Advanced Personal Finance

After recently changing jobs, I rolled over my 401(k) into my existing IRAs.  I learned an interesting tax quirk along the way, too.  Now I’m to the point where I need to rebuild the asset allocation I had in the 401(k)…or not.  My question about this is really simple.

Should my Roth IRA asset allocation be the same as my Traditional IRA asset allocation?

I can think of a couple of reasons why and why not.

Yes, the asset allocations should be the same.

1. Since both IRAs are for the same goal (retirement) and the same time frame, asset allocation theory seems to say they should be identical.
2. They should be the same just for simplicity.  Since you’re possibly going to change the asset mix as time passes (to reduce risk, say), keeping both IRA types the same makes it considerably easier.  However, the use of a lifecycle fund might mitigate this factor.

No, the Roth IRA asset allocation should be different than the Traditional IRA.

1. Using both a Roth and Traditional IRA allows you to do tax diversification.  As such, your goals and objectives for the two types of IRAs may be different.  [Thanks to Lily who pointed this post from Dough Roller out to me on this subject.]
2. Since conventional wisdom says there’s a certain order in which you draw down retirement assets, the allocations of those assets should differ.
3. There are some peculiarities about Roth IRAs that may dictate a different asset mix.  Specifically, you can withdraw contributions to your Roth IRA penalty free at any time.  That’s generally not so with a Traditional IRA.  This may mean the two types should hold different assets, especially if you anticipate you might need to take a withdrawal.

Anyone have any thoughts on this? 

I want to take action and set up my asset allocations, but I’m not sure which way to go.  Right now, I’m leaning toward having them a slightly different mix simply because of how I’ll (hopefully) be drawing down the retirement assets.

Share This

I’ve kicked around writing a post about gold for a long time.  Now, sitting in the tire place waiting for my tires to get rotated, I no longer have an excuse for putting it off.

Gold as an investment.  People seem to love it or hate it.  I’ve read quite a bit about gold from a personal finance standpoint.  And despite its recently approaching $1,000 per ounce, I’ve come to the conclusion that investing in gold is not for me.  These are my reasons.

It’s not the hedge people claim

Gold proponents love to tout its supposed hedging properties.  The thinking goes that gold is a hedge against inflation.  After reading several scholarly papers and articles from respectable sources, I believe this to be untrue.  Gold, it turns out, is a great hedge against uncertainty.  In times of war, political or economic uncertainty, gold performs well.  But in times of inflation?  Not so much.

I think the belief in gold’s supposed inflation hedging properties comes from the fact that inflation sometimes accompanies these other events.  For example, war very often brings with it inflation as government spending crowds out supply.  Lower supply, higher prices.  So if gold performs well during times of war, it will appear to be a good inflation hedge.  Analytically, it just ain’t so.

Gold isn’t the ‘ultimate currency’

In times of catastrophy, the idea goes, you want gold on hand to buy essentials.  Paper currency will be worthless in the most extreme circumstances.  Gold, on the other hand, is always accepted as payment.

I don’t think so.  True, if the world economy collapses, paper money won’t be valuable (or, at least, it will be heavily discounted).  But is gold a good substitute in a situation like that?  No.  Barter, cigarettes, gasoline - these things people will value highly.  But gold?  I doubt it, at least to the degree those who talk up gold think.

Gold as investment has unfavorable tax treatment

People who like gold as an investment typically don’t advertise how it’s taxed in the U.S.  Gold is treated by the IRS as a ‘collectible.’  That means gains in the value of gold are taxed at up to 28% instead of the 15% maximum long term capital gains rate (and many people are taxed at a lower rate yet).

You have to do something with the gold

When you own gold, you have to secure it.  This is obvious in the case of owning gold bullion.  The big thing now, though, is gold ETFs.  But the problem remains.  Gold Shares, the biggest gold ETF, still has to keep its gold somewhere and that costs money.  That cost is passed on to owners of the fund.  Of course all investments have fees associated with them.  Just don’t forget that owning gold has a cost, too.

Though I’ve personally toyed with owning some gold, I’ve ultimately rejected the idea.  For me, these reasons outweigh any potential upside to gold.

Share This

Now is not a great time to be a saver.  In fact, it’s a down-right lousy time.  Rates on everything from high-yield savings accounts to CDs are way down.  In the meantime inflation is up (though still moderate by historical standards), by even the federal government’s dubious accounting.  Mix that together and what you get is negative real interest rates.  I’m going to explain exactly what that means to you and your finances.

My use of the term ‘negative real interest rates’ refers to the phenomenon when the return from completely safe investments is lower than the Consumer Price Index (CPI) - commonly known as ‘inflation.’ 

So you know exactly where I’m coming from, let me specify a couple of the elements.  I consider ‘completely safe’ to be FDIC insured or US government backed.  For our simplified purposes, let’s take that to mean a high-yield savings account.

While the term ‘inflation’ isn’t technically correct in this context, it’s close enough.  Inflation for our purposes is the increase in year-over-year consumer prices.

Here’s where the numbers are for these elements right now:

• CPI 2007: 4.1%
• Typical high-yield savings account represented by ING Direct: 3.4% APY

If you keep your money in this savings account, after inflation, your real return is a negative 0.7%.

Strategies

A couple of thoughts on how to deal with the situation:

1. Consider saving using TIPS.  Treasury Inflation Protected Securities are essentially savings bonds that guarantee a real rate of return after inflation.  There are all kinds of things to consider when thinking about TIPS (like the tax implications), but for some situations they work.
2. Pay down debt.  I know this may seem counterintuitive but consider paying off high interest debt (think credit cards) at an accelerated rate instead of saving more money.  Sure you need an emergency fund, but if it just gets smaller in real terms, you’re losing.
3. Shift savings/investments into retirement accounts.  If you save and invest outside a retirement account, now might be a good time to bump up the amount you put into that tax-advantaged retirement account if possible.  Your investments inside those accounts will likely be slanted toward a more aggressive allocation.
4. Don’t try to ‘make up the difference’ by seeking out unnecessary risk.  So your super-safe savings are returning a negative real rate.  Don’t lose sight of what those funds are for and why they’re in a safe place to begin with.

That’s just what I could come up with.  Anybody want to chime in with other suggestions?  I’m interested to know how other people deal with negative real interest rates in practice.

Share This

If you or a loved one is in the military and is or is about to be deployed to a hazardous duty zone, there’s a great federal program that gives you a guaranteed 10% interest on savings up to $10,000.  It’s a great program I learned about recently offered by the military called the Savings Deposit Program (SDP).

Savings Deposit Program

Not to be confused with the Thrift Savings Program (TSP), the Savings Deposit Program is an awesome way for deployed military members to earn a great, guaranteed return on their savings.  By participating in the SDP, you are guaranteed to earn 10%, compounded quarterly, for as long as you’re deployed in a combat zone.  10% Guaranteed!  That’s phenomenal.  It would be a very respectable return in any environment, but with interest rates as low as their are right now and the volatility in the stock market, this is practically unbeatable.

The SDP has several key eligibility requirements:

• You must be an officer or enlisted member of any U.S. military service
• You must be deployed to a ‘hazardous duty zone’ for the period of time you participate in the program
• You must be in that combat zone for at least 30 consecutive days or one day in each of three consecutive months

Key things to know about SDP

Besides the stringent eligibility requirements (it sucks to be in a combat zone), there are a few key points about the program to be aware of.

• To participate in the SDP, you submit your deposit through your pay office either in cash or check, or you can set up an allotment out of your LES.  Obviously it’s to your advantage to deposit as much money as you can right at the start of eligibility since it gives you the most opportunity to earn the 10% interest.
• You’re limited to a $10,000 deposit in the program.  You can actually deposit more, but since anything over $10,000 doesn’t accrue interest, why would you?  This might be important to note if you participate by allotment.  Once you reach $10,000, you should stop the allotment.
• You can’t withdraw your deposit until after you redeploy except in extreme circumstances.  Don’t put in any money you might need before you get back.  On the other hand, your spouse can’t get at the money either, so that might be an advantage to some people.
• You can actually leave your deposit in the plan for 90 days after you return and it keeps earning interest.  After that, it stops earning anything, so you should close out the account.  Again, you could leave your money there, by why would you?
• Though your pay in a combat zone is free from federal tax, the interest earned in this program is not.

The Savings Deposit Program is simply a great benefit to the generally cruddy situation of being deployed to a combat zone.  I highly recommend looking in to it if you or a loved one is about to be deployed.

Links of interest:
DFAS homepage
SDP information pamphlet

Share This

With the floor dropping out of stock markets around the world, I’m amused by the reactions I see.  From the media, to bloggers, to neighbors and family - they all have an opinion and they all react in sometimes surprising ways.  But if you’re anything approaching a normal person, the recent market decline just isn’t that bad.

I’m okay.  You’re okay.

Here’s something to keep in mind when you’re hyperventilating watching CNBC.  Unless every dime of your net worth is in the stock market, you’re not taking the bath you think you are.

Yes, U.S. equities are down like 17% for the year.  But do you have 100% of your net worth in U.S. equities?  Almost certainly not. 

For example, if you have a ‘reasonable’ asset mix of 70% stocks and 30% bonds, your losses are decidely not 17% for the year.

If you’re like a great many Americans, much of your net worth is in your home.  Are average home prices down since their peak?  Yes they are.  But did you buy at that peak?  Probably not.  So even though houses have come down something like 10% from their peak price nationwide, you haven’t suffered a 10% loss.

More ways it’s not so bad

And think about a couple of other factors.  Inflation is rising.  Whether you believe the federal government’s specific numbers or not, the value of dollar continues to decline over time.  Yes, that means you’re paying more for stuff.  But it also means if you have debt (e.g. student loans, credit cards, car loans) you’re paying your creditors back with cheaper money.

Now consider time horizon.  You fall into one of four categories:

1. You are nowhere near retirement and your investments have years to recoup any losses they’ve recently suffered.
2. You are near retirement but you don’t have the majority of your savings in stocks, meaning what’s happening to the market doesn’t strongly affect your investments.
3. You are near retirement (or otherwise need money you’ve invested) but haven’t properly allocated your assets, in which case you’ve just learned a very expensive lesson and I can’t help you.
4. None of these applies.  You, like half of Americans, don’t invest in the stock market.  Go back to sleep.

So when you read that the stock market has dropped 5 kajillion points, just remember…it’s not so bad.

Share This