The Employee Benefit Research Institute (EBRI) shows 27% of people over 24 years of age have saved less than $1,000 toward their retirement! Additionally, the survey showed 54% have saved less than $25,000!

It is shockingly clear that a large percentage of Americans have saved little or nothing for retirement.  While recognizing job losses, mortgage problems, and the suspension by many companies of 401K employee contribution matches in 2009, the economy is not the entire problem. In previous years, there were a huge number of workers who had little or nothing saved. This is a major, ongoing problem. The void between what Americans are saving and what they will need to live in retirement is a big concern.

Financial planners stress that retirement savings, including social security, any company pension, and personal savings and investments should provide about 80% of preretirement income.

According to the EBRI survey, a big problem that exists with many people is that they have never tried to calculate what they will need for a comfortable standard of living in retirement—nor what they will need to do to achieve it. Too many people put off any thought of retirement planning until it is too late to do much about it.

First Steps to Retirement Planning

As a first step, you need to determine how big your nest egg should be at retirement and how much you need to save in the coming years to meet this goal.  There are many excellent retirement calculators on various internet sites that can help you in this process. Two, one at vanguard.com and the other at troweprice.com, are among the better ones and not difficult to use.  

By inputting answers to a few basic questions such as years to retirement, savings and investments to date, your current income, how much you save per month, and desired retirement income—the calculator will determine the probability of meeting your retirement goals. If it looks like you will fall short, the calculators provide suggestions to make up for the potential shortfall.

This process can give you a big boost in your retirement planning and help get you on a path to achieve a comfortable living standard in retirement.  Once the plan is in place, you can review and modify it as circumstances in your life evolve and change.

Plan Implementation

Once you have a savings and retirement plan established, take full advantage of tax-advantaged accounts such as the 401K, the traditional or Roth IRA, as well as your taxable brokerage accounts.

Many companies are planning to restore the 401K matching feature they suspended or reduced in the last couple of years. According to Hewitt Associates, a human resources consulting company, 80% of these companies are planning to restore the match in 2010. Depending on the extent of the match and the quality of investment opportunities, the 401K is hard to beat. The company’s match essentially provides 100% return on your contribution—this is “free money”.

In addition, a couple of new options planned by many companies in their 401K plans are (1) automatic portfolio rebalancing to keep employees portfolio diversification and asset allocation on track to meet their goals, and (2) automatic employee contribution increases over time. These options, along with the 401K matching feature can enhance your portfolio’s compounded growth while keeping you on course to achieve your specific retirement goals.

Put any surplus savings into a traditional or Roth IRA after you have maxed out your contributions to your 401K—at least up to the company’s maximum percentage match.  If you are stuck in a 401K plan with high fees and/or a lack of many good investment choices, after the company match, invest in an IRA where you have a lot more freedom in your choices of investments. As much as possible, the goal should always be to invest in low cost, diversified investments, and then to establish an asset allocation tailored to meet your specific retirement investment goals and needs.

For year 2010, you can put up to $16,500 into a 401K, and additional $5,500 catch-up contributions for workers age 50 or older. For IRAs, you can contribute up to $5,000 and an additional $1,000 for workers age 50 or older.  

Bottom Line:

• Large numbers of people have saved little or nothing for retirement
• A major problem is they have never tried to calculate their retirement needs and therefore have no goals or plan
• There are many excellent retirement planning calculators on line to help establish a retirement plan  
• 401Ks and IRAs are superb tax-advantaged vehicles to help implement a retirement plan along with a taxable brokerage account
• A good retirement plan can help determine how well you live in retirement and how much financial freedom you enjoy.

 So many people end up in trouble financially by not properly managing their money. Many wonder how they will ever be able to retire—and relatedly, many never achieve financial independence. The reality is they could if they knew a few facts and principles and used them consistently.

 Yes, things can happen to people that are out of their control. But too many people end up having financial problems because they are spending and borrowing more than they can afford. According to Thomas Stanley, author of a new book, “Stop Acting Rich…and Start Living like a Real Millionaire”, over 80% of luxury cars are driven by people who are not millionaires, and three times more millionaires are living in homes valued under $300,000 than there are living in $1 million plus homes!

The truth is, most self-made millionaires never choose to live in upscale neighborhoods, buy prestigious new cars, and wear expensive clothing and watches. Instead they chose to live modestly and quietly as they build towards their goal of financial independence. Fewer than 4% of Americans achieve millionaire status in their working life times—yet many more could if they followed the example of these self-made millionaires.

The key is that if you want to become truly wealthy—a real millionaire—you need to stop acting like you are wealthy. Pretending to be rich by buying expensive status symbols instead of focusing on building real wealth by saving and investing in growth and income assets like stocks, bonds, and investment properties, you will not likely ever achieve financial independence. Instead, like so many Americans in our consumption-oriented society, you will have chosen to live from paycheck to paycheck while not saving and investing much for the future.

An important point is that wealth or net worth is not the same as income–even high income. Wealth consists of those investments that you accumulate for the future that naturally increase in value over time. Monthly income that many people spend way to much of for expensive non-appreciating assets such as status cars, lavish clothing and jewelry, and exotic vacations is not wealth—it only gives the impression of wealth.

Here is a real eye opener: Stanley found that those who are among the least productive in transferring their income into wealth are in the highest income occupations! Yet, many members of lower income occupations such as teachers achieve millionaire status—about 350,000 according to Stanley!

So, it is not how much income you make, it is what you do with it based on your goals, priorities, and chosen life style. If people would stop acting rich to impress people with their expensive life-style, they could start on the path to real wealth-building while enjoying those simple inexpensive things in life that really matter.

There is really nothing magic about building wealth and financial security. However, it is a very disciplined and straightforward process that has worked consistently well in building wealth for self-made millionaires who represent about 80% of all American millionaires.

In summary, what did the real millionaires do to achieve their financial status and then maintain it?

1. They firmly believed that achieving financial security and independence is more important than displaying high social status with expensive trappings of affluence.

2. They lived a frugal lifestyle well within their income level.

3. They controlled their expenses with a disciplined budget

4. They regularly saved and invested up to 20% or more of their total income in appreciating assets

5. They continue their disciplined wealth-building habits and modest life style throughout their lives while maintaining their accumulated wealth

 Bottom Line

• Many people who display a high consumption life style never achieve even modest wealth.

• Those few people who have accumulated substantial wealth have not lived a high-consumption life style, preferring to save and invest to build financial independence.

• Self-made millionaires live frugally and are very disciplined in controlling their expenses and investment of their savings.

• If you forgo a high consumption lifestyle and commit to a disciplined budget, saving and investment program, you too can achieve financial independence while enjoying the simple inexpensive things in life that really matter. It is all up you.

Just like drivers on city freeways, many investors tend to frequently change to what they perceive as the fast-moving  lanes of the investment markets.  As with driving, the fast-moving investment lanes can become the slowest and the slower-moving investment lanes can become the fast-moving ones again.

 The problem is that by the time that ”hot” investments are recognized by investors, they have already increased substantially in price—whereas the investments being sold have decreased in price and are now good buys. As a result investors end up buying high and selling low as they chase performance—exactly the opposite of what investors should be doing. This is by far the biggest and most common mistake investors make. It is costly, potentially risky, and can greatly detract from investment returns.

 Numerous studies by major investment informational resources including DALBAR–a leading financial services market research firm, and the Hulbert Financial Digest--a highly respected independent authority on published investment advice, show that the typical investor earns far less than reported returns for mutual funds.

 For example, according to DALBAR, the S& P 500 Index’s average gain over the 20 years ending in 2008 was 8.4%/year. The average investor in mutual funds obtained only 1.9%/year during the same time period!  The same is the case for fixed-income investors.  The Barclays Capital U.S. Aggregate Bond Index returned 7.4%/year during the same 20-year period—yet the average investor in fixed income earned only .8%/year!

 How do investors do this to themselves? The primary reason is that emotion, not logical thinking, rules their investing habits. The result is an emotional “herd instinct” that hurts investors time after time. The volatility accompanying strong bull and bear markets accentuates the problem with strong emotional decision making based on fear and greed taking over with excessive buying and selling at precisely the wrong times.  In just the last 10 years we have experienced this twice with the technology and real estate bubbles and crashes.

 Investor’s emotional tendencies are well known in the growing field of behavioral finance.  So what can we do to counter these negative habits and obtain the investment returns the markets provide? One or more of the below strategies can help you discipline yourself and control your emotions for better decision making and much better returns.

• Tailor your portfolio to your risk tolerance.  Get fully tuned in to your risk tolerance and how much “safe money” you need to better keep your emotions in check.  Adding more safe and liquid investments such as bond and money market funds and reducing the stock allocation in your portfolio as appropriate would provide a more stable and less volatile portfolio.
• Establish a separate safe money account.  Consider establishing a separate “safe” money account containing stable, lower risk investments such as short-term bond funds and cash equivalents. Having a separate account with very safe money can help minimize the tendency to emotionally driven investing behavior during volatile markets.
• Incorporate proven strategies to neutralize emotional decisions.  Two of the best strategies to counter emotionally-driven decision making are (1) regular portfolio rebalancing and (2) dollar-cost-averaging. By rebalancing your portfolio’s asset allocation back to your established percent allocations when it gets out of whack, along with regular investing in both up and down markets (dollar cost averaging), you discipline yourself to buy low and sell high. You also maintain the target asset allocation you established that meets your personal needs including degree of safety.

Note: With rebalancing, you are selling part of your portfolio assets that have been the fastest growing (selling high) and using the proceeds to buy more shares of the assets that have not grown in value as fast (buying low). When using dollar-cost-averaging in making regular investment contributions to your portfolio, you can buy more shares when the market price is down than when it is up. Therefore, on the average, you are paying less for your investment contributions—buying low.  As a result, both strategies can greatly enhance portfolio growth potential over time.

Bottom Line & Final Thoughts

1. Portfolio volatility, emotion, and focus on short-term results collectively cause investors to lose objectivity and to make poor decisions.
2. Investors’ behavior often hurts their investing returns to a huge degree.
3. Investors can learn to do much better by (1) incorporating the stability in their portfolios necessary to match their risk tolerance, and (2) establishing disciplined investing strategies to maintain and grow their portfolio by buying low and selling high using rebalancing and dollar-cost-averaging.
4. Major studies have shown that portfolio asset allocation accounts for over 90% of a portfolio’s long-term risk-return performance. Therefore, it is very important to get this right by tailoring it to your specific needs, goals and risk tolerance.
5. The use of index mutual funds and exchange traded funds in your portfolio can help ensure market return performance and reduce the temptation to jump from one fund to another. This temptation so often happens when using actively managed funds as they go through the inevitable “fast to slow” lane ups and downs. Active fund managers can vary greatly in their performance relative to each other over the same time periods. Some can do very well, others not so good—then their relative performance can switch during another time period—it is unpredictable. Additionally, most actively managed funds have not performed as well as the indexes over the long-term–especially when considering their higher management fees.
6. For most individual investors, good long-term investing results come from staying the course with an appropriate individualized mix of both safe and growth-oriented investments, and through the use of the time-proven investment strategies—rebalancing and dollar-cost-averaging—as primary portfolio management tools.

“Normal” inflation can play havoc with portfolio values and income over time. At 3% inflation, in 20 years you would need double the income from your portfolio to maintain the same standard of living!

Presently, inflation is not a huge problem. It has been running at a 1 to 2% rate which is considered the ‘sweet spot’ by the Federal Reserve.  However, in the light of all the monetary stimulus and government spending in attempts to resolve our deep recession, higher inflation is a likely threat in time. An August 2009 editorial in the NY Times by Warren Buffet stated that the uncontrolled dumping of money into the US economy will “certainly cause the purchasing power of the currency to melt”—in other words, cause inflation.

Protecting the principal value of your portfolio should be the goal of every retiree and income investor. Stocks are designed to protect your portfolio’s principal value and as a result “purchasing power”.  Bonds and cash provide income and liquidity respectively but do not generally do well in maintaining purchasing power. 

Ibbotson Associates published a chart showing the compounded annual rate of return during the years 1925-2004 for stocks, bonds and T-bills at an inflation rate of 3%. After inflation and taxes, stocks returned 4.8%, bonds .6%, and T-bills -.9% annually during this time period.

So it is extremely important to properly configure your portfolio for both growth in value (e.g., stocks) as well as income (e.g., bonds) to keep up. Also, it is important that income withdrawals be adjusted to only the total portfolio returns above inflation. Without those adjustments, purchasing power is not likely to be well maintained over time. 

High Inflation Predicted by Many

It has been about 30 years since there was a high inflationary period. In 1979, the Fed really ramped up short term interest rates to battle high inflation. The result was economic activity fell and the major asset classes—real estate, stocks and bonds plummeted in value as did gold—although gold dropped to a lesser degree.  The Fed is expected at some point to raise short term interest rates again, likely next year, with the degree and magnitude of increase(s) dependent upon the economy and perceived risk of inflation.

So, what can the retiree do to protect his/her portfolio in the near future from a potentially high inflationary period beyond maintaining a traditional portfolio of stocks and bonds?

Many concerned investors have been looking for insurance in the form of inflation protection investments such as TIPs, commodities, and precious metals.  Today, these and other specialized asset types are easily purchased cost effectively through a wide variety of mutual funds and exchange traded funds (ETFs).  

Treasury Inflation-Protected Securities (TIPs) are a neat way to fight inflation. The principle value of your investment is increased along with the inflation rate. But being geared to fight inflation, returns are relatively benign with low inflation such as we have right now. With higher inflation, you get relatively more return.  Commodities and precious metals could also be considered with plenty of mutual funds and ETFs making it easy to add to your portfolio.  As commodities and precious metals are both volatile, it is probably best to keep them to a small percentage of your portfolio such as 5 or 6 %.

One caution: a Wall Street Journal article (Oct 5, 2009) addressed a number of these inflation hedges. The article emphasized that these investments have not been around long. TIPs were established in the late 90’s and many commodity and gold funds even more recently. As a result, these inflation hedges have not been tested during a significant inflationary period. As a result, there is no guarantee that they will perform as expected.  So it is probably best not to go overboard with these investments before they have proven themselves.

Check your portfolio before adding these inflation hedges because your fund managers may have already added some.  In any event, limit these specialized assets to a small percentage of your total portfolio asset allocation while keeping most of your portfolio in stocks, bonds, and cash.  Also, avoid buying when there is a mad rush into these inflation hedges. It is best to buy before the “stampede” to get better value. Otherwise dollar cost average over time into these fund(s).

Generally, real estate and Real Estate Investment Trust (REIT) funds have performed well in inflationary times and have had a relatively low correlation with the stock market thus providing good diversification. However, we are living in unusual times and there are no guarantees as to when real estate as well as the economy will recover and exactly what form it will all be.  If you do not presently have a real estate/REIT fund, establishing a small position (maybe 5%) makes some sense as real estate will eventually make a comeback—possibly bigger than many expect right now—and it is a good long term holding.

Bottom Line:

• Always purchase assets for sound investment purposes in your portfolio
• Maintain a diversified portfolio of global stocks, bonds, and cash as your core investments to meet your basic life’s growth and income needs.
• Limit your portfolio income withdrawals to only portfolio returns above inflation to maintain purchasing power
• Consider adding a smaller portion of alternative investments such as TIPs, commodities, and/or precious metals to help maintain purchasing power especially during significant inflationary periods.  
• As always, seek investments that are undervalued and likely to go up in value for your core portfolio. Stocks, bonds, and real estate/REITs have a long history of long term growth bias.
• Generally this has not been the case for commodities and precious metals. Volatility and unpredictability have been more their history. Time will tell how these new promising inflation fighting funds and others including TIPs perform in the next high inflationary period.

The last two years have not been kind to baby boomers who plan to retire soon or to retirees living off their retirement nest eggs.  Many are facing a major challenge these days: how to obtain enough income to cover their living expenses following the dramatic drop in portfolio values and the very low interest rate environment.  This educational article describes one way that could help many retirees increase their income.

An recent independent study showed that with an “immediate fixed annuity”, you can create a guaranteed stream of income over your lifetime with up to 40% less money than it would require to obtain the same income from a portfolio of bonds, stocks, and cash!

For example, a typical retiree’s portfolio may have 40 to 60% in bonds and cash with bonds earning 5% or less and cash providing low to negligible returns. If the retiree put one -half of this money into an immediate annuity, interest earnings could be anywhere from 7% to 9% (or more) depending on the age and sex of the retiree(s) and state lived in.

Let’s look at an example with the retiree a 70-year old woman with a 1 million dollar retirement account that has lost 25% in value, dropping to $750,000. With an annual  withdrawal rate of 4% of the portfolio value being the accepted standard for having reasonable probability the portfolio will last through retirement, it is clear this woman will have a substantial decrease in income—from $40,000 down to $30,000 annually.

If she purchased an immediate annuity with half of the depleted $750,000 portfolio value, or $325,000, the annuity would provide $26,000 a year income. The remaining $325,000 in her portfolio of stocks and bonds would yield an income of $13,000 annually at the 4% withdrawal rate. The result, total annual income from the $750,000 portfolio would increase from $30,000 to $39,000, $9,000 more than she would be receiving before purchasing the annuity and just $1,000 less than she was receiving before her portfolio shrunk in value!

The reason this is possible is because your annuities lump sum principal and the strong earnings—the result of the much higher interest rate—are both tapped along with the pooling of risk with thousands of other annuity owners.

An additional advantage beyond the increased and guaranteed income is that the immediate annuity is very tax efficient compared to other income vehicles such as corporate bonds, thus further increasing net cash flow.  Its benefits can even include additional tax savings from social security income depending on a variety of factors beyond the scope of this article.

One way to determine how much to invest in an immediate annuity is to add up your total monthly expenses and then subtract all the monthly income you already receive including pension and social security benefits. Then fill any gap with an annuity.

For those unfamiliar with immediate annuities, you provide the insurance company a lump sum of money, and it provides a check to you for a guaranteed amount every month for the rest of your life.  The money in your new immediate annuity will grow at a contractually agreed upon rate while you receive your monthly income.  

As with any good thing, there is usually something you must give up. When you invest in an immediate annuity, your money is now out of your control—you cannot get it back for any reason. When you pass away (and your wife  if a joint annuity), the insurance company retains what is left of your premium. So there is nothing left to pass on to heirs. This would be fine for people needing increased secure income, are not concerned about leaving an estate or have other funds to leave to heirs, and/or not wanting to deal much with managing investments on their own. 

Clearly, annuities are not for everyone. Further, most people should use annuities for only a select portion of their nest egg—retaining the remainder of their money in liquid form such as in stocks, bonds and cash for use in emergencies, for other needs and wants, and to position for growth to offset inflation.

A few insurance companies offer various annuity options that can be added. They include (1) providing a part of your remaining lump sum premium to your heirs if you pass away within a certain designated time, and (2) an annual cost-of-living adjustment. The downside is that your annuity payouts would be less.

How to purchase:  Start with the Vanguard Group (800-462-2391). Their rates are very competitive and they are one of the most reputable and solid companies financially.  Another good source with which to search and investigate a wide number of companies within your state is ImmediateAnnuities.com.   Stick with high rated companies, A+ or above with A.M. Best

Consider purchasing annuities from several companies spaced over time. This would do several things: (1) spread any default risk across several companies, (2) lock into higher annuity interest rates that are likely in the future, and (3) get higher payouts from newly purchased annuities as you get older.

The Bottom Line:

• An immediate annuity can substantially increase retirement income and guarantee it for life
• It can serve as a “pension” using part of your nest egg
• You lose control of the money and cannot get it back except through the annuity payout schedule over your lifetime
• It is important to retain liquidity with a portion of your nest egg
• Stick with highly rated companies, an  A+ financial strength rating or better with A.M. Best

Many families struggle with the family budget and wonder why they have such difficulties in making ends meet, saving money for the future and things important to them. A study by the National Bureau of Economic Research showed that only about a third of young adults had knowledge of important aspects of basic financial literacy.

 The fact is that basic money management has not been a requirement of most education curriculums unless you’re in an MBA program, studying finance, or the like. Many people never really learn it well and as a result never get on track to achieving their most important goals like retirement and college education savings–and ultimately a secure financial future.  So what to do?  The good thing is that most anyone can learn to be a good steward of their money and financial future.

 The first and most important steps are to know where your money goes and your financial priorities.  Go through your bank, debit, and credit card statements. Identify real needs from wants. Look carefully at small expenditures less than $100 dollars as well as those larger.

 The real villains are often high frequency smaller expenditures. Typically some are recurring monthly charges like subscriptions that are not always really needed. They are sneaky and can easily pass by your expenditure defenses as most of us look for the larger ones.  One direct result can be large balances on credit cards with steep interest rates—a double whammy that can effectively steal from your financial future. To avoid this, keep any charges to a minimum and pay off the balance every month.

 Having a clear sense of your priorities will help to sort out your real needs from “wants” when making spending decisions.  Once you delete the unnecessary expenditures—create a spending and savings plan. Redirect the “new” money into savings and investment accounts.

 Establish an emergency cushion savings account for those unexpected costs than can come up unexpectedly, such as car repairs, medical bills, and unemployment. Then set up automatic deposits into an investment account(s)—pay yourself first before you have the chance to spend it in other ways. These steps could make all the difference to achieving your financial goals and a secure future.

 For example, cutting back expenditures by just $300 a month or $3,600 a year and investing the money regularly into an investment account growing at the stock market average annual rate of 10% (since 1926), could be worth $1,000,000 in 35 years!

 Most anyone can achieve big financial goals by making small sacrifices consistently over time. You just need to start now and a sound financial future can be yours.

 The Bottom Line:

 Most anyone, regardless of education or even size of income, can learn to become good managers of their money and achieve bigger financial goals than they ever thought possible.  Small spending sacrifices made consistently and invested regularly over time can result in big money and a secure financial future.

Charles Schwab Corporation just launched its first exchange traded funds (ETF), a move that will likely change the playing field in this very fast-growing investment arena.

Schwab launched four commission-free ETFs and plans to roll out four more by year-end.  Five as planned are domestic-equity index funds and three  international-equity index funds.  Its slogan for its new product line is unforgettable: “Everyone Trades Free”.  Another big draw of the new Schwab ETFs is minimal expense ratios—undercutting similar ETFs on price.

This puts tremendous pressure on industry leading ETF providers such as Barclays Global Investors (I shares), Vanguard Group, and State Street Corporation, along with many other smaller providers.

In addition to initiating a potentially industry changing move with commission-free transactions, Schwab is also attacking what has been a major drawback of ETFs—the trading expenses that have made them inefficient for making regular dollar-cost-averaging contributions into investment accounts such as 401Ks,  IRAs and other recurring investment strategies.

This is a welcome development for individual investors and may be one of the most investor-friendly actions ever taken by a fund company. When fund companies are forced to compete, investors are usually the beneficiaries.

Schwab’s move will very likely push the cost of investing down for everyone investing in ETFs and other types of funds. It also has the potential to redefine ETF and fund investing in general.

Bottom Line:

ETFs have become an extremely effective and popular investment vehicle.  Buy-and- hold investors like their low fees, transparency, tax efficiency and diversified index approach for easy asset allocation.  Traders like them because they can trade entire sectors in real-time like a stock.

Now the door has been opened to still another effective application—making regular dollar-cost- averaging contributions commission-free into investment plans such as 401Ks and IRAs.

ETFs are an excellent vehicle for individual investors to implement the power of modern portfolio theory by establishing, regularly contributing to, and rebalancing their portfolio’s asset allocation effectively—and now more than ever, at very low cost.

As the result of the recent bear market—the worst in generations—most people’s portfolios were decimated.  Many people now question what to do with their money—question even the time-proven value of asset allocation, a cornerstone of sound investing.  Major studies and investment results over long periods have shown that the allocation of portfolio assets across broad asset classes is much more important than the selection of specific mutual funds or individual securities.  It is one of the most powerful investment strategies.

The way things are supposed to happen is that the investor establishes an asset allocation based on what is best for his/her financial situation and then holds to it through the natural up’s and downs of the market, rebalancing as required.

So why did so many investors lose the faith and opt to discard their asset allocation and even their entire portfolio at the worst possible time?

Chances are that many of these investors over-estimated their tolerance for risk. When a bad market causes people to become overly anxious and to opt out of stocks (or portfolio), they probably had too much committed to stocks and other more risky assets in the first place.

Ironically, the bear market has clearly demonstrated the power of asset allocation, not diminished it.  A portfolio’s risk level—determined in large part by the percentage allocation of more risky assets such as stocks—was a major determining factor in how much a portfolio lost in value.

A couple of examples based on the time period spanning Oct 2007 to April 2009 illustrate this. According to Bloomberg News, a portfolio with 80% in stocks and 20% in bonds would have lost a whopping 34.8% in value during this time period.  A more conservative portfolio with 40% in stocks and 60% in bonds would have lost only 13.1% in value over the same period!

So how well (or not) investors handled their portfolios during the last few years varies greatly depending upon how closely they were asset allocated according to their true risk tolerance. Those that were in their comfort zone were much more likely to have ridden things out than those who were not.   Many of those who were not in their comfort zone suffered the most, emotionally and financially.

This market crash has certainly been a wakeup call for many people. Actually, it has provided all of us the opportunity to get a more accurate determination of our true risk tolerance. In more normal times, it is not as easy to do nor is there the extent of motivation. The two major components of risk tolerance, (1) how long until you will need to withdraw money (e.g. retirement), and (2), how much change in value you can personally tolerate, should be easier to determine more accurately now given our experiences over the last few years. 

Bottom line:

Asset allocation remains a critically important ingredient of sound investing as the worst bear market in generations has demonstrated.  It is especially comforting to know that we can be in much better control of our portfolios degree of volatility (and overall performance) through asset allocation—we just need to know ourselves better to take full advantage and to be more in charge.

For the first time since October 2008 when the Dow seemed headed towards 6,000 and people were terrified, the Dow has again reached five digits at 10,000 after a 50% drop. The market has made a big run-up since the huge bear market losses—but what should the individual investor think about this Dow milestone? One of the worst things he/she could do is let either their excitement about the big run-up or continuing fears related to last years huge losses cause them to make decisions that may result in even greater financial pain in the future.

Instead, the Dow milestone should be viewed as a wake-up call to take a step back and review personal financial needs and long term goals along with the overall approach to investing. By doing this, investors will see more clearly how they may have to align their portfolio to place better emphasis on their personal financial needs and goals.

Placing the focus where investors have control—their financial plan and portfolio structure—is critically important. This can be of real value, especially today, as I am sure most of us have gained new perspective over the last couple of years about ourselves, our approach to investing—and of course our risk tolerance.

Some questions that we should all ask ourselves include:

• Have you learned more about your risk tolerance? It is easy to feel confident and aggressive when the market is going up. But, it is not easy to get a handle on your true risk tolerance until things get tough. Knowing your risk tolerance is extremely important before structuring your portfolio.
• Does your asset allocation match up with your risk tolerance, time horizon, financial needs and goals?  The weighting of US stocks, international stocks, US and international bonds, cash equivalents, and other asset classes is critically important to getting the rate of return we need along with an appropriate risk-return balance to help weather the ups and downs. 
• Are you properly diversified—or do you have too much of any one investment or asset class?  Broad diversification within and across asset classes is very important in helping to control risks and to sleep better at night.

Bottom Line:

You must never forget the nature of the market. It is very unpredictable and can be volatile with little warning.  Large losses or gains should never be allowed to drive you to the point that you make emotional decisions based on fear or greed.  Choices made under such conditions are rarely good ones and regretted later.

At this time, it is important not to pay too much attention to the Dow. What is important is to focus on your financial needs and goals, and your portfolio. Asset allocation, diversification, time horizon and risk tolerance are critically important for you to appropriately implement and account for in your portfolio to help ensure you meet your life’s financial plan. These are the things you have control of.

Finally, this would be a great time to meet with a qualified financial advisor to get specific investment advice regarding your portfolio based upon your present and future financial plans.

One-Time Roth IRA Investing Opportunity:  Should you Convert or Not in 2010?

According to a nationwide survey conducted recently by Natixis Global Associates, half of affluent American investors are not aware of the unique opportunity starting in 2010 to convert non-Roth retirement accounts into a Roth IRA retirement account.  Starting with this special conversion offer, the adjusted gross income limit of $100,000 for Roth IRA conversions will be repealed. This will make millions of investors eligible for Roth IRA conversions for the first time.

Also, as a bonus for converting in 2010, the IRS will allow eligible individuals the one-time opportunity to defer and spread their taxes due on the conversion over two years, 2011 and 2012.  Normally, you must pay taxes all at once on the whole amount in the year you convert.

Non-Roth retirement plans that can be converted to a Roth IRA include the Traditional IRA, SIMPLE IRA, 401(k), 403(b), and 457(b).

Now to the question of whether to convert to a Roth IRA or not given the opportunities starting in 2010—the answer depends on each individual’s circumstance’s including tax and estate planning considerations.

Tax considerations

• If you expect your income in retirement to increase, or expect tax rates to increase and you have funds outside your non-Roth IRA retirement account to cover the Roth conversion taxes, then it may make sense to convert.
• Converting only some of your non-Roth IRA investing retirement account assets to a Roth IRA can help you control your taxable income.  For example, withdrawals from Traditional IRAs or 401(k)s is taxable, whereas withdrawals from the Roth IRA are not. If tax rates decrease or remain stable, more non-Roth retirement account taxable assets could be withdrawn. When tax rates are going up, more Roth funds could be tapped.

Estate planning considerations

• If you plan to leave an inheritance for your children or grand children, the Roth IRA is hard to beat as a tool to transfer wealth. It is not subject to minimum distribution requirements and thus can continue to grow untouched throughout your life tax-free if you wish. Additionally, the beneficiaries will benefit from tax-free distributions over their life expectancy and the assets will continue to grow tax-free for many years.
• Paying the taxes for conversion to a Roth can reduce your estate taxes by the amount of the tax. This could be a huge benefit with a large estate and high tax rates—potentially as high as 45% depending on tax legislation this coming year.

Bottom line

Individuals and family circumstances can vary greatly. They need to be carefully considered before making a decision on whether to covert a non-IRA retirement account to a Roth IRA. The Roth is a powerful tool and can be a major asset in an overall financial plan under the right circumstances.  Seek professional advice from your tax and/or financial advisor before making a decision.

RETIREES IN A PICKLE: Retirement Income Down, What to Do?

An article by Morningstar’s Christine Benz (Sept 24, 2009) titled “Where to Look for Retirement Income”, stated that while the stock market has had a nice rebound, the yield environment for income investing has been different.  It is lackluster in many cases. Interest on cash is near zero, companies have cut back on their stock dividends, and bond yields have dropped significantly as demand for bonds has increased.

Lower income along with portfolio values that are still substantially below where they were, can be a big problem for retirees who depend on income from their retirement portfolios to cover their living expenses.

The biggest threat to retirement is withdrawing too much from retirement funds, especially after unusually large losses resulting from a major market downturn—such as we experienced in 2008. With portfolio income and values down, what is the retiree to do to ensure he has the necessary income throughout his or her retirement?

A few options follow:

• Reduce living expenses where possible and withdraw less to keep from depleting the portfolio until income from assets increase and portfolio values recover. 
• Establish a higher percentage of lower risk income producing assets in your portfolio such as CDs, high quality bonds, and a guaranteed immediate payout income annuity to provide higher income given today’s low interest rate environment.
• Seek higher income (and riskier) vehicles such as high yield bonds. 
• Focus portfolio on a total return approach where some principal (e.g., stocks) is sold to help meet income needs along with income from current income producing assets.

Bottom Line:

Of these options, the total return approach provides advantages over the others. You do not necessarily have to reduce living standards or focus too much on income producing assets at the expense of growth, which is risky.  (With 3% inflation, a focused income portfolio’s value could be halved in about 25 years!)  You can maintain a good balance of stable income and equity growth assets, which over time will likely provide a higher portfolio value and total return than the other options, along with covering your daily living expenses.

One neat strategy for the total return approach is to tap an assortment of income producing investments for daily living expenses for several years and leave the growth assets such as stocks alone to grow over time.  Then for example, every 5 or 6 years, you could tap you’re portfolio’s growth asset returns to replenish the current income side of your portfolio. In this way, you will always have both safe current income for daily living expenses and growth assets which will have years to grow and create a source of stable retirement income for the future.

Retirement Investing:  Is the 401(K) Worth It?

Retirement Investing: Is the 401(K) Worth It?  There was a very interesting article in The Washington Post by Michelle Singletary (Oct 11) titled “Over the Long Haul, Stats Show, 401(K) is Worth it”. 

It provides some very interesting statistics and insights resulting from a study run by the Employee Benefit Research Institute and the Investment Company Institute. The study showed that even though the average 401(K) retirement account fell 24.3% in 2008, the worst bear market period since 1931, account balances increased at an average 7.2% rate annually over a 5-year period spanning 2003 to 2008!  The calculations included ongoing worker contributions, employer matching contributions, and investment gains and losses.

For those more disciplined retirement plan participants continually contributing to their retirement accounts, the median account balance (or midpoint) increased to $43,700 at year-end 2008 from $25,507 at year-end 2003, an annual increase of 11.4 percent over the five-year period! This is a 4.2% greater average annual return than the average retirement account. Clearly, disciplined regular contributions pay off in a big way.

This study was large and very significant in its findings. It was based on 24 million participants, including 6 million who have had 401(K) accounts with the same employer each year from 2003 through 2008. The 2008 database covered 48% of active 401(K) plan participants. Data collected included that from 401(K) participants at both large corporations and small businesses—and with a variety of investment options. Overall, the results show that investing in a 401(K) or similar retirement plan at work is well worth it despite the horrible market years periodically.

Bottom Line: What is clearly shown by this study is:

• The power of disciplined regular contributions automatically added to your retirement account every pay period.

• The amplifying power of employer matching contributions.

Additionally, these 401(K) attributes enable the power of (1), dollar cost averaging (buying more shares on the average when the market is down) and (2), compounded growth of your savings over time.

In just a 5-year period, these powerful factors were able to overcome the huge 2008 bear market losses and still provide a substantial positive return. The 401(K) is very hard to beat especially if used to the fullest extent. It is well worth it for everyone who can to take full advantage of in building a nest egg for retirement.

Property Investing: Great Recession Puts America on Sale

The Associated Press published a most interesting and important article titled “Recession Fallout: America on Sale” (Oct 5). The article made the case that there has never been a better time for the consumer to find unheard of bargain prices for most everything from clothes, food and cars to single family houses.

The largest purchase that most people ever make, the single family home–is selling at unbelievable cost-reductions across the country.  Foreclosures have skyrocketed over 30% since last year and prices of homes have dropped on the average 30% nationwide—with some areas dropping over 50% since the peak of 2006!  So far, there are few signs nationwide of any solid recovery in the housing market.

The recession has been very hard on many people with job losses and in many cases, loss of the family home.  However, as is most always the case, difficult times can also present opportunities.

This is certainly the case with the single family house—especially so for those with the means and the motivation to profit from what is likely to be a once-in a-lifetime opportunity. On top of the huge price reductions in homes, thirty-year mortgage interest rates are at historic lows, less than 5% presently.

Some examples of the huge price reductions provided by Kiplinger.com include, (1) a three bedroom home in Bend, Oregon previously valued at $475,000, now selling for $270,500; and a four bedroom home in Bristow, Virginia, previously valued at $605,000, now selling for $320,250!  There are many thousands of similar bargains across the country for investors as well as the first-time homebuyer. There are probably many in your area(s) of interest.

Bottom Line:

For those serious about property investing, it is very important to first do your due diligence in thoroughly evaluating the area(s) you are interested in. Never forget that real estate is local. Different areas can vary greatly. So it is important to be careful.

First and foremost, before making any serious efforts to invest in single family homes in today’s market, it is very important to investigate and monitor your area’s trend in home prices.  There are two good indicators to help you determine if price stabilization is occurring. First, look at the houses-for-sale inventory trend over the last six months, and second, look at the trend for average number of days houses are on the market before selling.  If there is a declining inventory and a steady decline in days on the market, housing supply is falling and demand is rising. These are both good signs that the market is nearing a bottom in housing prices.  Be patient and see if the trends continue to decline before embarking on any serious efforts to invest in local properties. There are many important steps in successful property investing once you decide to begin.

Recent Study Shows Investors Ignore Mutual Fund Investing Costs to Their Detriment

A recent Associated Press article posted on Oct 6 reports that a study by university researchers in Boston suggests that despite providing all the facts to investors about the critical importance of mutual fund investing costs on long term performance, they still continue to largely ignore fund expense information and focus on past performance.

This study is the first to examine whether a new rule on fund advertising that took effect in April 2007 is likely to achieve better-informed investors regarding the importance of fund expenses.

The new advertising rule was adopted by the Financial Industry Regulatory Authority, which oversees fund advertising content.  FINRA’s rule requires that fund ads give both sides of the story. If the ad promotes past performance, it also must make an equivalently prominent disclosure about the fund’s expense ratio.  

Participants in the study, including the savvier ones who went into the study knowing about the importance of expense ratios, a funds cost of doing business, all tended to disregard cost information.  There was an overwhelming preference for past returns. Psychologically, people are absolutely focused on recent past returns in selecting funds.

As a result, the two-year old industry rule requiring disclosure of crucial fund expense information in advertisements is not likely helping investors to be more cost-conscious in their mutual fund selection decision making. 

Other independent studies have underscored the importance of considering expenses, which are a definite and easily measured drag on future returns. Mutual funds rarely sustain strong performance for long. As the market changes, top performers over the last year or two usually end up being also-rans. Study after study show that a mutual fund’s cost of doing business is a better predictor of long-term returns than any recent strong performance. Yet investors across the board ignore costs and chase performance—even after 2 years of this new rule in place for advertising

One prominent researcher has suggested that the standard mutual funds’ ad disclosure stating that “past performance does not guarantee future returns” have the following words added: “higher costs definitely lead to lower performance”.

Bottom Line: It is critically important for individual investors to understand and act upon the fact that higher mutual fund expense ratios definitely lead to lower performance.  It is very difficult for higher cost mutual funds to overcome the inherent advantages of lower cost funds. Generally, over the long run, fund performance is inversely proportional to fund expenses. The higher the expenses, the lower performance can be expected to be. Selecting lower cost funds that also meet your needs will put you ahead of the game and is the smart thing to do.

A recent article in Business Week magazine (Oct 5) titled “Searching for True North” discusses what some are describing as a new megatrend, referred to as the “new normal” for investment markets. The notion, championed by Pimco’s bond guru Bill Gross, is that the U.S. has entered a period of reduced expectations for stocks. As a result, Gross believes investors should hold as little as 30% stocks instead of the 60% long deemed proper mix for many investors.  He continues on to recommend holding more fixed income assets like bonds and bank loans, along with commodities.

Of course the risk for investors is that if this “new normal” prediction fails to hold true, by moving into bonds they miss out on future up trends in stocks.

The article goes on to say that these predictions of “new normal” conditions for investment markets are not new. They occur every 10 years or so and the records of accuracy are not good. For example, in the 1990’s investors were sold on the idea of a “new economy” that would support higher and higher stock prices for many years to come, without the gravitational forces normally in play with the investment markets. We all know the results of that notion.  There have been many others throughout market history.

Today as always, opinions vary among the experts in the investment community regarding predictions of what is to come in the future for the investment markets.  Some believe we are once again undergoing a reversion to the mean of the long term trend upward of the stock market.

Bottom Line:  What seems to make the most sense for the individual investor based on market history is not to focus too much on new megatrend predictions, but to maintain portfolio diversification and an asset allocation that will meet personal income needs and provide growth potential if the new normal is not so normal after all.  It is important to remember what we know and what we can control. We know that diversification and asset allocation are time-proven sound investment principles–and we know our personal financial needs and goals.  We also know that no one can be depended upon to reliably predict the investment markets in the future. Based upon these facts, focus on personal goals and needs along with maintenance of a portfolio that is tailored accordingly using the sound investment principles is probably one of the smartest things we can do in the long run.  Both stock investing and bond investing should still have an important role in most investor’s portfolios.

The LA Times had a front page headline Sunday, October 4, titled the “Era of Global Consumer May be Dawning”. The thrust of the article was that as US consumers have cut back in response to the recession, many US companies are increasingly looking outward to the very fast-developing countries such as China, India and Brazil.

Vast numbers of people in these emerging countries are spending like never before to improve their standard of living. The size of the international markets dwarfs our domestic markets. China, Brazil and India alone have a combined population of 2.6 billion people—with many of these people young and increasingly affluent. This is in contrast to the debt-burdened, aging, and far smaller combined populations of the US, Western Europe and Japan.

As a result, opportunities are tremendous both for US and foreign companies who are increasingly positioning themselves to become a center of the action and capitalize on this huge and growing trend.

The increasing focus overseas includes that by both small manufacturing companies as well as large multinational corporations. This appears to be the start of a movement in the global economy that relies less on the US consumer and more on the fast-growing foreign markets.

Many small domestic firms would have gone bankrupt during the recession had it not been for their foreign customers. One small company stated that 75% of their sales this year has been international versus 25% two years ago.  

Bottom Line: This all bodes well for the individual investor.  The investor should be aware of this massive global shift in consumer demand, monitor it closely, and gradually adjust his/her portfolio to reap big profits from this trend.  Appropriate domestic and international investing strategies and investments will be critical to capitalizing on this massive shift in consumer demand. Stay tuned to this one. IT IS BIG.