Be Smart When You Rollover Your 401(k) (2007-01-29)

Be Smart When You Rollover Your 401(k)

(2007-01-29) by David John Marotta

There are few better investment returns than an employer's matching contribution made to your 401(k). But after you retire or leave that company's employment, you should almost always roll your 401(k) into an IRA for better investment choices. Being smart by rolling over your 401(k) can pay dividends for decades.

Most people leave the money in their old 401(k) plan or roll the money into their new employer's plan. Neither of these options escapes the fees and limitations associated with 401(k) plans. Even worse, taking a lump-sum cash distribution and paying taxes and penalties can be detrimental to your long-term financial well-being. The best strategy is almost always to implement a direct "trustee-to-trustee transfer" to an IRA rollover account.

There are five main advantages that can be gained by completing an IRA rollover of your qualified plan assets.

Advantage #1: Full Range of Investment Vehicles

Employer-sponsored retirement plans tend to have a limited number of mutual fund investments for you to choose from, typically less than two dozen. Regardless of how good the choices are, an IRA provides the full range of investment options so that you can construct a portfolio better tailored to your financial goals. IRAs offers a nearly unlimited number of mutual funds, exchange-traded funds (ETFs), closed-end funds, and individual stocks and bonds to choose from.

Advantage #2: More Asset Classes for Better Diversification

Having the full range of asset classes is even more important than the full range of vehicles. We use the following six asset classes: Short Money, U.S. Bonds, Foreign Bonds, U.S. Stocks, Foreign Stocks, and Hard Asset Stocks. Further diversification can be achieved by adding subcategories such as small and mid cap stocks and by emphasizing a "value" approach over "growth" when investing in equities.

The average 401(k) plan is normally filled with several redundant U.S. large cap stock funds. By contrast, they lack multiple foreign investment choices. In addition, their foreign stock fund is sometimes a "global" stock fund that can be heavily invested in U.S. stocks. Global funds dilute the benefit of diversifying into foreign markets.

Another asset class often missing from a 401(k)'s choices is hard asset stocks. Hard assets stocks include natural resources, energy, timber, precious metals, and real estate investment trusts. Hard asset stocks have performed well over the past five years. Investment in hard assets protects your portfolio against some of the risks associated with inflation. This is particularly important if you have any fixed income investments.

Advantage #3: Lower Expense Ratios

Odds are that the choices in your 401(k) have higher than average fees. A 401(k) plan lumps administrative fees with management fees and does not typically make the total fees that you pay readily available. Employers aren't required to provide you with written information about the administrative costs for online account access, educational seminars and other third party administration.

On top of administrative fees, each fund charges an annual operating expense ratio. The average large cap equity mutual fund has an expense ratio of 1.28%. In contrast, a large cap exchange traded fund's expense ratio is typically under 0.15%.

While employers have a fiduciary responsibility to run the plan for the benefit of the participants, most plans make their money through maximizing these hidden fees and minimizing the out of pocket employer expenses. As amazing as it sounds, some 401(k) plan's generous matching contributions are completely eroded by the plan's excessive expenses. Some employers would do better for their employees to forgo the match and reduce the hidden expenses by paying some of the costs out of pocket.

Advantage #4: Roth IRA Conversions

Another benefit of completing an IRA rollover is gaining the ability to convert your rollover IRA to a Roth IRA. A Roth IRA not only grows tax free, but, unlike a traditional IRA, provides you with tax free withdrawals. Furthermore, Roth IRA's are not subject to required minimum distributions when you reach age seventy and a half.

Most of the benefits of a Roth account can also be passed along to your designated beneficiaries. This preserves their ability to stretch tax-free withdrawals from an inherited Roth over their entire life.

Converting to a Roth IRA is a taxable event and is subject to income eligibility. It requires some long range planning, and for many clients, the best strategy is to convert a portion of their traditional IRA each year to stay within their current income tax bracket.

In 2008 you will be able to convert a 401(k) directly to a Roth IRA instead of using the current two-step process. In 2010, there will be no income restrictions on who can do a Roth conversion. This is a rare tax gift from Congress and is a huge retirement planning opportunity regardless of your age.

Advantage #5: More Control for Estate Planning

Finally, an IRA account permits flexibility in designating beneficiaries and, therefore, allows you to control how your assets are distributed by your estate plan. Your heirs can have the ability to "stretch" the IRA's tax-deferred growth and required minimum distributions over their own life expectancies. This intergenerational planning can provide a tax advantage over several decades. In another significant change brought about by the Pension Protection Act of 2006, a non-spouse beneficiary (such as a child) who inherits an employer-sponsored retirement plan can now complete a direct rollover to an Inherited IRA and utilize this stretch.

When making an IRA rollover there are two important considerations. IRA rollovers have some fairly complex tax rules and procedures that must be followed to ensure that your rollover is a tax-free event. The distribution must be payable directly to your IRA's custodian and not to you, personally. Also, you need to be certain that the IRA custodian you are rolling your 401(k) to has the best possible selection of investments.

Retiring from your job or changing employers provides an important financial planning opportunity. You may benefit from having a fee-only advisor help you evaluate which strategies are in your best interest. To find a fee-only professional in your area, visit www.napfa.org.

from http://www.emarotta.com/article.php?ID=215

Australia: Investing Down Under (2007-01-22)

Australia: Investing Down Under

(2007-01-22) by David John Marotta

On January 26, Australians celebrate their annual Australia Day to commemorate the founding of the Colony of New South Wales in 1788 and their proud national history. This year investors down under have even more reason to celebrate.

The 2007 Index of Economic Freedom, published this week by The Heritage Foundation/The Wall Street Journal, rates Australia as the third most-free nation in the world. Of the 157 countries ranked by the Index, only Hong Kong and Singapore -ranked first and second respectively- outperformed Australia. But Australia's status as one of the most economically free nations is nothing new. The 2006 Index reported that Australia "enjoyed almost 14 years of uninterrupted economic growth -the longest sustained expansion in its history."

Structural economic reforms enacted over the last twenty years have emphasized deregulation, eliminated tariffs, and privatized state-owned businesses. The end result has been increased productivity and a decades-low unemployment rate. More recently, Australia's government has taken further action to deregulate its media industry. This has opened the way for additional private investment to flow into its domestic economy. According to data compiled by Bloomberg, buyout offers in 2006 for Australian companies increased to $27.3 billion from just $1.4 billion in 2005.

In addition to reaping the economic benefits of decades of increased freedom, Australia has seen China become its second largest trading partner behind Japan. Australia's diverse and abundant natural resources provide China with the critical inputs it needs to sustain its own record GDP growth of 10% per year. Approximately 60% of Australia's exports to China consist of US$10 billion worth of energy resources and raw commodities such as wool, iron ore, alumina, coal, beef, copper, and nickel.

In 2004, Australia signed its largest export contract ever by agreeing to supply China with a 25-year supply of liquefied natural gas (LNG) worth over US$20 billion. And just this past year, the two trading partners ratified a historic (and somewhat controversial) deal for Australia to supply China with uranium over the coming decades to fuel its insatiable demand for cleaner sources of energy. Australia owns 40% of the world's recoverable uranium, which should continue to be a resource highly valued by an international trading community seeking alternative sources of energy.

But Australia is more than just a natural resource superstore for Asia. The services sector accounts for roughly 70% of its GDP, followed by manufacturing with 11%, and mining with 5%. Australia also serves as a leading financial center with one of the largest stock exchanges in the Asia-Pacific region.

Reflective of Australia's diverse economy, top sectors of the MSCI Australia Index include 25% commercial banks, 15% metals and mining, 10% real estate investment trusts, 8% insurance, 5% food and staples retailing, and 4% oil, gas and consumable fuels.

Because of its economic freedom, Australia is one of the ten countries we emphasize as a foreign investment for clients. At the end of 2006, the MSCI Australia Index's five-year annualized return was 24.10% compared to 14.98% annualized for the broad-based MSCI EAFE (Europe, Australia, and Far East) Index and 6.19% annualized for the S&P 500 Index over the same period. While investing in the countries with the most economic freedom is only one part of a balanced asset allocation, having a component in your portfolio, such as the MSCI Australia Index, that is less correlated to U.S. markets can help boost investment returns.

Investors who have held shares of companies denominated in Australian dollars have also been protected from the U.S dollar decline as profits earned in Australia are translated back into additional dollar gains. Since 2001, the U.S. dollar has lost nearly 30% of its value against a basket of currencies of our major trading partners. The Australian dollar, as the currency of a commodity-rich and economically free country, has been a primary beneficiary of this trend.

Another significant economic factor that Australians have been celebrating was the end to double taxation of corporate dividends in the 1980's. Consequently, Australian companies, on average, have a dividend yield more than double the dividend yield of the S&P 500. Thanks to the aforementioned tax reform, the MSCI Australia Index is comprised of companies that, collectively, pay out over 60% of earnings as dividends, which has led to increased returns for investors.

Australia's sustained economic growth and burgeoning trade with other nations has not left it without some internal problems to address. Housing prices have inflated, there is a shortage of skilled labor, basic infrastructure is strained, and record droughts have created dangerous water shortages.

Prime Minister John Howard, of the more conservative Liberal Party, is facing increasing opposition from proponents of global warming, the labor unions, and the Labor Party. Political issues involving Howard's support of the uranium mining industry and his controversial proposal to increase domestic nuclear energy sources have recently come to the fore. How Australia's voters and politician respond to these domestic challenges in the 2007 federal election year will be factors of economic significance.

Fortunately for Australia, its culture of freedom and its position as one of the world's major suppliers of natural resources to the Asian industrial boom should continue to provide a foundation for sustained economic growth. Diversifying your investments outside of the United States by owning foreign stocks and bonds is an important part of an asset allocation strategy designed to help you meet your financial objectives. Investing in economically free foreign countries such as Australia is an additional way to limit risk and boost returns.

from http://www.emarotta.com/article.php?ID=214

What the Rich Know and the Poor Do Not (2007-01-15)

What the Rich Know and the Poor Do Not

(2007-01-15) by David John Marotta

This new year, resolve to get your financial house in order so that you can enjoy peace of mind. Financial planning is important, but it is never urgent. Most people fail to establish a financial plan because they fail to start planning. Some resolutions can be postponed, but for every six years that you delay saving and investing, you cut your retirement lifestyle in half. So, act on your resolution today.

To successfully build wealth, you must know the answer to two important financial questions. However, many Americans never bother to get the answer for themselves. Being able to answer these two questions is an important first step toward meeting your financial goals.

Depending on your station in life, this first question should be modified to fit your situation. For those who are still saving for retirement the question is "How much money do I need to save this month to cover my longer-term financial needs?" If you are already retired, the question is "How much money can I spend this month so that I don't run out of money during my lifetime?"

Don't try and sidestep this first question by thinking you will work forever. Assuming you won't retire is not a good retirement plan. Neither is dying young.

If you are a woman, you are much more likely to outlive your family's finances. If you fail to save enough during your working years, your investments may not keep pace with inflation or your spending may leave you out of money.

When you run out of money during retirement, you lose your lifestyle and your independence. Knowing how much you should be saving or spending minimizes the chance that you will outlive your money and provides you with peace of mind.

The second question you should be able to answer is, "What return on investment did your assets earn last year?" If you think a couple percentage points on your investment return each year won't make much difference, think again. Adding a few more percentage points to your return, compounded over 40 years, will double your standard of living in retirement.

It is also unwise to assume that your portfolio earned roughly the same as the indexes reported in the news. Your asset allocation will determine the majority of your investments returns. Consider the following different returns for the exact same year.

In 2000, when large cap growth stocks lost 33.51%, small cap value stocks earned 18.58%. In 2001, when the NASDAQ lost 21.05%, the Russell 2000 Value earned 14.02%. In 2002, when the S&P500 lost 22.10%, the Johannesburg Stock Exchange Gold Index earned 130.33%. In 2003, when the Lehman Aggregate Bond earned 8.44%, Emerging Markets earned 42.34%. In 2004, when the Dow earned 5.31%, the Goldman Sachs Natural resources earned 24.57%. In 2005, when the S&P500 earned 4.91%, the EAFE Foreign Index earned 25.96%. This past year, in 2006, while large cap value was earning 25.78%, large cap growth only earned 5.68%. How did your portfolio do?

If a few percentage points can double your retirement lifestyle, having a proper asset allocation is what makes it possible to retire comfortably in the first place. Until you know the exact return of your investments, you won't be able to evaluate the drag on your portfolio by being too conservative or the cost to your portfolio by being too aggressive. You also won't be able to evaluate the hidden costs of investments with high expense ratios or transaction fees.

There are three actions you can take this week to start the process of getting your finances in order.

First, Kiplinger's Personal Finance Magazine is partnering with the National Association of Personal Financial Advisors (NAPFA) to sponsor Kiplinger's "Jump-Start Your Retirement Days," a program offering free financial advice by telephone.

From 9 a.m. until 6 p.m. EST on Tuesday, January 16th and Friday, January 26th, NAPFA-registered financial advisers will be standing by to answer your questions. The toll-free number is 888-919-2345, and the service is free. If you have financial questions, just call.

Second, the non-profit NAPFA Consumer Education Foundation is dedicated to educating consumers about personal financial matters. The Foundation offers a free, monthly presentation series run by industry experts who volunteer their time to provide consumers with an educational forum on a broad range of financial planning topics.

This Saturday, January 20th, Rick Huff, CPA/PFS, is offering a free seminar on "New Ways to Save Smarter" as part of the NAPFA Consumer Education Foundation. From 12:00pm to 1:30pm, he will be reviewing new strategies for your IRA and retirement plan made possible by the Pension Protection Act of 2006.

All presentations are held at the Northside Library Meeting Room in the Albemarle Square Shopping Center. Presentations are free and open to the public. You are encouraged to attend and bring your financial questions.

Finally, a fee-only financial planner can help you develop and implement a sound financial plan, tailored to fit your specific financial needs and goals. They 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 1-800-366-2732 to get a list of members in your area. Visit their website at www.napfa.org.

from http://www.emarotta.com/article.php?ID=213

Minimum Wage Helps the Rich (2007-01-08)

Minimum Wage Helps the Rich

(2007-01-08) by David John Marotta

For the millions of workers who struggle to make ends meet, legislation to raise minimum wage cannot come soon enough. A December poll conducted by The Wall Street Journal/NBC News shows 77% of Americans support increasing the minimum wage. Ironically though, minimum wage does more to benefit rich suburban young people than it does for the poorest members of our society. At its worst, minimum wage paves the way for employers to discriminate against our nation's minorities.

Economist Robert Whaples of Wake Forest University recently surveyed American economists and found nearly half of the respondents said they were in favor of abolishing the minimum wage. And, a total of 62% of the economists said they were either in favor of making no change to current minimum wage, decreasing the minimum wage, or nixing it altogether.

Still, in light of everything we know about the negative effects minimum wage hikes have on minority groups and the poor, Nancy Pelosi has vowed to introduce legislation to raise the minimum wage from $5.15 to $7.25 per hour within her first 100 hours as Speaker of the House.

Take a moment to consider the faces of the working poor. Often, we think of single parents working long hours, earning $5.15 per hour, trying to provide their children with a coat for the winter and a pair of shoes for school. But, the truth is, these moms and dads are not the ones who will benefit from an increase in the minimum wage. Suburban teenagers stand to benefit the most.

The US Department of Labor reported 97.5% of working Americans make more than minimum wage of $5.15 per hour in 2005. Adults, age 25 or older, earning minimum wage accounted for only 1.5% of the labor force. And, among working adults earning minimum wage, only 0.3% were living at or below our nation's poverty line. In other words, 80% of those who stand to benefit from a hike in the minimum wage do not even come from households living at or below the poverty line.

The face of America's minimum-wage earner is typically not the single parent trying to feed his or her family. According to the 2005 Department of Labor statistics, over 82% of minimum-wage earners did not have any dependents. Half of all those earning minimum wage were under age 25 and one-fourth were between the ages of 16 and 19. Three-fifths of all minimum wage employees worked only part time.

In fact, America's minimum-wage earners are mostly teenagers and young adults who work only part-time, have no dependents and enjoy an average annual household income of $64,273, according to a 2006 report by The Heritage Foundation.

Of the many minimum wage earners, the vast majority do not stay at the minimum wage pay level. Only 15% are still earning minimum wage after 3 years. Within their first year, 65% receive raises.

Perhaps, most distressing about the fight to increase the minimum wage, is the fact that people blame their economic troubles on the poor, minorities, and foreigners. While support for raising the minimum wage can be attributed to economic ignorance, I fear some of the support is less than charitable. Minimum wage always hurts the employment of workers facing discrimination.

Nobel Prize winner in economics, Milton Friedman, warned that, "the high rate of unemployment among teenagers, and especially black teenagers, is both a scandal and a serious source of social unrest. Yet, it is largely a result of minimum-wage laws." He described those laws as "one of the most, if not the most, anti-black laws on the statute books."

Although the living wage debate in America seems to be fueled by good intentions, history provides us with examples which tell another story. During apartheid era in South Africa, white union workers demanded a minimum wage for blacks and whites. This seeming gesture of equality turned out to be a veiled means of discrimination.

Before the minimum wage laws were enacted in South Africa, blacks could offer their services at a lower rate and compete for jobs held by white workers. However, by passing the minimum wage laws, white unions were able to set a minimum wage above typical labor rates charged by black workers, in effect, strong-arming blacks out of the labor market. Employers could then afford to discriminate against blacks and hire only white workers. The net affect was minimum wage laws helped reduce the costs of discriminating against blacks.

Because 77% of Americans disagree with 62% of economists, I realize that winning this argument is a difficult task. The challenge is against me, but let me assure you the economists are right.

Instead of minimum wage, the best tool for actually providing assistance to the working poor is the earned-income tax credit. This tax subsidy is a "negative income tax" that tops the earnings of those who are the lowest paid. Introduced in the 1970's, it benefits families with children the most.

The earned-income tax credit actually targets the working poor. If you still advocate raising the minimum wage, then I'd like to leave you with a final challenge: Go and meet someone who is currently earning the minimum wage. Find out who they are and why they can't get a job paying more. If their skills and productivity don't warrant more than minimum wage, consider what will happen to their employment if the minimum wage is raised.

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See also:

1. Minimum Wage Hurts the Poor

from http://www.emarotta.com/article.php?ID=212

Minimum Wage Hurts the Poor

(2007-01-01) by David John Marotta

Americans are very much in favor of raising the minimum wage. This fall, five states saw legislation to raise the minimum wage pass, in some cases by wide margins. However, American compassion can at times be misguided. Economist Robert Whaples, of Wake Forest University, found in a random polling of American economists, that 62% believed the minimum wage should remain unchanged, if not lowered or abolished altogether.

Nancy Pelosi has vowed to introduce legislation to raise the minimum wage from $5.15 to $7.25 per hour within her first 100 hours as Speaker of the House. It may seem that anything less than a vote for raising the minimum wage would be unfair to the millions of workers who struggle to make the rent each month. However, raising the minimum wage will almost certainly hurt the poorest members of society the most.

Raising the minimum wage means business must find new ways to cover higher employment costs. And the most common ways businesses cope with budget shortfall is by cutting jobs, reducing employee benefits, and raising costs for consumers - or use all of these measures combined.

The consensus among economists is that 1% to 2% of entry-level jobs are lost for every 10% increase in the minimum wage. So, a $7.25 minimum wage would result in the loss of 1.6 million positions.

But, economists today are less concerned about increases to the minimum wage causing unemployment -although unemployment remains a real threat- and are more concerned about the negative repercussions of other market forces. These market forces, similar to mass layoffs, have their own way of equalizing the pressure brought on by minimum wage requirements.

Studies suggest that poor families are more likely to lose their jobs or to have their hours cut back because of an increase in the minimum wage. The poor wind up paying in more ways than one. Although only a fraction of the poor benefit from a higher minimum wage, they, like every other consumer, are stuck paying higher prices for the goods they buy.

In order to understand the negative consequences of raising the minimum wage, consider an example of wage hikes on a much larger scale. If raising the minimum wage to $7.25 can help the poor, then it would be logical to assume that raising the minimum wage to $100 per hour would likewise help the rich. But, as you'll see, it doesn't.

Imagine you are a medical doctor earning a salary of $120,000 per year, approximately $57.69 per hour. Now, assume the new minimum wage for doctors was increased to $100 per hour. Due to the new wage hike, your new salary would now be $208,000. With wages that high, the naïve assumption is that your employer would soon be forced to cut jobs. But, a more likely scenario would be a slash in employee benefits. In other words, what you would earn in wages you would more than pay for in lost employee benefits.

Now, in order for the hospital to pay your higher wages, the hospital could raise the cost of its services. But because businesses are loath to raise prices, your employer, like many others would instead cut employee benefits. For instance, it would only pay you for the time you actually see patients. You would no longer get all 12 paid holidays. Nor would you get the generous 24 vacation days. You would lose your insurance benefits. You would lose any shift premiums or severance pay. You would lose any paid on-the-job training, conferences, professional development or continuing education.

If, after all those cuts, your cost of employment was still too high, the hospital would look for other ways to limit your pay. They might refuse to pay for your set-up and clean-up time. Time spent on chart dictation and billing justification might not be allowed to be included in your hours worked. After all that, if your employer still needed to reduce costs, it might require you to pay for your medical supplies and to rent your equipment.

In order to net your original salary of $120,000, you will likely be working more hours, taking less vacation, and paying out of pocket for your insurance and continuing education costs.

If your employers could not reduce your benefits enough to pay $100 an hour, then by law they would not be allowed to continue employing you. Although you want to continue work as a doctor, the market says your skills are only worth $57.69 per hour.

But, with the minimum wage set at $100 per hour, you won't be hired as a doctor because your skills aren't yet worth the minimum wage. You have not only lost your job as a doctor, but you have also lost out on the opportunity for professional development so that one day your skills will be worth $100 per hour.

However, this doesn't mean you would be unemployed. Instead, you would likely be pushed downward into dead-end jobs which don't have minimum wage requirements. Current minimum wage legislation exempts several jobs such as: farm laborers, switchboard operators, newspaper deliverers, employees of seasonal recreational establishments, babysitters, and drivers. These jobs offer little opportunity for upward mobility. Like the doctor, those who don't possess skills currently worth the going minimum wage are locked out of jobs which provide the opportunity for advancement to higher job classes.

All of this seems absurd, but the truth is, raising the minimum wage forces employers to make cuts which leave employees worse off than before the wage increase. Often, workers value these fringe benefits more than the additional income. Firms offer health care benefits, professional development courses, and vacation benefits rather than salary because they can be paid on a before-tax basis and are less costly when coverage can be offered collectively. The loss comes when individual employees find they cannot replace such benefits without a much greater cost to themselves.

If raising the minimum wage for the rich doesn't work, then why think it will foster better work opportunities for the poor? Voting for a minimum wage increase is no more compassionate than if someone were trying to set your minimum wage to $100 per hour, forcing you to lose your benefits or your job. There is no such thing as a free lunch.

from http://www.emarotta.com/article.php?ID=211