Investing Curiouscatblog

Category: Tips

  • The 4% Rule is Overly Simplistic

    Time to replace the 4% rule

    Conventional wisdom suggests that you withdraw on average 4% adjusted for inflation. Now comes a paper co-authored by William Sharpe, the winner of the 1990 Nobel Prize in Economics, challenging the conventional wisdom.
    …
    According to Sharpe, who is also the founder of Financial Engines, the typical 4% rule recommends that a retiree annually spend a fixed, real amount equal to 4% of his initial wealth, and rebalance the remainder of his money in a 60%-40% mix of stocks and bonds throughout a 30-year retirement period.

    What’s more, he shows the price paid for funding what he calls “unspent surpluses and the overpayments made to purchase its spending policy.” According to Sharpe, a typical rule allocates 10%-20% of a retiree’s initial wealth to surpluses and an additional 2%-4% to overpayments.
    …
    The only problem with what academia knows to be right and what’s practical in the field — even by Sharpe’s own admission — is this: “Many practical issues remain to be addressed before advisers can hope to create individualized retirement financial plans that maximize expected utility for investors with diverse circumstances, other sources of income, and preferences,” Sharpe wrote in his paper.
    …
    Meanwhile, Stephen P. Utkus, a principal with the Vanguard Center for Retirement Research, agrees that the 4% rule is flawed. But he also notes, as did Sharpe, that there’s no practical mechanism to replace it with and that further research is required.

    I think this is exactly right. The proper personal financial actions in this case are not easy. The 4% rule is far from perfect but it does give a general idea that is a decent quick snapshot. But you can’t rely on such a quick, overly simplified method. At the same time there are simple ideas that do work, such as saving money for retirement is necessary. The majority of people continue to fail to take the most basis steps to save money each year for retirement.

    Related: Spending Guidelines in Retirement – How Much Will I Need to Save for Retirement? – Bogle on the Retirement Crisis

  • Avoiding the Vicious Cycle of Credit Problems

    Credit problems create a vicious cycle. Credit card interest rates are increased, fees are onerous and even applying for jobs is negatively affected (many employers look at credit reports as one factor in the hiring process), insurance companies look at them too and can offer higher rates. Employers and insurers have the belief that bad credit is an indication of other risks they don’t want to take on. Once into the cycle there are challenges to deal with. I must admit I think it is silly to look at credit for most jobs. But a significant number of organizations do so that is an issue someone that gets themselves in this trouble has to deal with.

    I think the best way to deal with this problem is to build a virtuous cycle of savings instead. We tend to focus on how to cope with a bad situation instead of how to take sensible actions to avoid getting in the bad situation. In general we spend far too much money and take on too much debt – we live beyond our means and fail to save. Then we have a perfectly predictable temporary hit to our financial situation and a vicious cycle begins.

    If we just acted more responsibly when times were good we would have plenty of room to absorb a temporary financial hit without the negative cycle starting. The time to best manage this cycle is before you find yourself in it. Avoiding it is far better than trying to get out of it.

    Build up an emergency fund. Don’t borrow using credit cards – or any form of consumer debt (borrowing for education, a car or a house, I think, are ok). Save up your money until you can afford what you want to purchase. Don’t buy stuff just to buy stuff.

    Re: The Vicious Circle of Poor Credit

    Related: Real Free Credit Report – In the USA 43% Have Less Than $10,000 in Retirement Savings – Financial Planning Made Easy

  • Protect Yourself from 11 Car Dealer Tricks

    Top 11 dealer tricks

    2. The single-transaction strategy: Many people view buying a car as one transaction. It’s not, and dealers know this. It’s really three transactions rolled into one — the new-car price, the trade-in value and the financing. The dealer sees all three as ways to make money. Treat each as a separate transaction, and negotiate each one. If you get a new car for $200 over invoice but receive only $1,000 for a trade-in car that’s worth $2,500, you haven’t done as well as you could.

    3. The payment ploy: A dealer might say, “We can get you into this car for only $389 a month.” Probably true, but how? In some cases, the dealer may have factored in a large down payment or stretched the term of the loan to 60 or 72 months. Focus on the price of the car rather than the monthly payment. Never answer the question, “How much can you pay each month?” Stick to saying, “I can afford to pay X dollars for the car.”

    Some good advice. I bought my last car at CarMax which gave a good price and none of these tricks (I didn’t have a trade in – I donated it) and I paid cash. They offered a great deal on a Toyota Rav4 when I was looking. I believe, those that are interested in getting the very best deal and are skilled and able to defend themselves from the dealer can do better than CarMax. But I would bet most people would be much better off using CarMax.

    Related: Manufacturing Cars in the USA – Avoiding Phone Fees – Actually Free Credit Report – How to Use Your Credit Card Properly

  • Bill Gross Warns Bond Investors

    Bill Gross Warning May Catch Bond Investors Off-Guard

    Pacific Investment Management Co.’s Gross, manager of the world’s biggest bond fund, said yesterday in an interview with Tom Keene on Bloomberg Radio that “bonds have seen their best days.” Pimco, which announced in December that it would offer stock funds, is advising investors to buy the debt of countries such as Germany and Canada that have low deficits and higher- yielding corporate securities.

    The prospect of a strengthening U.S. economy and rising interest rates makes an “argument to not own as many” bonds, Gross said in the interview.
    …
    Treasuries have rallied for almost three decades, pushing the yield on the 10-year Treasury note from a high of 15.8 percent in September 1981 to 3.89 percent as of yesterday. The yield reached a record low of 2.03 percent in December 2008 during the height of the credit crunch.
    Excess borrowing in nations including the U.S., U.K. and Japan will eventually lead to inflation as governments sell record amounts of debt to finance surging deficits, Gross said.

    “People have been making money on fixed income for so long, people assume it’s going to continue when mathematically, it cannot,” said Eigen, whose fund is the third-best selling bond fund this year, according to Morningstar. “When people finally start to lose money in fixed-income, they won’t hesitate to pull money out very soon,” he said.

    John Hancock Funds President and Chief Executive Officer Keith Hartstein said retail investors are already late in reversing their rush into bond funds, repeating the perennial mistake of looking to past performance to make current allocation decisions.

    I agree bonds don’t look to be an appealing investment. They still may be a smart way to diversify your portfolio. I am investing some of my retirement plan in inflation adjusted bonds and continue to purchase them. My portfolio is already significantly under-weighted in bonds. I would not be buying them if it were not just to provide a small increasing of my bond holdings.

    Related: Municipal Bonds, After Tax Return – 10 Stocks for Income Investors – Bond Yields Show Dramatic Increase in Investor Confidence – Investors Sell TIPS as They Foresee Tame Inflation

  • In the USA 43% Have Less Than $10,000 in Retirement Savings

    There are several personal finance basics that everyone must account for. Retirement requires the most planning and accumulating the largest amount of money. Luckily if you plan ahead you have a long time for compounding to work in your favor. Unfortunately most people continue to fail to make even the most minimal efforts to save for retirement: 43% have less than $10k for retirement

    The percentage of workers who said they have less than $10,000 in savings grew to 43% in 2010, from 39% in 2009, according to the Employee Benefit Research Institute’s annual Retirement Confidence Survey. That excludes the value of primary homes and defined-benefit pension plans.

    Fewer workers report that they and/or their spouse have saved for retirement (69%, down from 75% in 2009 and 72% in 2008. Moreover, fewer workers say that they and/or their spouse are currently saving for retirement (60%, down from 65 percent in 2009).

    27% say they have less than $1,000 in savings (up from 20% in 2009).

    46% report they and/or their spouse have tried to calculate how much money they will need to have saved for a comfortable retirement by the time they retire.

    What is a very rough estimate of what you need? Well obviously factors like a pension, social security payments, age at retirement, home ownership, health insurance, marital status… make a huge difference in the total amount needed. But something in the neighborhood of 15-25 times your desired retirement income is in the ballpark of what most experts recommend. So if you want $50,000 in income you need $750,000 – $1,250,000. Obviously that is difficult to save over a short period of time. The key to saving for retirement is a consistent, long term saving program.

    Related: Retirement Savings Survey Results (2007) – How Much Will I Need to Save for Retirement? – Personal Finance Basics: Long-term Care Insurance

  • Where to Invest for Yield Today

    Yields are staying amazingly low today. Due to the credit crisis the federal reserve is shifting hundreds of billions of dollars from savers to bankers to allow banks to make up for losses they experienced (both in losses on bad loans and huge cash payments made to hundreds of executives over more than a decade). For that reason (and others) yields are extremely low now which is a great burden on those that saved and counted on reasonable investment yield.

    Don’t be fooled by apologist for those causing the credit crisis that try and excuse their behavior and act as those paying back the bailout payments means they paid back the favors they were given. They have received much more from the policies of the federal reserve that has taken hundreds of billions of dollars from savers and given it to bankers. It has the same effect as a direct tax on savers being paid to bankers.

    What is an investor/saver to do? James Jubak provides some excellent advice.

    How to maximize what your cash pays even when nothing is paying much of anything now

    A three month Treasury bill pays just 0.12%. A two-year note pays just 0.79%. Inflation may not be very high at an annual rate of 2.6% for headline inflation (and 1.6% minus volatile energy and food prices) but it’s enough to eat up all the interest from those investments and more. (TIPS, Treasury Inflation-Protected Securities will protect you from inflation but the yields are really low (1.43% for a 10-year TIPS at recent auction) and they only protect you from inflation and not rising interest rates. I-Bonds, a savings bond that pays an interest rate that combines a fixed component, currently 0.3%, with an inflation-adjusted variable rate, current 3.06%, offer a higher yield but since the variable rate is pegged to inflation and not interest rates, the yield on these bonds won’t necessarily go up if interest rates do. You also have to hold for at least 12 months. (After that and until you’ve held for 5 years you lose the last 3-months of interest when you sell.)

    You could lock your money up for decades and get 4.56% in a 30-year Treasury bond but 30 years is forever. And besides interest rates have to go up from today’s lows and that means bond prices will be coming down, probably fast enough to eat up all the interest that bond pays and more.
    …
    Not if you remember that interest rates are going up in most of the world (except maybe Europe and Japan) quite dramatically over the next 12 months. A year from now, perhaps sooner, you’ll be able to get yields swell north of anything you can find now.

    That pretty much means that you’re guaranteed to lose money two ways by locking it up for the long term now.
    …
    For the short term you need to put your cash into something that’s as safe as possible but that offers you as much income as possible—and that doesn’t lock up your money for very long.

    My choice dividend paying stocks—if they pay a high dividend, are extremely liquid, and are battle tested.

    Whether you agree with his suggestions in the article is up to you. But even if you don’t he provides a very good overview of the options and risks that you have to navigate now as an investor seeking investments that provide a decent yield. I agree with him that interest rates seem likely to rise, making bonds an investment I largely avoid now myself.

    Related: posts on financial literacy – Jubak Picks 10 Stocks for Income Investors – S&P 500 Dividend Yield Tops Bond Yield: First Time Since 1958 – Bond Yields Show Dramatic Increase in Investor Confidence

  • Credit Card Issuers Still Seeking to Take Your Money

    The government has stopped some of the worst abuses by credit card issuers however, those financial institutions are not without ways of continuing to take advantage of customers, Credit-Card Fees: the New Traps

    Customers can only exceed their credit limit if they agree ahead of time to pay a penalty fee. And unless a cardholder misses payments for more than 60 days, interest-rate increases will affect only new purchases, not existing balances. Banning these and other profitable tactics is expected to cost the card industry at least $12 billion a year in lost revenue
    …
    Banks already are reaping more fees on overseas transactions. Not only are they raising foreign-exchange transaction fees—the cost customers pay for purchases made in foreign currencies—but they are expanding the definition of what qualifies as a foreign transaction.

    In the past, people who made online purchases from foreign merchants, or who traveled to a country where the purchases are often in U.S. dollars such as the Bahamas, were generally immune from paying such fees. But Citi and Bank of America recently imposed their 3% foreign-transaction fees on all foreign transactions—even if that purchase is charged in U.S. dollars. Discover Financial Services also began charging a new 2% for foreign purchases last year.
    …
    And there are ways to avoid annual fees. Citigroup is alerting some customers that it is assessing a $60 annual fee on their cards. The cure for that is simple. If you spend $2,400 on the card in a 12-month period, the bank will refund the fee.

    I’ll tell you a better way to avoid the abusive fees. Don’t deal with the large banks that the government bailed out. My credit union offers a credit card with no annual fee without any minimum spending requirements, and many others do as well.

    Related: How to avoid getting ripped off by credit card companies – More Outrageous Credit Card Fees – Sneaky Credit Card Fees – USA Consumers Paying Down Debt –

  • Building an Emergency Fund

    Many people find personal financial planing boring. Building a cash safety net is an important part of your personal finances even though it isn’t exciting. I have written previously the very simple idea that you can just not buy what you can’t pay for. If you can’t pay for it this month, don’t buy it.

    But that leaves out one thing. Even if you do have the cash you should be building up a cash reserve before buying luxuries. The typical advice is to build up 6 months of expenses in cash (rent or mortgage, food bills, utilities, health care, etc.). Now actually building up to that level can take awhile and forgoing all non-mandatory expenses until you have that saved is not usually reasonable. But as part of your personal finances building up an cash reserve is important (even if it is boring). And I believe you really should aim at a higher level – say building to 1 year.

    A significant portion of downward spirals in personal finances are started when people have emergency expenses and have to borrow that money (since they don’t have cash reserves). And even worse when they start racking up huge fees for late payments, increased interest rates on outstanding debt, health care expenses if they fail to keep health care insurance…

    If you are over say 26 and don’t have a cash reserve yet saving for it should be part of your monthly budget. How quickly you build that up is a personal decision but I would say a 2% of the target amount (so if you are aiming for a cash reserve of $20,000 then $400/month). If you have next to nothing saved now start aiming at 6 months. As you get 3 months saved up start aiming at 9 months. As you get 6 months saved up start aiming at 1 year. And you have to also be saving for other needs – you shouldn’t raid your emergency fund savings for other things (a new car, a vacation…). This takes real discipline but it is much easier than the challenges our ancestors had to face of billions of people face financially today. So yes it is not easy, but really those that feel sorry for themselves need to realize they shouldn’t expect that they are so special the world owns them financial riches with little effort.

    Doing something is better than nothing so do what you can (even if it is less than 2% of you target). But realize that is one of the weaknesses in your personal finances and try to fix that as soon as possible.

    Very important personal financial allocations for you to put first include: current needs (food, car payment, rent/mortgage, utilities…), insurance, creating a cash reserve, retirement savings, saving for future purchases. Then there are luxuries and treats, such as: eating out, vacations, cable TV… Many people put current needs, luxuries and treats fist and then say they don’t have the ability to do what is responsible (check how rich you are – before making such claims yourself).

    Related: How to Protect Your Financial Health – Save Some of Each Raise – Buying Stuff to Feel Powerful – Consumer Debt Down Over $100 Billion So Far in 2009 – posts on basic personal finance matters

  • Finding a Credit Union

    NCUA logo

    I have discussed the advantage of using credit unions over trying to cope with a bank since so many banks constantly try to trick customers into paying huge fees. Here are some resources to help:

    • Find a local credit union (site broke link so I removed the link) – with an overview of services offered
    • Find a local credit union from (NCAU) with links to Financial Performance Report data.
    • Credit Unions have National Credit Union Share Insurance Fund (NCUSIF) (“backed by the full faith and credit of the U.S. Government”) instead of FDIC. The limits on the share insurance are the same as the limits on FDIC, currently $250,000 per individual account holder. Use the link to make sure your credit union provides NCUSIF coverage.

    You can also get credit cards through your credit union. In general credit unions are much more interested in trying to provide the customer value instead of trying to stick them with huge fees. But don’t just trust your credit union, check out the rates and fees they charge and comparison shop for the best credit card.

    Related: posts on banking – FDIC Study of Bank Overdraft Fees – Credit Unions Slowly Fill Payday Lenders Void

  • Up to $6,500 Credit to Reduce Your Energy Bills

    The Federal Weatherization Assistance Program has been around for decades and funding has been increased as part of the stimulus bills. This type of spending is better than much of what government does. It actually invests in something with positive externalities. It targets spending to those that need help (instead of say those that pay politicians to give their companies huge payoffs and then pay themselves tens of millions in bonuses).

    The Depart of Energy provides funding, but the states run their own programs and set rules for issues such as eligibility. They also select service providers, which are usually nonprofit agencies that serve families in their communities, and review their performance for quality. In many states the stimulus funds have increased the maximum funds have increased to $6,500 per household, from $3,000.

    The weatherization program targets low-income families: those who make $44,000 per year for a family of four (except for $55,140 for Alaska and $50,720 for Hawaii).

    The program provides funds for those with low-income for the like of: insulation, air sealing and at times furnace repair and replacement. Taking advantage of this program can help you reduce your energy bills and reduce the amount of energy we use and pollution created. And it employs people to carry out these activities.

    The Weatherization Assistance Program invests in making homes more energy efficient, reducing heating bills by an average of 32% and overall energy bills by hundreds of dollars per year.

    Weatherization is also often a very good idea without any government support. If you are eligible for some help, definitely take a look at whether it makes sense for you. And even if you are not, it is a good idea to look into saving on your energy costs.

    Related: Oil Consumption by Country in 2007 – Japan to Add Personal Solar Subsidies – personal finance tips – Kodak Debuts Printers With Inexpensive Cartridges – Personal Finance Basics: Dollar Cost Averaging
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