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Welcome to Get Smart about Investing. Everyone is calling themselves financial advisors these days and to make matters worse, anyone could start their own financial planning company within a few weeks just by going through the paperwork despite not having any schooling or experience in the financial field. Reassuring, isn’t it? There are so many different credentials and initials after advisors’ names that making sense of it all can be daunting. Let’s look at the credentials that really matter.

A CFP stands for Certified Financial Planner. This is the highest designation for providers of comprehensive financial planning covering many different areas of personal finance. Basically it means that the person took advanced classes ranging from retirement planning to insurance, passed a 10-hour exam on all areas of financial planning, has industry experience, and has taken an oath to give ethical advice. When you are looking for an advisor to address a lot of different areas, you definitely want to look for someone who is a CFP.

A CFA stands for Chartered Financial Analyst. This is the highest designation for advisors who specialize in analyzing companies and making investing decisions. The advisor must pass three, very comprehensive tests over a three-year period, covering economics, security analysis and portfolio management.

A CLU stands for Chartered Life Underwriter. This is the highest designation for advisors who specialize in the insurance industry. It’s given to those who completed a lengthy series of 10 courses covering insurance and financial planning.

A CPA stands for Certified Public Accountant. This is the highest designation for advisors who specialize in taxes. You may not need a CPA right now to do your taxes, but as your tax situation becomes more complex, a CPA would be the person to see.

There are literally dozens of other certifications. There isn’t anything wrong with them,  but I would still recommend that you keep to the ones that we talked about. There are many good advisors out there without any designations, but all other things being equal, your chances of finding a good one increase if you find someone who meets these credentials.

I’m Greg McGraime and Now You Know!

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Welcome to Get Smart about Investing. Asset allocation was step one: Make sure you maintain a balance between aggressive and conservative investments. Diversification is step two: Make sure that within each of these areas, you’re exposed to many different assets so no area can dictate your entire investment return. Again, participate in areas that are doing well and limit yourself in areas that are not. Step number three is portfolio rebalancing.  Rebalancing is simply adjusting your investments to get back to the plan that you were following.

Over time, all of your investments will vary in performance and some investments will do better than others. What if you started the year with 80 percent of your money invested in stocks and 20 percent invested conservatively because you were following an 80/20 plan? If the stock market did very well over the next few years, it’s very possible that 95 percent of your portfolio’s value would be invested in stocks and just 5 percent of it in bonds, because the stocks grew faster than the bonds. Your portfolio is now overly exposed to stocks, with 95 percent of it invested in the stock market. The right plan for you to follow should have been an 80/20 plan. Rebalancing your portfolio would involve selling a small portion of your stocks and buying bonds to get back to the plan you were following.

By not rebalancing, you would actually be taking on too much risk. You’d be in a plan that’s more aggressive than the one you’re supposed to be in. The same concept would apply to each of the subcategories of different investment types we’re looking at. If the healthcare industry does really well, you’ll probably end up overinvesting in healthcare and would need to move into other areas so you’re not overexposed to any one risk. If small companies were performing poorly, perhaps too much of your stock portfolio would end up in large companies; and thus your diversification would be reduced; again, increasing your risk.
Why is rebalancing so important? The answer is it forces you to do three things that most investors don’t do:
1. Follow and stick to a consistent investment plan each year, tailored to your particular situation.
2. Keep emotions out of investments. Following a plan helps you make investment decisions based not on your emotions, but on a logical framework consistent with what your portfolio needs.
3. Rebalance investments. This forces you to buy investments that have gone down in value and sell investments that are going up. It’s the opposite of how most people think about investing. Think about it. If an investment did great, no one would want to sell it. Very few investors will ever take money off the table when they’re doing well. Look at the late 90’s as an example. Investors were receiving 50 to 100 percent returns and it was not enough for them.
If you were rebalancing your portfolio, you would have shifted some money from technology stocks to bonds and more conservative areas before the market conditions changed. On the other hand, no one wants to buy an investment when the market is doing terribly, although that’s the best time to invest. 2002 and 2003 would have been the best time to buy stocks, but very few people did. By rebalancing, you’re forcing yourself to make investment decisions that very few people can make on their own. Creating a successful plan is all about removing your emotions and gut feelings from the investment situation.

I’m Greg McGraime and Now You Know!

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Welcome to Get Smart about Investing. After you make the decision to invest in the stock market with a portion of your portfolio and have an idea of how much money you want to place in large caps, small caps and international stocks, the next decision to make is whether it’s better to use individual stocks or stock mutual funds. This choice comes down to understanding the pros and cons of each method well enough to make the right decision. We’ll talk more about stock mutual funds later on. But first ask yourself how active a role you want to play in managing the stock portion of your portfolio.

Individual stocks tend to be a lot more work than using stock mutual funds. Look at all the factors you need to be concerned with: How much should you invest in technology versus healthcare? How much should you invest in each stock? When should you sell a stock? How should you keep track of all the different stocks? What overall strategy are you following? I often run into clients who invested in individual stocks and ended up with a portfolio that was too complicated to keep up with; not to mention the headaches these clients got when tax time rolled around. They had bad stocks that remained in their portfolio for years and good stocks they didn’t even know about. Individual stocks are great, but there can be a lot more upfront and ongoing work involved.

Most of the people I talk with who want to invest in the stock market usually have two or three ideas for individual stocks that they’re interested in, or came across a stock recommendation in the newspaper or on TV. In many of the cases, a better way for them to get started would have been to use a combination of both individual stocks and mutual funds. For example, if you were investing $20,000 in the large-cap portion of your portfolio, perhaps you could invest $12,000 in an S&P 500 index mutual fund and $8000 in individual stocks. Or you could put $4000 in each. This way, if your stocks are doing better than the S&P 500 index, you become one of the few people to outperform the market. But if those stocks aren’t doing do as well, at least a bulk of your money is well-diversified, allowing you to participate in the overall growth of the market over time.
How much money do you have to invest or is already invested in stocks? Do you have enough money to buy 10 to 20 different stocks from each of the asset classes: large caps, small caps and international? Getting good diversification with smaller dollar amounts is harder and more time consuming when you’re investing in individual stocks, and much easier to do with stock mutual funds. This is especially true for the small cap and international portions of your portfolio because most people are less familiar with these types of companies. For example, you would probably have an easier time understanding Coca Cola’s business model compared to a bank in India. Generally, investors who plan to use individual stocks should have at least $50,000 to $100,000 for their portfolios.  Again, if you don’t have that much money to invest, use mutual funds for the bulk of your investment, then complement it with a few individual stocks.

Let’s say you had $60,000 to invest and wanted to put it in individual stocks. After some planning, you decided that you would allocate $30,000 to large caps and $15,000 to small caps and international stocks. Instead of investing all of the money in individual stocks, you can use mutual funds for the small cap and international portions of your portfolio, and individual stocks for the large-cap portion. That would enable you to focus your time on the area you’re more familiar with and use the expertise of mutual fund managers in these other areas.

How well have the stocks you’ve chosen performed in the past? Maybe you have the time and money to spend on enjoying the process of selecting individual stocks; but have you done it well? Can you tell me how your investments performed over the last year? Most people can’t. It’s challenging for anyone to separate the good stocks from the bad, year after year; not to mention someone who doesn’t do it on a full-time basis. For the average person, it’s difficult to implement a disciplined investment strategy for individual stocks. If it sounds like I’m trying to dissuade you from investing in individual stocks, it’s because I am. For most people I believe the convenience, professional management and diversification of a stock mutual fund outweighs its drawbacks and costs.

Most people I speak with say their financial lives are already too busy. They want to make good financial decisions but don’t want too active a role in managing their investments. The bulk of their portfolios should be in mutual funds, with occasional stock purchases, if they’re interested and have time for it. It makes sense to follow an investment plan that’s aligned with your interests and priorities.

I’m Greg McGraime and Now You Know!

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Welcome to Get Smart about Investing. Let’s look at the most common mistakes that individuals make regarding the taxation of investments.

1. Not knowing the cost basis
Very few investors actually know the cost basis of their investments. As a result, they are making investment decisions without considering one of the key factors - the tax consequences. It can make a big difference if you are selling a position that has a loss or gain. Professional portfolio managers will often make investment decisions that offset gains and losses to minimize the tax an investor is subject to each year.

2. Not considering the holding period
What if you had invested $20,000 11 months ago and your investment had grown to $40,000? If you sold today, your holding period would be less than one year and as a result, you would have to pay the higher, short-term capital gains rates. If you held onto the shares one extra month, you could convert short-term gains into long-term gains, thus saving on taxes.

3. Making taxes the primary focus in decision-making
On the other hand, you never want to make investment decisions solely due to taxes. I have met many investors who never sold an investment because they didn’t want to pay taxes; and all too often the result is holding onto investments of lesser quality simply to avoid taxes. Always factor in taxes, but do not let taxes dictate your investment decisions.

4. Getting upset about losses and forgetting about them
No one likes to have losses, and some people, after experiencing them, get really upset and tend to have an out of sight, out of mind perspective. This happened a lot in 2001 and 2002, when many stock investors suffered significant losses. If you experienced losses, you need to keep track of them, so at the very least, you can reduce your taxes ny deducting losses against your income. Again, I never want to experience losses, but if I do, I definitely want to use them on my taxes as a way of reducing their impact.

5. Buying mutual funds right before their distribution dates
Mutual funds usually make their distributions once or twice a year, most often in November or December. If you own the shares prior to the distribution, you will probably have to pay some tax on whatever the distribution amount is. The challenge is that you might be subject to taxes on an investment even though you did not receive any gain. This can be fairly complicated to understand and represents one of the disadvantages of mutual funds from a tax perspective. Always ask the mutual fund company when their distribution dates are prior to buying, particularly in November and December. Perhaps it would be better to wait until after the distribution to make the investment.

6. Not considering the account type along with the potential taxation of your investments. It makes a big difference, from a tax perspective, whether you are investing in a retirement account or a regular taxable account. Maybe you could hold income investments like bonds or dividend-paying stocks in your IRA to avoid taxes on the income. Perhaps you could structure more growth-oriented investments in your taxable accounts. Or maybe you should use index funds or tax-efficient funds in your taxable accounts, and actively-managed mutual funds in your retirement accounts. All of these are ways of minimizing your tax liability.

As you can see, the tax consequences of your investments can be complex. Your goal is to look at your investments from many different perspectives and it’s important that the tax perspective is one of them. So what should you do with the information we have just gone over? As a starting point, go through each of the investments in your taxable accounts and figure out what your cost basis is for each investment. If you need help, call the brokerage or mutual fund company and ask them to track how much you paid for the investments. This will give you some sense of how much gain or loss you would incur if you sold your investments and how much you would owe in taxes. At the very least, you will have this information organized and ready when you sell your investments and need it to complete your taxes. In the next chapter we will shift our focus to investing for retirement, which is perhaps the most important financial goal most people have.

I’m Greg McGraime and Now You Know!

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Welcome to Get Smart about Investing. A common question that comes up is, does it make sense to pay off your mortgage early? The argument goes something like this: If you have a 30-year fixed mortgage for $200,000 at 6 percent, your mortgage payment would be approximately $1,200 per month, not including real estate taxes or homeowners insurance, just the mortgage. Over the 30-year period - the life of the loan - you would have paid a total of approximately $430,000. I know it’s amazing how much you pay: $200,000 would be the principal and the rest would be the interest. If you took a 15-year fixed mortgage for the same amount at the same interest rate, your monthly payment would be approximately $1,700 per month. So every month you would be paying more than the 30-year fixed mortgage, but you would finish the mortgage in half the time. With the 15-year fixed, you’d end up paying $300,000 over the life of the loan, saving over $130,000 in interest. Now, most people can’t afford to get a 15-year mortgage because the monthly payments are a lot higher; but the question still remains, does it make sense to try and pay your mortgage off early to whatever extent you can?

Making the decision
In most cases I think it does make sense to pay off your mortgage early, particularly if you can pay it off by the time you retire. Too many people are entering retirement still carrying big mortgages on their homes. Retirement becomes a lot more affordable if you no longer have your biggest expense - namely your mortgage payment. Some people will argue that it would be better to invest any additional money you have instead of paying down the mortgage; but that’s really comparing apples to oranges. Paying off your mortgage has no investment risk, whereas trying to achieve a higher return on your money does have investment risk. In addition, you will have to pay taxes at some point on any of the gains you receive from investments, which can also eat away at your returns.

But before you start paying extra on your mortgage, we have to look at the bigger picture. In an earlier chapter, we looked at the different types of debt and mentioned how a mortgage is a good form of debt because you are building equity each month, the value of your home is appreciating, the interest rates are usually low, and the interest is usually tax-deductible. You should not be paying down your mortgage early if you have outstanding consumer debt like credit cards or car loans; they are typically at higher interest rates than your mortgage and don’t have the favorable tax treatment. All too often I see clients paying more than they need to towards their mortgage while carrying high interest rate credit cards or car loans. That does not make sense.

Another area to consider is your own personal savings for retirement. Are you doing a good job saving for retirement each year? Another mistake I often encounter is with clients who are paying extra on their mortgage, but aren’t contributing money to their company’s 401(k) account; often missing out on matching funds from the company. You should be saving at least 5 to 10 percent in your company’s retirement account and/or putting the maximum amount in an IRA before considering paying extra on your mortgage. Remember, no one is going to loan you money to retire. To summarize this point, if you don’t have any consumer debt and are doing a good job saving for retirement, I think paying extra on your mortgage makes great sense both financially and psychologically. There are few financial things that make an individual feel more secure than having their home paid for in full. I can’t remember meeting any client who had their home paid off early and was not in good financial shape.
I’m Greg McGraime and Now You Know!

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Welcome to Get Smart about Investing. Let’s take a look at the 6 most common mistakes people make with retirement accounts. Today we are talking about estimating how much college will cost for your kids. Now, there are obviously a lot of different factors involved and the younger your children are, the more difficult it is to know what direction life will take them. For example, if my son is four months old, how do I know if he will go to a public or private college? Will he stay locally or go to college in another part of the country? What if he does not go to college at all? What if he gets a scholarship or financial aid?

When you start thinking about all of these different variables, there is obviously a lot of uncertainty. What you don’t want to happen is for all of the unknowns to make you feel like a deer blinded by a car’s headlights. It can also be intimidating when you see some huge numbers that look impossible to achieve. With all of these variables and unknowns, people will often get frustrated, but try not to over-think this. The idea here is to get a better sense of the big picture, review your financial situation, and do the best you can with the resources you have. If helping your children with the costs of college is important to you, you have to do something. Many people don’t know where to start and as a result they do nothing. If you follow my method, you should be able to create a specific plan that gets you moving in the right direction, so that you can progress toward your goal.

Let’s look at how much college costs today and some of the factors involved in trying to plan appropriately. In these estimates, what I am trying to do is to get you in the right
ballpark to make sure you have a good sense of the bigger picture. For tuition and room and board, the average public school costs approximately $12,000 per year or $48,000 over the course of four years. The average private school costs approximately $30,000 per year or $120,000 over the course of four years. If a child attends a local college or a two-year program, the costs would obviously be a lot less.

Now, let’s also keep in mind some very important “real world” considerations. On the good side, very few people pay the full price for college. Nearly two-thirds of college students will receive some form of financial aid resulting in either reduced tuition or favorable financing. On the negative side, statistics show one-third of all college students drop out after their first year and just over half of all students who enroll in a four-year college end up getting their degrees within five years. These are other important considerations as you decide what types of investments to make for your child’s education.

The next step involves coming up with an estimate for how much it may cost for each of your children. Since most students will go to public colleges, $40,000 is a good starting point. But most students will also not have to pay full tuition due to financial aid, and student loans and grants, for example. As a result, a good estimate for the cost of attending a four-year, public university in another location would be $30,000 per student. So that can be a good starting point. Of course you should increase or decrease this number to reflect your own unique circumstances.

As with all investing, you need to have a specific plan to follow. Saving for college is like saving for a car. Very few people put money aside before they need it. The next step involves committing to a monthly savings plan. Statistics show that investors who commit to regular monthly savings plans are much more likely to reach their financial goals than those who don’t. We all know how much money will be available if we wait until the end of the month or year to save. You’re probably wondering how much should you save? If you have an exact amount you are trying to accumulate, you can work out specific numbers. But let’s look at a few examples. Let’s say your daughter was just born a few months ago and you wanted to start saving for college as early as possible. If you invested $100 per month for 18 years, you could accumulate over $50,000 for your daughter’s education. Starting right away sounds great, but in the real world, most people don’t. If you have any young children, definitely start investing today to take advantage of your longer time horizon. Maybe your son is nine years old and will be starting college nine years from now. If you invested $250 per month for nine years, you could accumulate over $41,000 for your child’s education. Perhaps you are concerned that your six-year-old daughter is going to choose a private school. If you invested $400 per month for 12 years, you could accumulate over $100,000 for your child’s education.

Basically, if your goal is to help your children pay for at least a part of their college education, you should plan to save anywhere from $50 to $500 per month for each child. Even if you don’t think $50 a month will do much, you need to do it anyway. So often people think that small amounts won’t make a difference, but they can end up having a huge effect, especially over time.

I’m Greg McGraime and Now You Know!

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Welcome to Get Smart about Investing. Let’s take a look at the 6 most common mistakes people make with retirement accounts.

1. Not using retirement accounts. Many employees do not contribute money to any type of retirement account. Where will their income come from in retirement? This is particularly costly if your employer provides a company match that you are missing out on. Everybody has to contribute something to a retirement account, even if it’s just 1 or 2 percent of their salary.

2. Not saving enough. Like we have mentioned, most financial professionals recommend saving 10 to 15 percent of your salary each year for retirement and most people are nowhere near that amount. How much money did you contribute to a company savings account or IRA last year? Take a look at how much you are saving each year and try to move in the direction of 10 to 15 percent. If you do nothing else, try to increase your contributions to your company retirement account by 1 to 2 percent this year. I have never met anyone who increased their 401(k) savings by 1 percent and were aware of the difference in their daily lives.

3. Investing too conservatively. Remember, retirement is usually a longer-term goal, and you want to invest appropriately for it. Taxes are one of your obstacles and retirement accounts can help minimize them. Inflation is the other obstacle and the best way to stay ahead of it is to use a combination of growth investments. If you invest too conservatively, there’s always the risk of not accumulating enough for retirement.

4. Investing in company stock. Many employees invest too much money in their own company stock. Most financial experts recommend having no more than 10 to 20 percent of your retirement savings in any one stock. It’s ok to invest in your company, but you never want to have your life savings dependent on the performance of any one stock.

5. Not having or following an investment plan. You need to create and follow an asset allocation plan that is appropriate for your situation. The plan also has to be well-diversified between different types of investments to minimize the amount of risk your investments are exposed to and maximize your potential return.

6. Changing jobs and taking out the money from the company retirement account. This happens all too often, especially with younger employees. If you did a good job at saving and investing money for retirement, don’t let all of that progress disappear by taking the money out and paying taxes and a penalty for it. If you are changing jobs, make sure to use one of the methods we had talked about to avoid taxes and penalties and keep your money growing for retirement.
I’m Greg McGraime and Now You Know!

Filed under "Investing by Greg McGraime" by gmcgraime