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AARP Article

Attention, Investors: Time to Check your Fees

Even small differences in your costs can slash savings

I preach constantly about low-fee investing. The less you pay in fees and sales commissions, the more you’ll save and the longer your money will last. Even small costs add up to huge losses over time.

For example, assume that you put $500 a month into an investment account for 30 years, earning an average of 7 percent. At a 2 percent annual fee, you’ll wind up with about $409,500, as calculated by NerdWallet, a consumer finance website. If you slash that fee to 0.25 percent, however, you’ll retire with about $561,500—that’s $152,000 more! Every penny you pay cuts into your future or current standard of living.

What qualifies as a low fee depends on the type of investment you choose and on how you opt to buy it. Here’s what thrifty investors should be looking for.

Mutual funds

The key is the expense ratio, which gathers together all the sales and administrative costs. Index funds—so-called because they track market prices as a whole— charge practically nothing. If you buy a fund that tracks the Standard & Poor’s 500 (S&P 500) index of big-company stocks, you’ll pay as little as 0.03 percent a year at the discount broker Charles Schwab (that’s 3 cents per $100), 0.035 percent at the fund company Fidelity Investments, and 0.04 percent at Vanguard. Index funds will be the lowest-cost choice in a 401(k), along with target-date funds—a mix of stock and bond funds appropriate to your age.

Index funds are called passive investments, as opposed to active funds in which managers try to beat the market by picking individual stocks. Active funds charge an average of 0.75 percent and usually don’t perform as well as the indexed group. Investors have noticed. They pulled $326 billion out of active funds in 2016 and poured a record $429 billion into passive funds, according to Morningstar’s report on mutual fund data.

Traditional brokerage firms

If you need advice, you might go to a stockbroker, aka “wealth manager” or “financial adviser.” But costs are high. For a broker-sold S&P 500 index fund, for example, you could pay as much as 1 percent a year or more. Your retirement account might be invested in high-cost shares of active funds when low-cost versions of the same funds are available. Mutual-
fund advisory accounts could cost up to 2 percent. “Wrap accounts,” invested with institutional money managers, range from 1.1 to 2.5 percent. Investors who don’t trade much could save a fortune by switching to an old-fashioned commission-based account.

Financial planners

You choose a planner for expert and ongoing advice about all of your personal finances. Typical fee:
1 percent for accounts under $1 million, with reductions for larger amounts. Underlying investment expenses might raise that to 1.5 percent or so among planners who don’t take sales commissions, and even higher among planners who do. The fee must include long-term planning. If you’re paying mainly for money management, you’re paying too much.

(Originally published in The AARP Monthly Bulletin.)

AARP Article

Investing If You’re Nervous

What to buy when the payoff you need is peace of mind

What should you do with your money if you’re deathly afraid of stocks and want to keep your capital safe? That’s a tough one. No-risk investing comes at a cost. You’re giving up the opportunity to make your retirement savings grow. Low-cost, broad-market index funds from companies such as Vanguard, Fidelity or Schwab will grow nicely over time if you leave them alone.

But your personal anxiety takes precedence over third-party financial advice. So, as a secondary goal, try to grow your savings at something close to the inflation rate. At this writing, both the principal consumer price index and the special index reflecting older Americans’ expenditures are rising at the rate of 2.9 percent. That’s the investment return you would need to preserve your purchasing power.

First choice, for people seeking safety first, is often a high-rate, federally insured bank certificate of deposit. One-year CDs with low minimum deposits are paying roughly 2.5 percent, according to Bankrate.com. For 3 percent, you have to deposit your money for five years. These rates are generally available only at online banks, such as Barclays and Capital One 360. Local banks might pay closer to the national average of 0.72 percent for one year and 1.29 percent for five years.

Even though these insured CDs may slowly lose purchasing power, they preserve the face value of savings, so you’re never alarmed when the financial world contracts. They’re also a good choice for people with smaller nest eggs—say, $50,000 or less—who can’t afford to take risks.

An option that pays a bit more than these CDs is what’s known as a multiyear guaranteed annuity. It’s a simple product with no links to stock-market indexes. You invest your money with an insurance company (minimums typically range from $2,500 to $100,000). In return, you get a fixed rate of interest for a specified number of years—usually at least three. You pay taxes on earnings only when you withdraw them. You can usually take out a certain amount of money each year, penalty free, although insurers will charge you penalties for quitting annuities early. Currently, five-year investments pay from 3 percent to 4 percent, and three-year investments from 2.5 to 3 percent. (For a list of multiyear guaranteed annuities, go to ImmediateAnnuities.com.)

You might get even more money over the long term from mutual funds invested in bonds. Their return isn’t fixed. As interest rates rise, the market value of these funds declines. But there’s a silver lining: As rates rise, the funds’ managers will buy new bonds that pay higher rates. So the income produced by a bond fund will rise too. Assuming that you leave that income in the fund, you’ll be buying new shares at higher yields, and all your shares will rise in value the next time interest rates decline. Current yields on general intermediate-term bond funds are running in the neighborhood of 3.4 percent, and blue-chip corporate bonds at 4 percent.

Warning: Don’t fall for fancy investments promising above-market rates. That always means risk. 

(Originally published in The AARP Monthly Bulletin.)

AARP Article

Managing Your Money Manager

Demand these things from your financial adviser

How do you know if your financial adviser has your best interests at heart? They all say they do. Then some of them turn around and sell you products with high (often hidden) costs that line their pockets at your expense. The government estimates that individual retirement accounts alone lose $17 billion a year to “me-first” investment advice from salespeople who wring large commissions and fees from their trusting clients. That’s money that could have been used to brighten your life.

Last year, the U.S. Department of Labor issued a new investor protection rule covering advisers who handle IRAs and 401(k)s. It would require them to act as fiduciaries—meaning that, when giving advice, they would have to put your financial interests ahead of theirs. If they sell you a mutual fund with a high commission when low-commission versions are available, their actions would be not only dishonorable, they would be against the law.

Not surprisingly, the brokerage and insurance industries hope to kill the rule. But because it was supposed to be implemented this month, financial firms necessarily prepared to comply. Fees dropped at some firms, and new, low-commission products were introduced. Then the Trump administration proposed putting off the start date until June, pending further review of the rule. What happens now?

Most likely, some of the reforms will last because the industry knows you want them. Others might be lost. Either way, here’s your path to getting trustworthy advice.

Ask the person managing, or offering to manage, your investments to state in writing that he or she will act as a fiduciary at all times, for retirement and nonretirement accounts. That’s especially important for less sophisticated investors who depend heavily on professional advice. Knowledgeable clients already demand fiduciaries for all their money.

Ask the adviser to compare the costs and benefits of leaving your retirement money in your 401(k) versus investing it through the firm’s IRA. You want a good-faith estimate, in writing, of what you’ll pay in direct fees or sales commissions, plus any payments the adviser’s firm quietly receives for selling particular mutual funds or annuities, says Ron Rhoades, director of Western Kentucky University’s financial planning program. Don’t settle for generalities; get specifics. True fiduciaries will give them to you.

Consider choosing an adviser who charges flat fees — such as a percentage of managed assets or a fixed amount per year — rather than those who also take commissions. Fee-based advisers can be expensive, too, so you still have to check. But commissioned advisers are those most likely to push complex products, such as annuities whose sky-high costs dwarf any benefits.

Don’t be blinded by titles like “financial adviser” or “wealth manager.” If they’re not fiduciaries, the advisers can earn commissions on sales, and they’re legally entitled to put your interests last. Even if they are fiduciaries, they still might persuade you (wrongly) that costly investments are in your best interest. The industry isn’t fighting the fiduciary rule for nothing. Remain on guard.

(Originally published in The AARP Monthly Bulletin.)

AARP Article

Get More Out of Your Savings Bonds

Avoid these four mistakes that can cost you money

Are you sitting on a pile of U.S. savings bonds? If not, should you be? For safety-first investors, savings bonds still hold an edge over bank certificates of deposit. Savers put more than $631 million into these bonds last year. Those of you sitting on a pile might find, to your surprise, that some of them currently yield 4 or 5 percent.

Savings bonds come in two flavors — EE bonds, at fixed interest rates, and I bonds, at floating rates that change with inflation every six months. You have to hold them for at least one year. If you sell before five years are up, you pay a penalty equal to three months’ interest. Bonds generally stop paying interest after 30 years.

Almost all savings bonds today are sold electronically, through treasurydirect.gov. You can invest up to $10,000 a year for each type of bond (double that if your spouse buys, too). An additional $5,000 is available in the form of old-fashioned paper I bonds, if you ask that your tax refund be paid that way.

I bonds are the most popular. At this writing, a new bond yields 1.48 percent — and before you turn up your nose, consider the competition. A five-year CD might pay 2 percent, but it offers no inflation protection. You’re taxed on the interest every year unless you buy through a tax-deferred individual retirement account. You also pay taxes at all levels — federal, state and local. The income from savings bonds is tax deferred and then taxed only by the feds.

A quick word about EE Bonds. New bonds are paying (if you can call it “paying”) just 0.1 percent. If you hold them for 20 years, you’ll earn at least 3.5 percent, thanks to a guaranteed catch-up payment. Still, not appealing.

If you’ve owned savings bonds for years and are ready to cash them in, be sure to find out exactly what each bond is worth. Without that information, you might make one of four big mistakes, says Jackie Brahney, marketing director of savingsbonds.com, a service that helps you manage your bond portfolio.

Mistake 1: You cash in the oldest bonds first. They might be your highest earners.

Mistake 2: You look only at the bonds’ face amount when deciding how many to redeem. That might bring you more taxable income than you want. Bonds that add up to $3,000 on their face might be worth $6,000 or more, once the interest is counted.

Mistake 3: You cash in so many bonds at once that the cumulative, taxable interest puts you into a higher bracket.

Mistake 4: You redeem a bond in the day or week before a six-month interest payment is due to be paid.

Free calculators at treasurydirect.gov and savingsbonds.com will tell you what each of your bonds is worth. For as little at $5.95 a year, Brahney’s service will value the bonds and brief you, monthly, on what they currently earn and how much interest they’ve accumulated. Knowing your bonds can save on taxes and raise your earnings, too.

(Originally published in The AARP Monthly Bulletin.)

AARP Article

Should You Exit the Stock Market?

Ask yourself these four questions before moving your money

Should the portfolios of older investors include stocks, and if so, what percentage? The issue comes up every time stock prices wobble or fall. If you’re in your 70s or 80s, how safe does your money have to be?

In part, the answer depends on your circumstances and temperament. But there’s one rock-bottom rule: You need to feel sure that, whatever happens to stock prices, you’ll be able to pay your basic bills. Assuming that you have savings to invest, there are several things you might consider.

If it does, forget about it and use some savings to buy immediate-pay annuities. You’ll get a guaranteed income for life and will never have to think about stock prices again. To see how much an annuity would pay, go to immediateannuities.com. The monthly amount will almost certainly exceed what you’d get from high-quality bond funds. Money that is not in the annuity could go into bank savings or CDs so you’d have extra cash on hand.

Do you have enough money from other reliable sources to cover your lifetime needs?

If you’ve got enough money from your pension, Social Security and other investments, owning stocks is optional. “You’ve won the game, so you don’t have to play anymore,” says Larry Swedroe, director of research for the BAM Alliance of wealth managers and author of many personal-investment books. You might want to keep a high percentage of your savings in stocks for the benefit of the next generation, or a low percentage in case your circumstances change. Either way, the investment needs to pass the “stomach-acid” test, Swedroe says. You have to feel safe enough to not feel sick in years that prices plunge.

Do you have savings but need to grow them to provide for your later age?

Well, if so, that’s what stock investments are for, says Judith Ward, a senior financial planner for the mutual fund group T. Rowe Price. At 75, you could live another 15 or 20-plus years, which historically gives the market time to rise in price. The firm recommends at least 20 percent in stocks, with the rest in bonds. Over the past 15 years, that mix of investments lost money in only one year (the loss was just 3 percent), measured by standard stock and bond indexes. For more growth, you might go to 40 percent stocks.

How do you stay “safe” when you have money in stocks?

“Put aside some money for now and other money for later,” says financial planner Judith Lau of Lau Associates in Greenville, Del. “Now” means cash — enough to pay your bills for two years. For example, say that Social Security pays you $1,300 a month and you’re spending $2,300. The difference is $1,000 a month or $12,000 a year. You buy two years of safety with $24,000 in the bank.

“Money for later” comes in two parts. The first part holds reasonably safe investments, such as short-term bond funds, that could pay your bills for three years. You’re now safe for five years, no matter what happens to stocks. The second part comprises stocks and stock funds for longer-term growth. Every year, you sell some of your stock funds to replenish your two-year cash reserve.

That’s the theory, anyway. Stress-test your choice by asking if you’d be OK if stocks fell 50 percent before rising again. That’s the stomach-acid part.

(Originally published in The AARP Monthly Bulletin.)

AARP Article

Risky Pension Bets

You might be making one if you take a lump sum early

Would you rather have a monthly pension guaranteed for life or a lump sum of money now? Before I address that question, let me say that you’re lucky if you have the choice. Private pensions are on the way out, even among old-line companies. In older age, there’s nothing more comfortable than a check in the mail every month.

Normally, you’re not offered the choice of a pension or lump sum until you retire. Rising numbers of companies, however, are extending this offer to former employees who haven’t taken their vested pensions yet. They want to shift the burden of retirement investing over to you.

In fact, they’d like to get rid of you in the next 12 months.

That’s because the size of your pension or lump sum depends, in part, on how long the people in your age group are expected to live. Currently, pension plans are using outdated life expectancy tables. Starting in 2017, however, they’ll have to use newer tables, which show that people are living longer. That will require them to pay you more. Hence the rush.

If you take a lump sum in place of a lifetime monthly pension, you’re making at least one of three risky bets.

Bet 1: You are betting that you can provide yourself (and your spouse) with a guaranteed monthly income for life that’s at least as high as you’d get from your pension. To check this, go to a website such as immediateannuities.com, which shows you what insurance company annuities pay. Enter the lump sum you’re being offered, your age and when you want the payments to start, then choose the type of annuity you want. Compare that payment with your vested monthly pension amount. Odds are, the pension will pay you substantially more, especially if you’re a woman, says Tony Webb, senior economist at the Center for Retirement Research at Boston College.

Bet 2: That your life span will be shorter than average. The lump sum is intended to last your expected lifetime, not your actual lifetime. If you live longer, you’ll need extra money in reserve.

Bet 3: That you can invest the lump sum in stocks and bonds and earn even more than the pension will pay. To check this, look at the “interest rate” in the fine print of your lump sum offer. (If it’s not there, ask the company for it.) Your investments have to grow by at least that percentage annually, after fees, to equal a pension that covers an average lifetime and much more, if you live longer than that.

Lump sums make sense if you’re terminally ill, if you have so much in other savings that you’ll never have to worry about running out of money or if the amount is small. To avoid taxes, roll the money into an individual retirement account.

But to assure yourself of an income for life, without taking stock market risk, pensions are hard to beat.

If the lump sum offer confuses you or leaves you anxious, don’t take it, says Ari Jacobs, senior retirement solutions leader at the benefits consultant Aon Hewitt. “You’ll be in the same spot you were before.”

For more information, go to pensionrights.org. In the search box, type in “Should you take your pension as a lump sum?”

(Originally published in The AARP Monthly Bulletin.)

AARP Article

Personal Financial Planning 101

How to take those first steps in dealing with your money issues

How do you learn about personal finance? This question came from a reader tussling with money issues that were new to her. You can pay the bills and manage a checking account for years without ever having to confront planning and investment issues.

From a distance, those issues look mysterious, even impenetrable. Anyone with math anxiety shies away. But personal finance is not — not! — about math. If it were, I’d be in a different line of work. I’m terrible even at arithmetic (embarrassing but true).

Successful personal planning depends on old-fashioned common sense. That means listing your priorities in life and using super-simple financial strategies to get you there. You don’t even have to think about investing your savings until you’ve figured out the basics. And forget about the complex stuff, like variable annuities. You never, ever have to consider an investment that’s complex. Believe me, it will cost too much and won’t accomplish what the salesperson says. I have relied almost entirely on bank accounts and the low-cost mutual funds called index funds — and I’ve done just fine, thank you very much.

To get started on your financial plan, get your records together. Create separate files for bank statements; insurance policies; the latest reports from your mutual fund company or brokerage firm; statements from your pension, annuity or retirement plan; records of any other source of income you receive; and a list of your debts.

People who have been single for a long time usually have a handle on their money. The problems arise when you’re married and your spouse has always managed the money. Sit down with him (sadly, it’s almost always a him) and go through the files one by one. He can tell you what he’s been up to. If you have consumer debt, what’s the plan for paying it off? How has he been investing the retirement savings, and why? If your spouse isn’t organized himself, now is the time to find out. You especially need to know how much income you’ll have from Social Security and savings if he dies first, and what kind of lifestyle it will support. If he has life insurance, check the annual statement to learn how long the policy will last (not all insurance lasts for life).

If you’re widowed, you can leave his arrangements in place while you figure out what you want to do. While you’re learning, put any life insurance proceeds in the bank. For higher interest rates, check online banks such as Ally and Synchrony, both FDIC insured.

While you’re at it, find out where your money goes. If you don’t have a working budget already, go over your bank statements and bills to see how much money is coming in and going out. This will take time, but without this information it’s not possible to plan. If too much money is going out, well, you know what to do.

(Originally published in The AARP Monthly Bulletin.)

AARP Article

You’re Moving: Should You Rent or Buy?

Here’s how to figure out which option makes more sense

It’s zero hour. You’ve decided to sell your house and move to something smaller or to another town. As a homeowner, you naturally think of buying again — a house or maybe a condo. But should you? Maybe you should rent instead.

Ownership is solidly entrenched among retirees. They weren’t even shaken by the real estate collapse. From the peak of the housing bubble in 2006 to the present, the rate of homeownership for people 65 and up has held steady at about 80 percent, the Census Bureau reports. It runs to over 90 percent among married couples in which one person is 65 or older.

For those 55 to 64, however, it’s another story. The portion who own the place where they live has dropped to 76 percent, compared with 81 percent in 2006. Some in this age group switched to renting because they couldn’t manage a mortgage anymore. Others, however, rent by choice.

It’s all about income

When might it make more sense to rent instead of buy? And how do you decide?

I start with the view that, later in life, your home, as a real estate investment, grows less important. You’re no longer hoping to sell at a profit in order to trade up to a bigger place. It’s nice for your kids to inherit an appreciated property. But for you and me, it’s more important to nail down enough income to keep us comfortable for life.

That leads to the question of how to dispose of the proceeds when you sell a house. You can use part or all of it to buy another house or condo, with or without a mortgage. That pot of money is now tied up. You could tap it at some point in the future, by taking a home equity loan or reverse mortgage, but that probably isn’t your plan.

Alternatively, you can put the proceeds into a mix of bank accounts and mutual funds and tap those savings and investments for rent. This choice provides ready access to your money, without borrowing.

Here’s where the sharpest of pencils comes in. Estimate your retirement budget with and without the home purchase. Where will the money come from to pay your housing expenses? Rents will go up (about 3 percent, currently) but, for homeowners, so will insurance, taxes and upkeep costs. If you can pay cash for a house or condo and still have plenty of money to live on, you’re a good candidate for buying. But if homeowning strains your lifestyle — even if you conserve cash by taking a new mortgage — you’re a candidate for renting.

In a very general sense, renting is cheaper than buying on the two coasts, where housing is especially expensive, and buying is cheaper than renting in the middle of the country, says Nicolas Retsinas, real estate lecturer at Harvard Business School (although some markets in the country’s middle are expensive, too).

Renting’s rewards

Becoming a renter has other attractions, even if you can afford to own. It’s a way of checking out a new area if you’re thinking of moving far away. It’s a safety net, if you move to be closer to your kids — in case your kids decide to move. It also makes it easy for you to travel because no one has to take care of the house while you’re away. It might be a temporary move — say, to an apartment in a culturally rich city — before making a final decision on the type of lifestyle you want. There’s a landlord to handle chores and no sudden expenses, such as a new furnace or roof.

For a longtime homeowner, however, the negatives are often strong. You can’t modify the space to suit your style of living. The landlord might decide to sell, forcing you to move out. Pets might not be allowed. Emotionally, you might not feel as comfortable as you did in your own place.

You might also resist the change because rent is supposedly “money down a rat hole.” It’s not, if it frees up cash to keep you living well. Besides, insurance, upkeep and most of your real estate taxes go down the rat hole, too. Why own a house and build equity for your heirs if housing expenses crimp your income and limit what you can do during your freedom years? I’m not renting now, but I can imagine doing so if I ever wanted to stretch my savings or travel more. Stay tuned.

(Originally published in The AARP Monthly Bulletin.)