Entries from August 2010 ↓

For the past decade or two, with the growth of IRA retirement accounts and employer-sponsored 401(K) accounts, more and more people are saving for retirement using these vehicles.  It’s widely assumed that Social Security will not provide enough money to live in a style to which many people have grown accustomed, and a way to save tax-free for the future is to open a retirement account.  Subject to IRA tax rules, you can invest pre-tax dollars, or in the case of a Roth IRA, after tax dollars, and have the funds grow until you are eligible to withdraw in retirement. 

Lately however as the stock market has been more volatile, many individual investors are foregoing their IRA contributions because they haven’t learned how to invest for long term growth in any but a bull market.  Many investors think that putting their retirement money in mutual funds is the only option they have to invest, and some individuals with retirement accounts aren’t even sure of the difference between the terms “IRA” and “mutual fund”. Hopefully we can clear up some of the confusion, and offer some ideas for finding good stocks to buy to keep your portfolio growing whether the market goes up or down.

Depending on the type of IRA you have, you may or may not have a good selection of investment choices.  This is also true of 401(K) account plans at most employers.  For example, many people open IRA accounts or retirement accounts with their bank, or an online bank, that restrict the choices available.  This means that there are likely several mutual funds, or particular mutual fund companies, that you can invest in, but you’re prevented from investing in ETFs, individual stocks, currencies, certain types of bonds, and so on.  These banks or employers do not want investors to come back complaining that they lost money in a particular stock, but as we’ve all seen, the potential for losses exists in all investment areas. 

As a result, poor information about investments, as well as the lack of education on the part of investors, are big reasons that people believe they don’t have to know anything about the markets, except to put their money into a so-called “good growth stock usual fund” and leave it there forever until they’re rich at retirement.  That scenario is now officially a pipe dream, and the best advice you can get is to move your money into a self directed brokerage account that gives you real choices and information.  You’ll need to take some time to learn to invest, and take that information into your planning process.  This is the only way you will be able to build a portfolio that can weather the coming economic turbulence.

When you switch to a self-directed IRA account, whether it’s a rollover 401k, or a new traditional IRA, you effectively open a brokerage account which you alone control. You are still subject to the withdrawal restrictions and penalties that apply to retirement accounts, but you can now invest in any investment vehicle which your broker offers.  This could include individual stocks, currencies, government and corporate bonds, options, mutual funds, ETFs, or any type of similar investment.  With this type of account, the choices for investment are much broader, and allow the investor to make decisions based on their personal financial plan, their own risk tolerance, and other goals that may or may not be fulfilled through the limited choices offered by employer-based plans or certain bank plans.

An important thing to remember is that with a self directed account, you can still invest in conservative investments like bonds and CDs or money market funds, or find good stocks to buy that match your investmnet goals, but you also have the ability to buy and sell holdings as you choose, or select new vehicles that fit your financial goals better. “Self directed” does not equate to “risky”.  It merely means you are now in control of your money and your financial future, which is the best way to make sure your money is working in ways that match your unique defined needs.

You’ve been saving for retirement, maybe you have been getting a company match; you have also either been adding to a Roth IRA account, or recently converted your regular IRA into a Roth to get the tax-free withdrawals in retirement. But now we are having a financial meltdown, and you know you can pull the funds from your Roth without the same penalties as in a 401K or traditional IRA.  You need the money, and you’re thinking about taking an early 401k withdrawal.  But should you withdraw from your 401k or Roth IRA?

When you withdraw from a traditional IRA or a 401(K), you pay taxes and penalties, because the intent of those accounts is to hold the money for retirement. Your contributions have been tax free, and you will pay taxes when you retire.  Withdrawal after 59-1/2 are taxable, but are also penalty free.  But if you want to withdraw before that time, you will not only pay the taxes you avoided earlier, but a penalty to prevent you from doing so.  Now comes the Roth IRA.  We’ve set up a 401k rollover into a Roth IRA, or opened a new Roth account, to take advantage of the future tax benefits.  We contribute to Roth accounts with after tax dollars, and as a result, in retirement we can withdraw from our account tax free also. It’s for this reason, because the growth in the account is also tax free, that many financial advisors are now recommending that you invest in a Roth for retirement. But there is a down side. Because there are not taxes to be paid, withdrawals, at least of the money you initially deposited, are penalty and tax free.  And when people who don’t save have retirement funds they can pilfer from, they start withdrawing form their future.

The vast majority of Americans have little to no money saved for their retirement over and above what they hope to get from Social Security. this grasshopper vs. ant mentality was possible a few years back, when it seemed like prosperity had nowhere to go but up.  But today, there is a distinct possibility that we will not see growth – of home values, salaries, or anything that would normally put money in our pockets – for a long time.  Even for people who have a twenty year time horizon before they retire, if the current situation in the United States is anything like the deflation Japan suffered, the likelihood may be that there will be little to no growth in any stock or savings accounts for the next ten years. 

So, do you really want to deplete what you have now, while you can still earn and save and sell off possessions, and be more broker when you’re 75 years old?  With life expectancy increasing, do you really want to be working that waitress job at 69 years old because you took money out of retirement to buy a new $40,000 car when you were 55?  Is it harder to ask your child to pay for college today by working their way through, or to expect them to support you alongside their own family in twenty years?  We tend to think in short term time horizons, and today’s needs may be immediate, such as a health care emergency, or job loss.  But using retirement funds to support a lifestyle that was built on credit and can no longer be supported unless you use up retirement money is a foolish choice.  By taking money out of your Roth IRA withdrawal, or a 401K withdrawal, you are essentially hoping that your kids or the government will be able to support you because you will have nothing left.  One is unfair, the other just plain crazy.  You really should get better 401k advice to decide what is your financial priority bore you take out the money.

Remember too that if things go horribly wrong, and you do have to file for bankruptcy, your retirement money cannot be touched by your creditors. That money stays put because it has a purpose to fulfill. If you use it all up and then declare bankruptcy anyway, you have truly robbed yourself.  It’s much better to tighten your belt as much as you have to right now, and leave that retirement money where it is – ten or twenty years down the road.

If you’ve been watching the market at all, you have probably been trying to decide whether to stay in or get into cash investments. The economy is still lagging, employment numbers falling, home prices dragging… it’s hard to figure out whether it’s even worth investing money in this situation.

Lately, many investors are moving into cash or things like gold, that do better in bad markets.  Keeping cash on the sidelines, in addition to some stronger investments as part of your portfolio, may be a good idea.  If you are not an experienced investor, who knows how to make money in down or level markets, you could get royally screwed by keeping money in index mutual funds for example.  The old saw about keeping money forever in a “good growth mutual fund” is a lot of hoo hah in markets like this, because the fact is these types of mutual funds have barely performed over 5% in the past 10 year period.

With so much uncertainty, if you are depending on a job for your income, you  might consider paying off debt instead of putting money in an investment account where you may or may not get 4% returns.  You could also lose your shirt.  Small investors are not the ones who will do well in this type of environment.  Many Americans are just paying off debt and saving their money, to make up for not being able to get credit, not getting raises at work, or getting their wages cut or even getting laid off.  Investing in this type of market is not always the best way to go.

If you really have extra cash you can afford to lose, it might be a good idea to look at the types of things that do well in an economy where people are not spending on big items, but have to purchase certain things like fuel, heat, and food.  International investments may also be useful to look at, since many retailers now are seeing no growth in the U.S., but finding their growth is coming from sales in Asia.

It’s worth taking a look at the variety of investments out there that could do well in a continued downturn, however keeping cash handy and getting out of debt continue to be priorities before earning low returns in a volatile market.