How to Double Your Retirement (2005-12-26)

How to Double Your Retirement

(2005-12-26) by David John Marotta

Every six years you delay saving and investing you cut in half the lifestyle you will have in retirement. You owe it to yourself and your family to make certain that your financial New Year’s Resolution are kept this year. Here are ways to save and to invest that are simple and specific enough to keep.

Tell someone. Goals that are shared are ten times more likely to be acted upon. Don’t wait until you have everything set up to seek out accountability.

Set goals. If your goals aren’t concrete and specific they won’t be achieved. Your savings goals should be a specific annual percentage of your Adjusted Gross Income (AGI). We recommend saving at least 10% of your AGI in tax-free retirement accounts and another 5% toward retirement in taxable investments. If you are behind on your savings (over forty with less than three times your AGI in investments) you may want to save more in order to catch up.

Translate your percentage goals into specific numbers. I receive correspondence from readers on a regular basis who assume this advice somehow doesn’t apply to them because they are rich and my average reader isn’t or because they are lower income and my advice is targeted at the rich or some other nonsense.

If you are accustomed to living on $200,000 a year, you will need to save enough in order to retire with that same standard of living. Once you retire, it will not be any easier to cut back on your standard of living. If you think it will be easy, then do it now and save and invest the difference.

If you have a $20,000 per year standard of living, you will still need to save enough in order to retire with that same standard of living. You are lucky because you won’t need to save as much as the person with a $200,000 a year standard of living. If you think that it is too difficult saving now, imagine trying to live off $10,000 per year from Social Security.

So, put your specific annual savings goals down on paper, one for your retirement accounts and a second for retirement savings which will go into a taxable account.

Now, prioritize the retirement vehicles that you can use for retirement accounts. We recommend investing just enough to get the entire match that your company’s 401(k) plan offers first, then funding your Roth IRA accounts. After these two, make certain you have enough non-retirement savings. Beginning January 1st, you may also have the option of investing in a Roth 401(k) through your employer-sponsored retirement plan.

The purpose of prioritizing your investment vehicles is to deliberately put your money into accounts that have the greatest number of asset allocation choices and the lowest fees. Many company 401(k) accounts have such high fees and poor choices they frustrate investors.

As an example, imagine that your AGI is $60,000 and you decide to save 10% in a retirement account and 5% in taxable savings. That translates to saving $6,000 in retirement accounts and $3,000 in taxable savings. Your company offers a dollar-for- dollar match on the first 2% of your salary, so you decide to save $1,200 in your 401(k) first in order to get a $1,200 match from your employer. After this, you decide to fund your Roth IRA before investing more in your company’s 401(k) or IRA. Since Roth IRA limits are $5,000 per individual, this finishes off the remaining $4,800 for savings in retirement accounts.

The remaining $3,000 earmarked for taxable savings we recommend saving in monthly installments of $250 each month. Since finding the money to fund your Roth IRA at the end of the year is sometimes difficult, we recommend saving toward funding your Roth IRA each month by adding that amount to your taxable savings. In our example, we would save $7,800 a year in $650 monthly installments and transfer $4,800 into our Roth IRA at the end of the year.

Our example assumes that you need to build up your taxable savings. It might be better for you to fully fund your Roth IRA and your Spouse’s Roth IRA instead. Also, depending on your specific needs, you may need to save more than $9,000 a year in order to catch up and meet your retirement needs.

Next, to help you save, automate your savings. Automating your contribution to an employer-defined contribution plan is easy. Automating a taxable savings plan is just as easy. Most brokers offer an automatic money link between your investment account and your checking account. They also offer a monthly automatic transfer between the two accounts.

If your paycheck is deposited on the first day of the month, ask your broker to transfer money (in this case, $650) from your checking account into your investment account on the second day of the month.

From there, automate your investing. If $650 is being deposited into your brokerage account each month, designate an asset allocation that purchases $100 or more of five or six funds. Again, most brokerage firms make this process easy to set up and easy to change.

Once a year rebalance your portfolio. I recommend doing this some time half way through the year after your June 30th statement.

You can get much more sophisticated than this, but set your sites on getting the benefit of saving and investing with a minimal amount of work. After all, the whole point is that you haven’t been saving and investing because it is too much work. New Year’s resolutions, if they are to be kept, should be simple and specific.

A fee-only financial planner can also help. They can act as a personal financial coach, offering suggestions, sharing ideas, and keeping you on track to reach your financial goals. Call the National Association of Personal Financial Advisors (NAPFA) at 1-888-FEE-ONLY (1-888-333-6659) to get a list of members in your area or visit their website at www.napfa.org

from http://www.emarotta.com/article.php?ID=159

Timing the Market Isn’t All Fun and Games (2005-12-19)

Timing the Market Isn’t All Fun and Games

(2005-12-19) by David John Marotta

Market timing is the attempt to switch a significant portion of your assets between different types of investments in an effort to maximize profits. If this is your investment strategy, good luck, because you’ll need it.

Academics such as Burton Malkiel, author of "A Random Walk Down Wall Street," believe it is impossible to time the market. But, active traders and the get-rich-quick disagree. They claim to have seen it work in practice.

Mathematics and game theory can help us determine if market timing is a good strategy. Too many investment decisions are made as a result of emotional considerations. Usually those emotions are greed, fear, or pride. Emotions can dim the vision of even seasoned investors, fooling them into thinking their personal experience represents the set of all possible outcomes. We can illustrate the problems of market timing by looking at a simple game.

Consider the following game. You start with $1,000 and play for ten turns. Each turn you can invest your money in Investment A or Investment B. There are only two possible outcomes each turn. The first possible outcome is that Investment A appreciates 30% and with Investment B you just get your money back. The other possible outcome is the exact opposite: Investment B appreciates 30% and Investment A just returns your money.

If you invest half of your money in Investment A and half in Investment B, you are guaranteed to earn 15% each turn. After ten turns your $1,000 will have appreciated to $4,046. I’m going to call this the 50-50 asset allocation model.

Now, imagine that you decide to take a chance and each turn try to pick the investment that will earn 30%. I’ll call this the lottery method. Since you can't lose money, and your average return is still 15%, you think on average you won't do much worse than the 50-50 asset allocation. You couldn't be more wrong.

Assuming that your choice is just a coin toss — and you don't have foreknowledge of which investment is going to do well — the odds are you will do worse.

Let's just take a look at the first two turns. With the 50-50 asset allocation model, your $1,000 grows to $1,150 and then to $1,322.50. The 15% gain on the first turn is compounded with another 15% gain on the second turn for a total compounded return of over 32%.

If, on the other hand, you try to guess the best category there are only four possibilities, and three of them are worse than the 50-50 asset allocation model. If you are wrong twice, you will end up with your original $1,000. If you are right and then wrong, or wrong and then right, you will earn 30% and end up with $1,300, falling $22.50 below the returns of the 50-50 asset allocation model!

Strategy	First Turn	Second Turn	Total Return
Asset Allocation	15.00%	15.00%	32.35%
Investment A	30.00%	0.00%	30.00%
Investment B	0.00%	30.00%	30.00%

Only if you are right on each of your two tries will you beat the returns of asset allocation. Your $1,000 from the first correct guess will appreciate to $1,300 and on the second guess to $1,690. Only in this case would your 30% compounding return beat the average return of the 50-50 asset allocation model.

For those of you trying desperately to remember your high school math, this is a case where the mean (average) return is higher than the median (middle or typical) return. On average you earn the same, but typically you fall below the consistent asset allocation model’s return.

Now imagine expanding this difference between mean and median for ten turns. In our 50-50 asset allocation model with consistent 15% returns, your $1,000 will grow to $4,046. If, instead, you use the lottery method, you will do better than the 50-50 asset allocation model less than 38% of the time.

While your average return with the lottery method is still $4,046, it is buoyed up by the extremely rare case when you guess right ten times in a row and end up with $13,786. If you are that rare individual, you will likely consider yourself brilliant and mistakenly believe that market timing works. You may even start an investment newsletter called "The Lucky Penny" and try to teach others your selection method.

The median or typical return of the lottery method, however, is only $3,713 representing only a 14.02% compounded return. Over half the returns of the lottery method fall within the standard deviation in the range of $2,856 to $4,827 (11.06% to 17.05%).

Remember, in our game the diversified 50-50 asset allocation model offers a safe 15% return. With those returns, is it really wise to press for the 17.05% return with the lottery method? It seems counter-productive to risk an extra 2.05% gain against a 3.94% loss, but that is what trying to time the market does on average in this case. Asset allocation produces not only more consistent returns, but better returns.

You have to pick the winning investment consistently in order for the lottery method to do better than the asset allocation model. Our game did not include the very real possibility of losing money. If the parameters of the game are changed to include the possibility of losing money, the 50-50 asset allocation does even better.

Losses are harder to recover from. In fact, losses hurt you more than wins help you. If you lose 50% of your capital one turn you must gain more than 100% to make up for what you could have had due to the power of compound interest.

In the real world, 50-50 asset allocation isn't the same thing as a risk-free return, but it does offer a smoother ride than trying to pick this month's winning category. Math can explain a lot; a few gray hairs help too.

from http://www.emarotta.com/article.php?ID=158

Why is Bob Cratchit So Poor? (2005-12-12)

Why is Bob Cratchit So Poor?

(2005-12-12) by David John Marotta

Christmas is a time for oft told tales like Charles Dickens’s "A Christmas Carol." At first glance, this story fills us with pity for the Cratchit family, always struggling to make ends meet. Poor Bob Cratchit is forced to work for Ebenezer Scrooge, whose personality makes an easy target for the cause of Bob’s financial troubles. But, the true source of the Cratchits’ poverty is not Scrooge but Bob’s own impulse to live a lifestyle worthy of the Lord Mayor himself.

Bob Cratchit is a clerk and a member of the British middle class. He lives a genteel life. He goes to work with a coat and tie on. His family lives in a four-room house and has a much easier working existence than most of Victorian England. Bob Cratchit earns more than an ample wage.

His salary, we are told, is fifteen shillings a week. The British pound was divided into twenty shillings, and each shilling was divided into twelve pennies or pence. So, Bob Cratchit makes 15 shillings or 180 pence each week—about the wage of a metropolitan police officer and well above the truly needy.

Essays of the Victorian era included titles such as, "How to live on eight shillings a week." The Cratchit’s daughter, Martha, is apprenticed to a milliner and earns additional income. And Peter, their eldest son, is about to obtain a job earning five shillings and six pence weekly. He, too, is to be a man of business.

So why is the Cratchit family so poor?

Bob Cratchit is a spendthrift, or shopaholic. The shopaholic is one of eight different personality types in Bert Whitehead’s book, "Facing Financial Dysfunction." Cratchit is on the opposite end of the spectrum from Ebenezer Scrooge. Whereas Scrooge combines greed with a propensity to save, Bob Cratchit combines fear with a propensity to spend.

Spendthrifts are some of the most pleasant people to be around. They are socially outgoing and often demonstrate their own friendliness by buying things for other people.

As a typical spendthrift, Bob was probably raised in poverty. Buying gives spendthrifts great pleasure in life. Spending produces an addictive high and helps them establish their social status. In Bob’s mind, raising his social status mistakenly depends on the amount he spends, not the amount he saves.

For Bob Cratchit, living within a budget and saving money would be like setting out to deprive yourself and suffer. Spendthrifts live for the pleasure of the moment. Eating out or buying clothes are viewed as immediate pleasures for relatively small amounts of money. They do not realize that the purpose of budgeting and saving is to make sure they are spending money on the things they really want instead of frittering it away.

On Christmas Eve, Mr. Scrooge has brought his banker’s book home with him to review all evening. Shopaholics, on the other hand, almost never keep any records of their purchases. But, records would show the Cratchit family that Bob’s spending habits are exposing his family to want and suffering.

Christmas grew in popularity during the Victorian era as a time of feasting and a time for those of stature to show their affluence. During the Victorian era, Christmas was more about food than about giving gifts and the Cratchit family is determined to show that they know how to keep Christmas.

The Cratchits buy a beautiful goose and then admired it for its cheapness. Spendthrifts typically go bankrupt saving money. We are not told what Bob paid for his Christmas goose, but stories of the day suggest that a goose conservatively cost about 400 pence (1.5 Pounds). At this amount, the Cratchit family goose is costing the family a year’s supply of medical attention for the entire family.

Many spendthrifts justify their purchases as "investments." They often buy jewelry, clothes, or even fancy house wares as an investment to provide themselves an excuse to gain the trappings of a richer lifestyle. This purposeful self-deception shows the depth of a typical spendthrift’s denial. An investment is something which pays you money, not an article of clothing.

But the Cratchit family are typical spendthrifts when it comes to clothing. On Christmas day, Bob Cratchit confers on his son Peter a shirt in honor of his apprenticeship. It was common in the day for the rich to go through the Parks to show off their finery. And Peter is amazed to find himself so gallantly attired that he too is anxious to show off his fashionable new linen in the park.

Even Mrs. Cratchit is described as "brave in ribbons, which are cheap and make a goodly show for sixpence." Making a good show is important for spendthrifts. Mrs. Cratchit’s ribbons cost about two to three weeks of medical attention for the entire family. Their second daughter, Belinda, is also brave in ribbons too—another three weeks of medical attention.

The Cratchit family is clearly living beyond their means.

While Bob Cratchit fears poverty, he also resents wealth. He is caught in the consumerism of the rising Victorian social and professional class. It is this propensity to spend that is the true cause of the Cratchit family’s lack of means.

The tendency toward over-consumption and immediate gratification isn’t limited to Victorian England. It is nearly the defining character traits of our baby-boomer generation. Like the Cratchit family, our generation has a tendency to blame financial troubles on the more productive members of society.

If Scrooge was shown the starving children of Ignorance and Want, Bob Cratchit would be shown the starving children of Addiction and Entitlement.

Scrooge has earned the financial means necessary to help the Cratchit family, but the Spirits don’t always give us a reformed Scrooge to bail us out of our financial problems. Sometimes they want us to become a reformed Cratchit! Perhaps this is why the Spirits visited Ebenezer? It was easier to make a frugal man generous than it was to make a spendthrift father financially responsible.

Bert Whitehead at the end of his section on shopaholics writes, "Before accepting a client whom I know is a severe shopaholic, I require them to begin intensive psychotherapy with a qualified professional." That sounds even worse than being haunted by Christmas Spirits!

from http://www.emarotta.com/article.php?ID=157

Should You Worry About Year-End Tax Planning?

(2005-12-05) by David John Marotta

Even if you didn’t make a penny more next year, how can you have more dollars for next year’s holiday season? Reduce your taxes. Between now and the end of the year there are several last-minute tax moves that may save you significant amounts of money. After January 1st, there’s little to do but pay-up.

Tax planning for Americans usually begins sometime in February. Many delay worrying about it until March or April, or even October! Tax planning before New Year’s may not make a difference in every case, but for some it is critical.

If you think you may be hit with the Alternative Minimum Tax or if you have taxable investments, make an appointment with your tax professional immediately. If you are a small business owner, year-end tax planning should be a habit by now.

AMT

Keep your eye on the Alternative Minimum Tax, which is a parallel tax system with different tax rates, income inclusions, and allowed deductions. This year, taxpayers earning as little as $75,000 may find themselves saddled with this tax. Originally instituted in 1969 to force 155 wealthy individuals into paying taxes, this year 18 million will likely pay AMT.

Because ATM turns many of the traditional tax-saving strategies on their head, your current tax plan may backfire and leave you paying more. If you think you might be hit with ATM, year-end changes can pay off.

Even if you didn’t pay AMT last year, you may get hit with ATM if you earn between $100,000 and $400,000. Large home equity or cash out refinanced mortgages, large state income tax payments, and other items may trigger ATM. And of course, if you were hit with ATM last year, you will probably be hit harder this year.

Investments

If you have significant taxable investments, tax planning can help you offset capital gains and limit your exposure to AMT.

Now is the perfect time to review your capital gains and losses. A standard tax-saving move is to offset capital gains by realizing losses before year end. After offsetting your gains, you may deduct remaining losses up to $3,000. Losses exceeding $3,000 may be carried forward indefinitely.

If you plan on significant end-of-year charitable gifting, consult with your tax professional to maximize your tax savings. You should know what effect different amounts of charitable gifting will have on your taxes. Should you have big capital gains this year, avoid paying tax on some of your gains by gifting appreciated stock to your favorite charity.

Stock options may also leave you exposed to capital gains or AMT. Depending on the type of stock options you have and when you sell your options, your investment may be taxed at the ordinary income rate and may increase your AMT. Unfortunately, there is no quick rule of thumb when navigating options. Review your holdings with your tax professional.

Year end is also the time to take care of investments for your children. If you have children 14 and older who have been given highly appreciate stock, take advantage of their capital gains tax bracket which may be as low as 5%. They should realize capital gains before they start earning a significant income.

If you have considered opening 529 college savings plans for your children or grandchildren, contributions in some states (like Virginia) can qualify for a state tax deduction if done before the end of the year.

Consider making your fourth quarter state estimated tax payment prior to year end so that you may use it as an itemized deduction next year.

Gifts and Estate Planning

You may also give $11,000 in 2005 to an unlimited number of individuals, but you may not carry over the unused exclusion from one year to the next. If appropriate, make gifts prior to year end.

Small Business

If you own a small business, make tax planning an intentional part of your business strategy. Small business owners bear the lion's share of the tax burden, but they also have some control over the structure their taxes.

This is the time of year to take advantage of your Section 179 deduction. Small businesses may deduct up to $105,000 in 2005 for business equipment. To receive the deduction, equipment must be placed in service before the end of the year.

If you are considering offering a 401(k), profit-sharing or SIMPLE retirement plan, a nonrefundable credit is available to offset some of the set-up costs associated with your new employee benefit plan.

Other tax-saving strategies for your business could mean reviewing how your business is set up. A regular corporation or LLC may want to make a Subchapter-S election. This process can be time consuming, so act now.

We recommend that our clients do end-of-year tax-planning in November or December. If you think you might benefit from last-minute tax planning, ask your tax professional to help you take advantage tax-savings before year’s end.

For more information on tax planning, we invite you to attend a free end-of-year tax-planning seminar held at our offices on Wednesday, December 7th, 2005 at 12:00PM.

from http://www.emarotta.com/article.php?ID=156