Personal Finance 101 Posts of the Day 6/6/07

• We're In Debt reminds you to make sure your spouse knows about the finances.
• Clever Dude talks about setting up house without breaking the bank (or getting divorced).
• The Dough Roller bashes one of Kiyosaki's Yahoo articles. (Kiyo is dangerous!)
• $1 Million to My Name has a series on retirement mistakes. Part IV covers IRAs and 401ks.
• Advanced Personal Finance talks about why you might want to wait to convert to a Roth IRA.
• Ask Uncle Bill has a list of 10 Financial Mistakes to avoid.
  

Personal Finance 101 Posts of the Day 5/17/07

• Vanguard talks about why you should get kids investing in a Roth early. My grandfather did this for me and it’s one of the single best things he’s ever done for me. If you need help motivating them, consider offering a ‘matching’ program of some sort. Most people like free money.
• Bankruptcy Law Network points out some sneaky credit card tricks to look out for.
• Wealth Building World wonders if paying off your mortgage early is actually costing you money.
  

Personal Finance 101 Posts of the Day 4/23/07

• Credit Card Blog lists 10 reasons why everyone needs a credit card.
• Debt Consolidation News talks about how to get a pre-nup signed. I know it’s a touchy subject for a lot of people but I’m personally in favor of pre-nups. People argue that it means you’re assuming the marriage will fail but IMO, all you’re doing is being realistic. There is a chance that the marriage will end and if you address that in advance it probably means you have great communication which will probably help your marriage last.
• Blueprint for Financial Prosperity has a great post on why it may make sense to NOT roll over a 401k to an IRA. I agree with him and I get asked this question all the time in my classes. There are times when it makes sense to leave your money in a 401k. Typically they are when you have access to investments that would otherwise be closed to you.
• Free Money Finance talks about asset allocation.
• Enhanced Life talks about the excuses people make for not saving.
• Life of a Resident Alien gives 22 tips on how to build an emergency fund.
• An Engineering Approach to Money talks about why it’s good to fund your Roth early.
• 3 Debt Consolidation talks about different debt consolidation methods.
• Canadian Financial stuff talks about how even our northern neighbors hate payday loans.
• Queercents talks about developing a spending plan.

Personal Finance 101 posts of the day 4/12/07

• Young and Broke talks about how people aren't saving these days.
• Broke Now Rich Later tells us how he's campaigning for a Roth 401k at his job.
• Consumerism Commentary asks if personal finance should be required in high schools. He says no but I strongly disagree.
• The 6 Month Project talks about ways to trim your budget.
• Mighty Bargain Hunter talks about pre-packing your lunch to take to work.
• The Thinking Men talk about how you can get a free credit report.
• Yahoo Finance has an article about how deluded people are about their retirement prospects.
• Free Money Finance asked his readers for suggestions on how to save on a small income (read the comments).
• Fool for Travel gives some great tips on how to save money while traveling.
• MSN Money talks about payday loans and their huge interest rates.

Personal Finance 101 posts of the day 4/2/07

• Blueprint for Financial Prosperity talks about Saving Beyond 401k and Roth IRA.
• Resident Alien lists 25 rules to grow rich by.
• Free Money Finance talks about how it’s the little splurges that can get you.
• Grad Money shows us how to get into the swing of cooking at home.
• Consumerist talks about how to stop living paycheck to paycheck.
• Make Love, Not Debt talks about how they developed their budget without killing eachother.

Reader question: How do I open an IRA?

Hi Mandy,

How are you? A quick question..I plan to contribute 4000 to IRA this year (I believe this is the max)...Can I contribute anything additional to Roth IRA?

Would you suggest that I put in Roth IRA or traditional IRA?

Also what is the yield I get out of this account?

I am planning to open it with Citibank, since it is close by

Thanks,

ANSWER

Hi,

You can only contribute $4k total to both accounts. Since I believe you have a 401k at your job, odds are very good that you cannot deduct your traditional IRA contribution so I'd strongly suggest you do the Roth instead. And even if you can deduct it, typically a Roth is a much better investment in the long run. See my article: What's so great about a Roth IRA?

Also, you should never invest through a bank. They are the worst places for investments since they typically offer loaded funds that have high annual expenses and underperform. Instead you should open your account with Vanguard or Fidelity.

As for what kind of yield you can expect, that is completely dependent upon what you invest in. IRAs are only accounts within which you buy an investment. You can choose almost any investment. Considering your age, you should be as aggressive as you are comfortable with. Since your balance in this account will only be $4k to start (assuming you don't have an existing IRA that you could add to) you probably don't want to invest in more than one fund (to minimize fees). If you're ok being very aggressive, or it's balanced out with your other investments, you could choose a total stock market index fund as it will give you great diversification and be 100% stock. If you prefer to be a bit more conservative and/or you just don't want to think about it again besides to put more money in, you should consider a Target Retirement Fund.

Target Retirement Funds are funds that hold a basket of funds that ensure that you are completely diversified and have an appropriate asset allocation based on your expected retirement date. They are a one-stop investment and you can put your money in and never think about it again because it automatically gets more conservative as you get older.

Final thing, assuming you didn't make a contribution in 2006 (otherwise you'd just add to it right?) when you open this account you should identify this money as 2006 money. You have until tax day to do this. Then you still have all of 2007 to contribute another $4k.

Let me know if you have any questions and unless I hear differently from you I'm going to post this (with your name removed) onto the meetin forums since it's a great question that lots of people probably have.

Have a great day!
Mandy

FOLLOWUP QUESTION

thanks Mandy,

I was planning on Citibank since some of my friends have opened accounts there...they don't charge any fees too.

Does Vanguard charge any fees?

However the trick is to find the mutual funds that I should be investing in.

I do not mind being aggressive...but i need to know how and what to look for in mutual funds...Any pointers on links, details that i should look for?

and no, I do not have a 401K account, since my company does not contribute...

thanks,

FOLLOWUP ANSWER

Ok. Well, since your company offers a 401k and you just choose not to participate you still may not be able to take the deduction. Check your tax form and see if there's a mark on it that indicates you're covered by a retirement plan. If that box is checked then you can't take the deduction.

Even if you can take the deduction you should still probably consider the Roth. The advantages are much better with a Roth than a Traditional IRA.

Regarding Citibank, they may not charge fees up front, but odds are great that the products they offer are loaded funds (means you have to pay a sales charge to buy them) and have high annual expenses (anything over .5% is too high unless it's a very specialized fund).

Vanguard charges $10/year/fund for investments under $10k which is why you only want to do one fund at a time. $10 may sound like a lot compared to Citibank's $0, but when you take into account that a load is typically 5%, that means on a $4k investment you're paying $200 just to buy the fund. That doesn't even include the difference that a .25% expense ratio will make over one that's 1%.

The main things you should look for in a fund are: Load (never pay a sales load. They're a waste of money), ER (stands for annual expense ratio) and should definitely be below 1% and ideally below .5%. You also want to look at what the fund is invested in. Funds can invest in almost anything so you want to make sure that whatever it is invested in meets your needs.

As a younger person you want your investment to be much more heavily weighed towards stocks than bonds. You also want to make sure that you have a little bit of everything (small, mid, large-cap and international) which will keep you diversified and boost returns and lower risk.

Since you're just learning how to pick funds, I would definitely recommend the Target Retirement fund. I would choose the 2050 fund which is the most agressive. I would do this just to get the account set up and then you can spend some time learning more about how to choose funds. After learning more you may decide to just stick to the target fund (they are great investments) or take a more active hand in your investment choices.

On my book recommendation page I list 2 books which I think are must reads for everyone. The first is The Automatic Millionaire and the second is Investing for Dummies. I'd recommend reading both since they'll give you a great educational foundation to get you started.

Mandy

This week in Blogs (1/14-1/21)

• JLP at All Financial Matters talks a bit about his concerns about Social Security as a follow up to comments about a prior post. It’s a divisive issue that many people don’t want to think about. Check out the comments that he’s getting. He also has a great post on how to calculate the expected return on a portfolio.
  

• Boston Gal talks about the cheapest way to get DIY tax software. She also made a great post about how having kids impacts your financial plans.
  

• At Blueprint for Financial Prosperity they take a look at historic federal tax brackets. I absolutely agree with his conclusions and have been saying it for a while. People who think that when they retire they’re going to be in a lower tax bracket are in for a rude awakening. When you take into account inflation and history it’s almost certain that rates will be higher in the future – and you should plan accordingly. Also, as a compliment to our article about why a Roth is great, here’s a post on why you should invest in your Roth right now.

What's so great about a Roth IRA?

It’s a question I hear a lot and the answer is: almost everything.

Let’s start with the basics. A Roth is a type of Individual Retirement Account (IRA) which allows you to save in a tax advantaged way even if your employer does not offer a retirement plan. The thing that differentiates the Roth from other types of IRAs (Traditional, SEP) is that the money you put into a Roth is put in after taxes are taken out which means that you’ll never pay taxes on that money again.

“No taxes?” you ask. That’s right. No taxes. That means if you contribute $40,000 to your Roth over the next 10 years and it grows to be $400,000 when you retire, you won’t pay a dime of taxes on that $360,000 that your investment earned.

Sound too good to be true? It really isn’t. Of course, there are a couple rules that you’ll have to follow.

Disadvantages

First, you are only allowed to put in $4,000/year (as of 2007, changes to $5,000 in 2008) and you have to have earned at least that much in income (unless you are an unemployed spouse in which case you can still contribute).

Second, there is a cap on how much you can earn each year and still be able to contribute to a Roth.

• Single: Under $95,000 = Full Contribution; $95,001-$110,000 = Partial Contribution; over $110,000 = No Contribution.
• Married filing Joint: Under $150,000 = Full Contribution; $150,001-$160,000 = Partial Contribution; over $160,000 = No Contribution.
• Married filing Separate: $0-$10,000 = Partial Contribution; Over $10,000 = No Contribution
  

* The above salaries are all your MAGI. MAGI stands for Modified Adjusted Gross Income and is an amount that is used for determining a taxpayer's IRA eligibility; it is generally the taxpayer's adjusted gross income (shown on IRS Form 1040 or 1040A) calculated without any IRA deduction, foreign earned income exclusion, foreign housing exclusion, student loan interest deduction, exclusion of qualified savings bond interest from Form 8815, exclusion of employer-paid adoption expenses from Form 8839, or deduction for qualified tuition and related expenses.

Third, since this is a retirement account, there are some rules for how and when you can get at your money without paying penalties and taxes. Luckily those rules aren’t too bad and the advantages make them worth it.

Advantages

First, as mentioned above, since you are putting in after-tax money, that money and all of the earnings grow tax free so when you access it in retirement you won’t have to pay taxes on it.

Second, Roth’s provide tax diversity in retirement. Because other retirement plans are taxable at income tax rates when you retire, having a Roth allows you to control how much you have to take out of those accounts and therefore control how much you pay in taxes each year. This can come in handy if you are on the border between two tax brackets.

Third, unlike other retirement accounts which require that you start taking money out at a certain age, with a Roth, if you don’t need the money you never have to take it. This means your money can continue to grow throughout retirement and you can leave a nice nest egg for your heirs.

Fourth, the Roth is much more lenient about letting you have access to your money before retirement. With a Roth you can take out your contributions at any time for any reason without taxes or penalties. Additionally, if your account has been open for 5 years, you can access your earnings without paying tax on them and there will be no penalties as long as you are using the money for a qualified reason:

• The distribution occurs on or after the Roth IRA owner reaches age 59.5.
• For un-reimbursed medical expenses
• To pay medical insurance (under specific circumstances)
• Due to disability
• As distributions to the Roth IRA beneficiary
• As part of an SEPP program
• For qualified higher-education expenses
• To purchase a first home
• For payment of Roth IRS levy

Fifth, there is no minimum age to start a Roth which means that if an 11 year old has a paper route they can contribute their earnings and start their retirement savings REALLY early. With the advantage of compounding, that is a great thing!

Conclusion

The Roth offers a great, user friendly way to save for retirement. It’s flexibility, tax advantages and other benefits make it an easy decision to participate and everyone who is able should be maxing out their Roth.

Are you ready for the new financial year?

2006 is ending and it’s time to start preparing for 2007 so you can start off on the right financial foot. Here are some things you can do now to make 2007 a financially fit year:

At work:

• Increase your retirement contributions. The 2007 annual retirement contribution limit for 401(k) and 403(b) plans was increased to $15,500, so make sure you adjust your contribution levels accordingly. If you can’t max out the annual retirement contribution, at least try to increase your contribution 1% this year.
  
• Review your FSA contributions. If your employer offers a Flexible Spending Account (also called a Cafeteria or Section 125 plan) it’s a great thing to take advantage of. Try to sit down and use your budget to figure out how much you’ll need for the next year. Remember, you can now use it for over-the-counter medicine like aspirin or cold medicine and things like contact lens solution. Just don’t over estimate since if you don’t use it by the end of the year you lose that money.
  
• Double check your taxes. If you’re getting a big refund for this year, you probably need to take a look at what you’re having withheld each pay check. Your goal should be to break even at tax time and take that money you would have gotten in a lump sum at tax time and invest it monthly. If you aren’t sure how much you should have withheld, www.paycheckcity.com has a great paycheck calculator. Similarly, if you’ve had a major life change (house, marriage, divorce, etc.) that impacts your taxes you should double check that your withholdings are still correct.

On your own:

• Review your asset allocation. As investments rise and fall throughout the year they can impact your asset allocation plan. Make sure that at least twice a year you are rebalancing your investment portfolio to make sure you stay on track.
• Max out your Roth IRA . If you contribute $333/month to a Roth IRA you will have maxed it out for the year. The easiest way to do this is to set up an automatic contribution plan that will deduct money automatically from your checking account and invest it in an appropriate mutual fund. If $333/month is a bit too rich for your blood, look at the program that T. Rowe Price has that will allow you to start a Roth IRAwith as little as $50 to start and $50/contribution. If you haven’t yet maxed out your 2006 contribution you have until April 15, 2007 to do so, just make sure that you indicate that the money is for your 2006 contribution or they will credit it to 2007.
• Do a budget check. Look over your budget for the last 12 months and see if there were any unexpected expenses that you need to plan for this year and adjust accordingly. Better to save up for that license plate renewal than to get caught by surprise!
  
• Review your financial goals. Are you on track for your financial goals? Have you added/removed/changed any of them? Take a look and see where you are. Increase or decrease your savings based on any changes to your financial goals.