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Guide to Choosing the Right IRA: Traditional or Roth?

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The Roth IRA versus traditional IRA debate has raged on for years.

What many retirement savers may not know is that most of the debate about whether it’s better to contribute to a traditional IRA or a Roth IRA is flawed.

You’ve probably heard that young investors are better off contributing to a Roth IRA because they’ll likely be in a higher tax bracket when they’re older. You’ve probably also heard that if you’re in the same tax bracket now and in retirement, a traditional IRA and Roth IRA will produce the same result.

These arguments are part of the conventional wisdom upon which many people make their decisions, and yet each misses some important nuance and, in some cases, is downright incorrect.

The Biggest Difference Between Traditional and Roth IRAs

There are several differences between traditional and Roth IRAs, and we’ll get into many of them below.

The key difference is in the tax breaks they offer.

Contributions to a traditional IRA are not taxed up front. They are tax-deductible, meaning they decrease your taxable income for the year in which you make the contribution. The money grows tax-free inside the account. However, your withdrawals in retirement are treated as taxable income.

Contributions to a Roth IRA are taxed up front at your current income tax rate. The money grows tax-free while inside the account. And when you make withdrawals in retirement, those withdrawals are not taxed.

Whether it’s better to get the tax break when you make the contribution or when you withdraw it in retirement is the centerpiece of the traditional vs. Roth IRA debate, and it’s also where a lot of people use some faulty logic.

We’ll debunk the conventional wisdom in just a bit, but first we need to take a very quick detour to understand a couple of key tax concepts.

The Important Difference Between Marginal and Effective Tax Rates

Don’t worry. We’re not going too far into the tax weeds here. But there’s a key point that’s important to understand if you’re going to make a true comparison between traditional and Roth IRAs, and that’s the difference between your marginal tax rate and your effective tax rate.

When people talk about tax rates, they’re typically referring to your marginal tax rate. This is the tax rate you pay on your last dollar of income, and it’s the same as your current tax bracket. For example, if you’re in the 15% tax bracket, you have a 15% marginal tax rate, and you’ll owe 15 cents in taxes on the next dollar you earn.

Your effective tax rate, however, divides your total tax bill by your total income to calculate your average tax rate across every dollar you earned.

And these tax rates are different because of our progressive federal income tax, which taxes different dollars at different rates. For example, someone in the 15% tax bracket actually pays 0% on some of their income, 10% on some of their income, and 15% on the rest of their income. Which means that their total tax bill is actually less than 15% of their total income.

For a simple example, a 32-year-old couple making $65,000 per year with one child will likely fall in the 15% tax bracket. That’s their marginal tax rate.

But after factoring in our progressive tax code and various tax breaks like the standard deduction and personal exemptions, they will only actually pay a total of $4,114 in taxes, making their effective tax rate just 6.33% (calculated using TurboTax’s TaxCaster).

As you can see, the couple’s effective tax rate is much lower than their marginal tax rate. And that’s almost always the case, no matter what your situation.

Keep that in mind as we move forward.

Why the Conventional Traditional vs. Roth IRA Wisdom Is Wrong

Most of the discussion around traditional and Roth IRAs focuses on your marginal tax rate. The logic says that if your marginal tax rate is higher now than it will be in retirement, the traditional IRA is the way to go. If it will be higher in retirement, the Roth IRA is the way to go. If your marginal tax rate will be the same in retirement as it is now, you’ll get the same result whether you contribute to a traditional IRA or a Roth IRA.

By this conventional wisdom, the Roth IRA typically comes out ahead for younger investors who plan on increasing their income over time and therefore moving into a higher tax bracket or at least staying in the same tax bracket.

But that conventional wisdom is flawed.

When you’re torn between contributing to a traditional or Roth IRA, it’s almost always better to compare your marginal tax rate today to your effective rate in retirement, for two reasons:

  1. Your traditional IRA contributions will likely provide a tax break at or near your marginal tax rate. This is because federal tax brackets typically span tens of thousands of dollars, while your IRA contributions max out at $5,500 for an individual or $11,000 for a couple. So it’s unlikely that your traditional IRA contribution will move you into a lower tax bracket, and even if it does, it will likely be only a small part of your contribution.
  2. Your traditional IRA withdrawals, on the other hand, are very likely to span multiple tax brackets given that you will likely be withdrawing tens of thousands of dollars per year. Given that reality, your effective tax rate is a more accurate representation of the tax cost of those withdrawals in retirement.

And when you look at it this way, comparing your marginal tax rate today to your effective tax rate in the future, the traditional IRA starts to look a lot more attractive.

Let’s run the numbers with a case study.

A Case Study: Should Mark and Jane Contribute to a Traditional IRA or a Roth IRA?

Mark and Jane are 32, married, and have a 2-year-old child. They currently make $65,000 per year combined, putting them squarely in the 15% tax bracket.

They’re ready to save for retirement, and they’re trying to decide between a traditional IRA and a Roth IRA. They’ve figured out that they can afford to make either of the following annual contributions:

  • $11,000 to a traditional IRA, which is the annual maximum.
  • $9,350 to a Roth IRA, which is that same $11,000 contribution after the 15% tax cost is taken out. (Since Roth IRA contributions are nondeductible, factoring taxes into the contribution is the right way to properly compare equivalent after-tax contributions to each account.)

So the big question is this: Which account, the traditional IRA or Roth IRA, will give them more income in retirement?

Using conventional wisdom, they would probably contribute to the Roth IRA. After all, they’re young and in a relatively low tax bracket.

But Mark and Jane are curious people, so they decided to run the numbers themselves. Here are the assumptions they made in order to do that:

  • They will continue working until age 67 (full Social Security retirement age).
  • They will continue making $65,000 per year, adjusted for inflation.
  • They will receive $26,964 per year in Social Security income starting at age 67 (estimated here).
  • They will receive an inflation-adjusted investment return of 5% per year (7% return minus 2% inflation).
  • At retirement, they will withdraw 4% of their final IRA balance per year to supplement their Social Security income (based on the 4% safe withdrawal rate).
  • They will file taxes jointly every year, both now and in retirement.

You can see all the details laid out in a spreadsheet here, but here’s the bottom line:

  • The Roth IRA will provide Mark and Jane with $35,469 in annual tax-free income on top of their Social Security income.
  • The traditional IRA will provide $37,544 in annual after-tax income on top of their Social Security income. That’s after paying $4,184 in taxes on their $41,728 withdrawal, calculating using TurboTax’s TaxCaster.

In other words, the traditional IRA will provide an extra $2,075 in annual income for Mark and Jane in retirement.

That’s a nice vacation, a whole bunch of date nights, gifts for the grandkids, or simply extra money that might be needed to cover necessary expenses.

It’s worth noting that using the assumptions above, Mark and Jane are in the 15% tax bracket both now and in retirement. According to the conventional wisdom, a traditional IRA and Roth IRA should provide the same result.

But they don’t, and the reason has everything to do with the difference between marginal tax rates and effective tax rates.

Right now, their contributions to the traditional IRA get them a 15% tax break, meaning they can contribute 15% more to a traditional IRA than they can to a Roth IRA without affecting their budget in any way.

But in retirement, the effective tax rate on their traditional IRA withdrawals is only 10%. Due again to a combination of our progressive tax code and tax breaks like the standard deduction and personal exemptions, some of it isn’t taxed, some of it is taxed at 10%, and only a portion of it is taxed at 15%.

That 5% difference between now and later is why they end up with more money from a traditional IRA than a Roth IRA.

And it’s that same unconventional wisdom that can give you more retirement income as well if you plan smartly.

5 Good Reasons to Use a Roth IRA

The main takeaway from everything above is that the conventional traditional versus Roth IRA wisdom is wrong. Comparing marginal tax rates typically underestimates the value of a traditional IRA.

Of course, the Roth IRA is still a great account, and there are plenty of situations in which it makes sense to use it. I have a Roth IRA myself, and I’m very happy with it.

So here are five good reasons to use a Roth IRA.

1. You Might Contribute More to a Roth IRA

Our case study above assumes that you would make equivalent after-tax contributions to each account. That is, if you’re in the 15% tax bracket, you would contribute 15% less to a Roth IRA than to a traditional IRA because of the tax cost.

That’s technically the right way to make the comparison, but it’s not the way most people think.

There’s a good chance that you have a certain amount of money you want to contribute and that you would make that same contribution to either a traditional IRA or a Roth IRA. Maybe you want to max out your contribution and the only question is which account to use.

If that’s the case, a Roth IRA will come out ahead every time simply because that money will never be taxed again.

2. Backdoor Roth IRA

If you make too much to either contribute to a Roth IRA or deduct contributions to a traditional IRA, you still might be eligible to do what’s called a backdoor Roth IRA.

If so, it’s a great way to give yourself some extra tax-free income in retirement, and you can only do it with a Roth IRA.

3. You Might Have Other Income

Social Security income was already factored into the example above. But any additional income, such as pension income, would increase the cost of those traditional IRA withdrawals in retirement by increasing both the marginal and effective tax rate.

Depending on your other income sources, the tax-free nature of a Roth IRA may be helpful.

4. Tax Diversification

You can make the most reasonable assumptions in the world, but the reality is that there’s no way to know what your situation will look like 30-plus years down the road.

We encourage people to diversify their investments because it reduces the risk that any one bad company could bring down your entire portfolio. Similarly, diversifying your retirement accounts can reduce the risk that a change in circumstances would result in you drastically overpaying in taxes.

Having some money in a Roth IRA and some money in a traditional IRA or 401(k) could give you room to adapt to changing tax circumstances in retirement by giving you some taxable money and some tax-free money.

5. Financial Flexibility

Roth IRAs are extremely flexible accounts that can be used for a variety of financial goals throughout your lifetime.

One reason for this is that your contributions are available at any time and for any reason, without tax or penalty. Ideally you would be able to keep the money in your account to grow for retirement, but it could be used to buy a house, start a business, or simply in case of emergency.

Roth IRAs also have some special characteristics that can make them effective college savings accounts, and as of now Roth IRAs are not subject to required minimum distributions in retirement, though that could certainly change.

All in all, Roth IRAs are more flexible than traditional IRAs in terms of using the money for nonretirement purposes.

3 Good Reasons to Use a Traditional IRA

People love the Roth IRA because it gives you tax-free money in retirement, but, as we saw in the case study above, that doesn’t always result in more retirement income. Even factoring in taxes, and even in situations where you might not expect it, the traditional IRA often comes out ahead.

And the truth is that there are even MORE tax advantages to the traditional IRA than what we discussed earlier. Here are three of the biggest.

1. You Can Convert to a Roth IRA at Any Time

One of the downsides of contributing to a Roth IRA is that you lock in the tax cost at the point of contribution. There’s no getting that money back.

On the other hand, contributing to a traditional IRA gives you the tax break now while also preserving your ability to convert some or all of that money to a Roth IRA at your convenience, giving you more control over when and how you take the tax hit.

For example, let’s say that you contribute to a traditional IRA this year, and then a few years down the line either you or your spouse decides to stay home with the kids, or start a business, or change careers. Any of those decisions could lead to a significant reduction in income, which might be a perfect opportunity to convert some or all of your traditional IRA money to a Roth IRA.

The amount you convert will count as taxable income, but because you’re temporarily in a lower tax bracket you’ll receive a smaller tax bill.

You can get pretty fancy with this if you want. Brandon from the Mad Fientist, has explained how to build a Roth IRA Conversion Ladder to fund early retirement. Financial planner Michael Kitces has demonstrated how to use partial conversions and recharacterizations to optimize your tax cost.

Of course, there are downsides to this strategy as well. Primarily there’s the fact that taxes are complicated, and you could unknowingly cost yourself a lot of money if you’re not careful. And unlike direct contributions to a Roth IRA, you have to wait five years before you’re able to withdraw the money you’ve converted without penalty. It’s typically best to speak to a tax professional or financial planner before converting to a Roth IRA.

But the overall point is that contributing to a traditional IRA now gives you greater ability to control your tax spending both now and in the future. You may be able to save yourself a lot of money by converting to a Roth IRA sometime in the future rather than contributing to it directly today.

2. You Could Avoid or Reduce State Income Tax

Traditional IRA contributions are deductible for state income tax purposes as well as federal income tax purposes. That wasn’t factored into the case study above, but there are situations in which this can significantly increase the benefit of a traditional IRA.

First, if you live in a state with a progressive income tax code, you may get a boost from the difference in marginal and effective tax rates just like with federal income taxes. While your contributions today may be deductible at the margin, your future withdrawals may at least partially be taxed at lower rates.

Second, it’s possible that you could eventually move to a state with either lower state income tax rates or no income tax at all. If so, you could save money on the difference between your current and future tax rates, and possibly avoid state income taxes altogether. Of course, if you move to a state with higher income taxes, you may end up losing money on the difference.

3. It Helps You Gain Eligibility for Tax Breaks

Contributing to a traditional IRA lowers what’s called your adjusted gross income (AGI), which is why you end up paying less income tax.

But there are a number of other tax breaks that rely on your AGI to determine eligibility, and by contributing to a traditional IRA you lower your AGI you make it more likely to qualify for those tax breaks.

Here’s a sample of common tax breaks that rely on AGI:

  • Saver’s credit – Provides a tax credit for people who make contributions to a qualified retirement plan and make under a certain level of AGI. For 2017, the maximum credit is $2,000 for individuals and $4,000 for couples.
  • Child and dependent care credit – Provides a credit of up to $2,100 for expenses related to the care of children and other dependents, though the amount decreases as your AGI increases. Parents with young children in child care are the most common recipients of this credit.
  • Medical expense deduction – Medical expenses that exceed 10% of your AGI are deductible. The lower your AGI, the more likely you are to qualify for this deduction.
  • 0% dividend and capital gains tax rate – If you’re in the 15% income tax bracket or below, any dividends and long-term capital gains you earn during the year are not taxed. Lowering your AGI could move you into this lower tax bracket.

Making a Smarter Decision

There’s a lot more to the traditional vs. Roth IRA debate than the conventional wisdom would have you believe. And the truth is that the more you dive in, the more you realize just how powerful the traditional IRA is.

That’s not to say that you should never use a Roth IRA. It’s a fantastic account, and it certainly has its place. It’s just that the tax breaks a traditional IRA offers are often understated.

It’s also important to recognize that every situation is different and that it’s impossible to know ahead of time which account will come out ahead. There are too many variables and too many unknowns to say for sure.

But with the information above, you should be able to make a smarter choice that makes it a little bit easier to reach retirement sooner and with more money.

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3 Strategies to Teach Your Child to Invest

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Chicago, Ill.-based actor Mike Wollner says at ages 7 and 10 his daughters are already learning how to invest.

Three years ago, Wollner opened custodial brokerage accounts for the girls through Monetta Mutual Funds, which has a Young Investor Fund specifically for young people to invest for the future. Through the fund, parents can open custodial brokerage accounts or 529 college savings accounts on behalf of their children, as well as get access to financial education and a tuition rewards program.

Wollner decided to open the accounts once his daughters began to nab acting gigs and earn an income. They’re already beginning to understand what it means to own a part of the world’s largest companies. “They will ask me to drive past Wendy’s to go to McDonald’s and say, ‘well, we own part of McDonald’s,’” he says.

Wollner hopes his daughters will have saved enough for college by the time they graduate high school. His 10-year-old’s account balance already hovers around $13,000, while his 7-year-old has a little less than $10,000 saved for college in her account.

The contents of the package a child receives in the mail when an adult opens a Monetta Mutual Young Investor Fund custodial account on their behalf.

The Value of Starting Young

The Monetta Fund is only one example of a way to invest on a child’s behalf. The downside to using an actively managed investment account like the one Monetta offers is that it comes with higher fees — the fund’s expense ratio of 1.18% in 2016 is higher than the 0.10% – 0.70% fees typically charged by state-administered 529 college savings plans.

In addition to 529 plans, parents can open Coverdell Education Savings Accounts, or other custodial brokerage or IRA accounts through most financial institutions like Fidelity, Vanguard, or TD Ameritrade.

A college fund serves as a great way to teach kids a little about the time-value of money, but they’ll need to know more than that to manage their finances as well as adults.

“There’s no guarantee that they are going to be financially successful because anything can happen in life, but you’ll be better off with those skills and have a better chance of being successful with those skills than without them,” says Frank Park, founder of Future Investor Clubs of America. The organization operates a financial education program for kids and teens as young as 8 years old about financial management and investing.

He says FICA begins teaching financial concepts at an early age with hopes that the kids who start out with good money management habits now will continue to build on them as they age.

“If they fail to get that type of training now, it may be years into their late 20s, 30s, or 40s before they start. By then it could be too late. It could take 20 years to undo the mistakes they’ve made,” says Park.

3 Ways to Teach Young Kids About Money

Use real-world experiences

Wollner has each daughter cash and physically count out each check they receive from acting gigs.

“They just see a big stack of green bills, but that to a child is cool. It’s like what they see in a suitcase in the movies,” says Wollner.

He then uses the opportunity to teach how taxes work as he has his daughters set aside part of the stack of cash to pay taxes, union fees, and their agent.

“They start to see their big old pile of money diminish and get smaller and smaller,” says Wollner, who says the practice teaches his daughters “everything you make isn’t all yours, and I truly believe that that’s a lesson not many in our society learn.”

Kids don’t need to earn their own money to start learning. Simply getting a child involved with the household’s budgeting process or taking the opportunity to teach how to save with deals when shopping helps teach foundational money management skills.

Park urges parents to also share financial failures and struggles in addition to successes.

“They need to prepare their kids for the ups and downs of financial life so that they don’t panic if they lose their job, have an accident, or [their] identity [is] stolen,” says Park.

Gamify investing

Gamified learning through apps or online games can be a fun way to spark or keep younger kids’ interest in a “boring” topic like investing.

There are a number of free resources for games online like those offered through Monetta, Education.com, or the federal government that aim to teach kids about different financial concepts.
Wollner says his youngest daughter benefited from playing a coin game online. He says the 7-year-old is ahead of her peers in fractions and learning about the monetary values of dollars and coins.

“This is how the kids learn. It’s the fun of doing it. They don’t think of it as learning about money, they think of it as a game,” says Bob Monetta, founder of Monetta Mutual Fund. The games Monetta has developed on its website are often used in classrooms.

When kids get a little older and can understand more complicated financial concepts, they can try out a virtual stock market game available for free online such as the SIFMA Foundation’s stock market game, the Knowledge@Wharton High School’s annual investment competition, or MarketWatch’s stock market game.

“The prospect of winning is what makes them leave the classroom still talking about their portfolios and their games,” says Melanie Mortimer, president of the SIFMA Foundation.

Anyone can play the simulation games, including full classrooms of students.

Aaron Greberman teaches personal finance and International Baccalaureate-level business management at Bodine High School for International Affairs in Philadelphia Penn. He says he uses Knowledge@Wharton High School’s annual investment competition in addition to online games like VISA’s websites, financialsoccer.com, and practicalmoneyskills.com, to help teach his high school students financial concepts.

Adults should play the games with children so that they can help when they struggle with a concept or have questions. Adults might even learn something about money in the process. Consider also leveraging mobile apps like Savings Spree and Unleash the Loot to gamify financial learning on the go.

Reinforce with clubs or programs

For more formal reinforcement, try signing kids up for a club or other financial education program targeting kids and teens.

FICA, the Future Investors Clubs of America, provides educational materials and other support to a network of clubs, chapters, and centers sponsored by schools, parents, and other groups across the nation.

When looking at financial education programs, it’s important to recognize all programs are not equal, says FICA founder, Frank Park.

“Generally speaking, you’re going to go with the company that has a good reputation of providing these services, especially if your kid is considering going into business in the future,” says Park.

The National Financial Educators Council says a financial literacy youth program should cover the key lessons on budgeting, credit and debt, savings, financial psychology, skill development, income, risk management, investing, and long-term planning.

Mortimer suggests parents also try getting involved at the child’s school by offering to start or sponsor an after-school investing club. She says many after-school youth financial education or investing organizations nationwide use SIFMA’s stock market simulation to place virtual trades and compete against other teams.

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Should My Spouse and I Have the Same Investments?

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Should My Spouse and I Have the Same Investments?

One of the golden rules of investing is not to have all of your eggs in one basket. This is pretty easy to do when you’re planning by yourself. It can get complicated when you are married. Should you both have the same investments or is it better to do something different?

Unlike combining checking accounts or getting a joint credit card, combining your investment goals and objectives with your spouse is a bit more complex. Legally, it is not possible to combine retirement accounts like a 401(k) or IRA. However, it is possible to align your retirement saving strategy. Typically these are the biggest investment accounts, and how you choose your investments will determine your level of financial freedom during retirement. Before you sit down with your spouse (possibly with help from a professional financial adviser) to determine how you can both approach your savings in order to maximize your joint benefit, it’s important to consider these things first.

Before you align your investments, start by aligning your investment goals

Before deciding on what investments you may need, you and your spouse should figure out your investment goals. If you’re around the same age, do you both plan on retiring at the same time? If there is a significant gap in age, there is a chance that one of you could be working much longer than the other, and your investments should reflect that.

A common example could be shown with target-date funds (TDFs). Currently, TDFs are offered by 70% of 401(k) plans, and they give investors the ability to invest according to the year they plan on retiring. Someone planning to retire in 2040 would choose the 2040 target-date fund. If you and your spouse are the same age, it would be OK to invest in the same TDF. But if one of you is choosing to retire in 2040 and the other in 2030, it may be in your best interest to choose funds that correspond to your individual goals instead.

Even if you don’t choose TDFs, your investment choices should be based primarily on your tolerance for risk and the amount of time you estimate working before you retire (also known as time horizon). If you and your spouse have different risk levels, then you should definitely have different investments.

If the younger spouse earns significantly less income, this presents a special challenge best left to a financial planner. A discrepancy in income would directly affect the amount you’re able to save and how it is allocated. In some cases you may have to adjust your allocation to compensate. Again, because there are several individual factors which could affect your investment decisions in this specific situation, you will want the guidance of a financial planner.

Understand diversification and asset allocation

The concepts of diversification and asset allocation are the cornerstones of sound investing. By diversifying your assets, you are spreading out your risk over several different types of assets, rather than simply owning one or two. This is why mutual funds have become extremely popular. Because mutual funds consist of a broad range of investments across the stock and bond market, they provide instant diversification. But it may not be necessary or helpful for you and your spouse to own different mutual funds in hopes of diversifying yourselves even more.

Sometimes it is best to keep things simple. You and your spouse could own the same investments but in different proportions.

For example, the two of you may decide to own Mutual Fund A, which is made up of stocks, and Mutual Fund B, which is made up of bonds. Because you’re older and more conservative, you may choose to invest in a portfolio that is split down the middle: 50% in Mutual Fund A and 50% in Mutual Fund B. Your spouse, especially if they are much younger, may choose a more risky asset mix, investing in a mix of 75% Fund A and 25% Fund B. Both of you would still own the same investments but own different amounts due to your preference for risk.

Additionally, if you invest consistently in funds from the same investment firm, such as Franklin Templeton Investments, MFS, or American Funds, you could qualify for discounts after investing a certain amount called breakpoints. Most companies will charge you a percentage to invest in the fund. For example, if you invest $10,000 consistently every year, you could be charged 2.25% or $225. When you hit a breakpoint, however, the fee goes down. After 10 years, you’ve invested $100,000 and anything you put in after this point will be 1.75%. Instead of paying $225 on every $10,000 you invest each year, you would now pay $175 until you hit the next breakpoint. Every company has their own breakpoint levels and fees they charge, which can vary wildly depending on the type of fund and philosophy of the company.

Most experts agree that it is better to choose a few mutual funds with one fund manager and take advantage of the breakpoints rather than choose one fund from several different managers. Using more than one manager can also make it more difficult to track your investment performance.

The Bottom Line

If you and your spouse are the same age and plan to retire around the same time, you should be OK holding the same investments, assuming they are solid investment choices. But if your age difference is more than three years, this should be reflected in your separate portfolios.

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Am I On Track For Retirement?

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Am I On Track For Retirement?

Inquiring about your path to retirement is one of the most important financial questions out there. Every year thousands of Americans are polled, and the overwhelming majority are worried about being on track for retirement or running out of money in retirement. According to Prudential’s 2016 Retirement Preparedness Survey, for 59% of current retirees, “not running out of money” in retirement is on the top of their priority list. Among those who are still approaching retirement, about one in four Americans are worried about not having enough money, with millennials leading the pack at at 29%.

There also seems to be a huge disconnect between our fears around money and the confidence in our ability to remedy those issues. Seventy-one percent of people consider themselves capable of making wise financial decisions, but only 2 in 5 don’t know what their money is invested in. Couple that with the fact that 25% of Americans have less than $1,000 in retirement savings, it is clear to see that we’re overconfident and underprepared.

While there isn’t a wealth of information as to why we’re so confident with our money, a part of the problem is not knowing where to start, not feeling like there is enough money to invest for retirement and paying down debt.

Some estimates say you’ll need as much as $2.5 million to retire comfortably, while the average 401(k) account balance is just $96,000, according to Vanguard. The truth is there is no one-size-fits-all figure. The number you need to retire comfortably depends heavily on when you plan to retire, your cost of living, your health, and how long you live in retirement. Additionally, those living in rural areas usually don’t need as much as those in metro area.

Here are a few ways to figure out how much you need and to check if you’re on track.

1. Do the math

Retirement planning calculators can get pretty complex, but to simply find out if what you have saved already is on par for what you will need in the future, there are some very easy calculations that you can use. One popular way to see if you’re on track is by using retirement benchmarks.

Using the chart below from JPMorgan is pretty straight forward. If you’re 35 years old with a household income of $75,000, you should have a total of $120,000 invested today. These charts, however, aren’t perfect because the underlying assumptions can vary wildly.

screen shot 1.2

This chart from Charles Farrell, author of Your Money Ratios, suggests at 35-year-old making $75,000 per year should have $67,500 saved. This is $52,500 less than the JPMorgan chart shown earlier. This is because different models use different assumptions about how much your investments may grow, how much you continue to save, and at what age you plan to retire.

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The JPMorgan chart assumes you will only save 5% per year versus 12% in Farrell’s model. Also when comparing both charts JPMorgan would have you on pace for saving just 8.4 times your salary versus 12 times your salary; a difference of $270,000. No benchmark is perfect. These estimates are meant to provide a quick assessment to let you know if you’re on the right track in terms of how much you have invested. They do not suggest which investments you should be holding.

2. Use a retirement calculator

In addition to doing the math yourself, there are some free tools to check your progress to retirement. Fidelity has a calculator that works very similar to the Charles Farrell mode, which gives you a factor that you need to have saved. Using the same example of a 35-year-old making $75,000, Fidelity’s calculator suggests having 2 times their salary, or about $150,000.

Get your retirement savings factor

It is worth noting that Fidelity’s assumptions of how they reached this figure were not on the site, but by age 65 they suggest having a factor of 12 times your salary saved.

The Vanguard Retirement Nest Egg Calculator takes a different approach. Instead of taking your age and spitting out the amount you should have saved, this calculator asks you your current savings and investment allocation and gives you a prediction of whether your money will last or not. This is done by using what is called a Monte Carlo simulation. Vanguard tests the factors 5,000 times by changing different variable such as investment performance and cost of living.

Keeping all factors the same, someone who has saved $900,000 (which is 12 times their annual income of $75,000) would have a 50% chance that their money would not run out in 30 years.

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Again, it is always important to consider the assumptions. In this calculator Vanguard is assuming you’re investing 20% of your money in stocks, 50% in bonds, and 30% in cash (indicated in the pie chart). This highlights the importance of asset allocation and its effect on your investment success. When we change the allocation, the success rate changes as well.

screen shot 4

In this example, by reducing the cash from 30% to 10% the chances of success increased to 68%. Vanguard also assumes you’re withdrawing 5% of the portfolio per year, meaning that from the $900,000 you saved, you should be spending $45,000 of it each year.

screen shot 5

If you were to increase or decrease this number, the chances of your money surviving would change as well.

By changing the withdrawal rate by just 1% to $36,000 per year, the probability shoots up to 92%. Most experts agree that a 4%-5% withdrawal rate is standard; what you decide to withdraw depends on what amount of money you think you can live off of at that point in time.

Finally, SmartAsset’s retirement calculator takes somewhat of a combined approach from the previous two we covered. Their calculator runs a Monte Carlo simulation like Vanguard and also takes into account what you’re currently making and when you want to retire, like Fidelity and JPMorgan. What makes SmartAsset’s calculator stand out, however, is that it takes into account your current location, monthly savings, and marital status. If you are falling short of your goal, the calculator tells you how much you need to save to catch up.

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retirement savings ove time graph

 

Meet with a financial planner

Finally, you can seek professional advice. Financial planners will take your investments, savings rate, and several other factors and show you if you’re on track. Additionally, a financial planner may also suggest better investments to get you closer to your goals.

Many banks and brokerage firms will run a comprehensive financial plan with no cost if you’re a customer. Independent financial planners may charge from $1,000 to $2,500 for a plan. Many people believe independent financial planners go more into depth with their analysis versus those who work in a bank. But it really comes down to a matter of preference, how well the person listens to you, and if they have your best interest as their top priority.

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Investing, Personal Loans

Earnest: Personal & Student Loans for Responsible Individuals with Limited Credit History

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The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Earnest - Personal & Student Loans for Responsible Individuals with Limited Credit History

Updated January 24, 2016

Earnest is anything but a traditional lender for unsecured personal loans and student loans. They offer merit-based loans instead of credit-based loans, which is good news for anyone just starting to establish credit. Their goal is to lend to borrowers who show signs of being financially responsible. Earnest is working to redefine credit-worthiness by taking into account much more than just your score.

They have a thorough application process, but it’s for good reason – they consider different variables and data points (such as employment history, education, and overall financial situation) that traditional lenders don’t.

Earnest*, unlike traditional lenders, says their underwriting team looks to the future to predict what your finances will look like, based upon the previously mentioned variables. They don’t place as much emphasis on your past, which is why a minimal credit history is okay.

Additionally, as their underwriting process is so thorough, Earnest doesn’t take on as much risk as traditional lenders do. With their focus on the financial responsibility level of the borrower, they have less defaults and fraud, which allows them to offer some of the lowest APRs on unsecured personal loans.

Personal Loan (Scroll Down for Student Loan Refinance)

Earnest offers up to $50,000 for as long as three years, and their APR starts at a fixed-rate of 5.25% and goes up to 12.00%. They claim that’s lower than any other lender of their type out there, and if you receive a better quote elsewhere; they encourage you to contact them.

Typical loan structure

How does this look on paper? If you needed to borrow $20,000, your estimated monthly payment would be $599-$638 on a three- year loan, $873-$911 on a two- year loan, and $1,705-$1,744 on a one-year loan. According to their website, the best available APR is on a one-year loan.

Not available everywhere

Earnest is available in the following 36 states (they are increasing the number of states regularly, and we keep this updated): Arkansas, Arizona, California, Colorado, Connecticut, Florida, Georgia, Hawaii, Illinois, Indiana, Kansas, Maine, Maryland, Massachusetts, Michigan, Minnesota, Missouri, Nebraska, New Hampshire, New Jersey, New Mexico, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, Tennessee, Texas, Utah, Virginia, Washington, Washington D.C., West Virginia, Wisconsin and Wyoming.

Get on LinkedIn

Earnest no longer requires that you have a LinkedIn profile. However, if you do have a LinkedIn profile, the application process becomes a lot faster. When you fill out the application, your education and employment history will automatically be filled in from your LinkedIn profile.

What Earnest Looks for in a Borrower

Earnest AppEarnest wants to lend to those who know how to manage and control their finances. They want borrowers to know the importance of saving, living below their means, using credit wisely, making timely payments, and avoiding fees.

They look at salary, savings, debt to income ratio, and cash flow. They want borrowers with low credit utilization – not those maxing out their credit cards and experiencing difficulty in paying.

Borrowers must be over 18 years old and have a solid education background. Ideally, they attended college or graduate school, have a degree, and have a history of consistent employment, or at least a job offer that gives them the opportunity to grow.

Overall, Earnest wants to make sure borrowers are taking their future as seriously as they are. After all, they’re investing in it! The team at Earnest knows that money often holds people back when it comes to being able to achieve their dreams and goals, and they’re all about helping borrowers get there.

For that reason, Earnest seeks to learn more about those that apply for loans with them. They review every line of your application, and they want to develop a lifelong relationship with their borrowers. They genuinely want to help and see their borrowers succeed.

The Fine Print – Are There Any Fees?

Earnest actually doesn’t charge any fees. There are no late fees, no origination fees, and no hidden fees.

There’s also no penalty for prepaying loans with Earnest – they encourage borrowers to prepay to reduce the amount of interest they’ll pay over the life of the loan.

Earnest states that one of its values is transparency (and of course, here at MagnifyMoney, that’s one of ours as well!), and they are willing to work with borrowers who are struggling to make payments.

Hala Baig, a member of Earnest’s Client Happiness team, says, “We would work with the client to make accommodations that are appropriate to help them through their situation.”

She also notes that if borrowers are late on payments, they do report the status of loans on a monthly basis.

What You Can Do With the Money

The $30,000 loan limit is enough to pay off debt such as an undergraduate student loan, medical debt, or consumer debt, relocate for a job, improve your home or rental property, help you fund a down payment, or further invest in your education.

Earnest’s APR is much, much better than you’ll receive on many credit cards, and it could be a viable way to decrease the burden of debt you’re currently experiencing.

Earnest logo 1

Apply Now

The Personal Loan Application Process

Earnest does a hard inquiry upon completion of the application. They’re very open about this on their website, stating that hard inquiries remain on credit reports for two years, and may slightly lower your credit score for a short period of time.

Compared to Upstart, their application process is more involved, but that’s to the benefit of the borrower. They aim to underwrite files and make a decision within 7 business days – it’s not instantaneous.

However, once you accept a loan from Earnest and input your bank information, they’ll transfer the money the next day via ACH, so the money will be in your account within 3 days.

Student Loan Refinance

When refinancing with Earnest, you can refinance both private and federal student loans.

The minimum amount to refinance is $5,000 – there’s no specific cap on the maximum you can refinance.

We encourage you to shop around. Earnest is one of the best options, but there are others. You can see the best options to refinance your student loans here.

Earnest offers loans up to 20 years. Unlike other lenders, Earnest allows borrowers to create their own term based on the minimum monthly payment you’re comfortable making. Yes, you can actually choose your monthly payment, which means the loan can be customized to your needs. Loan terms start at 5 months, and you can change that term later if needed.

You can also switch between variable and fixed rates freely – there’s no charge. (Note that variable rates are not offered in IL, MI, MN, OR, and TN. Earnest isn’t in all 50 states yet, either.)

Fixed APRs range from 3.75% to 6.74%, and variable APRs range from 2.55% to 6.03% (this is with a .25% autopay discount).

If you refinance $25,000 on a 10 year term with an APR of 5.75%, your monthly payment will be $274.42.

The Pros and Cons of Earnest’s Student Loan Refinance Program

Similar to SoFi, Earnest offers unemployment protection should you lose your job. That means you can defer payments for three months at a time, up to a total of twelve months over the life of your loan. Interest still accrues, though.

The flexibility offered from being able to switch between fixed and variable rates is a great benefit to have should you experience a change in your financial situation.

As you can see from above, variable rates are much lower than fixed rates. Of course, the only problem is those rates change over time, and they can grow to become unmanageable if you take a while to pay off your loan.

Having the option to switch makes your student loan payments easier to manage. If you can afford to pay off your loans quickly, you’ll benefit from the low variable rate. If you have to take it slow and need stability because you lost a source of income, you can switch to a fixed rate. Note that switching can only take place once every 6 months.

Earnest also lets borrowers skip one payment every 12 months (after making on-time payments for 6 months). Just note this does raise your monthly payment to adjust for the skipped payment.

Beyond that, Earnest encourages borrowers to contact a representative if they’re experiencing financial hardship. Earnest is committed to working with borrowers to make their loans as manageable as possible, even if that means temporary forbearance or restructuring the loan.

Lastly, if you need to lower your monthly payment, you can apply to refinance again. This entails Earnest taking another look at your terms and seeing if it can give you a better quote.

Who Qualifies to Refinance Student Loans With Earnest?

Earnest doesn’t have a laundry list of eligibility requirements. Simply put, it’s looking to lend to financially responsible people that have a reasonable ability to pay their loans back.

Earnest describes its ideal candidate as someone who:

  • Is employed, or at least has a job offer
  • Is at least 18 years old
  • Has a positive bank balance consistently
  • Has enough in savings to cover a month or more of regular expenses
  • Lives in AR, AZ, CA, CO, CT, FL, GA, HI, IL, IN, KS, MA, MD, MI, MN, NC, NE, NH, NJ, NY, OH, OR, PA, TN, TX, UT, VA, WA, Washington D.C., and WI
  • Has a history of making timely payments on loans
  • Has an income that can support their debt and routine living expenses
  • Has graduated from a Title IV accredited school

If you think you need a little help to qualify, Earnest does accept co-signers – you just have to contact a representative via email first.

Application Process and Documents Needed to Refinance

Earnest has a straightforward application process. You can start by receiving the rates you’re eligible for in just 2 minutes. This won’t affect your credit, either. However, this initial soft pull is used to estimate your rates – if you choose to move forward with the terms offered to you, you’ll be subject to a hard credit inquiry, and your rates may change.

Filling out the entire application takes about 15 minutes. You’ll be asked to provide personal information, education history, employment history, and financial history. Earnest takes all of this into account when making the decision to lend to you.

The Fine Print for Student Loan Refinance

There aren’t any hidden fees – no origination, prepayment, or hidden fees exist. Earnest makes it clear its profits come from interest.

There are also no late fees, but if you get behind in payments, the status of your loan will be reported to the credit bureaus.

Earnest logo

Apply Now

Who Benefits the Most from Earnest

Those in their 20s and 30s who have a good grip on their finances and are just getting started with their careers will make great borrowers. If you’re dedicated to experiencing financial success once you earn enough money to actually achieve it, you should look into a loan with Earnest.

If you have a history of late payments, being disorganized with your money, or letting things slip through the cracks, then you’re going to have a more difficult time getting a loan.

Amazing credit score not required

You don’t necessarily need to have the most amazing credit score, but your track record with money thus far will speak volumes about how you’re going to handle the money loaned from Earnest. That’s what they will be the most concerned about.

What makes you looks responsible?

Baig gives a better picture, stating, “We are focused on offering better loan alternatives to financially responsible people. We believe the vast majority of people are financially responsible and that reviewing applications based strictly on credit history never shows the full picture. One example would be saving money in a 401k or IRA. That would not appear on your credit history, but is a great signal to us that someone is financially responsible.”

Conclusion

Overall, it’s very clear that Earnest wants to help their borrowers as much as possible. Throughout their website, they take time to explain everything involved with the loan process. Their priority is educating their borrowers.

While Earnest does have a nice starting APR at 4.25%, remember to take advantage of the other lenders out there and shop around. You are never obligated to take a loan once you receive a quote, and it’s important to do your due diligence and make sure you’re getting the best rates out there. If you do find better rates, be sure to notify Earnest. Otherwise, compare rates with as many lenders as possible.

Shopping around within the span of 45 days isn’t going to make a huge dent in your credit; the bureaus understand you’re doing what you need to do to secure the best loan possible. Just make sure you’re not applying to different lenders once a month, and your credit will be okay.

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Featured, Investing, News

The Basics of a Backdoor Roth IRA

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The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

The Basics of a Backdoor Roth IRA

One of the nice things about making more money is that you have the opportunity to save more money.

But one of the downsides of making more money is that you eventually run into some restrictions on where you can save it.

Specifically, the IRS limits the amount you can contribute to a Roth IRA and the amount you can deduct for contributions to a Traditional IRA based on your income. Once your income reaches a certain point, those accounts are limited in their use.

However, there’s a loophole that can allow you to keep contributing to a Roth IRA no matter how much money you make.

It’s called the backdoor Roth IRA. Here’s how it works.

The Basics of a Backdoor Roth IRA

For 2017, Roth IRA contributions are not allowed once your modified adjusted gross income exceeds $196,000 for married couples, or $133,000 for single filers (source). And if you’re participating in an employer retirement plan like a 401(k), you would also be prohibited from deducting Traditional IRA contributions at that income level.

But there are two additional provisions that, when used together, can allow you to work around these limits:

  1. You’re allowed to make nondeductible contributions to an IRA no matter how much money you make.
  2. You’re allowed to convert money from a Traditional IRA to a Roth IRA no matter how much money you make.

So let’s say that between you and your spouse, you make more than the $196,000 limit for contributing to a Roth IRA. And let’s say that you also participate in a 401(k), meaning you can’t deduct Traditional IRA contributions.

Here are the workaround steps you could take to get money into a Roth IRA:

  1. Open a new Traditional IRA.
  2. Contribute to your new Traditional IRA. You won’t get a tax deduction for the contribution, but as you’ll soon see, that won’t matter.
  3. Wait until you receive your first statement from your new Traditional IRA, which should be in about one month. There is some disagreement around how long you should wait, but one month seems to be a fairly safe bet.
  4. Convert the money in your new Traditional IRA to a Roth IRA. Whichever company you have your IRA with can help you do this (it’s pretty straightforward).
  5. As part of the conversion you will be taxed on any growth that’s happened since contributing to the Traditional IRA, but since it’s only been a month or so, that should be minimal. You won’t be taxed on the amount you contributed, since that was already after-tax money.

And that’s how a backdoor Roth IRA works. And now that your money is inside a Roth IRA, you’ll eventually be able to withdraw it tax-free.

Of Course, There’s Always a Catch…

If you don’t have any existing Traditional IRAs, SEP IRAs, or SIMPLE IRAs, then it really is that simple. But if you do, there’s a big caveat you need to be aware of.

When you convert from a Traditional IRA to a Roth IRA, the IRS considers all of your IRAs to be part of one big pot, and it considers the money you convert to come proportionally from each part of that pot.

Here’s an example to show you what that means:

  • James has $20,000 in a Traditional IRA. All contributions to that IRA were deductible, so this money has never been taxed.
  • This year James makes too much to deduct contributions to a Traditional IRA, but he likes the idea of a backdoor Roth IRA. So he opens a new Traditional IRA, completely separate from his old one, and makes a $5,000 nondeductible contribution.
  • He converts the $5,000 in that new, nondeductible Traditional IRA to a Roth IRA.
  • From the perspective of the IRS, that $5,000 conversion was actually made from a single $25,000 IRA, even though James has two separate accounts.
  • Since 80% of James’ combined IRA money has never been taxed, 80% of his Roth IRA conversion will be taxed.
  • This means that $4,000 of James’ conversion will be taxed. Assuming James is in the 28% tax bracket, he will owe $1,120 on the conversion. And it may be more when you include state income taxes.

In other words, having an existing Traditional IRA that you’ve made deductible contributions to throws a big wrench in your plans to do the backdoor Roth IRA by subjecting a potentially significant portion of your conversion to taxes.

The Way Around the Catch

All hope is not lost. There’s a way to do the backdoor Roth IRA tax-free even if you have money in an existing Traditional IRA, SEP IRA, or SIMPLE IRA.

All you have to do is roll all of that existing IRA money into a 401(k) or other employer retirement plan BEFORE executing the backdoor Roth IRA. Then, when you convert your nondeductible contributions to a Roth IRA, there won’t be any other IRA money to look at and you’ll avoid the big tax hit.

Now, this may or may not be possible depending on your situation. First, you have to currently be participating in an employer retirement plan. And second, your plan has to accept rollovers from all of your existing IRAs, which they may or may not do. You can ask your employer for specific details.

It may also not be desirable for other reasons. Many 401(k)s are littered with high fees, and one of the advantages of having your money in an IRA is that you have much more control over both your investment options and how much you pay.

But if it’s allowed and if your 401(k) has reasonable investment options at a reasonable price, it can be a worthwhile move that frees you up to do the backdoor Roth IRA.

Tread Carefully

The backdoor Roth IRA is a legitimate tactic that’s used by a lot of people every single year.

But there are a number of moving parts and a number of potential hang-ups, so it makes sense to tread carefully and potentially even seek out the help of a professional before making any final moves. A financial planner could help you decide whether it’s the right move, and an accountant could help you navigate the tax issues.

Still, when it’s done right, a backdoor Roth IRA gives you access to a significant amount of tax-free money you wouldn’t have otherwise had.

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Featured, Investing

Hidden Fees That Could Ravage Your Investments

Advertiser Disclosure

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Hidden Fees That Could Ravage Your Investments

Most of the time higher quality things cost more money. As the saying goes, “you get what you pay for.”

But the opposite is true when it comes to investing. Research has shown again and again that lower cost investments perform better. Quite simply, the less you pay, the more likely you are to get better returns.

And the great thing is that cost is one of the few investment variables you can really take charge of. You can’t control or predict how the markets will perform, but you can definitely control how much you pay to be in the market.

The bottom line is that finding lower cost investments is one of the easiest and most effective ways to increase your investment returns. Here’s how to do it.

Two Big Investment Costs to Watch Out For

For most people, the majority of their investment costs will come from the following two places. If you can minimize these two things, you’ll be in good shape.

1. Expense Ratio

Every mutual fund or exchange-traded fund (ETF) has something called an expense ratio, which is simply the annual cost of investing in the fund. That money is used to pay for the cost of managing and administrating the fund for you.

The expense ratio is charged as a percent of the money you have invested in the fund. So if a particular mutual fund has an expense ratio of 1%, that means that 1% of the money you have invested in that fund will be taken out as a fee each year.

And while 1% may not sound like much, it can add up to a huge difference over a long period of time. Assuming you contribute $5,500 per year and earn an 8% annual return, a 1% difference in fees will likely lead to more than a $100,000 difference in retirement savings over a 30-year period.

In other words, you’ll want to pay close attention to your expense ratios and minimize them as much as possible. Most good mutual funds these days have expense ratios of 0.2% or lower, though some specialized funds might go as high as 0.5%.

2. Sales Loads

Sales load is a fancy term for commission. It’s a percent of your investment that goes to the person who sold it to you.

For example, if you contribute $1,000 to a mutual fund that has a 5% sales load, only $950 will actually go into the fund. The other $50 will go to the person who sells you that mutual fund. And that will be true for every additional contribution you make to that fund in the future.

There are two big things to understand about sales loads:

  1. Not all mutual funds or ETFs have them. In fact, it’s pretty easy to avoid them.
  2. Research has shown that mutual funds with sales loads underperform those that don’t have them.

For those reasons, it will usually make sense to avoid mutual funds that have a sales load. There are simply better options out there.

Four Other Investment Costs to Watch Out For

While expense ratios and sales loads are the two biggest costs to watch out for, there are plenty more to keep an eye on. Here are four of the most common.

  1. Trading Fees

Depending on the company you use to do your investing, you may be charged a fee each time you buy or sell an investment. For example, E*TRADE currently charges $9.99 per ETF trade (with some exceptions) and between $0 and $19.99 for mutual fund trades.

And while that may not sound like much, it can add up pretty quickly. If you make monthly contributions to three ETFs, you’ll end up paying about $360 per year just for the privilege of contributing.

Of course, there are ways around this. For example, major investment companies like Vanguard, Schwab, and Fidelity allow you to trade their own funds for free. And many ETFs are commission-free on certain platforms. So there are plenty of ways to eliminate or at least minimize this cost.

  1. Taxes

If you’re investing in a retirement account like a 401(k) or IRA, you don’t need to worry about taxes until you start taking withdrawals.

But every trade within a taxable account is subject to potential taxes, and the more you trade, the more you may have to pay. And even if you never sell anything, the mutual funds you own will make trades, and those tax consequences will be passed on to you.

We all have to pay our fair share in taxes, but there’s no need to take on more than that. In general, the less often you trade, and the more tax-efficient your investments, the less you’ll have to pay in taxes.

  1. Management Fees

Whether you work with an investment adviser who manages your money for you or you invest through a company like Betterment, there’s a cost to having someone else in charge of your investments.

And while that cost can be worth it, make sure you know what you’re getting and that you’re not paying more than you should.

  1. Account Maintenance Fees

Some companies will charge you a monthly or annual fee simply for the service of providing you with an account.

These can often be avoided by meeting certain conditions. For example, Vanguard charges a $20 annual fee for IRAs, but it’s waived if you either sign up for e-delivery of statements or you have a certain total account balance with them.

In some cases, like with health savings accounts, a small maintenance fee might be unavoidable. But in most cases there’s no need to incur this kind of cost.

The Bottom Line: Lower Costs = Better Returns

Watching out for fees may sound kind of boring, but it’s one of the easiest and most effective ways to improve your investment returns.

Remember, not only does a smaller fee mean that more of your money is invested, but the research shows that lower cost investments actually perform better.

It’s a double win that you should definitely be taking advantage of.

TAGS:

Featured, Investing

How to Set Up Your Investment Strategy for 2017

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The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

How to Set Up Your Investment Strategy for 2017

The end of 2016 is upon us, and it is the perfect time to reflect and retool your investments for the coming year. Fortunately for investors, 2016 was a pretty good year by most standards. Unemployment dropped to its lowest point in more than 9 years, and the stock market reached record highs at multiple points this year.

But before you set your sights on 2017, how do you figure out how well your investments did this year — and how to set yourself up for success next year? We’ll guide you in the right direction in this post:

Find out where you stand

To set an effective investing goal for next year, it is important to find out exactly where you are today. Openfolio allows you to compare your investment performance with more than 70,000 investors and benchmarks like the Standard & Poor’s 500 index. You can also create your own benchmark by comparing investors around your age and investing habits. Once you’ve got a handle on where you are, you can start to focus on your objectives for next year. 

As a guideline a good investment return in any given year is determined by the overall economy and your age. A gauge of the overall economy would be an index like the S&P 500; though difficult, any return near or above above the index is considered very good. This year the S&P 500 is up more than 10%. Usually a return between 5-8% is considered solid. A return below 4% is conservative if you’re at or in retirement and poor in you’re decades away from retirement. The average investor earned 5% in 2016 according to Openfolio.

If your investment performance falls below these thresholds in one year, don’t be too quick to ring the alarm. It could be that your investments aren’t properly allocated (more on that below) or it was simply a bad year. These thresholds are averages and it is rare that you’ll earn an exact percentage every single year. It is better to evaluate your performance by looking at 3, 5 and 10 year averages and make adjustments based this information.

Ask yourself: What are my goals and objectives for 2017?

Ask yourself: What are my goals and objectives for 2017?

Some people are looking to improve their investment performance generally, while others are investing for specific goals like retirement or college. Before deciding how to invest for those goals, you need to determine how much time you have. Your time horizon is the amount of time between today and the goal you want to reach. The amount of time you have to invest will determine what investments are best and what type of accounts are most beneficial for you.

Typically, for short-term goals (1 to 3 years) you’ll want to be more conservative in your investment strategy. This is because you’ll want to play it safe in case the market turns against you. Most goals that fall into this category are usually best suited for certificates of deposit or high-yield savings accounts. For goals that are four years away or more, you can usually afford to take on a bit more risk. This is where you’ll want to find the right mix of stocks and bonds in your portfolio.

One exception, however, is retirement. Unlike investing to pay for a down payment on a home or for college at some time in the future, retirement is not a financial goal that happens at one point in time. Though you may choose a specific retirement date, your money needs to be properly invested to last as long as you do. Your goal for retirement should be to invest “through” retirement not “to” retirement. Your tolerance for risk and the age at which you want to retire will be the biggest factors in determining the right mix of stocks and bonds. To find out what mix works best for you, you can use a risk-tolerance questionnaire.

Get organized

Get organized

Where are all of your accounts? When was the last time they were checked? Do you know what you’re investing in? All these are questions you need answered before heading into 2017. It can become very difficult to understand how well your investments have done and what investments you own if they’re scattered in different places. Take inventory of your investment accounts, including any accounts like a 401(k) left at a previous job. Also, be sure to update any beneficiary information on your accounts. You may have had an account at a previous job before you were married or had children, or in some cases you may have a different spouse. Outdated beneficiaries or no beneficiaries listed at all, can be a huge headache for families. If your account is at your previous job, you will need to contact them to make any changes. Alternatively, you can choose to roll over the old account to your new job (if they allow it) or roll it over to an IRA. 

Get properly allocated/balanced 

Get properly balanced

Your asset allocation should be aligned with your tolerance for risk, age, and how many years you have until your retirement date. If you do not reallocate at least yearly, you could be taking on more risk than you bargained for. A conservative 50/50 portfolio (stocks/bonds) could become a 70/30 portfolio if it goes unchecked for too long. The latter is considerably more risky, because 70% of the assets are in stocks. Staying properly balanced is much easier said than done. Because when the market does well, as we have seen this year, most investors prefer to ride the wave of growth. Though your portfolio could be growing, it could be growing too much in the wrong investments. When the market pulls back, you will not have enough in bonds and cash to balance the portfolio out.

To make sure you’re properly allocated for 2017 there are a few steps you can take. The first, as I said earlier, is getting organized. It can be extremely difficult to properly evaluate your total asset allocation across different accounts with different types of investments. For example, it would be hard to determine how to rebalance if you had a target-date fund at your previous job, individual stocks in your IRA, and index funds at your current job. The main reason this is difficult is because target-date funds don’t need to be rebalanced, they automatically change as you get closer to your retirement date. But if that fund is a small portion of your overall portfolio, you may need advanced software to determine what the allocation is when you factor in all of your investments. If you need help figuring out your allocation across different accounts, Personal Capital is a great, free tool.

Once you’ve gotten organized, you need to determine what your current allocation is. Most investment companies will show you a summary of your asset allocation, as seen below.

Now that you know what your allocation is, it is time to find out if you need to rebalance. Use your company’s risk-tolerance questionnaire or click here to use one from Personal Capital. 

Assest Classes

Comparing the two graphs, I would be very close to my ideal allocation and I do not need to rebalance; 82% of my money is in stocks and 18% is in bonds (as seen in the first chart). It is best to do this at least once a year, and if the numbers are too far off, sell some of the stocks, buy more bonds, or vice versa.

Screen shot 1 5th Janunary

There are two instances in which you will not have to rebalance your portfolio: if all of your money is invested in a target-date fund, or it is in an automatically managed account. Both will rebalance periodically according to your goals and time horizon.

Stay focused

Take advantage of your age and experience to expand your possibilities

Once you’re clear on your goals, stay the course. As we learned in 2016, those who were properly allocated and stayed the course after Brexit and the presidential election profited. Investing is a long-term game, and if you’re doing it right, it should be boring. While many investors check their accounts monthly, and in some cases daily, you’re much better off checking your progress no more than four times per year. Studies have confirmed that investors who check their progress frequently tend to get in their own way.

Additionally, remember that investing is a hurdle, not the high jump. It takes consistent efforts to succeed, not huge dramatic gains. Every year there are about 250 trading days; each will change the value of your investments. Do not make decisions because of one bad day. You will have 249 others to help you recover and grow. And if you’re holding for the long term, you have thousands more.

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Investing, Reviews

Hedgeable Review: Robo-Advisor for Investors Who Don’t Mind Risk

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The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

hedgeableYou may get overwhelmed when you think about wealth management. It can feel complex, and you may not consider yourself wealthy enough to justify the expense of having someone manage your investments.

In the past few years, though, wealth management services have been largely democratized by robo-advisers. Rather than paying an individual to handle your investments, robo-advisers manage your money through technology, letting algorithms do the heavy lifting.

In this post we’ll look at Hedgeable, a highly personalized digital investing platform.

What Is Hedgeable?

Hedgeable is a private wealth management platform that is accessible on your computer, tablet, and smartphone. Hedgeable actively invests across a wide range of asset classes, including exchange-traded funds (ETFs) and individual stocks. Because past performance cannot predict future returns, we have no way of knowing if this method will be successful in the future. But we do know that studies have repeatedly shown that the best-performing portfolios over time have often been forgotten.

While forgetting about your retirement account is certainly one way to passively invest, a more conscious option is investing in low-cost index funds. If, however, you are willing to take on the risk of lower returns associated with an actively managed account, Hedgeable’s personalization makes it worth examining.

Unlike other robo-advisers, Hedgeable takes and more active approach to managing client portfolios. When you sign up for an account, you take a portfolio customization quiz that asks you about your assets, goals, and risk tolerance. The quiz takes all of five minutes and then assigns you a very specific portfolio to match your needs.

You can either open a new investment account directly through Hedgeable, transfer an existing account, or roll over a 401(k), 403(b), or 457 to an IRA.

How Hedgeable Chooses Your Investments

While many robo-advising apps use modern portfolio theory to allocate money in a portfolio, Hedgeable uses an objective-based model, which relies less on what the market will do and more on what the investor wants their money to do.

The approach is three-pronged. First, it widens the amount of available asset classes. Your money may be invested in any of the following, depending on your personal risk tolerance:

U.S. Equities

International Equities

Emerging Market Equities

U.S. Fixed Income

International Fixed Income

Emerging Market Fixed Income

Commodities

Real Estate

Master Limited Partnerships

Alternatives

Absolute Return

Currencies

Short U.S. Equities

Short Emerging Market Equities

Short Fixed Income

Cash

To better understand the list above, there are a few key terms you should be familiar with. “Equities” generally means stocks or exchange-traded funds (ETFs). “Fixed Income” is typically indicative of bonds. When you “short” something, you’re betting against it.

Using all of these asset classes, Hedgeable then looks at the goal end date of your portfolio, whether or not you want to invest exclusively in a social cause such as female leadership, LGBTQ equality, or alternative energy, and your risk tolerance to decide where it should invest your money. Riskier portfolios generally have a better potential for return, while lower risk portfolios will likely bring in less, but run a lower potential for losing value.

After your money is invested in specific assets, Hedgeable doesn’t wait a year to rebalance your portfolio. Instead, it implements something called dynamic hedging. As assets become more volatile, the algorithm will cut exposure to them, moving your money into safer assets immediately. Portfolios on this platform are very much actively managed.

Users are also encouraged to take advantage of Hedgeable’s account aggregation, which allows you to link all of your financial accounts to the app. This gives Hedgeable an overall view of your cash and debts. When the app has more information, it can better allocate your money to fit your specific financial situation.

Fees and Costs

Hedgeable’s pricing depends on the size of your portfolio. While there is no account minimum, those with the least amount of money in their accounts pay the highest fees.

While the fees on Hedgeable’s pricing page are annual fees, customers are billed on a monthly basis. For example, if a customer’s fee is 0.75% per year, they would be charged 0.0625% each month. 

Fees cover management fees, trading costs, product fees, administration, technology, analytics, and customer support.

$0-$49,999 – .75%

$50,000-$99,999 – .70%

$100,000-$149,999 – .65%

$150,000-$199,999 – .60%

$200,000-$249,999 – .55%

$250,000-$499,999 – .50%

$500,000-$749,999 – .45%

$750,000-$999,999 – .40%

$1,000,000-$9,999,999 – .30%

Customer Service and Rewards

Hedgeable has a variety of ways to get your problems resolved and questions answered. You can open up a ticket and monitor the progress the support team has made in addressing your concerns. Alternatively, you can text or do live chat with the organization’s customer support team seven days a week. On top of all this, the CIO himself holds office hours twice a week via video conferencing.

In order to increase customer retention and give users the best experience possible, Hedgeable runs a rewards program known as ?lph? clu?. You can earn points by becoming a member, funding your first account, referring new users, sharing on social media, investing specifically for retirement, adding a recurring deposit, and sticking with the company. When you are rewarded for financial activity, your points correspond with how much money you add to your account.

You can claim points for prizes such as Airbnb gift cards, VR headsets, and donations to charitable causes. The more expensive an item is, the more points it will cost to acquire it.

Pros and Cons

Pro: The quick onboarding quiz makes it very easy for users to find an appropriate portfolio and invest without doing mental gymnastics.

Con: While the user might not feel actively engaged in the process, these portfolios are very much actively managed by Hedgeable’s algorithm. Many finance experts stay away from this type of management as it is extremely difficult to do successfully.

Pro: You can start investing with any amount of money, and can do so in accordance with your values through socially responsible investments.

Con: Those with the least amount of money will pay the highest annual fees.

Pro: There is one, flat-rate, easy-to-understand fee that is only assessed once per year.

Other Investing Apps to Consider

Betterment is another investing app with a relatively low barrier to entry. There are no minimum required investments, though it does not invest in as wide of an array of asset classes as Hedgeable. Its fees are lower though, ranging from .35% to .15% annually, depending on the size of your account. Betterment does require a $100 monthly contribution or you will incur a $3 fee.

Wealthfront uses modern portfolio theory like Betterment, but offers a wider variety of potential investable assets. Wealthfront is also free until you have $10,000 or more invested; at that point your fees jump to .25% annually, making it the cheapest option of the three. To get started, though, you must open an account with at least $500.

 

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Featured, Investing

3 Common Mistakes Savers Make When They Invest in Target-Date Funds

Advertiser Disclosure

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

archer target arrow investing retirement saving

Target-date funds (TDFs) are one of the most popular investment options offered by employers because they provide employees an all-in-one portfolio within their retirement plans. To show how popular they are, more than 70% of all 401(k)s provide TDFs, and approximately 50% of participants own them. However, most employees don’t even know what target-date funds are or how they work.

So why the fuss about target-date funds? Although popular, many participants are misusing them and hurting themselves in the long run.

What a Target-Date Fund does:

A TDF is simply an investment fund that owns a bunch of index-style mutual funds. Because TDFs include funds with broad exposure to different types of assets, they allow novice investors to access countless stocks and bonds. For example, the Vanguard 500 Index Fund tracks the S&P 500, which gives investors access to 500 different stocks. A TDF may contain several funds similar to the Vanguard one.

According to a recent study by Aon Hewitt, retirement savers who choose to invest in a single TDF and no other funds had higher investment returns by over 2%. In addition, those participating in TDFs outperformed people who manually managed their retirement investments by a whopping 3%.

Here are some reasons they have been misused, how to overcome them, and why you only need one in your portfolio.

Choosing the wrong year

The name “target-date fund” means exactly what it sounds like. You choose a fund based on the year or “target date” that you plan to retire. TDFs are offered in five-year increments — 2035, 2040, 2045, 2050, and so on. Your goal is to pick a TDF associated with a date that is closest to when you expect to retire.

For example, if you’re 25 years old today and plan to retire at age 65, you would opt for a 2055 TDF option.

Why does the year matter so much? Because the closer you get to retirement, the more conservative your investments should become. This is important, because you have less and less time to bounce back from setbacks as you get closer to retirement. The way TDFs work, they tend to be more heavily invested in risky assets like stocks in your early working years.

“As the investor ages and moves closer to their intended retirement date, a target-date fund will reduce the overall investment risk,” explains John Croke, a certified financial adviser with Vanguard. This process is known as the glide path.

Choosing more than one TDF

Since TDFs are pretty straightforward, many people mistakenly think that they need to split their retirement savings among more than one TDF in order to be truly “diversified.” But the whole point of a TDF is that you only need to invest in one — it is automatically diversified among many assets for you.

“TDFs are designed as ‘all-in-one’ solutions that provide automatic diversification across multiple asset classes,” Croke says. “Owning more than one TDF is not advised or necessary.”

You shouldn’t treat your TDF as if you were a day trader trading stocks either. It’s better to invest in your TDF and keep your funds there rather than to jump in and out trying to time the market.

Paying too much in fees

Compared to traditional mutual funds, TDFs are especially appealing because they charge such low fees. In the world of investing, fees come in many different forms, but the important fee to watch out for is called the “expense ratio.” This is the amount your fund manager charges you for the ability to own that fund. Expense ratios can be as low as a fraction of a percentage or as high as several percentage points. It may not sound like much of a difference, but even a difference of one or two points can mean losing tens of thousands if not hundreds of thousands of dollars over the decades until you retire.

Also, participating in more than one fund just subjects you to more fees that are unnecessary. Why pay more when you don’t have to?

The final word

All in all, TDFs provide an easy, diversified, and low-cost means to invest for retirement. All you need to do is choose one that matches the year you plan to retire, make tax-deferred payments from your paycheck into the fund, and allow your account to grow with history proving that time is on your side when it comes to the markets.

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