By Erin Baehr, CFP®, EA
Shawnee-on-Delaware, PA
http://www.baehrfinancial.com/
The holiday decorations are put away, things have been tidied up and we've turned the page on another year.
No need for post-holiday blues, though — a new season is coming. This time instead of opening Christmas cards, we'll be opening Important Tax Documents. With the new tax and stimulus legislation passed in 2009, this tax season is shaping up to be a confusing one. The best defense against missing deductions or credits and leaving money on the table is to be aware of the changes that apply to you and bring them up with your tax preparer.
The new credit I'm happiest about is the "American Opportunity Credit" for qualified college expenses. This credit is worth up to $2,500 per dependent student on 100 percent of the first $2,000 of qualified expenses plus 25 percent of the next $2,000, for the first four years of school. In previous years the less generous Hope credit was only available for the first two years of college; then the 20 percent Lifetime Learning credit would kick in. The Opportunity credit is 40 percent refundable, meaning that even if your tax is reduced to zero, you may still receive 40 percent of the credit as a refund.
For the first time books are considered to be qualified expenses, so if you find yourself short of $4,000 of "uncovered" tuition (tuition paid less grants or scholarships), dig up those book receipts and add them in. Note that loans do not reduce the amount of eligible expenses; only "free" money reduces the amount, and housing and meal costs do not count as eligible expenses. The income limits are double those of the Hope and Lifetime credits also; phaseout begins at $160,000 for married filing jointly ($80,000 single) vs. $100,000 ($50,000 single) for the others. The Opportunity credit is available for 2009 and 2010, and can also be combined with the Lifetime Learning credit for a different student.
Computers and related technology expenses, including Internet access, are now considered to be qualified educational expenses for 529 plan withdrawals for 2009 and 2010. That gives you more to work with for the "no double dipping rule" that prevents you from using the same expenses for both an education credit or deduction and a 529 plan withdrawal. Account withdrawals should be planned out in advance so as to maximize the tax benefit and avoid making non-qualified distributions leading to penalties and taxes.
One more trap to watch for: Make sure your withdrawal is in the same calendar year you make the payment to the school; it's especially easy to miss this with the spring semester bill due in January.
While you're enjoying the happy surprise of extra tuition credit money, your children may be getting a less than pleasant surprise. When Congress enacted the "Making Work Pay" $400 tax credit in 2009, it was intended to increase the paychecks of working adults, not dependents. Unfortunately, because it was integrated into payroll tax tables, dependent workers also received the credit in the form of lower withholdings, and when it comes time to settle up, they may find a smaller refund than expected, or possibly have a balance due. Some couples may find themselves in the same position, if they have a combined adjusted gross income of $150,000 or more and separately appeared to be eligible for the credit. People who work more than one job may have received excess credit also.
Taxpayers receiving only pension income are not eligible at all, yet may have lower withholdings due to the same tax table calculations. Those receiving Social Security benefits as well as earned income may have received both the one-time $250 Social Security "bonus" payment and the $400 credit in their paychecks, and will have to credit back the amount over $400. If you find yourself in such a situation for your 2009 taxes, you may want to adjust your withholding for 2010, as the credit is still in effect for this year.
On the deduction front, the Homebuyers' credits are getting a lot of press, but there are a few notable others as well. Sales tax paid on an auto (value up to $49,500) purchased between Feb. 17, 2009 and Jan. 1, 2010, can be deducted on Schedule A in addition to income taxes (but not if you take the regular sales tax deduction option), or as an addition to your standard deduction if you do not itemize. The benefit starts to phase out at $250,000 for married filing jointly ($125,000 for single), and can be used for multiple vehicles.
The property tax deduction for non-itemizers was continued into 2009 also, but in order to claim that, or the auto sales tax add-on for the standard deduction, we have a new form to complete — Schedule L. In typical IRS fashion, the standard deduction isn't so standard anymore.
Finally, a big change is coming to Roth IRAs: In 2010, the income restriction on converting from a Traditional IRA to a Roth will be lifted, and any taxpayer, regardless of income, will be allowed to convert. Converting requires paying tax on the amount of IRA converted, which essentially locks in your taxes at today's rates, rather than waiting to pay tax on your IRA withdrawals later, at whatever the prevailing rate will be. The amount converted is added to your income for the year, increasing your tax bill.
However for 2010 only, that conversion amount can be spread out and added to income in both 2010 and 2011. In that way, the tax can also be paid over two years, perhaps preventing a bracket creep also. The risk in that strategy, though, is that 2010 is the last year former President George W. Bush administration's tax cuts are in effect, and unless they are renewed or other changes are made, tax rates will automatically increase for 2011.
There are many factors that go into whether a conversion is right for you; your tax rate now, your expected taxable income in retirement, your ability to pay the tax due from outside sources, and more. There are also some creative strategies involving segregating your IRA by asset class and taking a wait and see approach; those are best discussed with your advisor.
February 28, 2010
February 25, 2010
More Proof Indexing Works
By John Scherer, CFP®
Middleton, WI
http://www.trinfin.com/
In this month's Forbes magazine, Rick Ferri talks about the performance of a basic index fund strategy over the past decade in his column 'A Decent Decade for Investors'. He calls it the 'Core-4' because he uses four Vanguard index funds - Total Bond Market, Total International Stock, Total US Stock Market, and REIT Index. His breakdown of the equity component of the portfolio always has the same ratio - 60% Total US, 30% Total International and 10% REIT, very similar to the allocation ratios that we employ at TFP (although we take an approach that expands on that basic theory with tilts toward small and value stocks per the Three-Factor Model, our overall domestic, foreign and real estate ratios are the same).
Ferri calculates that the returns on blended portfolios of those four funds for the decade ending 12-31-09 range from 3.1% to 5.4%, while the Consumer Price Index was 2.6% over that same time. Hardly a 'lost decade', as so many would have us believe. As Ferri says in the article "All portfolios outperformed the CPI, and that means all portfolios made money in real terms. Since this is true, was the first decade of this millennium really an investor's Hell? Not as I see it."
Active-management proponents often claim that when the markets go up index investing looks good, but when markets drop indexing doesn't produce results.
That sounds good, but the facts tell a far different story.
Middleton, WI
http://www.trinfin.com/
In this month's Forbes magazine, Rick Ferri talks about the performance of a basic index fund strategy over the past decade in his column 'A Decent Decade for Investors'. He calls it the 'Core-4' because he uses four Vanguard index funds - Total Bond Market, Total International Stock, Total US Stock Market, and REIT Index. His breakdown of the equity component of the portfolio always has the same ratio - 60% Total US, 30% Total International and 10% REIT, very similar to the allocation ratios that we employ at TFP (although we take an approach that expands on that basic theory with tilts toward small and value stocks per the Three-Factor Model, our overall domestic, foreign and real estate ratios are the same).
Ferri calculates that the returns on blended portfolios of those four funds for the decade ending 12-31-09 range from 3.1% to 5.4%, while the Consumer Price Index was 2.6% over that same time. Hardly a 'lost decade', as so many would have us believe. As Ferri says in the article "All portfolios outperformed the CPI, and that means all portfolios made money in real terms. Since this is true, was the first decade of this millennium really an investor's Hell? Not as I see it."
Active-management proponents often claim that when the markets go up index investing looks good, but when markets drop indexing doesn't produce results.
That sounds good, but the facts tell a far different story.
February 22, 2010
The Impact of High Mutual Fund Turnover
By Joe Alfonso, CFP®, ChFC
Santa Clara, CA
http://www.aegisadvisory.com/
Morningstar recently issued a report regarding the performance of the CGM Focus mutual fund. They reported how this fund was the decade's best performing mutual fund, rising more than 18% annually, yet investors in the fund experienced a yearly loss of 11% during this same period. How could this be?
CGM Focus Fund illustrates the issues with mutual funds that have excessive "turnover". Turnover is the rate at which a fund's holdings change every year. A turnover rate of 50% means that half of the stocks held by a fund are completely replaced within one year. The typical managed mutual fund has a turnover rate of 85%. Index funds, which hold all the stocks in a stock market index and do not sell unless the index itself changes or in order to generate cash for redemptions, typically have turnover rates in the single digits. According to Morningstar, CGM Focus's turnover rate is an astonishing 504%, meaning that its entire portfolio is replaced five times over the course of a single year!
In addition to generating excessive taxable gains in non-deferred accounts and driving up trading related costs, high turnover funds are very volatile. Due to their volatility, the actual return experienced by fund investors is often lower than the internal return of the fund itself because the fund’s volatility increases the likelihood that investors will buy and sell at inopportune times.
When asked about the great disparity in fund versus investor performance, CGM Focus Fund's manager Ken Heebner replied, "A huge amount of money came in right when the performance of the fund was at a peak. I don't know what to say about that. We don't have any control over what investors do."
I would argue that, while a fund manager may not be able to control investor behavior, any fund manager realizes that increased volatility also increases the likelihood that investors will buy high and sell low, and pay more in the process. John Bogle, the Founder of the Vanguard Group, Inc., certainly feels differently than Mr. Heebner. In a recent interview, Mr. Bogle rails against "...funds (that turn) over at 100% or 200% annual rates, leading, among other things, to incredible tax inefficiency." He goes on to ask, "Would you do that with your own money? Do you think those managers would do that with their own money?"
Like Mr. Bogle, I feel that the best approach is to work with investments that are low cost, tax efficient and have low turnover as part of a long term approach aimed at achieving a fair, market rate of return. The issues raised with the strategy of funds like CGM Focus illustrate why a "market return" approach is appropriate for most clients and is in fact the only approach compatible with a fiduciary standard of care that places client's best interests first at all times.
Santa Clara, CA
http://www.aegisadvisory.com/
Morningstar recently issued a report regarding the performance of the CGM Focus mutual fund. They reported how this fund was the decade's best performing mutual fund, rising more than 18% annually, yet investors in the fund experienced a yearly loss of 11% during this same period. How could this be?
CGM Focus Fund illustrates the issues with mutual funds that have excessive "turnover". Turnover is the rate at which a fund's holdings change every year. A turnover rate of 50% means that half of the stocks held by a fund are completely replaced within one year. The typical managed mutual fund has a turnover rate of 85%. Index funds, which hold all the stocks in a stock market index and do not sell unless the index itself changes or in order to generate cash for redemptions, typically have turnover rates in the single digits. According to Morningstar, CGM Focus's turnover rate is an astonishing 504%, meaning that its entire portfolio is replaced five times over the course of a single year!
In addition to generating excessive taxable gains in non-deferred accounts and driving up trading related costs, high turnover funds are very volatile. Due to their volatility, the actual return experienced by fund investors is often lower than the internal return of the fund itself because the fund’s volatility increases the likelihood that investors will buy and sell at inopportune times.
When asked about the great disparity in fund versus investor performance, CGM Focus Fund's manager Ken Heebner replied, "A huge amount of money came in right when the performance of the fund was at a peak. I don't know what to say about that. We don't have any control over what investors do."
I would argue that, while a fund manager may not be able to control investor behavior, any fund manager realizes that increased volatility also increases the likelihood that investors will buy high and sell low, and pay more in the process. John Bogle, the Founder of the Vanguard Group, Inc., certainly feels differently than Mr. Heebner. In a recent interview, Mr. Bogle rails against "...funds (that turn) over at 100% or 200% annual rates, leading, among other things, to incredible tax inefficiency." He goes on to ask, "Would you do that with your own money? Do you think those managers would do that with their own money?"
Like Mr. Bogle, I feel that the best approach is to work with investments that are low cost, tax efficient and have low turnover as part of a long term approach aimed at achieving a fair, market rate of return. The issues raised with the strategy of funds like CGM Focus illustrate why a "market return" approach is appropriate for most clients and is in fact the only approach compatible with a fiduciary standard of care that places client's best interests first at all times.
February 18, 2010
Divorce – Recession Style: Income and Expenses
By Linda Leitz, CFP®, EA
Colorado Springs, CO
www.pinnaclefinancialconcepts.com/
Divorce is never easy, but add on top of the emotional trauma, the uncertainly of a recession, it gets more difficult. The next few postings here will deal with some financial issues in divorce and how they’re impacted by our current economic landscape.
If both spouses are able to make ends meet comfortably on what they individually make after a divorce, income doesn’t really come up as a bone of contention. But if they can’t, then alimony – also called spousal maintenance – becomes an issue. In divorce cases involving alimony, generally every state looks at the reasonable income of each spouse and their reasonable expenses to figure out what the amount of spousal maintenance might be. The word reasonable – for both income and expenses – is key. If I’d like to leave my financial planning firm and try to become an actress, a judge probably isn’t going to require my ex to pay alimony to make that possible. Also, the courts don’t generally want me to live a substantially better lifestyle than my ex if we’ve been married quite a while. (All this doesn’t take kids into account. More on that in a future posting.) And most people, after a divorce, have to cut back their lifestyles since most marriages don’t have enough excess cash flow to support an entirely separate household.
So on the earnings side of the equation, in this economy, some people are taking a pay cut or losing their job. And people entering the work force aren’t having an easy time of it. Divorce isn’t intended to be a free ride or windfall to either spouse, but courts also don’t want people to have to stay married to survive. People who aren’t going through divorce are making some temporary compromises in their career paths. They’re taking a job to get their foot in the door at a company they’d like to work for long term. Or they’re taking a job they’d otherwise never consider to put food on the table. So people in the midst of divorce realistically may have to make some of the same choices. That may lower how much one spouse will pay in alimony, but that certainly doesn’t eliminate the possibility of spousal maintenance being paid. This may also be a time when people who wanted the security of knowing the amount of alimony was locked into their divorce decree may want the flexibility of having it subject to modification if circumstances substantially change.
Unreasonable spending levels are one of the factors that caused the recession. So this is a great time for everyone – in or out of divorce – to get back to sanity in their expenses. But it should be an equitable approach to cutting back. It’s not reasonable to have one spouse living in the penthouse with a view of the park while the other is living in a cardboard box in the park.
Colorado Springs, CO
www.pinnaclefinancialconcepts.com/
Divorce is never easy, but add on top of the emotional trauma, the uncertainly of a recession, it gets more difficult. The next few postings here will deal with some financial issues in divorce and how they’re impacted by our current economic landscape.
If both spouses are able to make ends meet comfortably on what they individually make after a divorce, income doesn’t really come up as a bone of contention. But if they can’t, then alimony – also called spousal maintenance – becomes an issue. In divorce cases involving alimony, generally every state looks at the reasonable income of each spouse and their reasonable expenses to figure out what the amount of spousal maintenance might be. The word reasonable – for both income and expenses – is key. If I’d like to leave my financial planning firm and try to become an actress, a judge probably isn’t going to require my ex to pay alimony to make that possible. Also, the courts don’t generally want me to live a substantially better lifestyle than my ex if we’ve been married quite a while. (All this doesn’t take kids into account. More on that in a future posting.) And most people, after a divorce, have to cut back their lifestyles since most marriages don’t have enough excess cash flow to support an entirely separate household.
So on the earnings side of the equation, in this economy, some people are taking a pay cut or losing their job. And people entering the work force aren’t having an easy time of it. Divorce isn’t intended to be a free ride or windfall to either spouse, but courts also don’t want people to have to stay married to survive. People who aren’t going through divorce are making some temporary compromises in their career paths. They’re taking a job to get their foot in the door at a company they’d like to work for long term. Or they’re taking a job they’d otherwise never consider to put food on the table. So people in the midst of divorce realistically may have to make some of the same choices. That may lower how much one spouse will pay in alimony, but that certainly doesn’t eliminate the possibility of spousal maintenance being paid. This may also be a time when people who wanted the security of knowing the amount of alimony was locked into their divorce decree may want the flexibility of having it subject to modification if circumstances substantially change.
Unreasonable spending levels are one of the factors that caused the recession. So this is a great time for everyone – in or out of divorce – to get back to sanity in their expenses. But it should be an equitable approach to cutting back. It’s not reasonable to have one spouse living in the penthouse with a view of the park while the other is living in a cardboard box in the park.
February 15, 2010
Why You Should Convert to a Roth IRA in 2010
By Judy Stewart, CFP®, MBA, EA
Carlsbad, CA
http://www.stewartfinancial.com/
2010 offers us some special and unique planning opportunities. It allows all taxpayers to convert IRA (tax deferred) money to Roth IRAs (tax free money) regardless of adjusted gross income. In the prior years, only taxpayers with adjusted gross income of less than $100,000 were allowed to convert IRA money to a Roth IRA.
When a taxpayer converts money from a regular IRA to a Roth IRA there is a tax bill due. The taxes are based on the amount of conversion and taxed at the taxpayer’s current tax bracket. In other words, if $10,000 of regular IRA money is converted to a Roth and the taxpayer is in a 15% tax bracket, then $1500 of federal taxes would be owed in addition to state taxes.
2010 also offers another special situation in that the federal taxes owed for conversions in 2010 can be spread over 2 years rather than all being paid in one year. So, if we look at the same example above, the $1500 in taxes could be paid in 4/15/11 and 4/15/12. However, please note that if the tax brackets are higher in the later years, you will pay more in taxes. So, if you believe that we will see higher taxes down the road, it might make more sense to pay the entire tax bill in 4/15/11!
The entire IRA does not need to be converted. So, if a taxpayer has a $100,000 IRA but does not want to convert the entire IRA because of the high tax bill, he /she can convert just a portion of the IRA. And pay taxes only on the converted amount.
If there are non deductible contributions in the IRA account mixed in with deductible contributions, you cannot just convert the non deductible amounts. It must be pro-rated. Assume that a taxpayer has a $100,000 IRA and $40,000 is from non deductible or post tax contributions, then only 40% is non taxable if the entire IRA is converted. The other $60,000 would be taxable. If the same taxpayer decided to just convert $50,000, then $20,000 (40%) would be non taxable and $30,000 would be taxable.
And the final good news sounds like a TV commercial “if for any reason you are not satisfied, you can undo your Roth conversion absolutely free, with no further obligation”. It’s called a recharacterization and if you convert this year you have until 10/15/2011 to undo the conversion. For example, assume you convert $100,000 in 2010 and the market totally tanks and you end up with only $80,000 in your Roth but will owe taxes on the $100,000 that you converted. You can do a recharacterization and put the money back into your IRA and undo the whole transaction. Sounds almost too good to be true!
The earlier that you convert, the better off you will be. Consider that, over time, stocks have risen more than they have fallen. All other things being equal, converting earlier means that the dollar amount of your conversion will be lower, thereby costing you less in taxes.
Carlsbad, CA
http://www.stewartfinancial.com/
2010 offers us some special and unique planning opportunities. It allows all taxpayers to convert IRA (tax deferred) money to Roth IRAs (tax free money) regardless of adjusted gross income. In the prior years, only taxpayers with adjusted gross income of less than $100,000 were allowed to convert IRA money to a Roth IRA.
When a taxpayer converts money from a regular IRA to a Roth IRA there is a tax bill due. The taxes are based on the amount of conversion and taxed at the taxpayer’s current tax bracket. In other words, if $10,000 of regular IRA money is converted to a Roth and the taxpayer is in a 15% tax bracket, then $1500 of federal taxes would be owed in addition to state taxes.
2010 also offers another special situation in that the federal taxes owed for conversions in 2010 can be spread over 2 years rather than all being paid in one year. So, if we look at the same example above, the $1500 in taxes could be paid in 4/15/11 and 4/15/12. However, please note that if the tax brackets are higher in the later years, you will pay more in taxes. So, if you believe that we will see higher taxes down the road, it might make more sense to pay the entire tax bill in 4/15/11!
The entire IRA does not need to be converted. So, if a taxpayer has a $100,000 IRA but does not want to convert the entire IRA because of the high tax bill, he /she can convert just a portion of the IRA. And pay taxes only on the converted amount.
If there are non deductible contributions in the IRA account mixed in with deductible contributions, you cannot just convert the non deductible amounts. It must be pro-rated. Assume that a taxpayer has a $100,000 IRA and $40,000 is from non deductible or post tax contributions, then only 40% is non taxable if the entire IRA is converted. The other $60,000 would be taxable. If the same taxpayer decided to just convert $50,000, then $20,000 (40%) would be non taxable and $30,000 would be taxable.
And the final good news sounds like a TV commercial “if for any reason you are not satisfied, you can undo your Roth conversion absolutely free, with no further obligation”. It’s called a recharacterization and if you convert this year you have until 10/15/2011 to undo the conversion. For example, assume you convert $100,000 in 2010 and the market totally tanks and you end up with only $80,000 in your Roth but will owe taxes on the $100,000 that you converted. You can do a recharacterization and put the money back into your IRA and undo the whole transaction. Sounds almost too good to be true!
The earlier that you convert, the better off you will be. Consider that, over time, stocks have risen more than they have fallen. All other things being equal, converting earlier means that the dollar amount of your conversion will be lower, thereby costing you less in taxes.
February 11, 2010
Giving Support While Saving Tax Dollars
By Troy Von Haefen, CFP®
Nashville, TN
www.vhfinancialmanagement.com
We have all watched over the last few weeks the horrific images coming from Haiti. It’s hard to imagine how difficult that would be here at home, but imagine how hard it must be in a country that struggles with the simple tasks we take for granted. They obviously could use our help.
The IRS has given us a little incentive to help out. On Jan. 22, 2010 a new law went into effect that will allow taxpayers to deduct qualifying contributions to organizations providing relief to victims in Haiti on their 2009 tax return.
The fine print
Contributions must be made after Jan. 11, 2010 and before March 1, 2010, and the taxpayer must itemize their deductions on Schedule A in order to take advantage of the benefit. Contributions must be in the form of a cash type donation, as opposed to a donation of property. Donations via text message, check, credit and debit cards are allowable. The IRS states that the taxpayer may choose either tax year 2009 or 2010 to take the deduction. Obviously, not both….the IRS frowns on double dipping!
I always tell my clients not to make charitable contributions solely based on the tax deduction. Make the donation because you choose to. This still holds true, but the flexibility to take this deduction either in 2009 or 2010 is fabulous. This is another opportunity to utilize a little forethought and tax planning to maximize tax savings…..all while helping those in need.
Nashville, TN
www.vhfinancialmanagement.com
We have all watched over the last few weeks the horrific images coming from Haiti. It’s hard to imagine how difficult that would be here at home, but imagine how hard it must be in a country that struggles with the simple tasks we take for granted. They obviously could use our help.
The IRS has given us a little incentive to help out. On Jan. 22, 2010 a new law went into effect that will allow taxpayers to deduct qualifying contributions to organizations providing relief to victims in Haiti on their 2009 tax return.
The fine print
Contributions must be made after Jan. 11, 2010 and before March 1, 2010, and the taxpayer must itemize their deductions on Schedule A in order to take advantage of the benefit. Contributions must be in the form of a cash type donation, as opposed to a donation of property. Donations via text message, check, credit and debit cards are allowable. The IRS states that the taxpayer may choose either tax year 2009 or 2010 to take the deduction. Obviously, not both….the IRS frowns on double dipping!
I always tell my clients not to make charitable contributions solely based on the tax deduction. Make the donation because you choose to. This still holds true, but the flexibility to take this deduction either in 2009 or 2010 is fabulous. This is another opportunity to utilize a little forethought and tax planning to maximize tax savings…..all while helping those in need.
February 8, 2010
Avoid Retirement Clumsiness with a Ladder
By Robert Schmansky, CFP
Franklin, MI
www.nfa1040.com
Originally published 1/20/10 at FiLife.com
My childhood neighborhood had everything a kid could want: A school with plenty of field space for sports and games, a wooded area to explore (and be terrified of) and a community pool.
During summers, I spent most of my time at the pool. When you’re young, there are two ways to exit the pool: the ladder (boring), or the cool way, which was any way other than the ladder. Clearly, there was only one way to do it.
Before you develop enough upper body strength to press yourself high enough to place a knee and raise yourself out of the pool, the ‘cool’ way was as follows:
1. Muster your strength, advance clumsily with elbows and forearms to lay your chest on the edge of the pool deck
2. Pull forward while twisting on your chest and belly far enough to hook a leg over the pool side
3. Continue to twist, pull and drag yourself until you were out
There was one downside to scraping exposed skin against the pool deck: It hurt!
Coolness aside, the ladder is clearly the smarter way to exit the pool. The ladder is also a way to avoid retirement cash flow “clumsiness.” I am talking about a bond ladder, composed of government-backed bonds or bank CDs.
When I first look at the portfolios for new clients exiting the working world, I see a lot of portfolio clumsiness. Most investors understand they need a portfolio of stocks and bonds for diversification, but they frequently abandon time-tested strategies for the latest Wall Street invention.
A bond ladder takes some of the income portion of your retirement savings and places it in bond ‘rungs’ that mature annually. As the rungs mature, you have cash flow for that year.
Each year a decision needs to be made with your financial adviser on whether to spend the cash from the maturing bonds, or instead sell stocks that have risen in value to maintain the desired asset allocation for the portfolio. That discussion is a side benefit of the bond ladder approach: encouraging prudent and deliberative investment behaviors.
Our preferred investment for a ladder is U.S. Treasury STRIPS bonds, which are bonds sold at a discount.
In summary, the key advantages of the bond ladder are:
If only that were true. A ladder and secure retirement cash flow plan should be the starting point, prior to looking to achieve excess return. Because being ‘cool’ with retirement income carries more hazards than a scraped belly.
Franklin, MI
www.nfa1040.com
Originally published 1/20/10 at FiLife.com
My childhood neighborhood had everything a kid could want: A school with plenty of field space for sports and games, a wooded area to explore (and be terrified of) and a community pool.
During summers, I spent most of my time at the pool. When you’re young, there are two ways to exit the pool: the ladder (boring), or the cool way, which was any way other than the ladder. Clearly, there was only one way to do it.
Before you develop enough upper body strength to press yourself high enough to place a knee and raise yourself out of the pool, the ‘cool’ way was as follows:
1. Muster your strength, advance clumsily with elbows and forearms to lay your chest on the edge of the pool deck
2. Pull forward while twisting on your chest and belly far enough to hook a leg over the pool side
3. Continue to twist, pull and drag yourself until you were out
There was one downside to scraping exposed skin against the pool deck: It hurt!
Coolness aside, the ladder is clearly the smarter way to exit the pool. The ladder is also a way to avoid retirement cash flow “clumsiness.” I am talking about a bond ladder, composed of government-backed bonds or bank CDs.
When I first look at the portfolios for new clients exiting the working world, I see a lot of portfolio clumsiness. Most investors understand they need a portfolio of stocks and bonds for diversification, but they frequently abandon time-tested strategies for the latest Wall Street invention.
A bond ladder takes some of the income portion of your retirement savings and places it in bond ‘rungs’ that mature annually. As the rungs mature, you have cash flow for that year.
Each year a decision needs to be made with your financial adviser on whether to spend the cash from the maturing bonds, or instead sell stocks that have risen in value to maintain the desired asset allocation for the portfolio. That discussion is a side benefit of the bond ladder approach: encouraging prudent and deliberative investment behaviors.
Our preferred investment for a ladder is U.S. Treasury STRIPS bonds, which are bonds sold at a discount.
In summary, the key advantages of the bond ladder are:
- A true guarantee of retirement cash (when using government-backed bonds or CDs)
- Allowing risk-taking in other parts of your portfolio
- Avoiding high costs and unknown performance associated with elaborate packaged financial products
If only that were true. A ladder and secure retirement cash flow plan should be the starting point, prior to looking to achieve excess return. Because being ‘cool’ with retirement income carries more hazards than a scraped belly.
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