund. There are a number of well known gold and precious metal ETFs and mutual funds. If he wants to own the gold itself, he'll pay commissions, a premium for the gold, storage fees, insurance and the like. There are many scamsters in the gold market, so if he buys bullion or coins I'd research the dealers very carefully. By the way, the U.S. mint has a list of authorized dealers for its gold coin, the American Eagle.
01/15/09 by Chris FarrellLeverage up?
Question: I can tap my home equity line of credit at an interest rate of 4%. I'm thinking about using my HELOC to fund an investment in a no-load tax-free bond fund earning a dividend of 5%. The dividend income would be tax-free, and the interest expense would be tax-deductible. What are the downsides or risks to this idea? Andy, Ankeny, IA
Answer: I am consistently against individual investors borrowing to invest. Borrowing against your home to invest in the financial markets is a bad speculation. Remember, market returns aren't guaranteed. But you will have to meet those interest payments on your loan no matter what.
We've gotten variations of this question over the years. Several years ago, a typical question involved taking out home equity and invest in stocks. After all, stocks have an average annual long-term return of 10% or so. Problem is, on average Lake Eerie never freezes and the stock market doesn't plummet by more than 40%--as it did last year. The numbers always appear to work on paper, but the investment history says leveraging up (the jargon term for borrowing) is a recipe for financial trouble.
To be sure, muni yields are intriguing. Since Uncle Sam doesn't impose a levy on muni bond interest payments. Tax exempt securities typically yield between 75% and 90% of their taxable Treasury equivalent. Yet muni's now yield more--considerably more. For instance, the yield on a 30-year general obligation (GO) single-A+ rated muni bond is around 5.5%. (General obligation bonds or GOs are considered especially safe since they're backed by the state's taxing power.) For an investor in the 35% federal tax bracket that's the equivalent of an 8.46% yield--instead of the less than 3% taxable yield on the 30 year Treasury bond.
The catch: The worst financial crisis since the Great Depression is fanning fears of widespread municipal bond defaults. Credit risk is an anathema to investors.
You want to put some risk money into a muni mutual fund? That's fine, but tap into savings. Don't double down on your bet.
A home dilemma
Question: In 2005 my son-in-law bought a house in Florida for $220,000. He financed this purchase with a 15-year prime-rate mortgage, which he has been prepaying ever since. This house is his residence and he owns no other real estate.
In 2008 he married my daughter, who has been accepted to a medical school in another state. They will need to sell the house and move this summer. The problem is that they will need to get $160,000 for this house, which is now worth only $140,000. What options are available to people who are current or even ahead in their mortgage payments, but whose homes have lost value and they need to sell? My daughter and son-in-law do not want to walk away from this house or do anything that will jeopardize their credit rating. Susan, Bethesda, MD
Answer: This is a classic real estate problem exacerbated by the historic downturn in home prices. It's not unusual even during goods times for homeowners to face a loss when they want to move for a job (or in their case professional schooling) and they've only owned the place for a few years.
The classic answer is to rent it out. They'll earn rental income until the market rebounds. Then they can sell off the property. To be sure, there are difficulties to renting. They'll have to figure out if it's a viable solution for them. They'll want to find a good tenant. Since they'll be living out of state they'll need to contract with a professional property manager to oversee their home rental (which cuts into rental income). They should research the rental market in the area to see how much they can realistically charge. Still, renting is a classic way to buy time. For instance, when the New York City real estate market declined in the late 1980s and early 1990s a number of my friends rented out their condos and co-ops until they could unload them several years later.
Another time-honored solution is to dip into savings and make up the $20,000 shortfall to pay off the mortgage. In essence, it's the cost of doing business, part of their "investment" in her medical career. Yes, this option is financially painful, but it also stops their exposure to the housing market in Florida, keeps their credit record sterling, and allows them to start a new life and a new career in another state with a clean financial slate.
Bailout banks
Question: I've done a bit of searching around and have had no luck finding a comprehensive list of organizations which have taken funds from the $700B bailout. This bailout is absolutely criminal and I really want to make sure I'm not doing business with thieves. Where can I go to find out who has stolen taxpayer money through this fund? Thanks for the show and any help with this issue! Mike, West Bend, WI
Answer: No one is happy with the bailout. It's very clear that the day-old Obama Administration is burning the midnight oil--after the inaugural parties I guess--devising a broader, bolder plan to stabilize the financial system. To be clear, I'm a supporter of the government committing more money, but this time around with a much clearer strategy and less concern about bank shareholders and management.
That said, a number of our listeners and readers have said they don't want to do business with bailout companies. The best resource I've found for looking at where the bailout money is going to is run by Propublica. It's a new independent, non-profit newsroom that focuses on investigative journalism. It has a comprehensive bank bailout page at www.propublica.org/special/show-me-the-tarp-money. It has a lot of detail and a bailout map at www.propublica.org/special/bailout-map. By their calculations nearly $302 billion of public bailout money has been disbursed to 3125 financial institutions.
01/21/09 by Chris Farrellhomebuyer tax credit
Question: My husband and I just bought our first home in South Minneapolis this past fall. Since then, I have heard a lot of talk about the IRS Federal Tax Rebate for first time home buyers that is being offered this year. I know that we qualify for the full amount of the rebate ($7500) but I am concerned about the provision to pay it all back in the remaining lump sum in the event we sell in the future. Is there a way to take less than the full amount or is this interest free government loan just too good not to pass up in its entirety? Christine, Minneapolis, MN
Answer: Thanks for the question. I hadn't looked very closely at the $7500 tax credit for first-time homebuyers. You've forced me to look at it more closely and, as far as I can see, it's a better deal than I thought.
Like all tax law today, there are quite a few wrinkles. (The IRS has a lot of good information here.) Here are the highlights:
*It's really an interest free 15-year loan. You claim the credit on your federal income tax form. The tax credit is equal to 10% of the qualified home purchase price, and tops out at $7500.
*You don't have to start repaying the loan for the first two years of homeownership. After that, you send the government $500 a year. If you sell the house before you have repaid the loan you pay it from the gains. No gain? The loan is forgiven.
*To qualify you have to buy on or after April 9, 2008 and before July 1, 2009. (Keep those dates in mind!). The purchase date is defined as the closing day. A first-time homebuyer is defined as someone who hasn't owned a home for 3 years preceding the closing.
*The income limits on adjusted gross income is $75,000 and less for single filers and $150,000 for married joint filers. For income above that a partial credit is available. Anyone with an adjusted gross income of more then $95,000 for single filers and $170,000 for married filers doesn't qualify.
The standard rule of taxes applies here: If taking the credit improves your finances then take advantage of Uncle Sam's offer. And for most people I think the credit will be a good deal.
Additional thoughts, anyone?
Here is an update. It's from a look at President Barack Obama's economic recovery plan as it was reported out of the House Ways and Means Committee. The analysis is by CCH, a Wolters Kluwer business.
New Rules for First-time Homebuyer Credit
The proposed legislation modifies the first-time homebuyer credit that was signed into law last year, removing a requirement that the $7,500 credit be repaid over 15 years, but the waiver applies only to houses purchased in 2009 and before the expiration of the credit on July 1. On the other hand, those who take the credit will have to repay the entire amount if they sell their homes within three years of purchase.
Under current law, those who purchased homes between April 9 and December 31, 2008, can claim the credit on their 2008 return, but must repay it over 15 years, beginning with their tax return two years after purchase. If they sell the home, they must repay the entire credit, but only up to the amount of their gain on the sale.
"Frankly, the distinction between 2008 and 2009 purchases is puzzling," Luscombe said. "It seems strange for the people who bought a home in December 2008 to be treated so differently from those who do so in January, 2009, so I wouldn't be surprised if somewhere along the line someone will take a second look at this."
No match for 2008?
Question: My company just announced that they are canceling the 401K match for all of 2008. It is now middle of Jan 09. I understand that they are free to cancel matching at anytime, but to cancel the match for all of the past year's contributions? Is this legal? Christina, Los Angeles, CA
Answer: A growing number of companies are saving money by reducing or eliminating the company match, including General Motors, FedEx, Eastman Kodak and Frontier Airlines. The typical matching contribution in a 401(k) or comparable savings plan is 50 cents for every $1 the employee puts in, up to 6% of the employee's contribution. Of course, some companies do more and some do less. Companies are desperate to conserve cash and hold on to employees, which is why they get rid of the match. But from a public policy point of view it's a terrible move.
Now, most publically traded companies that have suspended their match have done it going forward. But what happened to you can be done. It all depends on the plan's details. (The law gives companies enormous flexibility when it comes to their retirement savings plan.) For instance, when your employer set up its retirement plan it had a choice between providing a "fixed" match or a "discretionary" match. The most common--the one we're familiar with--is a fixed match contribution. But with a discretionary match (or profit sharing match) the company doesn't have to do it if dismay sets in among management after tallying up the results for the year. Your employer realized the profit wasn't there, and it took advantage of its "discretion" not to fund the plan.
A sign of the times? According to a recent the Wall Street Journal story Starbucks switched starting Jan 1, 2009 to a "fully discretionary match" from a "fixed employer match." In other words, the company can decide whether or not to match contributions into the retirement plan.
A break with student loans?
Question: I was doing 'ok' paying down credit card debt until HSBC raised everyone's APR 10%, mine went from 14% to 24%, now I am really struggling. My Student Loan payments are $600.00 a month. Is there any word on the possibility of a hiatus on making Student Loan payments for a few months, or better yet, a year for those of us in trouble? It would really help! Patricia, Washington D.C.
Answer: Arrgghhh. The still all-too-common tactic by banks hiking their credit card interest rates in this environment burns me. It's a bad move at a time when the taxpayer is bailing out the financial system.
That said, at the moment I'm not aware of any new legislative initiatives (with credibility and momentum) that aims at giving financial breathing room to anyone paying back their student loans. That could change, of course, since much of the $825 billion fiscal stimulus package remains to be negotiated before the legislation ends up on the President's desk.
Still, according to a recent story in Inside Higher Ed, it appears tens of billions of dollars are heading toward colleges and universities.
The initiatives highlighted by Inside Higher Ed would help out a number of students and their families. For instance, there's a proposed nearly $16 billion increase in Pell Grant funding, boosting the maximum Pell Grant by $500 to $5,350; an additional $490 million for federal work study funds; almost $13 billion to replace the Hope tax credit with a new tax credit worth up to $2,500 a year; and a $2,000 increase in federal limits on unsubsidized loans.
Two quick thoughts: Make sure to take advantage of all the tax deductions and tax credits you qualify for. Hopefully, you'll get a refund that you can put toward reducing the credit card debt. Similarly, you might get additional tax payments depending on what becomes law over the next few weeks.
Secondly, if toughing it out isn't working and you really need to reduce your monthly debt payments you could look into changing your student loan repayment options. There is a financial flexibility built into federal student loans. (The same can't be said for private student loans.) However, all the different ways to lower your monthly bill today come with a price: You end up increasing the overall cost of the loan.That's why if you or anyone else goes this route I always recommend getting more aggressive about paying down the loan later on when times are better. There is no prepayment penalty with student loans.
The main options for lowering the monthly payment are the Graduated Repayment Plan (payments start out low and increase over time), the Extended Repayment Plan (stretch out the payments), an Income-Based Repayment Plan (your monthly payment rises and falls with your income), the Income Contingent repayment plan (the payment can't exceed 20% of discretionary income), and the Income Sensitive plan (monthly payments are a percent of gross monthly income).
You can learn more about these loan options at Finaid at www.finaid.org/loans/repayment.phtml. If you are in more dire straits you could also qualify for student loan forbearance or deferment. Finaid also offers up good information on those two options.
Good luck.
Credit card debt
Question: Recently I received, unsolicited, a new credit card from JC Penneys with a higher credit limit. The new card comes with "benefits"--more opportunity to spend at a time when I want nothing more than to reduce my debt. Is there a downside to refusing the increase? Is there a downside to accepting it? Should I use it as leverage to request a lower interest rate?
I am also concerned in general about the fast-and-loose way banks can change credit agreements, and in particular, Bank of America, which also made changes in the credit agreement on my account with them in the last few months. I'm sure you've gotten this question often, but one more time--what can consumers do to protect themselves against the lack of regulation, aside from not holding credit at all? The looseness is reminiscent of the airline industry where you might book a flight, but they are under no obligation to get you there. Mary Rose, Montpelier, VT
Answer: Continue to pay down your debt. Ignore the increase in your credit limit. You don't want to carry debt on your credit card. Period. If you use a credit card for convenience--which is the reason to have one and use it--pay off your bill in full every month, as soon as the tab comes in. This way, there's nothing the credit card companies can do to you. You have a high credit score. And a pristine balance sheet.
To your second point, many people are getting a harsh lesson in how the credit card industry stacks the deck in its own favor. Here's one of my pet peeves. You probably have a "fixed" rate credit card. Now, to you and me a fixed rate means it can't be changed, just like a 30-year fixed rate mortgage. Problem is, that's not what the credit card companies mean by "fixed" rate. They can change their "fixed" rate with as little as 15 days notice, depending on the state or the credit card's contract terms.
Here's even worse behavior: "Universal default.' A number of issuers impose what's called a "universal" default clause hidden in the fine print of a credit card agreement. If you're late on any payment to any creditor, be it the electric company or your mortgage, the rate on your card could automatically jump--even if you are current with your payments on the card.
I could go on with abuses. The Federal Reserve has approved new rules that ban or clean up a number of these practices. Problem is, the rules don't go into effect until 2010. I don't understand why. It looks like the new Congress doesn't, either. There's a chance that new legislation will accelerate the timetable.
01/27/09 by Chris FarrellFile taxes now--or wait?
Question: For the first time in my life, I actually did my taxes earlier than usual. All this talk of stimulus packages, however, has me wondering: should I hold off on mailing my tax return? Are there any plans you know of in the house or senate that might affect typical 2008 tax returns? After not procrastinating on my taxes, I would hate to have to file an amendment at the last minute. Thanks. Ben, Madison, WI
Answer: Well, you're way ahead of me. Hopefully, you're getting a refund. If that's the case, file and get the money back fast from Uncle Sam.
The fiscal stimulus package is still being negotiated and much could change between now and the President signing legislation. Still, it looks like most of the individual tax changes kick in for 2009 and after. If you're interested in (a lot) more detail, check out this analysis by the tax specialists at CCH, http://tax.cchgroup.com/Legislation/2009-Recovery-Act.pdf.
By the way, filing an amended return to get even more money back? It's easy and well worth it.
Buy a home?
Question: With interest rates and real estate prices falling, I've begun looking around to buy a home. Some of my friends think this is a fine idea ("It's a buyer's market"); others think it's financially foolish ("Anything you buy now will lose value. It will be at least a year before the market bottoms out.") Where do you come down on this question? Lisa, Greenville, SC
Answer: I'm with you. It's a good time to look. But you have plenty of time. Of course, I have no idea how much lower home prices will go. In most parts of the country there's still downward momentum. I don't know how deep the recession will get and how high the unemployment rate will go. Still, the economic environment says there's no rush.
That said, why not start the process of figuring out the personal finances of homeownership for you? Run the numbers: Is it smarter for you to rent or own? Where is the breakeven point for homeownership? What's your credit score? Do you have 20% or more to put down? How long do you plan on staying in the home since the longer you live there the better the finances work out--and vice versa.
I'd also use this time to explore neighborhoods. What works bets for your lifestyle? A single family home? A condo? Townhouse? Research, plan, and then when the time is right act. It's a buyer's market.
What's a depression?
Question: You may have answered this already, but what is the difference between a recession and a depression? With daily news of layoffs, unemployment rates, home foreclosures, and the lack of jobs available, it seems like we're in a depression to me. How long will this last? And how are we going to get out of it. How can we jumpstart the economy? These are really scary times. Thanks. Joeth, Lincoln, NE
Answer: These are scary times. A recession is typically defined as at least two quarters of consecutive decline in gross domestic product. Recessions are dated by a group of scholars with the National Bureau of Economic Research, and this downturn is now more than a year old. What would turn it into a depression, besides the old quip a recession is when your neighbor loses her job and a depression is when you lose yours? There is no general agreement.
Richard Posner, the federal judge and University of Chicago scholar, recently said he believes we are in one: "I suspect that we have entered a depression. There is no widely agreed definition of the word, but I would define it as a steep reduction in output that causes or threatens to cause deflation and creates widespread public anxiety and a sense of crisis."
Of course, we're still far from breadlines snaking around city blocks or Hoovervilles set up outside city limits, visible, tragic signs that more than a quarter population unemployed and over a third if including those working only a few hours a week during the Great Depression. Louise Armstrong, a social worker in Chicago and later a relief administrator in a Michigan County during the New deal, recalls "One vivid, gruesome moment of those dark days we shall never forget. We saw a crowd of some fifty men fighting over a barrel of garbage that had been set outside the back door of a restaurant. American citizens fighting for scraps of food like animals!"
Several years ago, Nobel laureate Ed Prescott and economist Timothy Kehoe defined a great depression as a sustained drop of 20% or more in the economy. They were studying depressions in the latter part of the 20th century, including Mexico and New Zealand. We're still a long way from a depression by this metric.
The best definition I've come across was devised by University of California economist Brad DeLong. It's a chilling definition. A depression is when the unemployment rate breaches 12%, or stays above 10% for three years.
Here's a Marketplace Money interview from last year on the topic. And check out this video clip on the changing terminology of downturns.
Freelancers and unemployment insurance
Question: i am a self- employed artist. all of the news about record numbers of people collecting unemployment benefits has me wondering if these benefits are also available to self-employed people whose incomes dry up. i am currently managing to pay all of my bills and even save little bit of money but am concerned about what i will do in the future if i am unable to earn enough money/find a job. thanks, jenny, minneapolis, MN
Answer: One of the drawbacks of being self-employed is that you're usually ineligible for unemployment insurance once work dries up. The most common reason why artists operating as a freelance sole proprietor are excluded is that they file their income on a Schedule FC tax form. Yes, you get to take tax deductions as an operating business, but in most cases you can't claim unemployment insurance.
I want to emphasize the phrase, "in most cases." The rules surrounding unemployment insurance are complicated. So, if you ever do find yourself in need of filing, check with a professional. You can get good information at online resources geared toward artists in most major metropolitan areas.
A loan from family friend
Question: I'm turning 25 years old in a few months and am finally getting serious about eliminating my debt. I have a credit card with a $3,000 balance. It was at 24% APR until I called this summer and asked them nicely to lower it. It went down four points. Twenty percent is still too high. As our economy sours, my mom is preaching about this being a time for neighbor to help neighbor. During a conversation on the subject over the holidays, it came out that a family friend had a few thousand sitting in a savings account earning hardly any interest. She wasn't putting it in a CD because it wouldn't earn much more there. My mom pointed out that if Beth loaned me $3,000 to pay off my high interest credit card, Beth could earn more than one or two percent offered in a CD and I could get a lower interest rate on my debt. It's a win-win for all parties. Laura is ready to write the check and I'm ready to lower my interest payment. Do you have any advice as to how we structure the agreement? What's fair for all parties? Is there a precedent for this? Are there any online resources? I really enjoy your show. I learn new things ever week. Thanks for making us all better informed. Kindly, Virginia, Cincinnati, OH
Answer: Congratulations on getting rid of your debt. Now, what you're proposing isn't uncommon. There are a couple of important caveats. If I were writing to Beth, I would warn her to think seriously before mixing money and friendship. It's always risky proposition. Then, assuming she's still comfortable with it, just remember you are taking on an extra burden of making these payments no matter what. She's a family friend.
That said, it is a favorable deal to both parties, and it's done all the time. I strongly urge you to write-up a formal document laying out the interest rate, when the payments will be made, and when the loan will be paid off. This document will lay out her expectations and your obligation. A document like this for a small loan will also satisfy the Internal Revenue Service since she'll be receiving an interest income from the loan.
There are plenty of do-it-yourself documents on the web. For instance, Nolo.com, a legal self help company I admire a lot, has a standard form on its website here. You could also just do one on your own. However you do it, everyone signs it. Good luck.
Pay cut and may lose job
Question: A: I am currently employed (Not sure how long this will last?) just took a 30% pay cut and there is a good chance that I will either be laid off or the company will close it's doors within the next two months. I have a good amount of money in my 401K and a separate traditional IRA from a previous job.
My concerns are that I don't have an adequate emergency savings to draw from while I search for work and I will need to pay bills for quite some time as the current job market is awful...I may have to do some re-training/ie.. Find a new line of work.
As much as I hate the thought ...What are your recommendations in regard to an emergency draw of funds from either the 401k or the IRA to ensure my family does not find themselves out on the street? David, Livonia, MI
Answer: I'm sorry for your circumstances. That's tough and, sad to say, you have far too much company these days. The standard advice about not tapping into your retirement savings isn't so standard if you lose your job and your family comes close to finding "themselves on the street." Period.
You take care of your family first. That said, I'm hoping you are far from those dire circumstances. I would urge you to consider tapping retirement savings a last resort. It's the last financial defense in protecting your family.
I'm sure you're already doing all these things, but just in case, while you're still are earning a paycheck I'd cut back on spending, boost savings and plan ahead. This is the time to start going over your budget, and figure out where lie the savings. You also need to get a feel for income. Yes, you'll lose you job, but will there be severance? How much unemployment insurance will you get? Does you spouse work outside the home? What are the training opportunities open to you? Is there state, local or nonprofit money available to help foot the training bill or transition to a new career? I'd also talk to former colleagues, friends, tap deep into the network of people you've developed over the years. There are many steps to take preparing for the possibility of bad days ahead--and hopefully it won't come to pass.
One last thought: If after all this it turns out that you HAVE to touch retirement money, just draw what you need. That way you'll preserve as much of the retirement savings as possible while minimizing the impact of the 10% penalty and taxes on the withdrawal.
Convert to Roth
Question: Given the current Federal deficit, and the way the U.S. Government is currently burning through money, it seems like a sure bet that tax rates will have to eventually start going up in the future. Because of this I've been thinking of converting my current 403(b) into a Roth IRA. And given that value of my retirement account has gone down (like everybody else's) it seems like a good time to make the conversion. In my particular case, if I were to convert the entire amount, according to the calculators I've tried, I would still be able to pay the taxes and penalties for the conversion entirely from current savings. And again, given how little these savings are currently earning, it seems like good timing. What are your thoughts on doing such conversions? Bill, Durham, NH
Answer: Your basic insight is sound. A lot of people are rightly running their calculators to see if conversion into a Roth is a good financial move for just the reasons you mentioned. For many, the answer is coming out yes.
Problem is, you may not be eligilble. If this is an active 403(b) at work you can't convert it into a Roth. You can do it if you're no longer on the job but simply left the retirement plan alone with your former employer and the plan allows you to roll the money over into an IRA. (Before 2008 you had to roll a 401(k)-type plan into an IRA and then roll that over into a Roth. The law has been changed so that you can go straight to a Roth.) You're also eligible If you're over 59 1/2 and your company allows an in-service distribution.
Remember, before 2010 your adjusted gross income has to be below $100,000 to make a conversion. The same $100,000 limit applies to the overall income of couples filing jointly as singles. Those who are married but file separately can't convert at all. (I don't make these rules up; I'm just reporting on it).
I'm glad to see that you have other money to put toward the taxes owed on a conversion. That's an important test to pass to see whether conversion makes sense.
The IRA laws are not simple. You can see if you even qualify for conversion at the Fairmark website. The Roth information is here ( www.fairmark.com/rothira/index.htm.)
Starting 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?
Deduct 401(k) losses?
Question: Can I deduct the losses in my 401K on my tax return? I am 26 years old. Thanks, Leena, Dallas, TN
Answer: Most of us (almost all of us? Just about everyone?) have losses in their retirement savings plan at work. That's behind all the jokes about 201(k)s. No, you can't deduct those losses on your income taxes. It doesn't matter whether they are paper losses or realized losses. You're funding the 401(k) with pretax dollars and it's compounding (or losing) money sheltered from Uncle Sam. When you do withdraw the money some 40 years from now, you'll pay your federal income tax rate on it. Hopefully by then it will have grown a lot over the decades.
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.
Should we buy an apartment building
Question: My husband and I are ready to buy a home but given the uncertainty of these times and of even our seemingly secure jobs, we're thinking of buying a 2 or 3 family building, living in one of the units and using the rental income as a hedge against one of us losing our jobs one day. Or, if that doesn't happen, we would have the option of converting the building to a one-family home.
But my question is this--will banks take into account the value of the rental income when we are figuring out what we can afford and get a mortgage for? Is there any rule of thumb for that? Our income is about $250K and we would need to spend at least $1.1 million for a multi-family unit in our neighborhood in NYC. That's on the upper range of what most online calculators say we can afford, but with a rental income to help out, do you think we can do it? Any thoughts about whether this seems like a good idea? Erin, Brooklyn, NY
Answer: Buying an income producing property such as a duplex or fourplex is a classic way of lowering the cost of ownership. But the difference between being a homeowner and a landlord is comparable to the difference between driving a Volkswagen Beetle and a Mack Truck. Like a truck driver, when you're a landlord you're running a commercial business dependent on cash flow.
When we buy a home we hope to make money over time through forced savings (paying off the mortgage) and appreciation (a vague hope sometime in the future considering the state of housing). But a home is much more than an investment. It's a lifestyle, a neighborhood, a commute to work, school for the kids, and the like.
A rental property is a business. Like all small businesses, you'll get some tax advantages, such as depreciation (an offset to taxable income) and deductions tied to the repair and maintenance of the business. If the business does well and generates a good cash flow it will more than cover your mortgage and other expenses. It's a way to create wealth.
The size of the mortgage and the mortgage will be affected by a number of factors, such as the down payment, your income and debt ratio, and whether the apartments are empty or have tenants. The basic dynamic is the same as a home purchase: The larger the down payment the easier it is to get a loan and a decent rate. Mortgage loan limits are higher for a commercial mortgage, but so is the interest rate. The big issue for you--and the lender--is your ability to meet the monthly mortgage and other monthly financial payments even if rental units are empty. The banks will take the rental income into account, but at a discount because apartments can be empty.
In other words, like all small business there are genuine downside risks. For instance, you have to keep good books and your taxes will be more complicated. You'll need to work with a professional insurance agent to get the right kind of property and casualty coverage. Any landlord will tell you that the business is highly dependent on the quality of your tenants. It's a highly regulated business, especially in large metropolitan areas like Brooklyn or San Francisco, and landlords are sued more than any other group of business owners in the country. I would talk to landlords in your area about their experiences, go to some local landlord meetings, and tap into on the ground experience.
To be clear, owning rental property can be a great business. I just want to you to be sure this is the entrepreneurial venture for you.
Consolidate loans to mortgage
Question: Please help... Would it be a good or bad decision to put a non-consolidated Parent Plus Loan into a home refinance? The refinance rate is 4.5 and the student loan is 7.9 (!) I have two other consolidated loans at 3.25 and another at 5.875. I'm currently over the limit (2x) of interest I can deduct, so if included it, the interest it would be deductable, but does it make sense to increase my mortgage by so much (an additional 32K on a 156K mortgage? And I will have to pay an additional .25 point to do the cash out. Will the Plus Loan interest rate be reduced in July? Would it make sense to wait and consolidate? My refinance will settle before I know the next rate. Will the deductable student loan interest rate be raised? I have a line of credit rate currently at 2.5, but they will average 3 years interest to do a fixed loan, so that w on't help now. I would rather keep it separate, but am temped by the 4.5 rate. I want to make the best short and long term decision.... Thanks in advance for considering my question. Mary, Garrett Park, MD
Answer: I want to address the core of your question. I believe one reason why so many middle-income homeowners got into financial trouble in recent years is that they consolidated their debts into first and second mortgages. Yes, the interest payments are tax deductible. But I don't think the tax deduction is worth the extra risk.
For instance, it always upset me when financial advisors would recommend consolidating credit card debt into a mortgage. That's crazy. I feel the same way about student loans. There is financial flexibility with Parent Plus loans, such as a graduated payment plan, income sensitive payment plan, and an extended payment plan. (Of course, the price for taking advantage of these options is the overall cost of the loan goes up.) If you pay off the loan by rolling it into your mortgage you'll lose that flexibility, and increase the risk of losing your home if you have a job or income setback.
Refinance
Question: Today Friday the 13th, we signed refinancing papers for a 4.75% fixed 15-year mortgage. We had 6.0% 30-year fixed so this is a good deal for us. My first question. Will the "soon to be approved" stimulus packet have 4-4.5% refinancing available for those with good credit, as it was talked about last week? I have not heard anything this week about loan financing rates in the agreed upon plan.
If the lower refinancing rate will be available soon, it is worth it for us to decline the loan (within our 72 hours window) and take a chance on being able to get the lower rate loan in the near future. Or is the proverbial bird in the hand what we should hold on to at this point. Bryan, Ellicott City, MD
Answer: The fiscal stimulus package doesn't have anything to do with bringing down mortgage interest rates. The Treasury's proposed bank bail out plan does have the Federal Reserve buying securities in the market to bring down interest rates. (Don't worry; we're all confused about what is what these days)
No one really knows whether the Treasury and the Fed will succeed at lowering rates and, if so, by how much. So, the question is whether it's worth it to you to see if rates fall much farther and, if they don't, that it's a risk you're willing to take. My sense is that you got the mortgage and rate you want, and the cost/benefit trade-off for waiting isn't worth it.
Pay off credit card
Question: Out of the clear blue sky, I got a notice that my Capital One Platinum credit card rate is being raised from 4.99% to 13.99. I have a very high balance on this card (76% of available credit). I checked my own credit records (perfect, never late, all accounts up to date) and score (942) and figured they would want to negotiate with me, but no dice. The guy on the phone said they mailed out 8 million of these notices this week. My options are 1. Find a 0% introductory rate and transfer the balance (if I can even get one) or 2. Opt out of the change in the rate, close the account, and pay it off at 4.99%. Either way paying it all the way down will take me 12-18 months. What is the best alternative or is there another option that you would recommend? Katryn, Minneapolis, MN.
Answer: What the credit card companies are doing is legal. But it's wrong. That said, the best thing you could do is keep the 4.9% rate, close the account and payoff the debt. It's risky to carry a high balance in an economy sinking lower every day and it's prudent to eliminate credit card debt. So, unless there is some business reason why you need this particular piece of plastic, I'd get rid of it--and fast. Capital One loses a good customer, too. That's the power consumers have in our economy. I'm hoping after the shoddy way most credit card companies have treated their customers during the downturn everyone will refuse to carry a balance, slashing card company profits and practicing good personal finance habits.
Bankruptcy for fun?
Question: The economy is a hot topic around the water cooler these days, and I've been asking co-workers across my department about their financial strategies for the coming year. One co-worker said she was "advised" to "refinance her mortgage, buy two cars, then run her credit cards up to their limits and then declare bankruptcy". I was surprised at this financial self-destructive sounding plan - I asked 'what about your credit score, what do you plan to do when things turn around, you'll be in a credit pickle!!' and she shrugged her shoulders and said -- " so what, no one cares about credit any more and we're not going to get out of this. My children will never know prosperity in our country. I might as well get what I can get". This kind of thinking contributes to the downward spiral. I told her that I thought we would eventually pull out in a few years, and the responsible people (yep, the same ones that are getting the short end of the stick these days) will have the ability to recover faster with the economy. Everyone else who said 'who cares' and financially imploded will take years to repair the damage if they continue with reckless disregard for financial common sense. Whose outlook do you think is more likely? I want to be optimistic, continue to support my local businesses, and wait this thing out -- with my credit intact. I can't imagine planning to declare bankruptcy as a strategy. I see it as a last resort. Virginia, Raleigh, NC
Answer: To put it politely, your co-worker doesn't know what she's talking about. Her point of view is ignorant, irresponsible and, there is no other polite way to put it, financially stupid. Millions of people are being forced to declare bankruptcy after losing their jobs. They've lost their homes, spent hours dealing with creditors, lawyers and courts, and now they're trying to start all over again during a vicious economic downturn. Talk to them, and then say bankruptcy is an easy option. It isn't. Bankruptcy is a safety net.
Like the details or not, the Treasury and Federal Reserve, the Administration and Congress, are struggling to prevent the economy from sliding into depression and, at the same time, set the stage for the next upturn in the business cycle. I believe they are slowly succeeding, stumbling toward solutions as the depth of the problem become ever more apparent. But even if the economic troubles continue far longer than I imagine, even if we live a reprise of the 1930s, parents can do right by their children, educating them well, bringing them up a household where maybe there isn't much, but what you have is valued.
Last, you are absolutely right. Downturns eventually open up good opportunities for those with hefty savings and good credit. Yes Virginia, you're right on all counts.
02/18/09 by Chris FarrellHow 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 FarrellStudent loans and fiscal stimulus
Question: Is there any chance of bailout money for student loan borrowers? I assume that if there is any bailout money aimed at student loans, it will be given to the lenders and not to the borrowers, but if individual homeowners are eligible for bailouts, why not individual students? A lot of students imprudently ran up too much debt, just like home buyers. : Eric, San Diego, CA
Answer: It's a good question, and we've gotten a number of similar queries from listeners and readers. The bottom line answer is that indebted graduates with a college sheepskin aren't getting help. The stimulus package does direct money toward making college more affordable, especially for students from lower income families. Higher education isn't going empty-handed, either, with money available for investments like university research and university infrastructure. But nothing was targeted at easing the student loan debt burden of college graduates. My guess is that policymakers--if they thought about it at all--decided the tax breaks will give graduates extra money this year and, if it makes sense, they can direct the money toward debt payments.
02/24/09 by Chris Farrell
Mom 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 FarrellMortgage help?
Question: Hi Chris, I'm in more than a bit of a quandary...I purchased my home (townhouse) in 2005 and refinanced in 2006 (to get away from an frightful interest only mortgage to a traditional 30-yr fixed mortgage). While I live quite frugally, my mortgage is more than 60% of my income, and of course now my property value has tanked into what appears to be the abyss! I do also have a student loan that I'm paying off (great interest rate so I don't want to mess with that), so between all my mandatory payments, I feel I have absolutely no wiggle room at all, and do feel more than stressed. Will this new stimulus package be able to help someone like me, i.e., can I take advantage of this package to do some thing about my mortgage? Thanks so much. Mini, Herndon, VA.
Answer: I don't blame you for feeling stressed out. You're paying out way too much of your income for shelter. Let's hope the Administration's housing plan does buy you some relief. Now, it seems to me that the mortgage refinancing portion of the plan is designed for people like you. You're current on your payments. You have good credit, paying your bills on time. But you can't refinance into today's low rates because you don't have enough equity in your home after the steep decline in home prices. The new rules allow Fannie Mae and Freddie Mac to refinance mortgages where the value of it is between 80% and 105% of the value of the property. Many borrowers that are making their mortgage payments on time have seen their loan-to-value ratios climb into this range because of falling house prices. However, this program is for "conforming" mortgages, ones that fall within the $417,000 loan limit of Fannie Mae and Freddie Mac. (There are higher loan limits for 59 high-priced sections of the country.)
That's one avenue to pursue. There's another tactic to consider, or at least explore. The loan modification part of the package is aimed at borrowers in imminent risk of default. That's not you. But it has incentives for mortgage lenders and mortgage servicers to reduce monthly repayments to 31% of gross income--considerably less than you're paying right now. (And the new loan modification plan is supposed to stop the practice of lenders loading up mortgage modifications with fees, penalties and the like so that the new arrangement is actually more expensive than the previous one. How's that for disgusting?) I would at least try to see if you can get your loan modified. But if you do get an offer look carefully at the deal to make sure you come out ahead.
Hopefully, you will be able at least to refinance your mortgage at a lower rate.
Inheritance
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.
Lehman Brothers Bank?
Question: Several years ago my broker at Morgan Stanley bought me a CD at 5% which would not come due until 2016. Unfortunately this CD was with Lehman Bros. . Now I'm worried about the $10,000 I have invested. It is still paying interest but don't know if it will continue. Should I sell or what? My broker refuses to answer my questions about this- I'm changing brokerage firms! Phyllis, Lacey, WA
Answer: One thing that I love about the questions we get is that I always learn something new. I had no idea there is a Lehman Brothers Bank FSB. There is, and it's headquartered in Wilmington, Delaware. It's essentially an online bank that also offers community banking services in Delaware. Here's the really critical piece of information: The bank's deposits are insured by the Federal Deposit Insurance Corporation (FDIC).
According to a Reuters story last month, the U.S. bankruptcy judge overseeing Lehman let the company hike the capital level of the bank. It needed to boost it capital levels to prevent the Office of Thrift Supervision from taking enforcement action and placing the bank under government receivership.
What does this mean for you? Your $10,000 invested in the certificate of deposit is safe since you are well under the $250,000 FDIC limit. (Although on January 1, 2010, the FDIC insurance limit returns to $100,000 for most deposit categories.) That should give you some reassurance. And that's my most important message.
The story gets more complicated after that. There is a risk that at some point the bank gets taken over by regulators. If that happens another bank would take over your account. The new owner may or may not honor the existing terms of the CD. Traditionally, banks did stick with the CD terms because they wanted to keep you as a happy customer. More recently, a number of banks, nervous about their deteriorating balance sheets, have decided to change the CD terms.
My guess is that you have what's called a "brokered" CD, i.e. one that was sold to you by your broker. Brokered CDs come with some unusual twists and turns. If you want to get out early in a brokered CD, you'll probably have to sell it in the market like any other fixed income security. The risk is that you'll sell your CD for less than you paid.
I would definitely get a new broker, and work with that person. In the meantime, your principal is safe.
Downsize?
Question: I'm 50 yrs old and have been thinking about downsizing and relocating for a few years now. I am self-employed and can take my work with me, so my income is not tied to a particular location.
My plan is to sell my current home, of which I own about 70%, and take that cash to buy a different house that would better suit my needs as I age, etc. Hopefully I could buy this house without a mortgage, though I would consider taking a small 10 yr mortgage if necessary.
I realize that it may be impossible to sell my house in the current market, but if I DID sell my house near the market rate, and put the money into another house in a similarly deflated market, would this be a foolish endeavor? Or is it ok since I'm just moving my equity from one house to another? Thanks. Anne, Olivebridge, NY
Answer: As Jane Austen wrote in Emma: "Ah! There is nothing like staying at home for real comfort." Problem is, many people's homes--their most valuable asset and the foundation of their retirement plans--provide scant comfort these days. At some point, of course, real estate prices will stabilize and economic growth will pick up again. The question, as always, is when--and by how much.
That said, I think your idea of downsizing and taking into consideration aging is spot on. For one thing, you'll have a nice equity cushion going into retirement, and one of the worst ideas coming out of the boom years was that it was okay for retirees to carry a hefty mortgage. That was bad advice in most cases.
Large homes cost a lot more to maintain and are subject to higher property taxes. The savings from lower energy costs and other expenses associated with running a smaller home compound over time. Plus, as we age, few of us want to perform maintenance. Smaller yards and single-level homes become more attractive, as do condominiums and townhomes with maintenance staffs.
So, no, I don't think what your contemplating is a foolish endeavor at all. I hope more people are building downsizing into their retirement savings plan.
Tax credit and tax rebate
Question: We've heard about the $13 a paycheck 'tax credit'. What exactly is a 'tax credit' as opposed to the 'tax rebate'? Will we have to pay the credit back to the IRS come April? Should we adjust our withholding so we pay enough tax and avoid paying penalties? Lisa, Pinckney, MI
Answer: I thought I knew the difference between a tax credit and a tax rebate, but I wasn't quite sure. So I put your question to the financial advisor and professional polymath Scott Gislason at North Star Resource Group in Minneapolis. He's a lawyer, a CPA (certified public accountant), a CLU (chartered life underwriter) and ChFC (chartered financial consultant).
Here what he says: "There's an often overlooked difference between "tax credits" and "tax rebates". Generally speaking, tax credits only offset tax balances due - meaning if you have low income and owe nothing in tax, you get no benefit from a credit. Whereas, tax rebates are paid to a taxpayer regardless whether a tax is payable. There is an exception to this rule - the earned income tax credit which operates like a rebate."
Another exception: The new $8,000 credit for first time homebuyers. It's a "refundable tax credit." That means you can get a refund of the full $8,000 even if your total tax bill is less than that.
So, that's the difference between a credit and a rebate. He adds: "Neither credits nor rebates should generate additional taxable income necessitating a change in withholdings or estimates."
By the way, the change in withholding for the "Making Work Pay" credit is being done by your employer. You don't need to do anything.
by Chris FarrellGraduate school debt
Question: I'll be starting veterinary school in the fall, which means that over the next four years I'll take on something like $150,000 in debt. This will be mostly in the form of subsidized and unsubsidized Stafford loans, with rates in the neighborhood of 5 to 6%. My question is, is this an awful time to take on this kind of debt, or is it the perfect time? I haven't heard a single thing in all the coverage of the current crisis about how this might affect current student borrowers. Sarah, Portland, ME
Answer: At the moment, the federal government's focus when it comes to higher education seems to be twofold. First, make sure that there is enough loan money available for students, especially undergraduates and, second, to direct more financial support for college to low income families though a combination of more generous grants and tax benefits.
The downturn in the economy is unusually scary. But I don't think it's a terrible time to borrow and invest in your education or a perfect time.
Instead, I would go back to the fundamentals. What you're facing is the classic graduate school question: Do my future job prospects, measured in terms of career satisfaction, income and job security, justify taking on all this debt? Medical school students, law students, MBAs, MFAs, PhDs, future veterinarians like you and anyone else thinking about earning an advanced degree needs to weigh the income-in-the-future versus the debt-burden-to pay-down trade-off. Is there a good chance that you will earn a sufficient return on investment to pay down the debt within a reasonable period of time? What's the downside, and is the risk worth it to you? Those are the questions to research.
That said, it's smart to get more education and improve skills during an economic downturn. Hopefully, the economy will pick up before you get your professional credentials and get a job as a vet.
03/05/09 by Chris FarrellExtra 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.
Bankruptcy and Cobra
Question: We hear lots about the Stimulus Plan helping folks pay for their health insurance when they go on COBRA, but what about people who lose their jobs when their company ceases to exist. There are presumably lots of folks in that bind. They are not eligible for COBRA but are newly unemployed. Is there any health insurance help for them in the stimulus plan? Rob, Seattle,WA
Answer: In essence, the rule called Cobra-- Consolidated Omnibus Budget Reconciliation Act of 1985--requires most employers with group health plans to offer employees the opportunity to continue their health care coverage for up to 18 months. With the passage of the fiscal-stimulus package the federal government will now pick up 65% of the cost of Cobra for up to nine months.
However, you're absolutely right: If a company liquidates and discontinues its health plans, COBRA coverage for its former employees isn't an option.
The Department of Labor has a brief write-up on bankruptcy and Cobra. Here's the key paragraph:
"If, however, your employer discontinues all its health plans, COBRA continuation coverage will not be available. You will have to seek other coverage. Other coverage may be available by converting your employer's group health coverage to an individual policy. As mentioned above, you may also have rights to special enrollment in a spouse's employer's plan, or by being an "eligible individual" who is guaranteed access to individual insurance. The opportunity to buy an individual insurance policy is the same whether the individual is laid off, is fired, or quits his or her job. "
By the way, the Department of Labor has posted on its web site information on Cobra and the new subsidy on premium payments. However, the fiscal stimulus package is a huge bill so hopefully I've missed something. Is anyone aware of the new law changing the rules when it comes to liquidation and Cobra?
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.
Co-sign for brother
Question: I'm planning to cosign a home loan for my brother. What's the best way to insulate myself from unforeseen liabilities? Are there any pitfalls in joint ownership? I'm going to ask them to buy a life/disability insurance in my name. Though I'm not sure if the benefits of paying the insurance outweigh the cost of getting mortgage in their name. I'm cosigning to get them a better mortgage terms. He and his spouse earn a decent salary and want to buy a town house in LA suburb. They have recently moved to US, have less 15 month of credit history and 600+ score. House value: 350K. Income > 90K. Down payment - 10%. Naren, Boston, MA
Answer: Lenders love it when a loan is co-signed. It increases their security. More borrowers than ever are seeking better loan terms by turning to family members or close friends to co-sign loans. All I can tell you is that if your brother and sister-in-law can't meet the loan payments you are on the hook. There is no way out of it. There is no way to insulate yourself from that obligation. That's the risk you're taking.
It's wonderful that you want to help them out financially. The problem is we live at a time in our history when job security is vanishing, the depth and length of the recession is uncertain and the risk of unemployment unusually high.
I have two recommendations. The first is to question whether it makes more sense for them to continue renting for now, build up their credit and learn more about their new city. They have plenty of time. Home prices are not rising anytime soon. The other suggestion is not to co-sign but to help them out financially. For instance, you can gift to them up to $24,000 a year--$12,000 each--with no tax consequences. But you're not taking on the legal obligation of the loan.
401(k) safety
Question: The company that manages our 401k plans for my employer has had its rating downgraded by S&P recently due to concern about making its debt payments. Just before the turmoil in the markets, I changed my investment strategy out of stock funds and moved it all into a product touted as a no risk fund, basically a low, fixed rate deposit product with them. My question is two-fold: First, is there any government insurance for my 401k funds that is similar to the FDIC insurance for normal savings vehicles? Second, if there isn't, and I remain employed where I am, is there any way to transfer my funds from the 401k account to a traditional IRA account covered by the FDIC without incurring a tax penalty? My employer is doing fine and still providing matching funds, so I would consider moving the funds only if the rating continues to deteriorate. My account has approximately $130k on deposit and I am 53 years old. Thanks! Denise, Orange, CA
Answer: To your first question, there is no FDIC insurance coverage or its federal equivalent when it comes to the money in your 401(k) plan. Your money is at risk to what happens in the market. That said, there are multiple layers of protections surrounding your 401(k) to make sure that the account is safe. For instance, pension law requires that retirement plan money is kept separate from your employer's business assets and the money must also be held in trust. So, if your employer went belly up creditors can't get at the money and it is safe.
To your second question, in general you can't take the money out of your employer's plan and roll it over into an IRA until you stop working there. Then you can--and should--do what's called a rollover IRA. But since regulations give plan sponsors a great deal of flexibility when it comes to plan desgn you should check with your human resources folks just to make sure.
03/12/09 by Chris FarrellA bad credit card experience
Question: I just had an extremely frustrating conversation with my credit card company (Bank of America). I wanted to get your thoughts. Larke, Washington, DC
Answer: Larke sent us a long email, a self-described "rant." It details an all too common experience with government bailout-gorged credit card issuers. His case involves Bank of America. It raised the credit cards interest rate and cut the line of credit.
A couple of personal finance points: First, Larke is doing the right thing: Paying off the card in full. The beauty of capitalism is that you don't have to do business with companies that mistreat their customers. Second, everyone with a credit card should be prepared for a similar experience. It may not happen to you, but just as mailboxes stuffed with unwanted credit card solicitations was the bane of our financial existence only a few years ago, now hiking rates and slashing lines of credit is normal business practice. Be prepared. Third, don't volunteer to your credit card issuer that you've been laid off. In their business model, you've gone from a good customer to a high risk customer. Period.
Now, over to Larke's story. It needs no further comment:
I called BOA to try and get my interest rate down on my credit card. I have made this type of call in the past when I've been comparing offers from other credit card brands/banking institutions. In this situation, I was trying to use my current unemployment situation as leverage to get my interest rate lowered (i.e., I wasn't just shopping for a lower interest rate, I really thought that there wouldn't be an issue to lower my rate by a reasonable, appropriate amount; I was still riding the mortgage rate reduction train, I suppose).
Not only did the senior credit analyst not lower my interest rate, she cut my line of credit because I was just laid off. Instead of having a cushion of $10K, I now have a cushion of $500. Twenty minutes ago, if I never made the call, my limit would have remained the exact same as it was last night. I also just heard that BOA is experiencing gains. Great. So, BOA got to be irresponsible, get a slap on the wrist and now, can't possible lower someone's credit card rate by 2% (I do understand that rates are based on prime/t-bill calculations so I know that certain rates are just unrealistic, but I don't believe my request was unrealistic).
So, I got humiliated through a job lay-off and now , in trying to be responsible, my credit card company is reducing my credit (I have excellent credit history, always made my payments, own a house, etc.).
They offered me some kind of debt reduction program (a 5 year payoff program) - but I'm pretty positive that will end up costing me more in the long run. So, I'm just going to pay the card off, asap.
Thank you so much for reading my rant - I thought the bank's were supposed to be flexible. I'm very frustrated!
Social Security $250 stimulus check
Question: There was a brief mention of this on I believe it was the 2/13/09 show (on KPCC in Los Angeles). I have cut and will paste the portion of that show in which I am interested:
Dimsdale: Unless you're on Social Security, in which case you get a $250 check.
Vigeland: OK, so that's a separate part of the stimulus package. You want to give us a few more details about that?
Dimsdale: You also get a $250 check if you're a veteran with a pension and disabled people have a $250 check.
When are these checks going to be sent? This is the ONLY place I've heard about this. I can find nothing about it on the White House web site (lousy search app on that massive site). Randi, Long Beach, CA
Answer: You can get information on the $250 check from Social Security Administration at www.ssa.gov/payment
According to the SSA:
"President Obama recently signed the American Recovery and Reinvestment Act of 2009. This act provides for the one-time payment of $250 to individuals who get Supplemental Security Income (SSI) or Social Security benefits.
We expect everyone who is entitled to a payment to receive it by late May 2009. No action is required on your part.
We are currently working on the details regarding how we will issue nearly 55 million one-time payments to our beneficiaries."
The Administration will post any updates on the SSA website. You don't need to do anything to get the money. The payment will be made to you automatically. You'll get the money the same way you get Social Security--either through direct deposit or a check in the mail. As for veterans that don't get Social Security or Supplemental Security Income will get their $250 payment automatically from the Department of Veterans Affairs.
03/16/09 by Chris FarrellA loss on selling home
Question: Hello, I sold my house last year and lost 30K. Can I claim any capital loss on my tax returns? Rozario, Nashua, NH
Answer: No, when you sell a home at a loss you can't turn to Uncle Sam to lesson the financial hit. A home enjoys enormous benefits when you have a profit at sale. A single filer gets to exclude $250,000 from capital gains tax and a joint filer a $500,000 gain. (There are some restrictions surrounding this capital gains exclusion.) But on the downside the loss is all yours.
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.
AIG policyholder
Question: I'm the beneficiary on a traditional life insurance policy (i.e. the basic AIG business) on the lives of my parents who are still alive. What protections are there on the beneficiary in various scenarios that might happen to AIG including bankruptcy, selling the traditional life business, etc. Thanks so much, and thanks for your weekly recommendations. Susan, Baltimore, MD
Answer: With all the anger directed at AIG, it seems that the millions of life insurance policyholders have been forgotten. Like you, many are nervous, wondering if their money is safe, and the hysteria in Washington isn't helping. The simple, direct answer is yes: Your money should be safe.
Life insurance policyholders have several layers of protection. None are foolproof, of course. But AIG life insurance operations have a good reputation. First, the AIG turmoil involves the parent holding company, and not its giant life insurance and retirement money management subsidiaries. Second, the life insurance operations are well funded, and by law the assets of the insurance company are segregated from the parent company. Insurance company assets are supposed to be invested conservatively. If the insurance companies did get into trouble state regulators would take them over, and the law requires them to be run by regulators in the interests of policyholders. Creditors and any other claimant take a backseat. Last, there are state insurance guaranty funds that offer another layer of protection.
There is one new buffer, perhaps the strongest yet: You, I, and all other taxpayers now own most of AIG through the federal government. Even in an era when the financially unthinkable happens, I can't imagine the federal government allowing the AIG insurance companies to short-change its policyholders.
03/20/09 by Chris FarrellTIPS
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.
Hybrid tax credits
Question: My car is on its last legs. Its engine is slowly dying. I know I am going to need to buy a new (which to me usually means used) car this year. I am confused about all the offers currently around. I understand there's a tax deduction for new car purchases, which basically makes the purchase "tax free." I'm considering purchasing a new car to take advantage of the tax benefits, but also realize that a used car might still make more financial sense. Are hybrid tax benefits still around? The sub $20,000 Honda Insight is looking quite appealing... Alex, San Diego, CA
Answer: The credit is only for new cars. The hybrid tax benefits still exist. They're available for four kinds of vehicles: fuel cell, advanced lean burn technology, hybrid, and alternative fuel. That's the good news.
The bad news--aarrrgggghhhhh--is that rules are stunningly complex. I know I shouldn't be surprised at this point, but it's ridiculous. No, it's stupid. For instance, the credit varies significantly by car. According to tables published by Cars.com, the tax credit attached to the 2009 BMW 335d is $900 while the credit on a 2009 Ford Escape Hybrid is $3,000 (for the two-wheel drive version). The credit also runs out. There is a limit of 60,000 cars per automaker, and then the credits are phased out. As I understand it you already can't get a claim the full credit (or even get a credit) on Toyota and Honda alternative cars. For the life of me I can't figure out how all these tax credit twists-and-turns, phase-ins and phase-outs are good public policy.
You're right about the ability to deduct state and local taxes on a new car purchase. (Again, not for used cars.) Of course, there are wrinkles to this tax perk. You can deduct local sales and state taxes on a new car purchase if you file jointly and make less than $250,000 or if you earn less than $125,000 for a single filer. The car, motorcycle, RV or light truck must cost less than $49,500.
You can read a good explanation of the rules at Cars.com The hybrid tax credit section is here.
Borrow to boost credit score?
Question: Hi Chris: Thanks to you and Tess for your informative show. It's appointment radio for me on weekends. :)
Here's my question: I've worked to get my finances in order and bring my credit score up over the past several years. Currently I have only one credit card with a very low limit, which I can and do pay off in full each month. I have no student loans or other debts and no mortgage. I've been contemplating trying to buy a house for the first time this year and have been watching my credit score through Equifax. This month when I pulled the report, the summary told me that one of the factors that could work against me was that I had had no new credit or loans in several years.
I had intended to put off buying a car for another year or so, but could afford it now, though it would mean saving a little less each month. I want to get the best interest rate possible when I finally get a mortgage, so I've been paranoid about adding any new debt. Has being prudent held me back? Could taking out a small loan (less than 10k,) for something like a car, and making on-time payments actually help my score in advance of trying to get a mortgage? And if it lowers my score initially, how much of a penalty would it be? And at what point in the loan is it actually helpful? 3 months in? 6? a year? Thanks, Kerri, Washington, DC
Answer: When it comes to question like this my starting place is good savings and debt management practices. The peculiar dynamics of the credit scoring business comes second (or third or even farther down the list). My basic belief is good savings and debt habits will pay off in all economic and financial seasons, and those sound principles will pay off in a good credit score. Not everyone agrees with me, and their personal finance advice is more tailored toward manipulating credit score higher. I don't agree. What's good for the profits of the credit reporting and credit scoring industries is not necessarily good for your personal fiscal health.
We're in a recession. It's unclear how deep the recession will go and how long it will last. You've already gone through the tough slog of getting your personal finances in order. You pay off your credit card bill in full every month. Bravo. I would not take out on unnecessary debt and create a more fragile balance sheet in an attempt to boost your credit score. My fear is that the strategy could backfire on you badly.
What's more, my educated guess is that you'll be fine when it comes to buying a home. Remember, there is a range to credit scores and if you keep paying off your bills on time you'll be pretty high up. Take this example drawn from the FICO website. The key assumptions: The mortgage loan is for $150,000 and the borrower is making a 20% down payment on the home
FICO Score Mortgage Rate
720-850 4.760 %
700-719 4.885 %
675-699 5.423 %
620-674 6.573 %
560-619 N/A
500-559 N/A
The reason for the "NA" or Not Available for the two lowest score levels is that borrowers with such a low score and damaged credit can't qualify for better loan terms.
It would be much better for you to spend the time researching the home you might buy, and the neighborhood you want to live in. Remember, you have a lot of negotiating power in this market. You should visit with a bank loan officer or credit union lender to see what rate you qualify for currently.
Let us know how it goes for you.
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.
Home buying tax credit
Question: Is there an income cap for single first-time homebuyers to be eligible for the $8,000 tax credit? Is there a sliding scale of eligibility amount? Sandra, New York, NY
Answer: This is the U.S. tax code. Why make it simple? Yes, there is an income cap and a sliding scale. The home buying credit is for 10% of the purchase price of the home or $8,000--whichever figure is lower. For a single filer, the credit starts getting phased out with a modified adjusted gross income of more than $75,000, and it's eliminated once your income is $95,000 or more. For a married couple, the phase starts with a modified adjusted gross income of more than $150,000 and the credit ends if your income is above $170,000 (married).
Remember, the $8,000 credit applies to homes bought between January 1, 2009 and November 30, 2009. You must keep the home for three years, and you cannot have owned a home for the past 3 years to qualify.
Clearly, considering the volume of questions we're getting the home buying credit has grabbed the attention of potential home owners. I'll be curious to see how much the interest in the credit translates into actual purchases this year.
03/27/09 by Chris FarrellWithholding taxes
Question: Is it better to owe the federal/state government tax, or receive a refund? How much money should one aim to owe/receive when deciding how many exemptions to take on a W-4 form? In anticipation of buying a house last year, my husband and I took more exemptions, and now owe quite a bit more than we have in previous years. We found our home late in 2008, and closed at the end of January. Now we are trying to plan for 2009 taxes. Thank you for your help, Jeannine, San Diego, CA
Answer: Congratulations on getting a jump on your tax filings for next year. Many people haven't even filled out this year's return. (And you know who you are.)
Ideally, you won't owe anything and you won't get anything back either. It's always nice to get a refund rather taking out the check book in April. Still, if the refund you are used to is over a few hundred dollars I would adjust your withholding. The reason is that the government doesn't pay you any interest while holding on to your money. In essence, you're making an interest free loan to Uncle Sam. On the other hand you can also make an adjustment if you will owe more than you're comfortable with come April. Remember, your withholding has been reduced slightly because of the Making Work Pay Credit that was part of the Obama Administration's fiscal stimulus package.
The IRS has a withholding calculator here.
It reflects the new withholding tables. The IRS recommends that any employee use the calculator if they work two jobs, are a two-income couple (that's you), and if you can be claimed as a dependent to make sure that the amount being withheld is what you want--and so that you don't owe more than you expect next year.
Investing in toxic assets
Question: Is it possible for a small investor to invest in the toxic assets that the federal government is buying and loaning money against? I think they have the potential for high returns and I would like the opportunity to invest a small part of my savings in them, but I don't know where, or if, they will be available. Most of what I have read about them suggests they are available to high income investors only. Thank you, Mary, Seattle, WA
Answer: It sure looks like individual investors will get the chance to invest in toxic assets. It will be an extremely high risk bet, especially after taking into account the cost of entry, fees, and the uncertain value of the underlying assets.
A trip to Las Vegas might be more fun.
Of course, the big players in this market will be hedge funds, giant institutional investors, and high-flyers from the multi-millionaire and billionaire club. Still, a number of major fund companies, such as Pimco and BlackRock, are interested in creating funds open to individuals. The funds wouldn't welcome the Joe the Plumber investor, however. So far, it appears that the basic blueprint is a closed end mutual fund with a hefty minimum investment in the $25,000 to $30,000 range. A closed-end fund sells stock to investors, and then the fund takes that money and invests it. In this case, the investment would go toward toxic assets. The shares of a closed end fund often trade on an exchange, such as the New York Stock Exchange or the American Stock Exchange.
Stay tuned.
Credit counseling
Question: I have, unfortunately, managed to rack up about $30,000 in credit card debt. Financially I'm okay and working to pay off the debt and not in danger of bankruptcy or anything right now. I am considering using a credit counseling service to help me negotiate a lower interest rate on some of my cards, and am wondering how it works if you have a balance on a card but close the account? How does it reflect on your credit report? Thank you, Mark, Ashburn, VA
Answer: The answer lies in a world of "sometimes," "maybe" and "not always." Fair Isaac, the 800-pound gorilla of the credit scoring industry, explicitly states that participating in credit counseling doesn't factor into your credit score. That's the right approach. Problem is, there are other credit scoring companies and it could show up elsewhere. Closing a credit card account will usually nick your credit score.
Of course, my reaction is "so what"? The real concern is getting rid of the debt, and congratulations on working so hard to pay off your credit card bill. Your credit report and your credit score will rebound with good debt habits.
One last thing: Be careful when you look for a credit counseling service. It's an area ripe with fraud, malfeasance and fly-by-night operators. The nonprofit affiliates of the National Foundation for Credit Counseling are legitimate. The quality of the service can vary, but it's a good organization and a good place to start. The United Way and a number of churches also offer honest services.
By the way, they may tell you you're doing fine on your own. But it's always good to talk to someone knowledgeable and have them review your situation and go through your options.
Community bank
Question: I am trying to decide which lender to use to refinance my home mortgage. The small, neighborhood bank is offering the lowest rate with mortgages backed by Fannie Mae/Freddie Mac. Their closing costs are slightly less than the big name mortgage lenders in my home city. Is there anything else I should consider in this decision regarding which lender to choose? I like the personal service and convenience of the neighborhood lender, but are there any risks that I'm overlooking with using a smaller lender? How is the smaller lender able to offer lower rates? Thanks. Elsa, St. Louis Park, MN
Answer: There is no reason why you shouldn't go with your community lender so long as you've shopped around (which you have) and it's a bank insured by the FDIC. The risks are the same. There could be a number of reasons why they're offering lower closing costs, from a business strategy to compete against the big banks to having a healthier balance sheet. When the numbers line up, it's good to support neighborhood institutions.
04/02/09 by Chris Farrell
Buy GM
Question: I have a little bit of money that I wouldn't mind speculating with. (Nice way to say gambling) But I don't want to just throw it away. For that I can go to the casino. I was actually thinking of buying GM stock. It's certainly cheap enough. But I wonder about bankruptcy and how that affects stock owners. I understand bankruptcy is not the same as ceasing to exist, indeed if I understand it correctly it is one of the first steps to ensure it continues to exist, but how do stock holders fare in the process? Do they face the same kinds of risk that bondholders and creditors do? Thanks for taking the time. Michael, Harshaw, WI
Answer: Putting money into the battered, beleaguered automaker is speculating at the extreme. As you well know, this is making a bet on a wing and a prayer, pulling the slots on the corner of Wall Street and Broad.
On October 1, 2007 GM's stock price peaked at $42.64 a share. Today it trades a few pennies over $2.00 a share. Here's a chart of GM's stock price over the last two years from Marketwatch.com.
The risk of GM declaring bankruptcy is very high. If GM does go into Chapter 11 bankruptcy existing shareholders will probably be wiped out. That's what typically happens with Chapter 11.
Creditors usually come out much better. Depending on the terms of the loan contract, bondholders, bankers and other creditors have far better financial protections. Still, odds are that many creditors won't recover their whole investment in GM. Creditors will negotiate for a big chunk of the new equity in a reorganized GM. These former-debtors turned equity-holders will own much of the company when it emerges from bankruptcy.
If you want to speculate in the stock market how about putting the money into a broad-based low-fee equity index fund. I know it isn't exciting. But if the recent market rebound--the best four weeks since 1933--is for real you'll pocket a nice gain. Of course, it's impossible to know if the market has hit bottom or whether the gain is nothing more than a traditional sucker's rally in a bear market. If it's the latter, at least you'll own a stake in real companies while you wait for the recovery.
Of course, if you bet on GM and it avoids bankruptcy its stock should sizzle, at least or awhile. But I'd bet on the market and not a fallen giant.
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.
A home? a Master's? both?
Question: My son wants to buy a home and get his masters degree in the next five years. He is single and in his early 30s. He has excellent credit, very little debt, earns about $80K gross a year, and has cash for a 20% down payment. He has been with his current job for less than two years and is going to school part-time. If he gets laid off in this economy, he will have trouble paying his mortgage but it will put him back into school full-time and get him through his degree quicker. He is making a career change with the Master's degree program, which will take 2 years if full time and will leave him with $20K in student loans. When he graduates, he will have to look for a job in another field with a starting salary that is lower than his current job.
What suggestions do you have for him in terms of timing of his home purchase and education vis-à-vis the economy and his personal circumstances? I had suggested that he postpone his career change until the economy rebounds, but these days you can't convince kids to hold down unsatisfying jobs just for the sake of income and financial stability. Thank you. Ellie, Fitchburg, MA
Answer: Your son is making a big investment in his new career. He knows he'll probably graduate with student loans to repay, and he'll end up with a lower paying job once he has his Master's in hand. The return on investment comes from entry into a career he will enjoy and higher pay as he gains experience in his new field. He's making a big investment in his future.
I would advise against making an additional investment in a home. Sure, home prices look increasingly attractive. But he will be creating a high-risk personal balance sheet if he goes into debt to buy a home and takes on debt to get an advanced degree. He might come out okay if everything goes well. But the unexpected always happens--another bear market? a spike in interest rates?--sometimes on the upside and sometimes on the downside. He'll be at risk with all that debt if it's the latter.
He can always buy a home when he's embarked on his new career. Instead of using his savings for a 20% down payment, I'd use the money to reduce or even eliminate any student loans. He could also tap into that savings to help fund his career shift once he reenters the job market. I'd encourage him to invest in his career now, and buy a home later on.
04/08/09 by Chris FarrellGetting rid of escrow
Question: My mortgage (with GMAC) has an escrow element tied to it. Every year, the amount collected exceeds the amount needed for the tax payment, but when the annual Escrow Analysis statement comes in, the mortgage company declares there is a shortage, and the amount of my mortgage payment will go up whether I pay the shortage or not.
First of all, what is up with that? If I paid in more, how is there a shortage?
And secondly, can I remove the escrow from this mortgage without refinancing? I know I can easily save for this tax payment throughout the year, and collect interest for myself. Thanks very much. Diane, Milwaukee WI
Answer: I wish you luck. The money that goes into an escrow account is used to pay for expenses such as real estate taxes, property taxes, and homeowners insurance. Lenders require an escrow account if you put less than 20% down. That's a lot of people in the 2000s when a 20% down payment became the exception. The fluctuating payments could reflect a number of factors, ranging from higher bills to changes in the amount the lender requires as a cushion. Whatever the reason, some homeowners love escrow for its convenience and others can't stand it.
Here's the thing: If you have 20% or more equity in your home you can approach your lender. They may waive it for a fee. But lenders like escrow accounts so they aren't eager to make the change. That's why many homeowners with 20% or more in equity in their house end up refinancing to eliminate escrow (or perhaps more accurately, getting rid of escrow is an additional benefit to refinancing).
I-bonds for Roth?
Question: I was told by my bank that it is not possible to put I-Bonds in my Roth IRA. If not, why not? I want to make a contribution that will not shrink like my mutual funds. Suzanne, Los Angeles, CA
Answer: That's right. There are technical and legal reasons why it's almost impossible to do. For instance, the U.S. Treasury rules say you can't open an account to buy savings bonds electronically through Treasury Direct in the name of an IRA.
Here's the thing: I don't think you should do it anyway. It isn't a good idea even if you could convince a bank to go through contortions to do this transaction for you. In essence, you're wasting a valuable tax shelter with the I-bond. You buy an I-bond with after-tax money. The savings compounds tax free. That is, until you cash it in and then you pay ordinary income tax rates on the gain. The I-bond is like a non-deductible IRA.
By the way, I-bonds are a terrific fixed income investment for most people. I like owning I-bonds, just not in an IRA.
Another inflation-indexed security is the Treasury Inflation Protected Securities, better known as TIPS. These default-free securities are also designed to hedge the value of your money against the ravages of inflation. The big drawback with TIPS is that Uncle Sam requires owners of TIPS in a taxable account to pay income taxes on the inflation-adjusted gains before getting any of the inflation-adjusted money at maturity. That's why TIPS work best in a tax-sheltered account, like an IRA or Roth-IRA.
It would be a better idea to use TIPS in your Roth.
You do need to go through a broker if you want to own the TIPS directly. A number of brand-name mutual fund companies sell funds made up exclusively of TIPS, too.
You could also buy short-term CDs insured by the FDIC at your bank for your Roth. You wouldn't have any credit risk with the FDIC insurance. You'd earn a decent rate of interest. And by keeping the CD terms short you could always be earnings something around the prevailing rate of market interest rates.
I-bonds vs TIPS
Question: I have the opportunity to buy $10,000 worth of I-bonds this year, or $10,000 worth of TIPS in an IRA account. Which is better--or is it more or less the same risk and return? Is it better to by a TIPS bond directly, or in a bond fund?
PS: Your book was great and I enjoy hearing you on public radio. Ken, Swarthmore, PA
Answer: Thanks a lot. Just a quick definition: TIPS are Treasury Inflation Protected Securities. These inflation-indexed bonds come in 5, 10 and 20 year maturities. TIPS offer a fixed interest rate above inflation, as measured by the consumer price index. TIPS are designed to protect the value of an investment dollar against the ravages of inflation (as measured by the CPI). Uncle Sam levies income taxes on the inflation-adjusted gains before you get any of the inflation-adjusted money at maturity. That's why you're right to see TIPS as the better investment in a tax-sheltered account, like your IRA.
Taxes aren't an issue with I-Bonds, a savings bond that is the federal government's other inflation-protected security. There are no commission costs when you buy or sell savings bonds, and your savings compound tax deferred. I-bonds redeemed before the 5 year mark forfeit the 3 most recent months' interest, but after 5 years that there is no penalty at redemption.
The key to answering this question is when do you need the money? It's advantage I-bond if you might tap the savings at some point in the future but before retirement. You can sell the I-bonds without incurring a penalty even if you're under 59 ½. You just pay Uncle Sam whatever you owe in taxes after the sale (and I'm assuming you'll own them for 5 years).
In sharp contrast, if you buy TIPS in your IRA, you can't get at that money without paying taxes on it plus a 10% early withdrawal penalty if you're under 59 ½. You'll have to pay a broker a fee to purchase the TIPS for you in an IRA (although the charge should be very small.) If you're okay with the extra work and monitoring the bonds then I would lean slightly toward owning individual TIPS. This way you know what you have and when the bond will mature. You could care less about fluctuations in the bond market. But a very low cost TIPS mutual fund is just fine for those who favor its convenience.
Long term stock market returns
Question: I have just read several books on investing in mutual funds for retirement. I am 35 and would be investing about $300 a month. I want to invest in a Vanguard mutual fund and am having a hard time deciding on one. Part of the problem is that I am suspicious of the yearly return figures that are always used as examples in these books and that are posted on the "performance" window of a mutual fund's overview (like on the Vanguard website). So many authors say things like, "your investment should be able to average an 8% return per year". The historical return charts on a typical mutual fund seem to support this statement, but when I played a few examples out on paper it didn't add up!.... My question is...Are proponents of mutual fund investing misleading me with their claims of 8% yearly returns?? Does the 5 or 10 year return percentage (found in the performance section of mutual found websites) actually give me any valuable info in selecting a fund? Natalie, Sedro Woolley, WA
Answer: You're right to be suspicious. There are a number of different series that capture long-term stock market returns. My favorite is the series put together by Professor Jeremy Siegel of the Wharton School. Since 1802, he figures, the compound average annual return on stocks adjusted for inflation has been about 7%. The same average return figure holds for the post World War 11 era. However, on average Lake Eerie never freezes. For instance, the bull market of the 1990s lasted for much of the decade and the stock market rose by some 300%. But the stock market is currently down 45% from its October 2007 high. Yet it's up 27% from its March, 2009 low. Even a cursory glance at history shows that stocks fluctuate wildly.
The return figures you're seeing at the mutual fund websites do tell you how the fund has done over time. It's useful information. I also like to send time studying even more detailed return figures published by mutual fund rating services Morningstar. A number of factors account for the difference between an equity mutual fund performance and the stock market. Among the most important are fees and the composition of the portfolio.
Congratulations on setting up an automatic savings plan. For the stock market portion of your portfolio I am an advocate of investing in a broad-based equity index mutual fund. The fund will mirror the results of the underlying index, such as the total stock market index or the Standard & Poor's 500. It's also important to diversify among a number of different assets. A good, short primer on the investing basics is The Random Walk Guide to Investing: Ten Rules for Financial Success by Burton Malkiel.
04/14/09 by Chris FarrellSocially responsible retirement savings
Question: My retirement begins 01/10. I will receive $148,000 in Feb. 10 and my monthly state retirement check will begin. I must roll-over the lump sum into an IRA, which I do not have. I've never heard of a socially conscious IRA! How can I be sure my hard earned money is only invested in socially responsible ways? (I will be 60 this summer and want to wait til 66 to get my whole SS.) Diane, Perry, FL
Answer: You want to be part of a growth business. The Social Investment Forum estimates that total industry assets were closing in on $3 trillion in 2007 (the latest data available). That's up from $639 billion in 1995. Most of the socially responsible money is managed for institutional investors and high net worth individuals. But assets managed by socially responsible mutual funds, exchange traded funds (ETFs), and the like are also up, to over $200 billion in 260 funds last year. Investing in socially responsible funds remains popular despite the bear market in stocks.
To take a slight detour, the biggest rap against the movement is the belief that marrying personal values to an investment portfolio cuts into returns. In other words, doing good and making money don't mix. I don't agree. A number of studies suggest there's little difference between pooling money to make money and pooling money to make money and express values. This came home to me in a series of papers by Meir Statman, a finance economist at Santa Clara University. Among his conclusions, the risk-adjusted return on socially conscious index funds is roughly comparable to the Standard & Poor's 500 index. His research also showed that the performance of actively managed socially responsible mutual funds is about equal to their conventional mutual fund peers.
Put somewhat differently, socially responsible index funds do better than their actively managed socially responsible peers. One troublesome aspect of the industry is that socially responsible funds tend to have high fees that cut into returns. It always pays to shop around, but it's especially true with these funds.
To your specific question, any socially responsible mutual fund company will open a rollover IRA for you. Two websites for researching socially responsible investing from your computer are socialinvest.org and socialfunds.com. The mutual fund and investment research company morningstar.com also has good information on socially responsible funds and ETFs.
04/15/09 by Chris FarrellCash 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.
Investment grade corporate bonds
Question: Most investment grade short term corporate bond funds contain about 30 % financial holding in their portfolio. Would this stop you from investing 20% of your portfolio in this type of fund in retirement for income? Milton, Albuquerque, NM
Answer: Outside of the U.S. Treasury-only bond funds, a majority of funds in the bond market mutual fund category posted losses in 2008. The performance has been better in so far this year. To take one representative example, the Vanguard Short-Term Investment Grade mutual fund had a total return of -4.7% in 2008, according to Morningstar, the fund rating service. It has sported a total return of 3.13% year-to-date in 2009.
Investment-grade short-term corporate bond funds are increasingly popular. These are the debt obligations of brand-name blue-chip companies. The risk of the owning the debt is further reduced by short-term nature of the I.O.U. The yield on these funds is much better than the yield on comparable Treasuries. And you're diversified within the corporate bond sector with a mutual fund.
Still, there is credit risk with the downturn. Some of the companies in the portfolio might be downgraded, and others could fall into financial trouble. That's why owning a portfolio with nearly a third of the IOU's the obligation of financial institutions gives me pause--as it does you.
A fifth of your portfolio in retirement exposed to one sector seems like a lot to me.
I imagine you want the higher income. The questions I'd be asking are: Am I being compensated enough for taking the risk? How much of my portfolio do I really want to expose to this sector? What is my downside if the economy takes another step down, inflation picks up or something else happens that affects the value of this investment? How much would a poor performance mean to me and my income in retirement?
I think the economy is doing better, thanks to a combination of fiscal stimulus, Federal Reserve policy, mortgage refinancing, TARP funds, lower inventories, and fiscal spending and monetary easing overseas. It's one reason why more investors are feeling confident enough to put money into corporate bonds. But the economy remains fragile. My bias is to stick with financially safe investments and only take greater risks if your household balance sheet is strong enough to ride out another round of bad times. This is especially true for retirees.
The education IRA
Question: My wife and I had our first baby in January of 2009 and are looking into saving for her education. I have heard a lot about 529 plans but very little about Coverdell accounts. So far I have learned that both 529s and Coverdell's allow money to grow and be withdrawn to pay for the education of the beneficiary tax-free. While the Coverdell does have a $2k/year contribution limit, contributions are also tax deductible while 529 contributions are not (at least in California). Why haven't I heard more about Coverdell accounts? Is there a reason why I would not max-out my Coverdell contribution and then put additional money into a 529? My wife and I make a combined taxable income of about $150k. Hans, Sherman Oaks, CA
Answer: The Coverdell Education Savings Account is one of the least understood ways to save for college. It used to be known as the Education IRA. In essence, it acts much like a Roth-IRA. You contribute up to a maximum of $2,000 in after-tax dollars--contributions are not tax-deductible--at a financial institution of your choice. There income phase outs and limits to the Coverdell. Joint filers with $190,000 or less in modified adjusted gross income qualify for the full $2,000 contribution. The income limit for single filers is $95,000 for single filers. For joint filers the contribution amounts is reduced for modified adjusted gross income between $190,000 and $220,000--after that you're out of luck. The comparable figures for single filers are $95,000 and $110,000.
The money compounds tax free. If it is used to pay for qualified educational expenses withdrawals are tax free too. Unlike a 529 plan, the account can be tapped tax-free to cover qualified education expenses at primary and secondary schools as well college.
Here's the rub: The annual contribution limit is $2,000 until 2010, when the figure drops to $500. A number of other college savings attractions attached to the Coverdell will end that year, too. I'm not sure why Congress liberalized the rules surrounding the 529 college savings plan in 2006 but left the Coverdell vulnerable to changes in its treatment in 2010. After 2010, the Coverdell will be a much less attractive way to save for college compared to the 529. That's why I favor the 529 plan.
But there is no reason why you couldn't contribute to the Coverdale to the maximum for now, in addition opening up a 529 plan. You can learn much more about the details of the Coverdell at savingforcollege.com.
File taxes
Question: I have not filed a return this year because the preparer told me that I did not have enough taxable income that I needed to file. Comment, please. James, Hastings, NE
Answer: You're probably fine. Some people don't have to file if they make under a certain sum of money and can't take advantage of any refunds, credits, deductibles and the like. (An exception was the tax year 2007 when you had to file to get your tax rebate.) "Many people will file a 2008 Federal income tax return even though the income on the return was below the filing requirement," according to the IRS
Here's how to make sure: The IRS has a section of its website that asks a series of questions to help you determine if you need to file a federal income tax return. Check it out.
04/21/09 by Chris FarrellTransfer retirement savings?
Question: I know that we're supposed to do an "institution to institution" transfer when we roll over our 401K from one employer's plan to another, but I'm wondering if I should be rolling over my 401K balance from my previous employer at all in this current economic climate. I'm still fairly young (I'm only 41), so my 401K plans are still heavily weighted toward stocks, and I can't help but feel that if I transfer funds out of a mostly stock-based 401K I'm essentially "locking in my losses," even if I'm transferring those funds into another mostly stock-based fund where I'd be buying in at bargain prices. Is the convenience of having all my eggs in one employer's plan worth ignoring my (possibly irrational) fear of locking in losses? Packy, Jersey City, NJ
Answer: You shouldn't be locking in losses with the transfer, although there will be some minor "frictional" costs that will fade with the passage of time. I'm assuming you'll be able to transfer the money reasonably quickly from your previous 401(k) plan into your new 401(k). I'm also supposing that you'll transfer the savings into comparable investment portfolios. The frictional costs come from the inevitable time gap from moving the money, and the market could move agasint you during that time. Of course, it could also shift in your favor. There may be some other minor cost incurred if the investment options aren't exact mirror images of one another.
My general bias is for you to take control of the money by transferring it into your new 401(k) plan at work. (I'm assuming your new employer allows the new money to come into the plan; if not you can always do a rollover IRA.) Now, your previous company will live up to its obligations and behave ethically toward your retirement portfolio. That's not my concern. (And if there is a worry about management I'd get the money out as fast as possible.) It's really a question of control. It's your money and if it's under your control you'll watch it more carefully.
To emphasize a point you made, there are no tax consequences or penalties imposed by Uncle Sam if the money is transferred from your former plan directly into the your new 401(k). Check with human resources at both companies before you do anything to make sure you understand any transfer requirements.
There is one good reason for keeping your money in your former employer's retirement plan: If it has good low cost investment options, perhaps even better than your current plan. If that's the case leave the money alone for now.
401(k) withdrawals
Question: Has the law been changed to allow employees vested under an employer pension plan (401K) to withdraw up to $10,000 without penalty? I am 51 years of age and I have been working for the same company for 28 years. Thank you for your attention and your time. Madeline, Miami, FL
Answer: No, the rules weren't changed. The proposal to allow for penalty-free withdrawal from a 401(k)-type retirement savings plan was one of many options debated in the weeks leading up to the fiscal stimulus package. It never really gained traction. Since you're under 59 ½ you would pay a 10% penalty of the withdrawal, plus ordinary income taxes--a big hit to savings.
04/23/09 by Chris FarrellAn adventure travel
Question: Hi, I can already hear you replying "are you nuts? Worry about reducing debt and stockpiling your emergency fund first!" But I feel that it's one of those things that you must check off the list, before I am tied down with kids. Do you have any suggestions on how I can fit this in without dropping the ball on my financial, educational and career goals? I am about to start graduate school, and could take some time in between semesters or wait until after I graduate. I was thinking 4-6 weeks of adventure backpacking. 1-2 weeks at a time wouldn't work for this type of excursion. PS -- I do love listening to your show! Thank you. Mia, Marlborough, MA
Answer: Go! You're not going to hear from me that taking an adventurous backpacking trip is nuts. (I might say I'm jealous but that's a different story.) The economy may be down, but that doesn't mean your spirits should spiral lower, too. You want to take a break to refresh your mind and body and spirit before during or after graduate school? That's wonderful. So let's make that happen without taking on any or much debt.
One questions is how to hike and walk for several weeks frugally? A trip with a backpack should be a low cost excursion anyway. Better yet, there are plenty of deals in the travel business right now, from low cost flights and cheap excursions to price cuts on rental cars and hotel rooms. Travel is down, and businesses of all kinds are cutting deals to stay in operation.
The real trick is to carefully plan ahead. Map out your route. How will you get to where you are going? Where will you stay? What is your budget? It's so much easier to be frugal when you take the time to do research and planning. We all end up spending more than we should when we rush to book a flight or dash off to the grocery store at the last minute. With research and planning you'll be able to find and book deals, create a tight budget that you can live with during the trip.
If the numbers still don't quite work out, consider hiking for 4 to 5 weeks rather than 6 or choosing a less expensive spot for your adventure. It will still be worthwhile, and you'll have plenty of opportunity to go on long trips later in life--even with kids in tow.
Of course, there are the bigger financial questions, such as the debt burden you're taking on at graduate school and the kind of income you'll earn when re-enter the job market. Still, with careful planning and a frugal budget you should be able to come up with a trip that's both cost-effective and soul nourishing. It's also good to go off on a trip like this before you embark on your new career. That's an adventure in itself. .
Have fun with your frugal adventure. Let us know how the trip goes, and relay any "frugal" tips you pick up along the way.
A target date fund or CD?
Question: I retired from teaching in Michigan in 2005 and immediately took a job teaching in China. I'm now 62 and currently receive my teaching pension of $30,000. I'm fortunate to still have approx. $350,000 in high-fee mutual funds, 403(b), and IRA.
I'm also fortunate to be able to save approx. $20,000/year from my job in China. I want to invest this money and would like to hear your opinion about CDs versus a target retirement fund. Is it "too late" for me to do a target retirement fund? I don't think I will need this money for several years and I plan to teach for another two years. What are the advantages and disadvantages of each - other than the obvious one that the CD will hold its value and the target fund might not? Should I be considering something else instead of these two investments? Thank you. Janet, Kalamazoo, MI
Answer: Teaching in China must be a fascinating job. On the financial side, target date funds and a CD are two very different investments. You've hit on the key distinction: Risk.
There are target date funds for people at or near retirement. Yet it's apparent the risks of these funds are greater than the marketing of their conservative reputation suggests. A number of target date funds dropped 25% or so in value during the bear market thanks to a hefty exposure to stocks. The fund companies justify the large stock portion by emphasizing that most retirees live another 20 years or so, a fairly long time horizon. The observation about longevity is right. That doesn't mean the "conservative" target fund portfolio should hold much in the way of stocks. Remember, this is supposed to be the retiree's conservative investment option. As one money manager put it to me, maybe the mutual fund companies should market target date funds as death funds instead. Somehow, I don't think savers would embrace them as readily.
The advantage of the CD in an FDIC insured institution is that the safety of those savings is guaranteed. The drawback: You'll make a pittance in interest on your money.
The question of "how to invest the money" is actually quite complicated, depending on how your going to spend money when you get back to the States. You have a pension, savings, you'll eventually start taking Social Security, and so on.
That said, one thought is to take the savings from teaching in China and decide how much of it you want to be safe for when you come home and how much you'd like to put at risk to the stock market. The "safe" money could go into Treasury bills (no default risk; will hold its value against inflation if it rises), short-term CDs (no default risk; can reinvest at higher interest rates if inflation surges) and teh U.S. Treasuries I-bonds (no commission costs; no inflation risk; compunds tax deferred but should be held for at least 5 years to get the full interest benefit). Then, with the remaining portion you're comfortable with putting at risk to the vagaries of the stock market, invest it in a very low cost broad-based stock equity index fund. This way you can tailor a low-fee portfolio to what you'll need over the next several years.
04/27/09 by Chris FarrellA Roth-IRA conversion in 2010
Question: As I understand it, Congress has lifted the income limits for Roth IRA roll-overs starting in 2010. How likely do you think it is that Congress will leave that tax change in place? Paul, Seattle, WA
Answer: My best guess--and it's just that, a guess--is the shift in the Roth-IRA conversion rule will hold for 2010. After that it all depends on whether the Obama Administration pursues dramatic tax reform and manages to get Congress to agree to a major overhaul of our Byzantine tax code. The Administration has appointed a tax reform commission headed up by former Federal Reserve Board chairman Paul Volcker, but with everything that is going on in the economy and markets it hasn't had much traction.
For the moment it looks like 2010 is fast becoming the equivalent of a conversion gold rush. Here's why: Up until now, you could only convert a traditional IRA into a Roth-IRA if your modified gross adjusted income was under $100,000. The income limit lifts in 2010. What's more, when you convert from an IRA to a Roth you owe income taxes on the amount converted. The reason is a traditional IRA is funded with pretax dollars while a Roth is funded with after-tax dollars but withdrawals are tax free in retirement. Well, the 2010 conversion amount may be included as taxable income in 2011 and 2012. That helps spread out the tax bite. It's a one-time perk.
To convert or not to convert, that is the question. There are many factors to consider, but for many people the answer will be yes. The benefit of tax free withdrawal is huge. The argument for converting strengthens the longer your money can compound after conversion and before retirement. It's also important to have other savings on hand to pay the tax bill. Another advantage of the Roth is there is no required minimum distribution at age 70 ½ as there is with a regular IRA. For those with substantial assets converting to a Roth may make financial sense simply from an estate planning perspective.
There are many twists and turns to this conversion story. For instance, should you pay the tax tab in 2010 or spread it out depend on whether you believe the money you make off the delayed payment will offset the risk of a higher tax bill. What will happen to your income in 2012? Maybe your income will plunge in which case you'd probably elect to pay the tax over two years. But if there's a chance of a big bonus in 2012 you'd get rid of the tax liability in 2010.
One place to get started researching the economics of conversion for your household is at web-based calculator, like this one.
04/28/09 by Chris FarrellEconomic stimulus check
Question: I turned 62 on April 5, 2009, and I will receive my first Social Security check in June. Will I get the $ 250.00 stimulus check or will I miss out on it? I have not been able to determine the eligibility requirements. Thanks for your help. Thomas, Chesapeake City, MD
Answer: No, it looks like you will miss out. According to the Social Security Administration, only "individuals eligible for Social Security, SSI, Veterans, or Railroad Retirement benefits at any time during the months of November 2008, December 2008, or January 2009 may be eligible for the one-time payment."
Dividend funds
Question: Hey Chris, I'm just finishing up my second year at Wake Forest University, and I recently started investing in the stock market with the belief that it will rebound eventually. One of my friends recommended that I invest in dividend funds. From the research I've done and they seem like a very profitable with relatively low risk option compared to individual stocks. But, I feel like they are too good to be true. Can a dividend fund collapse or go bankrupt? Besides looking at there individual holdings what are other indicators that might indicate if a dividend fund is safe? Patrick, Cranston, RI
Answer: It's great that you're investing so early. Terrific. Here's a grief look at dividend funds, also known as equity income funds.
The income from dividend payments typically moderates the volatility of mutual funds that focus on owning dividend paying stocks. That's why these funds are often recommended to retirees that want to stay exposed to the stock market and earn an income. Dividends are a big part of the long-term return of stocks. However, the importance of dividends shrank during the Go-Go '90s when the investing game became a matter of chasing high flying growth stocks that didn't pay dividends. Think dot.com. Companies started hiking their dividends around 2003, and investors have been eager buyers with the tax rate on dividends reduced to a low 15%. That favorable rate is scheduled to disappear in 2011. Dividends will be taxed as ordinary income, although who knows what Congress will do between now and then.
I don't see a dividend fund collapsing or going bankrupt. (It is far more common for a poorly performing mutual fund to be quietly closed or merged with a better performing peer.)
That said, there are risks. The bear market has mauled these funds this year. For instance, the T. Rowe Price Equity Income Fund is down 3.97% year-to-date and it has fallen 35.41% over the past year. The Vanguard Equity Income fund is down 9.11% year-to-date and -34.16 for the past year. What's more, companies usually raise their dividend to keep shareholders happy in good times and bad. But the Great Contraction is forcing a swelling number of companies, especially financial services firms, to slash or eliminate their dividend. According to the Wall Street Journal, there have been 45 dividend reductions and six dividend suspensions among the Standard & Poor's 500 companies.
When it comes to picking an equity income fund the single most common mistake is putting money into the highest yielding funds. The yield is nice, but it also means there is a lot of risk built into that portfolio. I would stick to well-diversified equity income mutual funds with a track record. Better yet, there are equity index funds that focus dividend paying stocks and exchange traded funds (ETFs) that do the same. You research your choices at Morningstar.com. Good luck.
05/01/09 by Chris FarrellCut 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.
Home equity and credit cards
Question: I have a $16,000.00 credit card balance with Chase at 3.99 % until balance is paid off. I also have a home equity credit line that would support paying this balance off. The home equity interest rate is currently at 4.12%.
My question is would I be better off paying off my credit card and putting it into my home equity line of credit where I could deduct the interest on my taxes even though the interest is slightly higher or stay the course and continue to make monthly payments on my credit card. Some one told me it is not a good idea to put your credit card balance against your mortgage. What do you think? Roger, Minneapolis, MN
Answer: I am against using home equity to pay down credit card debt. Yes, you get to deduct the interest. But you're hardly paying much of an interest rate anyway.
Far more important, once all your debt is home-based you risk losing the house if you suffer a setback. If you look at the credit problems of recent years a common mistake was homeowners tapping into their home equity to consolidate debts for the tax break. Then they got into financial trouble--lost their job, suffered a major medical illness, got divorced--and suddenly they couldn't make their mortgage and home equity payments. Results: Foreclosure, a short sale or extreme stress holding on to the property.
Yet there are a number of ways to get financial relief on auto loans, credit cards and similar consumer debts. For instance, you can make minimum payments for a while, go into debt counseling, and even declare bankruptcy. And you get to keep the home. The bottom line: I don't like the risk-to-reward ratio.
I would just focus on paying off the credit card and leave your home equity al
Take on graduate student loans
Question: My son graduated in December in one of the worst economic times. He was fortunate to land and entry level job in his field with an international company. One day shy of three months (the probation period) the company has laid him off. His goal was always to go onto graduate school after paying off his student loans (they would have been paid off in June if his job had lasted). Coincidentally a graduate school he had applied to has an unexpected opening in August. The bottom line: $91,000 for a 4 year doctorate program with little chance for a scholarship. When do you decide to take on this much debt? With his degree, when he graduates, he will start making $80,000/year.
Does he go on to graduate school or does he stay in the job market and try for another job? Thank you so much. Leslee, Boulder, CO
Answer: Traditionally, it has been a smart move to get additional education when the economy is down and jobs scarce. Then in several years you reenter a hopefully improved job market with a new degree.
However, the numbers you give tell me that your son needs to make a series of green eyeshade calculations, and then carefully think through the potential upside and the potential downside. For instance, with the numbers you sent in (and assuming a 6.8% interest rate) your son would end up putting over 15% of his gross monthly income toward student loan debt repayment. That's a very high percentage. It sets off warning bells. Most students carrying that much debt end up feeling oppressed by their debt burden, especially if they take out additional loans, say, to buy a car. To get that debt repayment figure down to a still steep but more reasonable 10% of monthly income he'd need a starting salary of about $126,000. We're living in an economy that is punishing for borrowers.
I just made a very simple calculation. He'll need to make a much more detailed budget to paint a more accurate picture. But once he has done that I would look into what steps might he take to lower the amount he borrows and cut down on living expenses. For instance, can he live at home while going to school or after he graduates? Are you in a position to help him out? Is there a cheaper school with a comparable graduate program that still opens up good career prospects? What if he got another job, lived frugally and saved money for a couple of years--would that make sense?
Then there is the long-term return on investment. Even when the job market recovers wage increases will be scarce in many professions. What is the experience of other graduates from the program he's thinking about attending? Are there reasons to believe he'll enjoy good jumps in pay? Or is the starting salary of $80,000 about what he should expect with 1% to 3% pay increases a year at most? Will this degree open the door to a career he really wants to do and is getting the degree now the best and fastest way to get in?
I don't know the answers to these questions, of course. My main recommendation is to really try and understand the financial and career risks and rewards of taking this step now, and make his decision from there.
05/08/09 by Chris FarrellA 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.
The Administration's home refinance program
Question: WE OWE 3 mortgages at 5.3755% 6.25% 6.98% for three different homes. Would we be qualified to refi under the HOME AFFORDABLE REFINANCE program with the current rate under 5%? Thank you so much. Mai, Los Angeles, CA
Answer: It's always worth a phone call to try and negotiate a deal, but I doubt that you'll qualify under the Administration's program. The reason is the way the Administration's homeowner rescue plan is designed, it explicitly won't help out anyone with homes purchased as an investment. The home must be owner-occupied. The federal government says it doesn't want to be bailing out speculators (unless they call Wall Street home and gambled with billions of dollars).
The Administration's home rescue plan is complicated with a number of twists and turns. For instance, the federal government isn't reaching out to borrowers who misrepresented their income on no-doc loans. The plan loosened the rules so that homeowners current on their mortgage can refinance even if their mortgage represents as much as 105% of their home's current value. But the sharp decline in prices in many parts of the country means many troubled homeowners still don't qualify for relief.
I would call your lender and see if you qualify for a refinancing under their normal guidelines.
Public or private graduate school
Question: I am trying to decide between two different graduate schools: a state school and a private college. Both have good, well respected programs, although I'm fairly certain that the private school has a slightly better reputation and would probably improve my chances of getting a good job after I'm done at least a bit. The real difference between the two schools is the cost, and it's the reason I'm concerned about accepting admission at the private school. I would probably have to take on between $30,000 to $40,000 in student loans to attend the private college, in addition to spending my entire life savings of about $30,000. This concerns me especially because the program - A masters in English literature--isn't going to greatly increase my earning potential. I plan to become a teacher, hopefully at a community college, although there's a chance I may want to go on to do a PhD. Also, I'm 31, and hope to buy a home and have children sometime in the not too distant future. And I have no retirement to speak of.
I'm really torn, because while I think I may get a better education at the private school, it seems like a bad idea financially, especially since the state school MAY be just as good (if not as cushy and warm and fuzzy). Should I take the risk and take on the debt required to go to the private college? Thank you! Anna, San Francisco, CA
Answer: Anna, I think you already answered your question as you wrote it out. You believe it doesn't make sense for you to take on that much debt and drain your savings for a degree that won't increase your earnings potential (much). If you go to the private college you'll spend years after getting your degree struggling to pay down debt, living on a financial high-wire. I take seriously the importance of enjoying your graduate school experience. But I worry that you'd end up financially strapped, limiting your freedom of choice once you have earned your degree.
I hope you've really explored that the state college graduate degree will pay off in terms of job and career. I'm not an expert, but I do know that the competition for teaching jobs at community colleges and junior colleges is soaring. When it comes to graduate school, it's less about getting an education (which is vital with an undergraduate education) and more a cold, rational calculus on the return on investment.
You might want to check out my answer to a related question that I posted on May 8th, Take on graduate student loans? Better yet, read the comment section. There are some very sharp observations on money and the risks of getting a graduate degree.
Anyone else want to weigh in with some insight for Anna?
$250 is in the mail
Question: Hello Chris. I got a letter stating that the 250.00 checks would be mail by the end of May. I notice that some people have already gotten theirs. My question: is there a website you can see when these checks go out and how they might be sending them on certain days? Or where the names of people and when they might be sending them. Thank you very much Donna, Spring, TX
Answer: According to the Social Security Administration, the federal government sent out the first of its more than 50 million payments on May 7th. The $250 payment to those on Social Security and Supplemental Security Income (SSI) are being mailed out on a staggered schedule throughout May. The agency requests that you don't contact them about your payment unless you haven't gotten it by June 4th. You can read the entire statement 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?
Buy a home soon?
Question: My girlfriend and I want to buy a house soon. My credit is great, I have no debts, but I have been unemployed living on my savings since 2006, continuing my good credit history with the use of a credit card. Together, we have about $20,000 in savings and $7,000 in a Roth IRA. She also has great credit that she built with Macy's and personal loans. She has secured full time employment in the LA County, making about $37000 a year. She just earned her MPH with potential for a better position that pays $52800 a year. She has $13,000 in student loans. Should she pay her loans off before we apply for a home loan? Should she get a credit card to continue her good credit history? Should we wait for her to get a higher position? Gerardo, Los Angeles, CA
Answer: A house is expensive to buy and to own. My concern is that your finances are too fragile for homeownership, and you'll end up buying financial trouble. The lesson of the recent real estate boom and bust is that stretching to own is truly risky.
Now, it's wonderful that your partner has landed a good job with the prospect of a promotion. I would wait until the promotion came through. I wouldn't buy anticipating that she'll get the higher paying job, especially with all the state and local government financial problems in California. She doesn't need a credit card, either.
Instead, I'd focus on paying off loans and building up savings. I'd let your partner get established in her job and, hopefully, you'll find one soon. This will put you in a much stronger financial situation whether you end up buying or not.
To be sure, you might miss being able to take advantage of this year's first-time homebuyer tax credit of $8,000. That's a lot of money. But I don't believe home prices will skyrocket anytime soon, either. The latest figures show home prices continuing to decline both nationally and in Los Angeles. And I don't want to see your finances stretched too far.
Buying a home
Question: My wife and I are considering buying a house but don't really know where to begin. We've spent the past few years rebuilding our credit after having both filed bankruptcy. We have a good income to debt ratio. We will be first time home buyers.
Can you recommend some resources that will help us get started? There is so much information out there, we are willing to pay someone to help sort through it all. We know we should get prequalified for a loan, but don't know the best resource for that. How do we determine what we can really afford (accounting for property taxes, HOA dues, etc.)? Thanks, Paul, Aliso Viejo, CA
Answer: A good starting point is Home Buying for Dummies. It's by Eric Tyson and Ray Brown. I've interviewed Eric over the years and he's always thoughtful. He's out to help you, not line the pocket of real estate agents or mortgage brokers. It's a bit dated since it was published in 2006, but the basic informaiton is solid. Another useful book is Elizabeth Razzi's The Fearless Home Buyer: Razzi's Rules for Staying in Control of the Deal.
There are a number of home affordability calculators on the web, such as Dinkytown.net and hsh.com. A home is the biggest financial purchase most of us ever make, so be sure it's a wiser course for you financially than continuing to rent.
If you do decide to buy keep the finances conservative. The experience of the past couple of years tells all of us the risks of stretching our finances to own. It's not just the mortgage, taxes and insurance costs that matter. A home is expensive to run and maintain. When you move in, you'll see that the furniture you've accumulated over the years looks wrong. You'll probably need more furniture if you're moving from an apartment into a house. You may love tending to your garden, but that pleasure will costs money. Financial conservatism means leaving behind the notion of buying as much house as you can afford.
Once you've gone through some basic books you can start talking to professionals, such as a banker. Take your time. There is no rush.
Good luck.
Small business credit card
Question: We started a small business in July 08. We received an Advanta business credit card with a $20,000 credit line. It was perfect for me and 3 employees. We paid our balance every time. We were notified this week that Advanta was closing all business credit card accounts. Do you know of this? I tried Chase, CITI, and Bank of America for replacement cards but was denied because of too many credit requests on my personal credit report. Any suggestions what to do? This is really bad timing in the life of the business that otherwise is doing well. William, Fort Collins, CO
Answer: Well, you have plenty of company. After posting a $76 million loss in the first quarter, Advanta announced it was closing more than 1 million small business owner credit card accounts.
In the latest twist in the credit crunch, credit card companies are wary of small businesses. For instance, almost two thirds of small business owners said their interest rate had gone up over the past 12 months, and 41% reported that their credit limits were reduced, according to latest survey by the National Small Business Association.
The Credit Card Accountability Responsibility & Disclosure Act recently signed by the Obama only applies to consumer credit cards. Small business cards aren't covered. In practical terms, the credit card reforms protect you if you use your personal credit card for business. But the new credit card rules don't come into play for small businesses that are incorporated, limited liability corporations, and the like.
You can learn more about the current state of small business and credit cards at this Business Week story. To research getting a new card, here is a list of terms from 14 business card issuers (although some have already turned you down). I would also check out your local credit union or community bank. Both of these neighborhood institutions tend to work with local businesses. For instance, I just checked out the website of the Community Development Financial Institution that's a few blocks away from where I work in St. Paul and it offers corporate credit cards.
06/01/09 by Chris FarrellThe $8,000 home buying credit
Question: My husband and I are looking to buy our first home. Since our annual income is around $34,000, we tend to get all of our tax money back at the end of the year (at least until I'm out of college). Is the tax credit a wash for us? Thank you for your help, Leslie, Lemon Grove, CA
Answer: No, it should be a real financial help for you. The tax credit is for qualified first-time home buyers that purchase a primary residence between January 1, 2009 and before December 1, 2009. The tax credit is equal to 10% of the home's purchase price up to a maximum of $8,000. You should qualify for the credit since you're a first time homebuyer and you come in under the income limits. (For instance, the income limit for married taxpayers is $150,000, and it phases out at modified adjusted gross income of $170,000.)
Like most tax law changes, the $8,000 homebuyer credit has created a lot of confusion. The National Association of Home Builders offers up detailed information on the tax credit here. I've also answered a number of other question on the credit on the Getting Personal blog.
Your question is about the tax implications. You have a choice when it comes to filing for the credit. You can amend your 2008 tax return to get the money quicker or you can elect to file for the credit on your 2009 return. However, you must have purchased the home before filling for the credit.
There is additional news this week on the $8,000 tax credit front: The Federal Housing Administration (FHA) has come up with new rules that allow new home buyers using an FHA-insured mortgage to tap the credit to pay for closing costs and the down payment. The lender must be FHA approved. You can find a list of qualified FHA lenders by tapping into this