Personal Finance Articles

The 78 million Americans who make up the baby boom generation started turning 65 in 2011, and almost 30 million of them have a defined contribution retirement plan such as a 401(k) account, according to the Employee Benefit Research Institute. That means these near-retirees face an important question: How much money can they afford to withdraw from their retirement accounts?

Prior to 2008, financial advisers often encouraged investors to withdraw as much as 7% of their retirement assets each year. The idea was that the return on the retirees’ portfolios could potentially be greater than 7%, so the sizes of the portfolios would stay about the same.

Now it’s a new world, with market volatility the norm. If a new retiree withdrew 7% from a $2 million nest egg each year starting in 2000, he or she would have been left with only $394,634 by the end of last year, according to The Wall Street Journal.

The market’s volatility over the past few years has made it impossible for many new retirees to determine how much they can safely withdraw from their retirement accounts each year without running the risk of depleting their nest eggs before they die.

For example, if you adopted a 5% withdrawal rate in 2007 and your portfolio was decimated in 2008, you’d need to withdraw a much greater percentage in 2009 to obtain the same income.

It’s impossible to devise a one-size-fits-all withdrawal strategy,
but one thing is fairly certain in today’s market environment: Investors can’t just set their asset allocation and forget about it. It’s important to examine your portfolios and adjust your withdrawals regularly, such as annually.

Full Social Security benefits are available as early as age 65, depending on your date of birth.

If you choose, you may receive benefits at age 62, but your benefits will be reduced. Or you can delay benefits until age 70, in which case your benefits will increase.

Which option you choose depends on your life expectancy and your needs.

Life Expectancy:

Social Security calculates monthly payments so that if you start taking payments early, the smaller payments received over a longer time could total the same amount as if you had started receiving benefits at normal retirement age.

On the other hand, if you start taking payments late, the bigger payments received over a shorter time could total the same amount as if you had started receiving benefits at normal retirement age.

However, all these calculations are based on your normal life expectancy. If you live beyond that life expectancy, then delaying benefits will result in higher monthly payments and a potentially higher lifetime total. So, if you are in good health and have a family history of longevity, delaying benefits may provide more money in the long run. But if you don’t expect to reach or exceed your life expectancy, then it may make sense to start as soon as allowed.

Needs:

If you plan to save your Social Security benefits, taking them early – even though they will be reduced – may be a good idea.

That’s because the return you receive on the invested money might make your total benefit greater than the increased benefits you will receive if you take Social Security on time or delay benefits until age 70.

There are many other factors to consider when deciding when to take Social Security benefits.

For more information, it is probably wise to seek advice from a professional.

Investors may face greater challenges today than at any other time in history, given the uncertain economy and volatile markets.

So where can they turn?

Traditional investing wisdom holds that the solution is diversification, a concept based on the idea that by holding investments from different asset classes, the investor may increase his or her chances of obtaining a compelling total return.

Asset managers, however, diversify in different ways.

Some diversification strategies are passive, buying and holding securities for the long term regardless of market fluctuations. A mutual fund, for example, may have a prescribed hypothetical allocation mix of 50% equity, 45% fixed income and 5% alternatives that would not change, even as the equity market rallies and the fixed income market comes to a standstill.

Other diversification strategies are active, adapting to evolving market conditions by shifting assets in response to market fluctuations. Portfolio managers using such active strategies may have the flexibility to adapt to evolving market conditions by shifting entire asset classes in response to market fluctuations.

Advocates of active diversification strategies – also referred to as tactical-allocation strategies – believe these strategies can potentially be beneficial in volatile markets. When market risk is low, for example, the portfolio manager can increase exposure to growth by allocating assets toward the market’s top-performing sectors and countries. When market risk is high, the portfolio manager can preserve capital by shifting to a blend of high-quality, fixed income products and perhaps even cash.

Of course, no investing strategy is appropriate for every investor.
Your financial advisor can provide you with more information about what might be suitable for you given your individual financial circumstances, goals and risk tolerance.

Price-to-earnings (P/E) ratio has long been a standard measure of a stock’s value – but there are more ways than one to measure it.

Are you using the most appropriate measure?

P/E ratio is a company’s current stock price divided by its annual earnings per share.

For example, a stock trading at $40 per share with earnings per share of $2 would have a P/E ratio of 20 ($40 divided by $2).

A stock priced at $20 per share with earnings per share of $1 would also have a P/E ratio of 20 ($20 divided by $1).

P/E ratio is effective in expressing how much investors are paying for the value a company creates.

The problem is, there are more ways than one way to calculate P/E ratio, and all have their flaws.

Trailing P/E ratio, for example, is based on known earnings over the past year.

So, if a company’s past year’s earnings were unsustainably high, today’s P/E ratio might be deceivingly low.

On the other hand, another P/E ratio measure uses earnings forecasts, which may change in response to economic conditions.

Another trick used when calculating P/E ratio is to use so-called operating earnings instead of earnings as defined by regulators – and there’s no legal definition for operating earnings.

That said, stocks still appear cheap, at least by trailing P/E ratios, as of late September 2011.

At that time, at least 81 large U.S. companies had single-digit P/E ratios, according to Thomson Reuters.

In general, investing in stocks with low P/E ratios, whatever the measure used, may be a good idea because P/E ratios show what investors are prepared to pay for every $1 of a company’s earnings – and this, in turn, reflects the stock market’s view of the outlook for the company.

Smart investors understand the importance of rebalancing their portfolios by bringing their mix of stocks, bonds, cash and other assets back in line on a regular basis – even when markets threaten that orderly mix on a daily basis.

And what better time to rebalance than year-end?

The idea behind rebalancing is simple. If you never do so, over the long term, your better-performing investments will make up an ever-growing piece of your portfolio – and because these investments are likely those with higher risk, such as stocks, you could end up with a more aggressive allocation than you initially wanted.

When the markets are volatile, you may think you need to rebalance more often than usual, but that’s probably not the case. Why? Large moves in the market don’t necessarily lead to large moves in a portfolio.

For example, in a portfolio with 60% allocated to stocks and 40% allocated to bonds, a 5% drop in the stock market would still leave almost 59% of the portfolio in stocks. To push the portfolio five percentage points off its target, stocks would have to decline by 19%.

Instead of chasing daily market movements, consider rebalancing on some kind of schedule.

But don’t do that more than once a month.

And only do it when allocations stray more than, say, five percentage points from their targets.

Your financial advisor can help you decide what’s appropriate given your risk tolerance.

There has been plenty of drama recently, with the debt-ceiling debate, the downgrade of U.S. debt and concerns about European debt. But weathering such storms doesn’t have to be gut-wrenching, as there are some alternative investment strategies for volatile markets. For example:

Move to Cash: While putting all your assets in cash for the long term probably isn’t a good idea – as the return won’t outpace that of inflation – having some kind of cash cushion will help you weather volatility. It will also leave you something to reinvest when markets reach what you and your financial advisor think might be a low.

Look Into Utilities: Utilities aren’t sexy, but they’re often stable, and they have tended to provide the potential for strong dividend yields.

Consider Dividend-Paying Stocks: Dividends can provide a bit of solace in the absence of capital appreciation.

Investigate Gold: Gold prices have risen recently, which isn’t surprising. Because gold is seen as a hard asset, it often tends to rise when stock prices fall.

Give Into Your Vices: Does all the recent market volatility have you craving a drink or a smoke? If so, you’re not alone. Vice-related stocks may perform well when other stocks don’t. These include alcohol, tobacco and gambling stocks.

Once you’ve positioned your portfolio to offer some peace of mind, you can start to think in a more clearheaded manner about values that have emerged as a result of the panic. Your financial advisor can offer some suggestions.

Late last year, financial analyst Meredith Whitney rattled investors when she warned that many municipalities were poised to default on their bonds, and municipal bonds sold off.

Today, however, they’re making a comeback as volatility in other financial markets has rekindled interest in an asset class that has long been considered a solid investment.

Municipal bonds are issued by state and local governments, counties, cities, schools and water districts, and agencies.

They’re used to finance public projects such as roads, schools and airports and certain types of private projects, such as nursing homes and assisted-living centers.

Traditionally, investors have purchased municipal bonds primarily because they offer stability of principal and tax-free income.
Defaults in the market are rare, and the interest on municipal bonds is exempt from federal taxes. And because most states don’t require their residents to pay state and local taxes on interest received from bonds issued by political entities within the state, the interest may also be exempt from state and local taxes.

For example, in most cases a resident of Massachusetts wouldn’t have to pay federal taxes or state or local taxes on interest and dividends paid by a state of Massachusetts bond or a mutual fund that holds bonds issued by political entities within Massachusetts.

Because municipal bonds offer tax-free income, they are typically sought by investors with higher income levels. Why? Although the actual yield may be lower than on a taxable investment, the “tax-equivalent yield” – the yield after you’ve taken account of the fact that you aren’t taxed on the bond’s interest – may actually be higher.

Thus, the addition of municipal bonds to your portfolio may not only lower your tax bill – it may also help protect your portfolio from volatility. Your financial advisor can help you decide if municipal bonds are right for you.

Investors who have reached age 70½ can make charitable donations directly from their traditional individual retirement accounts (IRAs), saving taxes in the process.

But you need to act quickly, because this opportunity will expire at the end of 2011 unless Congress acts.

This donation option is called a qualified charitable distribution (QCD). Unlike most IRA distributions, which are taxable, the QCD is not.

However, a QCD must meet several tax-law requirements.

You must be 70½ and your IRA trustee must make QCDs directly to an eligible IRS-approved charity.

The QCD must meet normal tax-law requirements for a charitable donation that is 100% deductible, meaning if you receive any benefits that would be subtracted from a donation under the normal charitable deduction rules, you can make a QCD.

The QCD must be otherwise taxable, meaning a Roth IRA distribution generally does not meet this requirement.

Additionally, there’s a $100,000 limit on total QCDs per year.

However, if both you and your spouse have IRAs, you are entitled to $100,000 each, for a combined total of $200,000 – and that’s the case even if you file jointly.

Finally, note that you can’t claim itemized deductions for QCDs as you would for traditional donations to charities.

That’s because QCDs are already tax-free.

But there are a number of ways you save taxes using QCDs.

First, QCDs are not included in your adjusted gross income.

Second, QCDs fulfill required minimum distribution (RMD) rules – so you can take an RMD without paying taxes on it.

Third, QCDs reduce your taxable estate.

What you don’t know can be costly – which is why you should be familiar with the ins and outs of your retirement savings plan.

Such plans include individual retirement accounts, 401(k) plans and other retirement savings vehicles.

You probably know such vehicles have some fees – but do you know what those fees are and how much they are?

Many American investors are unaware of the fees they pay their retirement plan providers.

In fact, a recent study by the AARP found that 71% of 401(k) plan participants think they don’t pay any fees, and 6% don’t know.

That’s a total of 77% of American investors who are misguided.

Annual maintenance and account termination, or account transfer fees, are perhaps the most common retirement plan fees.

Depending on what share class of mutual funds you own in your account, you may also be assessed a fee called a contingent-deferred charge as well.

That’s not to say all retirement plan fees are bad. Your plan provider has to be compensated somehow. But the question is, are the fees too much?

The good news is that starting Jan. 1, 2012, retirement plan providers will have to disclose the fees participants pay for their 401(k) plans.

Meanwhile, there are also many calculators that can help you determine what you’re paying in retirement plan fees.

Real estate investment trusts (REITs) may present a compelling investment option in today’s economic and market environment.

Despite the dismal state of the U.S. real estate market, many REITs have performed well recently.

Housing prices were down again in the first quarter of 2011, according to the S&P/Case-Shiller national home price index. The index shows that housing prices decreased 5.1% in the first three months of 2011, compared to the same period in 2010. Prices were also down 32.7% from their peak set five years ago.

However, as of May 31, U.S. REITs were up 14.09%, according to the MSCI U.S. REIT Index.

Investors purchased nearly $22 billion in new REIT shares in the first five months of 2011, almost triple the amount they purchased during the same period the year before, according to The Wall Street Journal.

A REIT is a company that owns and, in most cases, operates income-producing real estate.

The shares of REITs are traded on major stock exchanges.

Each year, REITS distribute at least 90% of their taxable income to shareholders in the form of dividends.

Of course, REITs aren’t for everyone. There are special risks associated with investments in real estate, including credit risk, interest rate fluctuations and the impact of varied economic conditions.

However, investors may be able to mitigate these risks by seeking REITs in certain categories, such as the health care sector, which may benefit from growing demand as baby boomers age and the population enjoys a longer life span. Your financial advisor can help you determine if REITs are appropriate for you, given your individual financial circumstances and goals.

Index returns assume reinvestment of all distributions and do not reflect fees or expenses. It is not possible to invest directly in an index.