Advanced Personal Finance

The basics of ETFs is something I’ve wanted to investigate for a while now and I finally got around to it. I’ve read a couple of posts on other PF sites about ETFs (here’s an excellent one on how to construct a comprehensive portfolio using only three ETFs) and wanted to learn what they were all about. Here’s what I found out.

ETF Basics

An Exchange Traded Fund is a financial instrument that tracks an index, but trades like a stock. The index can be anything from the common (like the S&P 500 SPDR - also called a ’spider’) to the obscure (the Global Vaccine Index, whatever that is). There are currently over 200 ETFs being offered, many really narrow in scope. Keep that in mind when investing. It kind of defeats the purpose of investing in an index if the ‘index’ tracks only nanotechnology companies.

ETFs have a couple of nice advantages over index mutual funds:

• ETFs trade throughout the day, unlike a mutual fund which has its price set at the market close.

• ETFs have lower expenses than even index funds. The Vanguard Total Bond Market ETF, for example, has the stupid-low management fee of 0.09%.

• ETFs can be sold short and bought on margin.

• ETFs don’t have investment minimums. If you have $50, you can buy $50 worth of an ETF. Mutual funds have minimum investments usually starting at $1,000.

• ETFs only generate capital gains when you sell them, unlike a mutual fund.

Index funds for long-term investment growth

So if ETFs are so great, why would anyone invest in an index mutual fund? Well, mutual funds have one very important advantage.

Every index mutual fund I know of has a way to invest periodically, automatically. The programs go by names like “automatic asset builder” or “wealth builder.” They’re just automatic withdrawals from your bank account into your index fund. Typically, you can invest really small amounts every month (like $50 or $100) and avoid the usual minimum investment.

ETFs, because they trade like a stock, can only be purchased through a broker. Brokers charge a commission for every transaction (in and out), so fees can add up if you do small, regular investments.

If you invest small amounts regularly, an index fund is the way to go. If you have a large lump sum to invest, it makes more sense to use an ETF.

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There’s something I hate even more than a 5% drop in the S&P 500 in one week. It’s any mention of this being “a buying opportunity.” No - it’s not a buying opportunity, it’s a serious, sharp loss. And it hurts.

I hate all the platitudes and cliche phrases that inevitably get slung around when there’s a sharp drop in stocks.

“It’s alright. I’m a long-term investor.” Yeah, so am I and my long-term investments just lost 5%.

“It’s a buying opportunity.” So why wasn’t it a buying opportunity four months ago when the price was even cheaper? Somehow that wasn’t a good point to buy?

“The market was overvalued. A correction was needed.” Who says it was overvalued? And why does that mean a correction is somehow inevitable? My portfolio certainly didn’t feel ‘overvalued’ to me. I didn’t need a correction.

“If you dollar cost average, this is a good thing.” If your assets go down in value, it’s not a good thing.

“Now I can pick up some bargains.” And how are you buying these bargains? With money you kept out of the market, presumably. So if you’re such a long term investor who ignores market drops, why did you have money sitting around not in the market?

I’m not complaining about the market drop and I never will. That’s how the game is played. I’m comfortable with my risk exposure. But spare me the talk about what a good thing a sharp market drop is.

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About a year ago, my wife was hit from behind and her car was ultimately declared a total loss. She was not seriously injured, thankfully. We did learn from the experience, though, and I’d like to share some of those lessons here. (We also later learned how not to buy a car)

I hope you never have to use this list.

1. Go to a hospital if you suspect any injury, no matter how slight. Except in the case of very low-speed collisions, you will certainly feel sore in the back and neck the next day. So there’s very little reason not to go to a hospital and get checked out.

2. Get a police report. This might seem a no-brainer, but insist that the police write up the accident. Sometimes they’ll be unenthusiastic about doing so. Make them do it anyway.

3. If at all possible, get phone numbers from witnesses. This is absolutely critical. In an accident, you must assume the other driver will give a version of events that puts them in the best possible light. People will often lie about the circumstances of the accident. I know. It happened to me. A woman drove into the side of my car on the beltway in broad daylight and told her insurance company it was my fault. Naturally, any insurance company is going to side with their client - they have a financial interest in doing so.

4. Take pictures. With the ubiquity of cell phone cameras, it’s pretty easy to take pictures of the scene and both cars. It takes a more than a little presence of mind, though, so if you don’t remember, don’t worry about it.

5. Call your insurance company as soon as possible. It’s important to immediately make a statement about the accident to your insurance company. You do not want them to hear about the accident first from the other insurer. Plus, the details of the incident are fresh in your mind.

6. Keep good records. Keep copies of all reports, medical bills, and estimates. Also start a log of contacts with both insurance companies. Record who you spoke to, when, and what the conversation was about.

7. Don’t mention a lawyer unless you truly intend to hire one. As soon as you mention to an insurance company you are talking to a lawyer, they will immediately stop talking to you. Then your hand is played - your committed to hiring one.

8. Don’t accept the first settlement offer. I’m definitely no negotiating professional, far from it. But I have it on good authority from a friend in the business and from personal experience that the first offer is always going to be laughably low. Just tell them that’s not an acceptable number.

9. Using your records, develop a reasonable settlement offer from your point of view. Things to consider include property damage, lost wages, medical payments, car rental, and personal inconvenience. I’ve been told it’s best to stay away from mention of ‘pay and suffering.’ It’s overused and tends to turn off claims agents.

These are all things we learned from our experience when my wife was hit from behind and went through the process. I’m not an expert in this (and don’t want to be!), so take this list as a starting point.

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I was getting some concert tickets out of our safe when I saw all of the stuff we keep there. It got me thinking about whether that’s the right place for some of that stuff.

How we do it

We keep ‘valuable’ documents in a small fireproof safe in our office closet. What’s ‘valuable’ you ask? It’s kind of like pornography to Justice Potter Stewart of the U.S. Supreme Court - I know it when I see it. Briefly, we keep the following there:

• Vital records - birth certificates, passports, social security cards
• Insurance records - primarily life insurance
• Deeds & titles
• Temporary, but expensive stuff I don’t want to lose track of (like concert tickets)
• Home inventory from 1995 saved on floppy disk (memo to me, memo to me - update home inventory when new digital camera arrives)

Jim at Blueprint for Financial Prosperity published a nice comprehensive list of resources for how to replace lost or destroyed personal documents. I don’t really ever want to use any of these resources, though. That’s the point of the safe. Incidentally, we just keep the key to the safe tied to it. It’s purpose is fire protection and to be in a central location, not keep away thieves (it wouldn’t do a very good job of that since you can pick it up and carry it like a suitcase). So if anybody reading this intends to rob us, don’t hurt yourself looking for the key.

Other options for storing important documents

1. Safe deposit box. My main objection to using this method is inconvenience. I’m not likely to put stuff into a box I need to drive to during business hours and get someone else to help me open. Contrary to what some people think(myself included until I researched this), in the event of your death, your spouse and/or executor can get to your box provided they have a key (you get two when you rent a box). In a few states, they can only remove a will, but in many states the restrictions are looser.
2. Digital storage. I’ve heard of services where your documents are scanned and stored electronically. The problems I have with this, though, are online security and the legality of a reproduced document. Ultimately, you’d still be storing the originals somewhere anyway, so this isn’t really a substitute but more of a backup.
3. Buried in the yard, under the mattress, etc. Ok, maybe not.

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The Roth IRA has one distinct advantage over the newly-arrived Roth 401(k).

With a Roth IRA, you can withdraw your initial investment fee- and tax-free at any time. Not so with the Roth 401(k). You can’t withdraw your contribution to a Roth 401(k) until you actually retire.

Should you want to withdraw your contribution from your Roth IRA, simply contact the financial services company where you invest and tell them what you want to do. They’ll be able to tell you the amount you’ve contributed if you don’t remember. Let them know your intentions and they can set the whole thing up. It’s very straightforward.

Now don’t get me wrong. I love the Roth 401(k) and invest a majority of my 401(k) contributions in it. With a Roth (either the 401(k) or IRA) you get your contribution and its gains tax-free at retirement. Pay no taxes on your retirement money - awfully sweet deal if you ask me.

Most people agree, which is why you’ll continually see the advice to fund a 401(k) to the employer match then switch to a Roth IRA. I don’t completely agree, though. I think the better technique is to fully fund your 401(k) then put money into a Roth IRA.

The reason is simplicity. If you have to take two actions every year - fund the Roth IRA and modify your 401(k) contribution somewhere during the year - it’s less likely you’ll actually do it.

So when comparing directly, the Roth IRA has the distinct advantage of your being able to get at your contribution before retirement. Though I don’t recommend raiding your IRA for spending money, a Roth IRA can function as a back-up emergency fund. There are different rules for withdrawing money before retirement from a traditional IRA.

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