Archives for June 2009

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2010 Income Limits for the Retirement Savings Contribution Credit

While recently updating my series of tax books to include 2010 information, I was surprised to find that the 2010 income limits for the Retirement Savings Contribution Credit have thus far been unpublished almost anywhere on the web.

What’s the Retirement Savings Contribution Credit?

It’s a tax credit available to you if:

  1. You contribute to either an IRA (of any kind) or to a retirement plan at work, and
  2. Your income is below a certain level (see below).

The best part is that this credit is in addition to the normal tax benefits that come with investing in an IRA or 401k.

How is the credit calculated?

It’s calculated as a percentage of the contributions you make to a qualified retirement account (up to $2,000). As your Adjusted Gross Income increases, the percentage of the contribution used to calculate the credit decreases. The income ranges for 2010 are as follows:

Married filing jointly:

  • Up to $33,500: credit = 50% of contribution
  • $33,501-$36,000: credit = 20% of contribution
  • $36,001-$55,500: credit = 10% of contribution
  • Above $55,500: Not eligible for credit

Single:

  • Up to $16,750: credit = 50% of contribution
  • $16,751-$18,000: credit = 20% of contribution
  • $18,001-$27,750: credit = 10% of contribution
  • Above $27,750: Not eligible for credit

Head of household

  • Up to $25,125: credit = 50% of contribution
  • $24,751-$27,000: credit = 20% of contribution
  • $27,001-$41,625: credit = 10% of contribution
  • Above $41,625: Not eligible for credit

Example #1: You’re single, your Adjusted Gross Income for 2010 is $25,000, and you contributed $3,00o to an IRA. Your credit will be $200. (10% of the eligible contribution, which is limited to $2,000.) Remember, this is a credit, not a deduction, meaning it will actually save you $200 on your taxes.

Example #2: You’re married filing jointly, your Adjusted Gross Income is $35,000, and you and your spouse each contributed $2,500 to a Roth IRA. The total amount of your credit will be $800. (20% of each of the eligible $2,000 contributions.)

Do not miss out!

If your income level makes you eligible to take advantage of this credit, do everything you can to make sure you contribute at least $2,000 to a retirement account of some sort. There’s no sense in passing up an immediate, guaranteed 10%, 20%, or 50% return.

For More Information, See My Related Book:

Book6FrontCoverTiltedBlue

Taxes Made Simple: Income Taxes Explained in 100 Pages or Less

Topics Covered in the Book:
  • The difference between deductions, exemptions, and credits,
  • Itemized deductions vs. the standard deduction,
  • Several money-saving deductions and credits and how to make sure you qualify for them,
  • Click here to see the full list.

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Competing for Attention

…as opposed to competing for accuracy.

That’s the state of media in general, and the financial media is no exception. (In fact, it could very well be the single worst offender.) This competition for attention is a reality whether we’re talking about books, blogs, TV, or newspapers.

Of course, it’s no surprise. A media company’s revenue is proportional to the amount of attention their publications receive. That’s, in large part, why we continue to see articles touting:

  • hot stocks,
  • hot fund managers, and
  • market timing strategies

…despite the fact that an overwhelming body of evidence shows that investors would be better off following a buy & hold strategy with a diversified portfolio of index funds.

As they say, it’s difficult to get a person to understand something if his livelihood depends on his not understanding it. (I’m embarrassed to say that I’m a perfect case study–I used to make a living selling actively managed funds.)

The Ugly Truth

What I (perhaps naively) found surprising recently is that many members of the financial media know full well that the strategies/investments they’re promoting are complete nonsense.

What am I talking about? I’m talking about a classic article that Rick Ferri recently shared from the April 26, 1999 issue of Fortune magazine: “Confessions of a Former Mutual Funds Reporter.” Here’s the introduction:

“Mutual funds reporters lead a secret investing life. By day we write “Six Funds to Buy NOW!” We seem to delight in dangerous sectors like technology. We appear fascinated with one-week returns. By night, however, we invest in sensible index funds.”

Yikes. I wonder how many readers (or viewers) have any idea.

When a reporter writes an article about a stock he owns, he’s required to disclose his ownership–reason being that reporters could otherwise write articles solely for the purpose of pumping up the price of stocks they already own.

Perhaps the opposite disclosure should be required as well: “I do not own this fund. Nor have I ever. Nor do I have plans to buy it at a later date.”

That might give investors a fighting chance at determining which sources to trust.

CDs vs. Bond Funds

I recently finished reading Allan Roth’s How a Second Grader Beats Wall Street. (Highly recommend it, by the way.)

In the book, Roth brings up a topic that I’m surprised isn’t discussed more frequently: the idea that if you’re willing to put in the time, you can very likely increase the long-term return on the fixed income portion of your portfolio without increasing your risk at all.

How? By shopping around for CDs rates rather than investing in bond funds.

Why would CDs earn more?

The limit on FDIC insurance for CDs is set at $100,000 (temporarily increased to $250,000). This amount–while more than enough for most individual investors–is practically meaningless for the large institutional investors who make up the bulk of market demand for investments.

As a result, if institutional investors want something backed directly by the Federal government, they have to invest in Treasury bonds or bills. Therefore, the demand for CDs of a given maturity is lower than the demand for Treasury investments of the same maturity, despite the fact that–if you stay under the FDIC limits–they both have essentially zero risk of default.

Lower relative demand for CDs means that they must provide a greater rate of return.

CD Rates: An Inefficient Market

Also, because of the lack of institutional demand for CDs, the market for CDs is far less efficient than other security markets. What does that mean for you? It means that if you spend the time to shop around, you’re likely to find that certain banks are offering significantly higher CD rates than other banks.

Further, if you make sure to compare early withdrawal penalties while doing your CD shopping, you can limit your interest rate risk considerably.

Is it worth your time?

The downside to this strategy, of course, is that all this CD shopping takes time (more than simply DCA’ing into a low-cost bond index fund).

Whether it’s worth your time is largely impacted by the size of the fixed-income portion of your portfolio. For example, I doubt I’ll be spending my time on it, as my wife and I have a very equity-heavy allocation given our young age. But I could easily see it making sense for us a while down the road.

Index Investor Profile: Interview with J.D. Roth of Get Rich Slowly

Most buy & hold index investors seem to be converts from various schools of active investing. At the same time, I’ve met very few investors (none, off the top of my head) who have moved from being index investors to being fund pickers or stock pickers.

There seems to be some sort of lesson there. ๐Ÿ™‚

In that vein, I thought it would be interesting to hear the stories of a few different investors, and what paths they followed to becoming buy & hold indexers.

On Tuesday, J.D. Roth from Get Rich Slowly was kind enough to answer a few questions about his own path to index investing.

Mike: You’ve mentioned before that the bulk of your retirement portfolio is invested in index funds. When you began investing for retirement, did you immediately opt to use index funds, or did you try anything else at first? If you did try something else first, how did it go?

J.D.: I didn’t actually move to index funds until recently. I kept thinking that I could beat the market with my superior stock-picking skills. So, I picked Countrywide. And GM. And Washington Mutual. And The Sharper Image. After losing several thousand dollars of retirement money, I finally admitted to myself that I ought not be allowed anywhere near a stock ticker, and I began to invest in a variety of index funds. That has worked much better.

Mike: Was there any particular book or article that you read–or discussion you had with somebody–that led you to use index funds? If so, what was the most compelling part of the argument in favor of index funds–what was it that really convinced you that this is what you should do with your money?

J.D.: I was introduced to index funds by an early GRS reader named Vintek. He offered this guest post: Intro to Index Funds

But it was really Mark Dowie’s article in San Francisco Magazine that pushed me over the edge: The Best Investment Advice You’ll Never Get.

I still didn’t move into index funds just yet, but I began to watch for information about them. After I read The Four Pillars of Investing and The Random Walk Guide to Investing, I was essentially converted. The strongest argument I can think of is that over the long term, 90% of professional money managers fail to beat index funds. Are individual investors going to do better? (And, more to the point, am I going to do better?)

Mike: I heard you mention in a recent interview on Behavior Gap Radio that you once dabbled in stock picking with an investment club and that it didn’t go as well as you might have hoped. Were there any lessons you learned from that experience that readers might benefit from hearing?

J.D.: Oh my word. There are dozens of lessons. I need to tell that story at Get Rich Slowly.

I think the number one lesson I learned is that you can’t succeed by investing “by gut.” Our investment club was six guys contributing $50 per month during the height of the tech bubble. We thought we were going to get rich. Our primary strategy seemed to be: Buy the stock that went up the most the previous month, and then watch as it crashes to the ground. We were idiots. We were buying high and selling low, panicking when our “sure things” proved not-so-sure after all.

Part of the problem was that we didn’t have a procedure. We didn’t have a system. We’d each bring a stock to suggest to the group, and then we made our decisions not on any sort of logic, but based on who could carry his argument (which usually meant yelling louder than the other fellows).

We weren’t investors. We were speculators. We were gamblers. We wanted to pool our money together to get rich quickly. It didn’t happen.

Mike: Do you ever feel that you’re missing out because your funds are guaranteed to never outperform the market? And if so, are you ever tempted to try any other investment strategies?

J.D.: Yes, I do feel like I’m missing out. On the other hand, I remember very well all of the losses I’ve had before. Those underperformed the market by substantial margins. I cannot guess which stocks are going to increase and which will decline. I’ve given up trying.

All the same, I do allocate a small percentage of my money to purchase individual stocks. Right now, I’m not making use of that. The only individual stock I still own is The Sharper Image, which at 3.5 cents per share is worth $39.04 for me today.

Mike: Final question (if you’re comfortable sharing): Can you give us a rough breakdown of your current asset allocation in terms of percentages?

J.D.: Actually, my current allocation is in flux. I’m in the process of consolidating all of my accounts at Fidelity, and as I do that, I’m shifting things around. Most of my money is in cash right now, which has been making me cranky. (How I wished my money was moved by early March.)

Of the money I do have invested, most of it is temporarily in FFNOX, which is the Fidelity 4-in-1 Fund (55% S&P 500, and 15% each of Extended Market, International, Bonds). I hope to write more about asset allocation in the future at GRS.

Thanks again to J.D. for taking the time to share the story of his conversion to index investing. ๐Ÿ™‚

If you haven’t already, I highly recommend subscribing to Get Rich Slowly.

How to Get Rich with Stock Market Newsletters

Write one.

Then sell subscriptions.

Ta-da! ๐Ÿ˜€

Troubleshooting (in case you need a little more help)

What’s that? You don’t have a history of successful stock picking? No problem: Just come up with any stock-selection strategy and back-test it to see if it’s worked over the past [period of your choosing].

It didn’t work? Again, no problem: Just continue back-testing assorted strategies until you find one with an absurdly high performance record. Once you do, heavily promote that past performance, while only mentioning in a small footnote that you didn’t actually own any of the investments mentioned over the period in question. [Update: The prior sentence used to be a link of an almost-hidden disclosure on the Motley Fool website, which has since been removed completely.] Apparently, nobody will notice.

Won’t people figure out that it’s a scam once they see that your strategy isn’t working going forward? Yes, they will. But don’t worry; it will probably take a few years. In the meantime, just start a new newsletter with a new back-tested-for-success strategy.

Or–if you don’t like my method–Carl from Behavior Gap has an alternative (and perhaps better) way to manufacture an excellent past performance record.

Now get out there and go make your fortunes! ๐Ÿ™‚

Asset Allocation for 529 Plans (and other similar scenarios)

In a post a couple weeks back, I asked readers their thoughts (and provided my own) on asset allocation, specifically:

  • At what point should you begin shifting your allocation away from stocks? and
  • How gradually or suddenly should you do so?

In the comments, Neal brought up the fact that in the article I was making the (unstated) assumption that a person’s investments were intended exclusively for retirement, when clearly that’s not always the case.

So today the question is: What should a person’s asset allocation look like when the investment portfolio is intended to pay for a specific cash outlay at a known time in the future? (Example: A 529 plan intended to pay for college in X years.)

What guideline could an investor use as a starting point (which then, of course, must be adjusted for personal factors such as volatility tolerance)?

My own thoughts

My own attempt at a generalized guideline (for a cash outlay X years from now) would be something to the effect of:

Stock allocation = 4x – 10 (with all negative values considered to be zero, and possibly with a cap at, say, 90%), thereby yielding the following allocations:

  • 1 year: 0% stocks
  • 5 years: 10% stocks
  • 10 years: 30% stocks
  • 20 years: 70% stocks
  • 30 years: 90% stocks

Thoughts from the Bogleheads & David Swenson

I asked over on the Boglehead forums for their thoughts on the matter. One of the replies brought up the method suggested by David Swenson (in his book as well as in this interview), which is essentially to have two separate portfolios:

  1. A long-term portfolio, in which you maintain an (unchanging) equity-oriented asset allocation, and
  2. An extremely low-risk portfolio, such as a money market or online savings account, possibly with some TIPS thrown in.

And, as the date of the expenditure draws nearer, simply shift money from the first portfolio toward the second. This would provide an asset allocation as follows:

  • More than 8 years from expenditure: 70% stocks, 30% bonds
  • 6-8 years: 52.5% stocks, 22.5% bonds, 25% cash
  • 4-5 years: 35% stocks, 15% bonds, 50% cash
  • 2-3 years: 17.5% stocks, 7.5% bonds, 75% cash
  • Less than 2 years: 100% cash

What do you think?

What guidelines would you use as a starting point for consideration when developing an asset allocation (and glide path) for a portfolio that’s intended for a specific expenditure in the future?

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