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Why Guaranteed Value Variable Annuities are not what they seem.

Tuesday, June 8th, 2010

Many of my clients have been sold a type of variable annuity that has a guaranteed value and a minimum guaranteed annual payout after a holding period. The guaranteed payout is often 5% of the guaranteed value. So if the guaranteed value is $100,000 you would get $5,000/year regardless of what the investment value of the annuity is. If the value of the annuity rises above $100,000 you would get 5% of that higher value.

Sounds like a great deal. Upside potential and downside protection.

Well a fellow NAPFA advisor analyzed one of these annuities on the insurance company’s website. Here is what she found:

On a $100,000 contract the guaranteed payout was $416/month. This compares to $609/month for an immediate annuity (a different animal)
In order for the contract value to grow above $100,000 there would have to be a return of at least 9%/year. This is because the internal expenses (fees, premiums, commissions etc. were 8% per year!)
Assuming 3% inflation the annuity growth would have to be 12% per year. That would be very difficult to achieve over the long-term!

If someone offers this type of product to you. Take the time to analyze it looking at what rate of return you would have to achieve in the long-term in order for your payout to rise.

As an alternative consider a combination of an immediate annuity at retirement for some guaranteed income, along with a combination of stock mutual fund investments for long-term growth.

Posted in Insurance, Investing, Retirement Plans | No Comments »

Money Bus Serves Over 100 People in Chicago

Tuesday, April 27th, 2010

Well the numbers are in and the Money Bus (www.yourmoneybus.com) served over 100 people in two days in the Chicago area. The Money Bus was sponsored by the NAPFA Consumer Education Foundation, Kiplingers, TD Ameritrade, and FiLife/WSJ. The bus travels the country and at each stop local NAPFA advisors provide free advice (no product sales!!) to consumers. We answered questions about retirement planning, 401ks, credit card debt, college savings, emergency funds, layoffs, foreclosures, mortgages, etc.

Posted in Fee-Only, General, Home Financing, Investing, Money Values, News, Retirement Plans | No Comments »

Our latest poll

Thursday, April 15th, 2010

Posted in General, Investing | No Comments »

401k vs. Roth IRA, vs Traditional IRA — what should you do?

Friday, March 26th, 2010

Many of us face a dilemma: Should I invest in a Roth IRA, my 401k plan, or a Traditional IRA or some combination? Here are some simple rules of thumb:

If you employer matches your 401k contributions:

Invest in your 401k up to the amount to get the maximum match
Then invest in a Roth IRA if you are eligible
Then invest in your 401k again (no match)

If you employer does not match

Invest in a Roth IRA if you are eligible
Invest in your 401k

The situation is more complex if you are not eligible to contribute to a Roth IRA with many contingencies that are best handled on a case by case basis. Also, if your employer has a high cost 401k plan you may actually be better off investing some of your funds outside of your 401k in a regular taxable account once you have invested enough to receive the maximum 401k match.

The reason why Roth IRA contributions are a better bet for most people vs. a regular 401k contribution include:

Tax rates are likely to be higher than they are today in the future when you withdraw your 401k contributions.
You will have Required Minimum Distributions from a 401k plan at age 70-1/2.
Your heirs will required to take distributions from your 401k plan and pay taxes on them. There are no required distributions from a Roth IRA and any distributions are tax free.

Tags: 401k, IRA, Retirement, RMD, Roth IRA
Posted in 401k and 403b Plans, Estate Planning, Investing, Retirement Plans | No Comments »

Bet On Red!

Thursday, February 25th, 2010

I’m sure you have seen those mutual funds ads where they brag about their performance. Well I have a new fund that blows most of them away! It’s called Bet on Red — 100% return last year — really! Watch the video for the whole story . . .

Posted in 401k and 403b Plans, Investing, Money Values, Retirement Plans | No Comments »

Tax cut expiration makes Roth conversion more advantageous in 2010

Friday, February 5th, 2010

With the Bush tax cuts expiring at the end of this year and unlikely to be renewed, taxpayers in the highest income brackets that are considering a Roth IRA conversion should think about doing it this year.
The highest federal tax bracket next year will go from 35% to 39.6% meaning the taxes on a $1,000,000 conversion will increase by $40,600 in 2011. If you will turn 59 and ½ next year you may want to consider waiting because the penalty for early withdrawal will expire for you next year lowering the tax on your conversion form 45% in 2010 (35% + 10% early withdrawal penalty) vs. 39.6% next year.

Young tax payers in any tax bracket with small IRA balances may also want to convert this year. That is because by converting now they will be able to shelter any future gains on their current IRA from taxes, and for a young person those gains could be substantial. For example the future gain on $10,000 for a 30year old could be $310,000 by the time the person reaches 70. In addition if your current IRA contributions were not tax deductible because your income was too high, most or all of your Roth conversion could be tax free.

One last benefit for converting in 2010 is that you are able to spread any taxes you do owe over a 3-year period vs. paying them all this year.

Posted in Investing, News, Retirement Plans | No Comments »

Investing – Some Lessons From 2009

Monday, January 18th, 2010

2009 was not a year for investors with weak stomachs. After a plunge of 46% from August,2008 through March, 2009, the U.S. markets started rising, recovering almost all of the losses since last August. The same was true for international stock markets. Unfortunately, many investors I spoke with locked in their losses by selling in late February, and then never got back in and missed the 50% rise from March on.

Lesson 1:

When the markets fall by 40% or more in a year it almost always signals we are near the bottom of the market. The major post-WW2 declines have been about 40% (1974, – 37% in 9 months; 2001-2, -35% in 14 months; 2008-9, -46% in 6 months). So once the market has declined sharply in a short period selling will almost guarantee a big loss.

Lesson 2:

Although the market declines are steep and fast, so are the rebounds (1974-5, +45% in 14 months; 2002-3, +47% in 14 months; 2009,+63% in 6 months). Most people who sell at the bottom are also slow to get back in since they are afraid of future declines and miss out on most of the rapid gain.

Lesson 3:

Younger investors should not be soured on investing. Poor market performance in their younger years could benefit them in the long-term. If you are in your 20s or 30s the markets have not seemed to be a great place to put your money. That is not long-term thinking. Your time horizon is at least another 30 years. The lower prices are now, the more shares you can buy and the more room your have for appreciation.

Posted in Investing, Money Values, Retirement Plans | No Comments »

When Index Funds Perform the Best

Monday, November 2nd, 2009

I read an interesting article in today’s Wall Street Journal about when index funds do the best vs. actively managed funds. Index funds do the best in the asset classes that are seeing the strongest returns. The study was based on a 10-year period from 1997-2007. The reason for this is active managers tend to deviate from their primary asset class (e.g. Large-Cap manager buying Mid and Small Cap stocks) when the primary asset class has performed poorly and then miss the quick run up when the primary asset class recovers.

Does this mean that you should use active managers for poorly performing asset classes? No. The problem with this conclusion is not that actively managers are picking better stocks in their primary asset class but they are moving outside their designated asset class to try and improve performance. When they do this they change your overall asset allocation and risk/return profile without telling you. If you wanted to you could do the same thing with index funds but at least you would be aware of the changes you were making.

The article also did not address if they active managers’ performance was after all fees and expenses. Actively managed funds have management fees that average 6x higher a low cost index funds. In addition if you buy an actively managed fund through a broker you load fees in addition. There is also the issue of taxes. An actively managed fund turns its stock portofilio over about 3x/year which could generate signficiant short-term capital gains on which the mutual funds shareholders are taxed on lowering their overall retrun. An index fund may only turn over 20% or less of its portfolio generating much lower taxable gains.

My advice: Stick with low-cost index funds, for superior long-term performance.

Posted in 401k and 403b Plans, Investing, News, Retirement Plans | No Comments »

Index Funds Make Even More Sense in a Downturn

Monday, August 3rd, 2009

According to the Wall Street Journal many large institutional investors are turning too index funds after finding that actively managed mutual funds have not performed well during the downturn.

They would rather have the guaranteed lower cost of an index fund vs. the unfulfilled promise of better performance through an actively managed fund.

This is the strategy that I use with my clients. Although some actively managed funds will out perform an index fund the percentage that do is actually less than chance would predict. It is also difficult to predict which managers will outperform and index fund year after year. This is especially true for bond funds. According to Morningstar the Vanguard Total Bond Market Index Fund has outperformed 83% of its peers over the last 10-years.

Index funds charge substantially less than their actively managed peers. A low cost index fund costs about 1% per year less than its actively managed peer. That means that the actively managed fund would have to outperform the index fund by 1% per year just to be equal. That is very difficult to do for almost all managers.

Posted in 401k and 403b Plans, Fee-Only, Investing, Money Values, News, Retirement Plans | No Comments »

Asset Allocation is Like Democracy

Wednesday, July 15th, 2009

The Wall Street Journal says that asset allocation has “failed miserably” as an investment strategy. That is like saying democracy is a failed political system because it allowed the severe recession to happen. The problem with the WSJ analysis is that neither asset allocation nor democracy is a perfect system. Far from it; but the real measure of success of either is evaluated over the long-term not on a single year. In addition, no one has come up with an alternative strategy that has stood the test of time.

What I have seen from many new clients whose portfolios were managed by large brokers was no asset allocation strategy but just a random collection of stuff that the brokerage houses were trying to push on their clients. For clients who did have a semblance of an asset allocation strategy their broker had not explicitly explained the downside risk of their investment portfolio.

Here are two questions that you should always ask your advisor:

* What is my potential percentage loss on this portfolio (1%) chance?
* What is my potential dollar loss on this portfolio (1%) chance?

If she can’t answer those questions then you should find another advisor.