What to do, What to do...

So I've clearly been on vacation for this whole summer. Maybe not a physical vacation, but certainly a mental vacation. And now that September looms and I'm coming back to earth, I realize that my finances are in disarray. Mental disarray, that is.

While I was away, the price of gas went down. Considering we drove 3,000 miles in our trusty Chevy Prizm (ie Toyota Corolla), it was a welcome reprieve from the oil madness. And while our economy is floating about as well at the Titanic, there's positive and negative sides to the drama, never mind the economic debate about are we or aren't we in a recession. So while all this was going on, what did I do? I ate Maine lobster. And lots of it.

Thank god for autopilot. Every month our checking account is drained for our Roth IRAs and our ING accounts (travel, Christmas, gym membership, car, emergency fund). It's not a lot of money, really, but over the course of a year it adds up to a softer cushion than a crash landing. And so not much changed. Well, except for the drooping value of my IRA, and the fact the car fund and travel fund got drained.

So I realized when I got back that I like to have my head actively wrapped around my finances. Autopilot or not. And that part of all that sitting around dreaming up goals and ways to meet them is the planning part of financial planning. After looking at my Roth IRA mutual funds, I decided to sell off one of the losers (I know I'm not supposed to do that but whatever) and transferred it to my online brokerage account. Why? Because I'm convinced that the iPhone will propel Apple farther than the S&P average.

However, I'm sure there's an actual, like, method to picking stocks that involves math and other values of sound judgment. So over the next few days I'll dig up some dusty econ book and figure out just how a person looks at a stock and assesses whether it is a good buy or not. And since I'm feeling like a delinquent poster, I'll post my trials and tribulations as an amateur stock picker here.

I'm excited about my project, but a little worried. While I can appreciate the crack-like epidemic that is sweeping iPhoners, it is, after all, my retirement we're talking about here.

Saner Savings

Forbes has a recent article, Seven Steps to Saner Savings, that lays out the different ways an individual can save for retirement.

There's little question as to if one wants to save, it's a matter of in what account?

"Most investors ignore the asset-location issue. They fail to recognize the significant impact of placing the right assets in the right buckets," says John Nersesian of Nuveen Investments' Wealth Management Services. General advice: Use taxable accounts to hold individual stocks (these present better opportunities for loss harvesting) and index funds or exchange-traded index funds that don't throw off much taxable income. Put your assets with the highest growth potential in a Roth. Taxable bonds and REITs belong in a pretax 401(k) or IRA; the income they generate is taxed at ordinary rates anyway, and this way the tax is deferred. Also good for your pretax 401(k) or IRA are assets that generate short-term gains, which are taxed at ordinary income rates--stocks you trade a lot and actively managed small-company or international funds.

Phew! The article breaks down each vehicle, from a 401k, to a Roth, to a taxable account (ie brokerage account such as Sharebuilder). It's one of the shortest guides I've seen, and pretty easy to digest.

Profit Like Yale: Breaking It Down

I'm sick as a dog today and spending a little more time than usual catching up on the online news. One of my stumbles was the Times article, Keep It Simple, Says Yale's Top Investor. The "Investor" happens to be the guy who runs Yale's endowment, David F. Swensen. Last year when everyone else's portfolios were toeing the precipice (yours truly included), he killed the market with a 28 percent gain, bringing the portfolio up to $22.5 billion. E-effing-gads.

So his advice to the little guys and gals is exactly what the title suggests.

For most people, he recommends a very basic approach: use index funds, exchange-traded funds and other low-cost instruments, and stick to your long-term asset allocation — even when the markets are in tumult.

Don’t be distracted by market forecasts, he said. “You have to diversify against the collective ignorance,” he said. “I think nobody is in a position to react to these big macro-issues. Where is the dollar going to be or what is G.D.P. growth going to be in China? For every smart person on one side of the question, there is another smart person on the other side.”

To translate the first paragraph, index funds are mutual funds that track an index. And to translate the translation-- a stock index is like a book index. So let's take a cookbook. Everything under the Soup section of the index is the contents of the book that are soup. An index lists contents, that's all.

So a stock index of the S&P 500 is a listing of the contents of the S&P 500; the 500 largest market cap (what they're worth) companies publicly traded on the NYSE and NASDAQ. So how would a mutual fund track the index? The same way a book would, two pages for vegetable soups, one page for green eggs and ham stock. Microsoft 2% of the S&P and Apple 1 %-- I totally made those numbers up. So with an index fund you will never beat the market, but you are the market, so you'll never do worse (within hundreths of one percent, perhaps, because the math is never perfect). And if you'd rather be worried about beating that other bidder on eBay, rather than beating an index return on the New York Stock Exchange, then index funds are for you. They also cost less, sometimes a lot less, than actively managed mutual funds. Paying fees on your investments eats away at your earnings; you pay 2 percent and gain 1 percent, you just lost 1 percent. You pay .018 of 1 percent and gain 2 percent, you just gained- well, you do the math. Over the course of a few decades, the hundreds of dollars turn to tens of thousands.

His next suggestion was ETFs, Exchange Traded Funds. The short answer to what is an ETF is that an ETF is an index fund traded on an exchange (the stock market). While mutual fund companies create their own index funds and you buy from them, ETFs are index funds that you can buy or sell like stock, for example through an online broker like Sharebuilder or Scottrade. A more detailed description of their differences can be found here and here.

So that was a long explanation for a simple investment strategy, but that's partly why Swensen advocates for them. Their low costs boost your returns, their built-in diversification spreads your risk, and the index tracking removes the headache of stock picking.

He proposes a portfolio of 30 percent domestic stocks, 15 percent foreign stocks, and 5 percent emerging-market stocks, as well as 20 percent in real estate and 15 percent each in Treasury bonds and Treasury inflation-protected securities, or TIPS.

So here's an easy example for illustrative purposes only, I do NOT suggest you go out and do this. Let's use Vanguard's ETF page, Vipers, as an example. Let's say you have $5,000 in a savings account. So you would transfer money to an online broker like Scottrade and fund a ROTH IRA account to the annual max, buy $1500 of VTI (30% domestic), $750 of VEU (15% foreign), $250 VWO (5% emerging markets), $1000 of VNQ (20% real estate), and $750 EDV (15% Treasury Bonds), and 15% TIP (not Vanguard, but Lehman's TIP ETF, 15%Treasury inflation protected securities). In this example, ETFs make it easy to plug in asset allocation.

So I decided to compare my largest ROTH IRA holding, T. Rowe Price Retirement 2040 Fund. This is not an index fund or an ETF, it's an actively managed mutual fund, but one of those target funds I like to rave about. Again, target funds should be for your own retirement date. This fund is for a targeted retirement date of 2040 and its asset allocation is as follows:

Domestic Stock 65.5%
Foreign Stock 22.3%
Domestic Bond 8.4%
Cash 3.2%
Convertibles 0.4%
Foreign Bond 0.2%

Swensen's domestic allocation is a little low, and I'm kind of okay with mine (yes, I realise I've never gained 28% annually on my quote unquote portfolio), but I did discover I have no real estate, particularly REITs (Real Estate Investment Trust), which is kind of a big deal. So I think I'll sell off one of my overweights (too much of a percentage in my asset allocation pie) and buy Vanguard REIT Index ETF (stock ticker VNQ), which is, shocker of all shockers, way off its 52 week high so I'll definitely be buying low. Which brings us to his other piece of advice. Rebalance. The market value of your stocks and bonds changes all the time, so at least once a year just buy and sell shares to bring your asset allocation back to target.

If all of this sounds like a lot of work, it's really not. Even if you don't follow his exact percentages, and I don't think you should follow any one person's exact percentages (especially mine!!), the idea is right on the mark, there's a lot of white noise out there for some very simple ideas. And speaking of white noise, I do love when he takes Jim Cramer down a notch.

When possible, he said, rebalancing should be done in a tax-sheltered account, like an I.R.A. or a 401(k), to avoid tax liabilities. “When you are putting fresh money to work,” he said, “you put it in an asset class where you are underweight and take money out of a class that is overweight.”

He says it is fruitless for individual investors to pick stocks. “There is no way that an individual can go out there and compete with all these highly qualified and compensated professionals,” Mr. Swensen said.

HE criticized the approach of Jim Cramer, the CNBC host, who encourages investors to trade stocks in strategies that Mr. Swensen says cost heavily in commissions and taxes.

“There is nothing that Cramer says that can help people make intelligent decisions,” Mr. Swensen said. “He takes something that is very serious and turns it into a game. If you want to have fun, go to Disney World.”

$416.66666666667 (again)

Sorry, a re-post here- I accidentally deleted the original, and I have the mind of mayhem right now so god only knows what I said in the original post. But suffice it to say it went something along the lines of-- this is what I will have to contribute, $416.66666666667, each month to max out the NEW $5,000 annual contribution limit on a Roth IRA. Man, there goes my monthly cheeseburger budget...

photo by Alaina B. via flickr

Why You Need To Start Saving NOW

I was talking with a friend this weekend about financial stuff. It started with a simple question, how do you save and pay off debt at the same time? A simple question begat a long ass answer and, many emails later, I think she is on her way to a monthly spending diary. Because the first answer to any question is, do you know how much you spend?

It's a good question, though. And I kind of think the answer is you can't afford not to save. In 2008 the max on your Roth IRA is five grand a year (again a warning to bartenders, waitresses, and other cash cow hustlers- you cannot contribute more than you earn, as in what's reported to the IRS). So I did a quick calculation and came up with the following.

If you were to start saving in January for your retirement, you're starting with zero balance, and you were to max out your Roth IRA contribution at $5,000 a year for 30 years, could you retire? Drumroll please... The answer is with $713,182 (assuming 8% annual returns). Great, you say. Not so fast. The same calculation, but with 3.1% inflation, and you get $264,353. What?!

Well, remember that time way back when and you took the subway with a token and it was a buck and a quarter? Or that time when you gave the movie theater a ten dollar bill and got change back? That is called inflation, the nasty fact of life that a dollar today is worth less tommorrow. The adjusted figure is what $700,182 is worth in today's dollars. $264,353. I know I've harped on this before. Blogger redundancy. But with oil near $100 a barrel, major banks and lenders on market welfare (aka the sub prime loan mess), and recession arguably on the radar, all of which means the smarty pants with MBAs are defecating bricks right about now. Since they're the ones running the economy, it might be prudent of us to to take care that our own finances are in order.

The first step to any financial plan is to track your spending and then make a budget. So my friend will submit her monthly budget, and I'll start posting on the practical side of how to pay off debt and start saving for your future.

PetroChina and my IRA

A few years ago I was buying stock. Not a lot. I was mostly doing a hundred bucks here or there through Sharebuilder. Sharebuilder is an online broker that buys dollar amounts of stock, as opposed to number of shares. Because they buy stock in "street name"- as opposed to Ms. PiggyBankBlues, you end up with fractional shares. After the tech crash I was buying up internet stocks, etc. and after a year or two I would sell them. Because I had an emergency without an emergency fund, I ended up using that money. Thankfully, I didn't touch the stock held in my Roth IRA. Eventually, I switched to Scottrade after Sharebuilder began to charge annual fees for IRA accounts. And then I forgot about it.

Recently Warren Buffet sold off his shares of PetroChina. I sort of remembered that I had bought some shares a few years ago. Because I only sort of remembered, I was like you really need to get your crap together and figure out what stock you own and don't own, ya numbnut. But that was last week and this is this week. And then I saw this morning that PetroChina is now the wealthiest public company in the world.

On PetroChina’s first day of trading on the Shanghai Stock Exchange, it surpassed the combined capitalization of Exxon Mobil and General Electric, the world’s next two most valuable companies.

Because I was buying such low amounts of stock, I knew that if I still had it I probably only owned one share. So after hunting around for my Scottrade file with my account number, I logged on to my account and found out that indeed I owned a single share. I bought it for $53.69, and it is now worth $227.07. And for what it's worth, during the time I started writing this post and the time I'm writing this sentence, the price went up two dollars. Which leads me to my question, now what???

I will be the first to admit I am just an average to considerably below average stock picker. In fact, any misconstrued-as-advice I give or tales I tell in relation to stock you should never ever take as sound advice for purchasing said stock. You should be entertained by my efforts, at most. Which is why, I might point out, my Roth IRA has only been invested in mutual funds over the last few years.

I am not a fan of oil stocks. They are profitable, but they throw my moral compass off a bit. It's an unreliable compass and I don't venture on its sole direction, but still. I made a decent amount, a couple thousand dollars, off of BP stock two years ago. I sold it in order to go away for a month to a writer's colony. So while BP has refinery fires and oil spills and god only knows what else, I still drive a car and bought and sold its stock. But that writer's residency was an experience of a lifetime, and I would not have been able to afford to take the time off at the time had I not bought the stock. So I draw the line and the line moves. For now, no war profiteering stocks.

And PetroChina? Well, I think I'll revisit that stock in another five years. I've never had any stock quadruple in value! In the meantime, I have $205 I forgot about in available funds to buy stock. Hmmm, Apple?

Steering yourself toward retirement

If you want to be able to be seventy years young and not living like you're a nineteen year old street urchin, you better start steering yourself toward retirement now. It's kind of like mapquesting. You have a known point of origin, a destination that is unfamilar, and you need to know what roads to take to get there, distance markers along each path, and that it's almost gauranteed that the mathematical certainty of GPS coordinates matched with Rand McNally-like cartography will almost always be, at some pivotal point, outright wrong- to which end you will find out the hard way while you're mid trip and cursing the program that told you where to go.

The stats are sobering. In ten years it is expected that Social Security Trust Fund will pay out more in benefits than it will take in FICA taxes. By 2041 it is expected to run out completely. Just in time for our retirement. This is all from the horses mouth, or the 2007 Trustee report. Lots of things can happen to divert this- the GAO (Government Accountability Office) suggests that the year before Social Security goes bankrupt the shortfall could be met by cutting federal spending by 60% or by doubling taxes. Fun stuff. Or cutting Social Security and Medicare benefits. More fun stuff that won't happen on the Baby Boomers' dime, but on ours. All scenarios rely on politicians doing right by us. Therefore, moving right along...

Assume you will not see one penny of Social Security. Assume that unless you save for your own retirement your own damn self, you will be one piss poor i-pod deaf senior citizen. To get started we turn to the abacus. (Not really, but I saw you falling asleep at the wheel). Retirement calculators for people who freelance, or people who are in the restaurant & bar industry are about as helpful as an abacus. Why? Because online (and offline) retirement calculators take your pre-tax income and calculate Social Security taxes, after tax income, projected annual income raises, and other fun factors. All of which reflect the unpredictable to the straight up non-existent for a bartender whose entire income may be undeclared cash. Nevermind the fact that nobody is going to start voluntarily tipping $1.04 a drink instead of a dollar a drink, just because inflation went up 4% that year. So not only do New Yorkers live in a city that tends to have higher inflation and/or cost of living increases than the national average, freelancers and service industry worker bees have an income stagnancy not shared with many nine-to-fivers clutching contracts. I don't advocate tax avoidance, but let's just admit that everyone from your doctor (insurance co-pays are mostly paid in cash) to large corporations who DO exploit the tax code for their benefit in so many brilliantly legal ways that it makes people in the service industry seem soooo i-work-for-free, manage to jiggle the tax code, and move on from there.

If the online retirement calculators don't work, you have to come up with your own using a compounded savings calculator instead. I like Dinkytown.com's, which I used for the following example. First off, let's wrap our heads around the idea of inflation. In thirty years one million dollars will be worth just a hair over $400,000. In other words, 3% annual inflation (ie projecting how much things like the Consumer Price Index (CPI) go up, let's say your rent, the cost of dinner for two, utilities, etc.) means that in thirty years the buying power of a single dollar bill will have the same buying power as today's forty cents. And if you dream of retiring on a million of today's dollars, it will take you almost two and a half million dollars in 2035 to be worth equal buying power. Which means you better start saving now, because the statistics are outright scary if you don't.

But forget the million dollar retirement. Your destination is simply to be able to retire with as much money as you can save, by spending less than you earn and saving the difference. Let's say you're currently 35 and would like to retire at 65 but so far have nothing to show for it. So you start to sock away 10% of your income for retirement in a ROTH IRA. If you make $600 a week that's $240 a month. So if you have zero retirement savings right now, you save $240 a month for thirty years, you'll have $340,247 in the end. Don't let me lose you, if you know the difference between a fifteen percent tipper and a twenty percent tipper you can follow these numbers. Now this is the best thing about saving- compounded interest (which is tantamount to investment returns). Because while $240 bucks a month over thirty years is just $86,400 in money you put in, it's the 8% returns that have generated the other $253,827. That 8% annual (projected) return must come from the stock market. There is no other way for the small investor to generate a comparable return. I'll get into portfolio allocation later, but for now just know that in order for money to work for you, you have to be invested in stocks. And in order for you to get all of that money when you retire, you should invest in a Roth IRA, because all qualified withdrawals are tax-free. That's right, your Apple (AAPL) stock gains are all tax-free.

You should know that there are two different kinds of IRAs (Individual Retirement Accounts), the Tradional IRA and the more recent Roth IRA. The Roth IRA uses after-tax income (ie the cash sitting in your sock drawer) to invest in stocks and/or bonds, while the Tradional IRA uses pre-tax money (ie directly from your pre-tax paycheck). It's just a matter of when you pay the piper; in a Tradional IRA you pay taxes when you're retired and withdrawing the money, with the Roth IRA it's before you invest the money and have presumably paid regular income tax. The Roth IRA is better for people who expect to have a higher income tax bracket when they retire than they do now, and/or people who need the stock market's compounded return to come tax free, which is almost everyone I know. The idea is to pay the least amount of taxes, and for most it's before you invest, not after. The Roth IRA is your new best friend.

And if you are twenty five years old? Ten more years of investing $240 a month will bag you $778,033- more than twice as much money for less than half the amount of time and money invested. It's not that you can't afford to save, it's that you can't afford to wait. Because compounding interest/market returns work most of its magic in the later years. Obviously, years of an 8% average return on a few thousand dollars is nothing compared to years of an 8% return on a few HUNDRED thousand dollars.

Now that you know what to drive, next up I'll suggest where to park it. That and the shock and awe of what it takes to max out your annual Roth IRA contribution.